Owens & Minor Inc (OMI) 2002 Q3 法說會逐字稿

I'd like to thank you all for holding, and welcome to your conference call to the Owens & Minor Third Quarter 2003, earnings conference call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session and at that time if you have a question, please press star followed by zero from your touchtone phone to place your line into queue until your name is announced. As a reminder, this conference is being recorded for transcription today, Thursday, October 17, 2003. I would now like to turn the conference over to Gil Minor, Chairman and CEO of Owens & Minor. Thank you for using Sprint Conferencing Services.

Good morning, America. This is Gil Minor and I'm very pleased to have you with us today. I'm actually calling in from Southern California. No, not to attend the World Series but a technology conference out here, and the rest of our team is right there in Richmond. I'm very excited about our results this quarter. I'm very excited about where we are. We had a strong quarter and Jeff and Craig are going to tell you all about it. We have some excellent results to share with you. On the call today are Craig Smith, President and Chief Operating Officer; Jeff Kaczka, Senior VP and Chief Financial Officer; Drew Carneal, Senior Vice President and General Counsel; Dick Bozard, Vice President of Treasury; and Olwen Cape, Vice President and Controller.

Now, before we begin, our very own Trudi Allcott, our communications manager, will read a brief safe harbor statement. Trudi?

Thank you, Gil. Except for any historical information, the matters discussed in this conference call may constitute forward-looking statements that involve risks and uncertainties that could cause the actual results to differ materially from those projected. These matters include the rate at which new business can be converted to the company; intense competitive pressures within the industry; the success of strategic initiatives; changes in customer order patterns; pricing pressures; changes in government funding to hospitals and other health care providers; the potential loss of major contracts; and other factors discussed from time to time in reports filed by Owens & Minor with the Securities and Exchange Commission. The company assumes no obligation to update information discussed in this conference call. And just a reminder-you can find the audio of this conference call on our corporate Web site until November 6th. Thank you. Gil?

Thank you, Trudi. First of all, Jeff will give you some remarks and then Craig will follow, and then we'll open it up for questions. So, Jeff, take it away.

Thank you, Gil. Good morning, everyone. Let's get right to the numbers. Sales for the quarter were $992.5 million, up 2.5 percent from last year and up 3.2 percent on a year-to-date basis. That's a record level of quarterly sales but a somewhat slower pace of growth than we'd anticipated, and Craig will give you more background on this in a moment. We're pleased with our earnings results. Net income was $12.5 million, up 11 percent from last year, and diluted earnings per share was 33 cents, an increase of 10 percent and in line with consensus.

Of course as we noted in our press release, these numbers and comparisons exclude good will amortization, the impact of restructuring credits and other unusual charges in both years. They also exclude the extraordinary loss on the early retirement of our bonds in the prior year. The unusual item recorded this quarter results from our comprehensive new deal with Perot Systems which we announced in August. We took a $3 million charge to SG&A this quarter related to the cancellation of the mainframe services contract.

This new agreement with Perot Systems is a great deal for Owens & Minor. We expect it to generate approximately $30 million in operating expense savings over the seven-year life of the contract, of which a significant portion will be reinvested in enhancing our leadership position in technology.

Now, let's discuss the details of the quarter's results. Gross margin dollars for the quarter were $105.1 million which was 10.6 percent of sales, and this rate has remained very consistent. We're pleased with our progress on SG&A which improved to 7.6 percent of net sales for the quarter, and that's compared to 7.7 percent in last year's third quarter. Field personnel costs, delivery expense and travel all improved this quarter. Cash flow has continued to be incredibly strong, driven by our strong fundamentals in asset management. Free cash flow was $28.5 million for the quarter. And we're particularly pleased to report that our quarterly DSO is the lowest it's been in the last five years at 31.5 days.

We recently converted to a new receivable system which has given us greater efficiency, quicker resolution of disputed items and ease of use. Inventory turns were 9.9, also a very healthy performance. And because of this strong asset management and a favorable rate environment, we're also seeing a positive impact on our financing costs.

Year to date, gross margin was 10.6 percent, unchanged from the first nine months of 2001, while SG&A was 7.7 percent year to date, consistent with the first nine months of 2001. And we've seen continued improvement here, despite lower sales growth. Interest expense has continued to decline due to a favorable market rate environment as well as the reduced borrowings, and year to date free cash flow was a positive $95.2 million.

Let's talk about the outlook for the rest of the year. Based on what we've seen to date, we're adjusting our sales outlook in light of the current conditions. We now anticipate that sales growth for the year will be in the 2 to 4 percent range. We remain confident in our earnings per share guidance of $1.27 to $1.29, which we've maintained all year. This is due in large part to the healthy fundamentals in the business, stable margins, as we add value for our customers, improving SG&A, and we've seen improvement each quarter this year, and excellent asset management coupled with a favorable interest rate environment.

Now, I'll turn it over to Craig.

Thank you, Jeff, and good morning, everyone. Now that we've given you a look at the numbers, let me take a moment to explain the trends we are seeing in our marketplace. As we discussed in last quarter's call, we are seeing unexpected softness in our sales growth rate, but our fundamentals remain strong and we remain committed to our guidance on other measures, particularly on EPS. Our strong asset management, successful expense reduction efforts, leadership in technology and deep customer relationships are factors that have not changed. I would like to take a moment to outline where we lost momentum on the sales growth rate and why. Then I will outline for you the steps we've taken to address the sales issue. This quarter we reported a 2.5 percent growth rate for our top line. While this rate is roughly in line with industry averages, it is slower than we had anticipated. I might add, however, that this is the highest quarterly sales volume we've ever reported.

Now, let's take a look at the factors behind our change in our sales growth guidance. As you know, at the end of the last quarter we lowered our sales guidance. We gave it our best shot, but we came up short. We are disappointed that we are having to adjust our guidance again, but I would note that overall Owens & Minor is doing very well.

This slower pace of sales growth resulted from the impact of certain company and industry factors. These are the facts as we see them. As some of you mentioned last quarter, we had a tough year-over-year comparison. If you'll remember, last year's third quarter showed a 10.7 percent growth rate. While we expected strong sales growth at the beginning of the year, we lost some business primarily on price. As a result, sales were down significantly in one geographic area of the country and up only slightly in another. Our eight other areas across the country are growing at levels we expected at the beginning of the year. Overall, we have replaced the lost business with new business, but it has transitioned more slowly than we expected, affected our growth rate in the last quarters.

Also, in the last two quarters we've seen a deflationary trend on some product categories in our sales mix. Typically, we see an overall one to 1.5 percent growth in the inflation rate and essentially it's been flat. While we're unable to predict future inflationary trends, we continue to work on product category management and our relationships with the most efficient suppliers to offset these trends. Also, industry sources indicate that total surgeries were down slightly year over year, which has an impact on us, as many of the products we sell are used in the operating room.

We have moved quickly to address these issues. First, we have made sales leadership changes at the home office and in the two affected areas to ensure that we have more consistent top-line performance. In the Midwest, we have renewed our contract with [Consorta]. We have a distribution agreement in place with Henry Ford Health System in Detroit and we've added a new customer, Health Enterprises of Iowa, a group purchasing organization for 14 hospitals.

In addition, we have signed agreements with a number of small to medium size customers that are in various stages of coming on board with Owens & Minor. We are seeing great success with penetration of existing accounts. This is the most profitable way to grow our business and a way to ensure that our margins remain stable. Also, our medical specialty sales group continues to expand our sales opportunities within the clinical area and the operating room. We continue to have the absolute best service in the industry and the most innovative technology in health care to support our efforts. In combination, these factors give us confidence about where we are now and where we are headed.

Now, let's talk about some of the highlights for the quarter. I am very pleased to say we grew contract sales to 31 percent of our total sales. We continue to believe that [Cost Track], our activity-based costing model, is a win/win for our customers and ourselves. We continue to work with our customers to find new ways to improve the supply chain. We have signed a variety of outsourcing deals with customers across the country.

For example, our distribution agreement with Henry Ford in Detroit includes several outsource supply chain management positions. Also, we have recently signed an agreement with Yale New Haven to manage the cath lab and its inventories, providing clinicians more time to focus on patient care.

We've continued our focus on technology innovation this quarter. You'll remember, we signed a comprehensive new deal with Perot Systems, giving us the added capacity to spend more on IT development and innovation. In the Annual Information Week 500 announced this quarter we were ranked number one again in health care for the third year in a row and number 11 overall. And while we are disappointed that we have to adjust our top-line growth estimates, we do stress that our EPS guidance remains steady. Our fundamental operating numbers are strong and our balance sheet is healthier than ever with free cash flow at an all-time high.

We plan to launch our strategic initiatives for 2003 and beyond at our Investor Day on November 19th and 20th. Our strategic initiatives have a strong foundation in customer research, which shows we must broaden Owens & Minor's horizons within health care. We will demonstrate how Owens & Minor plans to play a more dynamic role in health care supply chain management while protecting our culture and building our profitability. Most importantly, when we look to the future, we see opportunity. We would love to have you at our Investor Day in Boston in November.

Thank you, and now we'd be happy to take your questions.

OK, Ruth.

Yes, sir. I'm here with you.

OK.

You're ready for questions?

Yes, ma'am.

All right. At this time, if anyone has a question, please go ahead and press star one on your touchtone phone.

Thank you. The first question is from [Robert Willoughby]. Sir, go ahead, please.

Good morning. [Sean Harrington] in for [Robert Willoughby]. My question relates to the strategic initiatives you guys are alluding to. I know you're going to provide more detail at the conference, as you said. But just in terms of the broader picture of those initiatives, are these moves that will truly differentiate you from your customers or you're just broadening your perspective on your markets?

Well, Sean, I think what we would really like to do is to have-love to have you come to Boston because really to give our strategy the due that it is due, we need to spend a fairly significant time and we believe a picture is worth 1,000 words. And we'd love to have you come to Boston and see it because we're very excited.

All right. Thanks a lot.

Thank you. The next question is from [Kip Hewlett]. Go ahead, sir.

Yes. On the sales growth, you pointed to several factors here that lead to the deceleration from your prior expectation. How much of-can you give a sense just looking out beyond 2002 how much of this is tied to I guess price deflation, so an industry-wide factor versus-and just the slowing of the overall market that you can see continuing into 2003 versus maybe competitive developments or what you've indicated as some of the short term company-particular company issues.

Kip, this is something we'd like to provide guidance on in conjunction with our Investor Day in November. Our intention is to provide guidance for next year and the out years.

OK. Well, then in just speaking on the quarter itself, would you say half of this was-or, you know, give us a perspective on what role price deflation played versus the transitional issues.

Well, again, Kip, I think, as I said in my remarks, you know, we see typically one to 1.5 percent and we're seeing that as flat. We really see the opportunity in, again, the product category management and working with the efficient suppliers. We do have a supplier strategy in place. We've had it in place for some time and we're going to go into great detail in November about how we'll move forward in the core business with the suppliers. We also did, again, have some business that transitioned slower than we would have liked. And so there's a combination really of a couple of things from that standpoint. But, you know, we feel we've got the right management in place in our two areas. We've got a plan in place to protect the margin and to offset the deflation.

OK, and then just a follow-up question. The free cash flow which was, you pointed out, very, very- well, it was very, very strong-is this a-it's quite an increase, certainly, from where I had you forecast, but is this something that is sort of a one-time quarterly phenomenon? That kind of a jump, $28.5 million, or is this-and what are the particular factors that drove it that high?

Kip, it's actually been strong all year. Certainly the slower sales growth is a factor in generating cash in this business but the fundamentals, the improvement in the DSO which we hope is a long-term improvement-we put in a new accounts receivable system, we take the asset management very seriously. The inventory levels-or the inventory turns are up to 10. That's certainly the type of standards which we'd like to continue and will continue to emphasize. Quite frankly the use of cash is driven by a lot of factors, including the level of sales growth and will be much dependent upon that going forward as well.

OK, thank you.

Thank you. The next question is from Glen Santangelo (ph) with Salomon Smith Barney. Go ahead, please, sir.

Yeah, hi. My questions sort of relate to the top line as well. You know, Craig-I'm not sure-can you give us any better sense for maybe, you know, the magnitude of the contracts that you might have lost in the quarter which might be creating the weakness in this one geographic region that you talked about?

Well, Glen, we really usually don't get specific. What I would say again is, is that we have replaced the lost business with new business.

Are you now-I mean you did say now that you think the market, you know, was growing. Are you suggesting the market is now growing in the 2 to 3 percent range?

Well, I think we've seen the analysts range anywhere from 2 to 5 percent.

Forget about what the analysts think. I mean what do you think the market is growing at?

I would say we're right at about industry average.

All right. So you don't think the company is losing market share? I mean, talk to me about competitive landscape with the primary customers. Is there share shifts going on in the business, anything along those lines related to your primary competitors? Can you just give us-you know, a sense of the competitive dynamics here and what's going on?

Yeah. Let me say again, eight of our 10 areas geographically in the country are doing very well and we are very pleased with their performance and they're taking share. One of the areas, again, we had that was affected-again, we put the management in place and I'm very pleased. I was personally involved with the new sales management team that's there and one is flat but he has a very good plan in place and he's on track. So in eight of the 10 areas in the country we're doing very well. We're very focused on these two areas and then we're also focused from a corporate standpoint on competitive [IDNs] that we're targeting and going after.

OK. So I mean I guess as I model this company going forward, and I know you're going to give us all this stuff next month, but essentially without a material uptick in surgeries and without any market share gains we're now using roughly 2 to 3 percent as the market growth for the med surg business. Is that right?

I think that's a pretty good number right now, Glen. I don't know how long this decline in surgeries is going to continue. That will be to some extent dependent on the economy. We think there's some influence there. And we expect to be very aggressive with our new initiatives and go after some new types of business within our industry. So we feel pretty good about where we're going.

OK. Thanks a lot. I appreciate the comments.

Thank you, Glen.

Thank you. The next question is from Chris McFadden (ph) with Goldman Sachs.

Good morning, Chris.

Good morning, everyone.

Good morning, Chris.

Good morning, everyone. Good morning, Gil.

Good morning, Chris.

Talk a little bit about kind of operating leverage in the business, if you would. I mean we saw in this quarter and we've seen in the last couple of quarters that EBITDA growth running about the rate of sales growth-a lot of focus that has gone on around cost containments, IT strategies and others hasn't really gotten us as much multiple or I should say margin expansion as I guess we'd like to see. What's your expectations going forward? And I guess, you know, what should we reasonably expect would be the amount of operating leverage that you'll be able to deliver?

And then secondly, Craig, if I could pick up on a point you made in your opening comments which had to do with some price competition that resulted in some lost volumes. Is that becoming pervasive in the industry? Could you I guess highlight where you think some of that pricing pressure may be coming from? Thanks.

Well, I think part of the pressure comes from the manufacturer, Chris. And with the economy the way it is, there is some price competition among the manufacturers. We are very pleased that we have held our margins. We will continue-as you know, we watch our margins very carefully and we are really working on getting business from customers that are really more interested in driving process costs down, efficiency and productivity. So there is some price-some price in the marketplace, somewhat driven by the manufacturer. But we are focused really on gaining market share through our tools and through supply chain management. So overall, that's where we've been focused on.

I'll turn it over to Jeff on some leverage from the operations standpoint.

Clearly, leverage points include the control on the SG&A along with continued sales growth and the effective asset management. I might point out that sequentially our EBIT, our operating income has moved from 2.4 percent in the first quarter to 2.5 in the second quarter to 2.6 in the third quarter. And that is despite slower than anticipated sales growth. And certainly if the momentum ticks up on that and we maintain the controls and the focus we've had on the productivity and the SG&A, we would expect improvement on that line as well.

Jeff, in the past we've talked around the idea that a target, you know, sort of operating leverage multiple would be, you know, greater than 1.25 to the rate of sales growth. Is that still a reasonable longer-term objective for the business model?

Yes, Chris, it is. It is. And we'll actually discuss more of this in conjunction with our Investor Day.

OK, great. Thank you.

Chris, I would also just say on the technology side we plan to take that money and reinvest it in the technology for innovation and we want to maintain our leadership role with Perot in technology so we will be making investments back into the business in the technology.

And just one more follow on to that, Craig, which is I think very important strategically is to work with Perot and to leverage our relationship there. They have a growing health care business within the provider community and that's where I am in California. There's a Perot conference and it's more or less a user conference. So we think there's some opportunity to leverage our relationship with Perot into the provider community.

Great. Gil, I appreciate the comments.

Thanks, Chris.

There are no other questions in queue at this time.

No other questions, huh?

No, sir.

Well, that's pretty good. Well, now, Ruth, do you have any questions?

I have no questions, Mr. Minor.

OK. That's exciting. Let me just close it up, then, and we'll get on with business. Thank you all very much for listening and for being part of the presentation this morning. And please call with questions. We're right here. I'm not, but the other-the rest of the team is. And I look forward to hearing from you and hopefully seeing you in November. Thank you very much.

Thank you.

Thank you all, ladies and gentlemen, and at this time this does conclude the conference call for today. We thank you for your participation and we ask that you please go ahead and disconnect your lines.