Owens & Minor Inc (OMI) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Owens & Minor fourth-quarter 2005 year-end earnings conference call. [OPERATOR INSTRUCTIONS] As a reminder this conference is being recorded for replay purposes. I would like to turn the presentation over to your host of today's call, Mr. Craig Smith, President and Chief Executive Officer of Owens & Minor. Please proceed, sir.

Good morning, everyone and welcome to the Owens & Minor fourth-quarter conference call. We will review our results and take your questions in a moment, but first, let me introduce who is on the call today. Jeff Kaczka, our CFO; Dick Bozard, our Treasurer; Olwen Cape, our Controller; and Grace den Hartog, our General Counsel. Before we begin, Trudi Allcot our Communications Director will read a Safe Harbor statement. Trudi.

Thank you, Craig.. Except for any historical information, material discussed today may constitute forward-looking statements that involve risk and uncertainty that could cause actual results to differ materially from those projected. These include the ability to simulate the operations of an acquired business, the potential loss of key personnel, intense competitive pressure such as pricing within the healthcare industry. They also include the success of direct marketing program sand attracting new customers, the ability to retain existing customers, changes in customer order patterns, changes in healthcare laws and regulations, changes in government including Medicare reimbursement guideline, and private insurer reimbursement amounts, the ability to maintain product suppliers -- product price increases by suppliers, and other factors discussed from time to time in reports filed by the Company with the SEC. The Company assumes no obligation to update information contained in this call today. This conference call will be archived on our website for the next three weeks. Thank you. Craig?

Thanks, Trudi. Jeff is going to give us a rundown on the numbers, and then I will make a few comments before we take your questions. Jeff?

Thanks, Craig. Good morning, everyone. I am pleased to report that our results for 2005 were on target with our expectations with the exception of a $3.5 million write-off of software assets. We took this impairment charge because we've chosen to pursue an option that we expect to be much more beneficial to the Company. So before I go through the financial highlights, let me give you a little insight into this opportunity. When our new CIO Rick Mears came on board midyear he began reviewing our ongoing projects one of which was a large ERP system replacement. With Rick's leadership, we began looking at alternatives, including newly available technology.

We are pleased to report that advances in technology will allow us to migrate key operating systems from a mainframe environment to a modern web-based environment rather than replacing these systems, thus avoiding the enormous cost of purchasing or building a new ERP system. We, therefore, have written off the software asset associated with our initial plan and are in the early stages of working with appropriate parties on the new plan. The bottom line is that we believe this is great news because in addition to avoiding a significant capital investment, we expect to achieve cost effective systems with greater flexibility for growth, and we will provide more information on our progress in the future.

Okay. Moving on to the financial results. Revenues for the year were strong, up 6.6% to $4.82 billion and for the fourth quarter, were up 4.3%. The revenue growth this year came from a healthy balance of penetration with existing accounts and new customers, along with the growth in OMSolutions and the addition of our direct-to-consumer sales.

Now turning to net income and diluted earnings per share, remember these results were affected by the $3.5 million write-off that had about a $0.05 per share impact to earnings. This, by the way, was recorded in the "other income and expense" line. Reported net income for the year was $64.4 million, up 6.5% and for the quarter was $15.7 million, improved slightly from last year. Diluted earnings per share for the year was $1.61, up 5.2% compared to last year and $0.39 for the quarter. Other total year results. Operating earnings as a percent-to-revenue was 2.4% which was the same as last year despite the write-off and the impact of the Gulf Coast hurricanes in the second half of the year.

Our gross margin for the year was 10.7%, significantly increased from 10.2% last year. The improvement resulted from progress in our initiatives, including direct-to-consumer sales, MediChoice product sales and OMSolutions, offset partially by lower contributions from alternate source purchasing. And we are pleased with the SG&A results for the year which came in at 7.9% of revenue up from 7.5% last year. The increase resulted from the higher expenses of our direct-to-consumer acquisitions, partially offset by improved productivity in our core business.

Asset management was excellent. Inventory turns were 10.0 and DSO was 26.3 days at the end of the fourth quarter, both improved from last year. This continued strong asset management allowed us to generate exceptionally strong operating cash flow for the year of $135 million, and I would like to congratulate all the field and home office teammates who helped make this happen.

Turning to our guidance for 2006, we expect to see revenue growth in the 6 to 8% range and diluted earnings per share in the range of $1.75 to $1.80 with stronger comparative earnings growth after the first quarter. You should be aware of a couple of things in our guidance. First, we will be moving to our new home office during the first quarter and expect to incur additional pretax expenses of about $1.2 million associated with the move, which is about a $0.02-per-share impact to EPS. And second, our earnings per share outlook also includes an estimated $0.05-per-share impact from the expensing of equity-based compensation associated with the new accounting rules.

So in summary, healthy total sales growth of 6.6%, EPS of $1.61, including a $0.05 charge, continued strong asset management, exceptional cash flow of $135 million, great success in growing our direct-to-consumer business, a wonderful IT opportunity that will allow us to avoid a much more significant investment, and a solid outlook for 2006. Thank you. Now I will turn it over to Craig.

Thank you, Jeff. And let me open up by saying we had a very busy and productive year in 2005. We accomplished a successful leadership transition during the summer. We grew our market share, and we entered a new direct-to-consumer market. Looking at our financial results, we had good revenue growth for the year. Penetration of existing customers was strong all year, and we have booked new business, especially in the fourth quarter, putting us in strong position for 2006.

Now along with the top-line growth, we are very proud of the productivity gains we achieved in 2005 in lines per hour, sales per teammate, gross margin per FTE, sales per square foot, and while doing that, we have been able to hold our headcount steady in our core business. We continue to focus on improving operating margin. We believe this is the best way to measure our progress as our business grows more complex. Our operating margin improved in the third quarter and held steady for the year, even with the fourth-quarter write-off and the second-half impact of the Gulf Coast hurricanes.

With 2006 well underway, we are in good position to take advantage of opportunities in a growing healthcare market. We will do this with best of breed distribution, advance supply chain solutions, and a direct-to-consumer pipeline that let's us follow the patient. In January, Gil and I traveled to California and met with hospital CEOs, CFOs and Chief Purchasing Officers who validated our strategic direction. These executives are not focused on price but want real improvement in supply chain process. They want partners with the technology and the know-how to manage information, improve inventory management, and handle big outsourcing projects such as warehousing, transportation, and distribution. And in short, Owens & Minor is providing these services and solutions today.

Technology is an essential element of these solutions. We've said before that we will either develop or acquire the technology we need to serve our customers. During 2005, we acquired Cyrus Medical and Paragon. Both companies gave us talented new teammates and innovative new technology. With the guidance of our new CIO Rick Mears we are making important changes with our information technology approach. By migrating our key operating systems rather than replacing them, we will avoid the disruption and cost of an ERP replacement project, and we will improve our flexibility and capacity for growth.

Looking at some of our other initiatives, MediChoice, our private label grew strongly last year and has aggressive goals for 2006. We are pleased with the growing acceptance of MediChoice, and, for example, MedAssets, a group purchasing organization has approved the entire product line for sales to its members. With OMSolutions our team has built an improving annuity business and brought on a number of new engagements. While they are still working toward our profitability goals as a stand-alone division, they did contribute an estimated 130 million in cross sales to our core business in 2005. Also, our integrated service centers continued to exceed our expectations. With three projects on board, we have targeted additional ISC projects in 2006.

Our direct-to-consumer business also exceeded our expectations. The team at Access doubled their customer base to approximately 115,000 customers for the year and made an overall positive contribution to our financial results. In 2006, we will continue to build this business. As consumers use more healthcare products in the home, we have an excellent opportunity to leverage our direct-to-consumer platform and armed with our strong cash flow, we continue to search the direct-to-consumer industry for acquisitions. Looking ahead, we will execute our plan to link product, process, and patient across healthcare by providing best-of-breed distribution, offering advanced supply chain solutions, and building a direct-to-consumer pipeline that follows the patient from the hospital to the home.

In summary, our long-term plan to build a fully integrated healthcare solutions company is working. We have built platforms for growth and for all of the teammates and Owens & Minor, we are very excited about the future. Thank you and we would be happy to take your questions.

Thank you, sir. [OPERATOR INSTRUCTIONS] Our first question is from the line of Larry Marsh with Lehman Brothers.

Thanks, good morning, Craig and Jeff.

Good morning.

Good morning.

Just first of all, a clarification of the software write-off. Is this the -- ending the IT outsourcing relationship you announced back in 2002 with Perot? And if so, is there going to be a new prime vendor relationship on this web-based system? And if you can elaborate on are there any cost savings we should think about with this new software platform?

Larry, let me answer the first part of that question. This does not cancel our agreement with Perot. Actually we have had a wonderful relationship with them over many, many years. We consider them a very strong partner, and we assume that they will be very much a part this new web-based technology as we move forward. From a standpoint of cost savings, I am going to turn that over to Jeff to answer.

Sure. Larry we -- certainly we expect to continue this very valued partnership with Perot, but we will likely work with other world-class partners in terms of this project. We are at the onset of the discussions with these parties. We've done enough work to have tested this process and feel very confident that we can pull it off. There will be clearly the savings associated with the avoidance of a very expensive investment in a new ERP system, but the ongoing savings associated with that have yet to be determined, and, of course, in the future as we enter these discussions and negotiations and it becomes more clear, we will be able to articulate that.

So we shouldn't really think about specific cost savings in 2006 based on this announcement?

I don't think you should, Larry. I think everything we know to this point is incorporated in the guidance that we have provided and this will be a little longer-term project that will go beyond 2006.

Okay. Second then around top line. Obviously you are communicating what could be some acceleration in your top line in 2006, certainly at the high end of your guidance. What is the biggest factor that would give you confidence in that? And is the DOD prime vendor relationship you announced back in October a noticeable contributor to that or is that just a small incremental add-on?

That is actually a small piece of it, Larry. We were very fortunate in the fourth quarter of 2005 to win some fairly significant business with the Premiere -- with the new Premier contract and the CHI contract, which will start to ramp up here in the first quarter. We did get a little bit of that in the fourth quarter. But primarily in the first and second quarter, we have a couple of new competitive customers coming on late in the first quarter of 2006. So we have a pretty good pipeline. Also, Access is starting to kick in and contribute probably on a smaller scale, but that should still continue to grow in 2006. So it's really is going to be a combination of some core wins that we've won, and then Access continuing to ramp up.

Okay. It sounds like you have renewed most of the Novation business that you currently had?

Well, again, that comes out to bid, but we have been working very diligently the last six months to a year to work with our individual members of Novation, and in the normal course of business, you win business and you lose business, but traditionally, we have fared fairly well through the sign-up piece. So we will go through the process. We will have to go out and prove our value like we do every day to our customers, but we feel that we've got the right programs and services for our Novation customers.

Okay. A third quick point is on gross margins. If we try to back out the Access contribution, were gross margins about the same as last year? Or a little bit less? And how do we think about that for 2006 apart from the Diabetes business.

Well, let me answer that. Let me take that. I -- we have been very forthright about the alternate source piece and offsetting that, and we have been working on that for the last 18 months. We also had the challenge of inbound freight going up in the fourth quarter. We happen to believe that we now have the sales force alignment in place for programs and services that bring more profit in 2006. The MediChoice sales are ramping up nicely. The MedAssets relationship has gone very well. Premiere has put us on for two or three product lines. On MediChoice, the SurgiTrack, which is our packaging procedure-based system is ramping up.

So I would say we dipped a little in 2005, but it clearly, Larry, is the top focus for the sales force. They are now in alignment, and we feel we are ready to start driving margin. But a lot of that margin was not really the customer margin it was the backside margin that we had been working on. We've gone back out, we're aggressively working with our manufacturers also, to improve penetration, market share, operating efficiencies and other thing I would say is is that we did an outstanding job on SG&A in 2005. You know in distribution there are three keys, sales, SG&A, and margin, and we did a phenomenal job in SG&A in 2005.

Okay. Then finally, it sounds then that you are not seeing quite as much push back of the GPOs at large on some of the MediChoice product line if Premier is adding you on a couple of products; is that right?

Well, again, that is an opportunity for us in all of our accounts. The GPO, again, negotiates the price with the manufacturers, but our strength, as you know us pretty well, has always been with the individual hospitals. So we think now that the alignments with the sales force is ready, we continue to have more launches. We -- we've done a great job on QC in 2005, quality control on our projects, that we are aligned and ready to go with our individual customers in 2006.

Okay. And just one final point of clarification. Jeff, are you assuming the redemption -- you're calling your 8.5 senior subordinated notes in the second half of '06 in your guidance?

No, Larry, that has not been incorporated in our guidance. We have not made a decision on that. It is nice to have options though that the bonds are callable in July of '06. And when we do make a decision on that, we will incorporate that.

Okay. Very good. Thanks.

Thank you.

Sir, our next question from the line of Lisa Gill with JP Morgan.

Good morning, everyone.

Good morning, Lisa.

I was wondering if you could just talk a little bit about manufacturers raising prices. I think you guys expected in 2006 that we would see prices going higher, and I am just wondering thoughts around contribution from inflation. Is that incorporated into your guidance on any of the top line of any of these products? And then secondly, Craig, just a bigger picture type of question. You obviously have pretty good cash position. You are talking about doing more and more in the direct-to-consumer area. Can you just give us some other thoughts of things that would fit well within the Diabetes business? And then, just lastly, I think you said that as of the end the year you had 115,000 patients under the Diabetes program and I think that was the same number you gave in the third quarter so was there no growth in the fourth quarter?

I will let Dick answer the last part of that question and then I will answer the first two parts of question.

Lisa, at the end of the third quarter we reported 100,000 patients. At Investor Day which was in December we said it was about 115,000. So we have seen a lot of growth. Actually if you look at -- from the time of acquisition, the patient count has grown from 50,000 to over 115,000, and that took place during 11 months. So when we looked at Access, we saw the revenue grow from 32 million to 59.2 million, and then the fourth quarter, we saw strong growth even with the storms of 19.2 million. So we are very pleased with the growth that has taken place, and we have only had modest acquisitions that were made last year so a lot of that was internally generated so.

I think I was using the 115,000. I thought that was from the third quarter when Craig had talked about it at our healthcare conference. So I apologize on that. Would you expect the continued growth? What is your expectations as far as growth goes in 2006?

Well, we really haven't given a lot of guidance in that respect other than you know what our strategic plan is, and this is an area of huge interest for us and we continue to evaluate all of the opportunities.

Will you continue to give us the number of lives on a go-forward basis?

I would think so.

Okay, great.

Lisa, let me answer the first two questions that you had. The first one is based around inflation, and we are seeing some resin products and latex products that are going up. As you know, we have been facing deflation pretty much the last three years, and we do have some modest inflation in the top line for 2006. There's probably some opportunity for us also in the noncontract portfolio for us to have the ability to take price up on some of our product lines going forward. So we do have a little bit in that, but, again, it would be modest.

In terms of cash, obviously the first thing is, we are looking obviously at acquisitions, but our commitment to the Board is first and foremost that they be accretive. So as we look at these, and we always have a number that we are looking at, primarily in the chronic care area, obviously we are taking a great deal of interest and focus. There are some other areas and some other platforms that we would like to leverage off of that Diabetes business. Really the first year what we wanted to do was to make sure that we grew the customer base which I think we have done very nicely, and part of that customer number that Dick gave you does not include all of the eye care customers that we brought over in the fourth quarter. So there's probably a little bit of a number in there in terms of some growth, and we just -- we expect that there's going to be natural growth. But that's really our platform to grow into other areas. As you know, diabetes patients, unfortunately, have several illnesses other than diabetes, and we are looking for acquisitions that would complement that in 2006.

Just as a clarification, Jeff hasn't included any these acquisitions or potential acquisitions in the guidance?

That's correct, Lisa.

Okay, thank you.

Also, Lisa, just to follow-up, they have all been small acquisitions. So primarily around technology or small tuck in acquisitions. So they have been all very small from an impact standpoint.

Okay, great, thanks.

Sir, our next question from the line of Robert Willoughby with Banc of America.

Good morning. Maybe just adding on to that question. In terms of acquisition spending for '06, what is a reasonable level to assume? I would expect it to be down, I guess, from what you spent this past year. Is that a safe assumption?

Well I think, Robert, we are going to really look at the opportunities and how they complement the Company and complement the strategy. So we look at all sizes of acquisitions from small to medium size, and as you know, in any acquisition strategy, for every ten you look at, you might be lucky to close one. So the fortunate thing is, we have the capacity, and we have the cash to be able to do those acquisitions, and really what we are looking for is -- is any key companies that might help complement our strategy either in OMSolutions or in our chronic care business or if actually something came up in our core business we would take a look at that also. But the nice thing is is that we have the ability to be able to do that and are in a great, great position.

And do you have a CapEx assumption for '06?

Robert, we haven't provided guidance on the CapEx, but historically, we spend in the 15 to $20 million range and in '06, we will have a little additional expenditures associated with the completion of our new home office.

That's great. Thank you.

Thank you, Robert.

[OPERATOR INSTRUCTIONS] And sir we have a question from the line of Terri Powers with Robert W. Baird.

Good morning, everyone.

Good morning, Terri.

Just wanted to move back to the topic of the alternate source profitability for a second here. It seems to me that we've been -- we know this has been a trend for a while, but it also seems to me we would have probably stopped hearing about this at some point in time as the contributions have continued to decline. Can you give us a little more color on that? And at what point are we going to stop hearing about this as a negative contributor to gross margin performance.

I think, Terri -- I think you are right. It has pretty much run its course. We made the right decision obviously in reducing the alternate source. It has had some impact. It will be good for us, good for the industry. Long term. We have mentioned it on this call because, as you know, it has had an impact to the total year 2005, but as we run into 2006, those comparables are not there, so hopefully this will be the tail end of our discussions in regard to that impact.

So it would be fair to say that there is probably more of an impact on profitability towards the beginning of '05 rather than towards the latter end of '05.

That's correct.

Okay. Fair enough. And is it possible to give any color related to the fourth quarter performance, as far as impact on either revenue and/or profitability related to the Gulf Coast hurricanes and fuel costs clearly being larger.

Let me put a little bit on that, Terri. As you know in the third quarter, we talked about the impact of roughly -- I think it was $1 million to the earnings in the third quarter, and what we told you is is that the fourth quarter we would still have an impact from that standpoint on earnings. Let me put a little color on it from a sales standpoint. Six of the hospital that we serviced throughout the year are still closed, and there are another eight that are well below expectations for the year in the fourth quarter. Also, fuel has been, as you know, all over the board in terms of price-per-gallon, and we saw some relief early in the fourth quarter and then of course it went right back up later in the fourth quarter.

So we have taken the appropriate measures to adjust our freight factors for this year to adjust for the fuel that just doesn't seem to be coming down at all. Now if it does come down, we will adjust our freight factors appropriately but there is still some carryover from Katrina now. The positive I would say is is that we do have two new customer from the Gulf Coast ramping up here in the first quarter based on the fact that we were able to service some competitors' accounts during that time and they have moved over and we are ramping up the sales on those two customers.

Okay. Great. That's good color. Thank you very.

Thank you.

And then I just had a question very quickly for Jeff. Any update on tax guidance for '06, please. Tax rate.

Terri, we haven't provided guidance to that level, but I think you can see over the course of the last couple of years that the range it has been in and this year's range is around 39%. And we have nothing else substantial to report in regard to things that would, in fact, change that rate.

Great, thank you very much.

Thank you.

Sir, we have another question from the line of Larry Marsh.

Just two follow-ups. Dick, you had said access or Diabetes revenue is about 19 million in the fourth quarter. Do you have a Q3 revenue figure handy?

Actually I do. In Q3, we did 17.2 million.

Okay. And you said about 52 million for all of '05?

No, it is actually 59.2, Larry.

59.2 for the full year?

Correct, yes.

Okay. 17.2. I am sorry. Do you have a Q2 figure then? I think I had it already?

Larry, you are great. We love you.

Larry, would you like me to add a footnote.

There you go. Just spoon-feed it to me.

Yes, we are going to give it to you Larry.

Larry, the Q2 number was 14.5.

Okay. Thank you. The provision for doubtful accounts I guess was what 3.9 million in Q4. Was that just -- was that associated with any particular customer? And what sort of expectation do we have for '06?

Larry, that is the result of the acquisition.

Okay.

And one of the thing that you experience in that sector is deals with co-pays, which is a small amount. It's a -- when you are dealing with someone that is on Medicare and they are 84 years old and can't pay the $20, how far do you go. So it is not related with a major core customer or anything of that sort.

Right. So obviously the nature of that business means that that provision would be running, what, in sort of that couple million a quarter range? Or is it hard to quantify it that specifically?

I wouldn't want to quantify it. As you know, we're just -- actually two days ago celebrated the one-year anniversary. So we are learning a lot, we are trying to put together all of the documentation to make sure -- we are very comfortable that we are adequately reserved and we will continue to monitor that every month as we go forward.

Okay.

Larry, I think if you look at our mix of business, we still had a record DSO, especially in the core, and I believe our overall DSO, even with that was 26 days. So it's still the best in the industry and even with that mix, that is still the best in the industry. So we do see a little bit of impact on that, but Dick does a great job of overall managing that asset for us.

Okay. Two final things. The solutions business, I think Q3 you talked about Mark and his team showing good progress. You are saying 130 million of cross-selling revenues. Is the comment here today that you are still feeling very good about the progress with solutions? And that the earnings contribution that you were hoping for would -- you think will come through in '06?

Yes, Larry, as you look at that, and I mentioned this in the third quarter call, we are probably really looking more at OMSolutions and how it supports the core really versus how it is as a stand alone. Now we have done a great job of reducing expense and taking the margin up, but as you know just like any other business then your top line slows down a little bit. But I think we are in the right place now, with the right people, and the right programs and services with this Paragon acquisition that we now have WISDOM Gold that takes WISDOM1 and WISDOM2 to a whole new level and helps us with data cleansing. So we think we are really developing and buying the right programs and services that our customers are asking for today. So again, as a stand alone, they had a huge improvement over '04. We expect improvement in '06. But we also feel that from a competitive standpoint and retaining business, just like the question on Novation, we have a lot of customers that are going to look for not just a competitive price but programs and services. So they will continue to play a very key role, especially in our mid-sized and our larger customers in terms of moving from price to process improvement.

Okay. And then finally, I know you talked about the moving costs as you get to the new facility in the first quarter. After the first quarter, are there any incremental costs associated with the consolidated facility that we should be thinking about that are incorporated in your guidance?

The primary difference, Larry, is in the first quarter. We do have two facilities here that have space of just over 100,000, so we will be expanding the space there and bear in mind when we opened the facility here we were a $1 billion company and now we are nearly a $5 billion company. So it does require a little additional space, but I wouldn't expect substantially different impacts to the earnings as a result of that on an ongoing basis.

Okay. Very good, thanks.

Thank you, Larry.

[OPERATOR INSTRUCTIONS] And sir, we have no further questions at this time. Back over to the group for any further remarks.

Thank you. Again, I just would like to say it was a very productive, busy year in 2005. We are looking forward to a very strong and productive 2006, and I am just very grateful to the 3900 teammates throughout the Company that work hard very -- every day to achieve better customer service and to work a little bit harder for our shareholders. Thank you for listening, and we will talk to you at the end of the first quarter. Thank you.

Ladies and gentlemen, we thank you for your participation in today's conference. This concludes your presentation and you may now disconnect.