Owens & Minor Inc (OMI) 2006 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Owens & Minor's first-quarter 2006 earnings conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Mr. Craig Smith, President and Chief Executive Officer of Owens & Minor. Please proceed, sir.

Good morning, everyone, and welcome to Owens & Minor's first-quarter conference call. In a moment we will review our results and then take your questions. 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 Allcott, our Communications Director, will read a Safe Harbor statement. Trudi?

Thank you, Craig. Except for any historical information, materials 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 assimilate the operations of an acquired business, the potential loss of key personnel, intense competitive pressures such as pricing within the health care industry. They also include the success of direct marketing programs and attracting new customers, the ability to retain existing customers, changes in customer order patterns, changes in health care laws and act regulations, changes in government including Medicare, reimbursement guidelines 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 conference call today. The 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?

Thank you and good morning, everyone. We are off to a nice start this year. Since the last call, we have received another investment-grade credit rating. We have refinanced the bonds, we moved to our new home office and we have seen productivity gains in the core business.

Our financial results met our expectations with revenues for the first quarter coming in at $1.26 billion, up 5.7% over last year. Diluted earnings per share were $0.41, up from $0.40 last year, and net income for the quarter was $16.5 million, up 3.7% from last year. Both of these earnings measurements were, of course, impacted by the expensing of equity-based compensation associated with implementing FAS 123R and the expenses associated with our move into the new home office in the first quarter. These two items decreased pretax earnings by $1.3 million.

Turning to other results. Operating earnings for the quarter were 2.4% of revenue compared to 2.5% in the first quarter last year. Gross margin for the first quarter was 10.8% of revenue, improved from 10.5% in the first quarter of last year. This improvement is attributable to our growth in direct to consumer sales. We are very pleased with our SG&A results for the first quarter, which came in at 8.0% of revenue. That is up only slightly from last year despite the growth in our direct to consumer business and the additional expenses related to equity-based compensation and the move. The field and home office teams have made real progress in generating productivity and controlling expenses.

Turning to asset management. Inventory turns came in at 10.3 and DSO at 25.5 days. This strong asset management, coupled with our earnings, allowed us to generate $21.6 million of operating cash flow in the first quarter.

As many of you know, asset management has been a strength of ours for years. That along with strong operating cash flow and investment-grade credit ratings allowed us to refinance our bonds at a very favorable rate during April. Our new senior notes were priced at 6.35%, and we have used the proceeds and available cash to redeem our 8.5% senior subnotes. This establishes us with a solid financing position for the next 10 years.

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, excluding an estimated onetime charge of $11.5 million related to the early retirement of debt which will be recorded in the second quarter.

So to recap we are off to a good start. Revenue growth of 5.7%. Earnings per share at $0.41. Excellent asset management and cash flow. We've moved into our new home office facility. We received a second investment-grade credit rating. We refinanced the bonds at a favorable rate and positioned ourselves well for the future.

Thank you. Now I will turn it over to Craig.

Thank you, Jeff, and good morning, everyone. Well, we are finally moved in to our new home office and we're settling in, and we're thrilled and pleased to have all of our teammates finally under one roof.

Looking at our business from a big picture perspective, we remain focused on driving further productivity improvements while improving margin in our core business and diversifying into higher growth areas in health care. We are pleased with our performance from the first quarter, which has given us a good start for the year.

During the quarter we reported steady revenue growth. We improved overall gross margin, and we reduced expenses as a percent to revenue in our core business. We continued to demonstrate solid asset management, which allowed us to generate cash for another quarter. Our direct to consumer business continued to grow.

Revenue growth during the quarter came primarily from our existing customers but was supplemented with contributions from new business and revenue from our direct to consumer effort. Now while several of our new customers did not come on board during the first quarter as expected, these accounts and others are in the pipeline for conversion.

Core business productivity was a big story for us this quarter as we again saw improvement in many key areas including lines per hour, sales per teammate and sales per square foot. Productivity gains will continue to be a focus for the Company this year, and to that end we have expanded our Six Sigma team with operation experts from the field. They are developing a lean Six Sigma process aimed at rapidly streamlining processes such as transportation, purchasing and warehousing.

I am very pleased to say that our programs and services such as MediChoice and SurgiTrack showed positive growth in the first quarter. As we have said before, these programs benefit our customers by reducing costs and improving productivity. They also cement our relationships and deliver higher margins to us.

Taking a look at some of these initiatives, MediChoice, our private-label, reported strong growth in revenue over first-quarter 2005. Our SurgiTrack services is now a major focus of our medical specialty sales team, and we are making inroads with our customer base. PANDAC continues to be a strong contributor to our overall gross margin. With OMSolutions, our team has new businesses in each of its services lines, including a new QSite agreement with a large nationally ranked academic medical center for all of its clinical areas. We also continue to seek integrated service center projects.

Turning to our direct to consumer business, we crossed the one-year mark during the quarter, and our team at Access has made very solid progress. We doubled the customer base to more than 124,000. We made a few tuck-in acquisitions which we successfully integrated, and Access has made an overall positive contribution to our financial results.

Over the past year, we also learned a few things about the consumer market, and we will apply these lessons as we build our direct to consumer platform. Among the lessons learned, there are some timing issues in our new business. Customers were motivated to buy medical supplies in December before having to satisfy a new insurance deductible in January. You could almost describe it as a use it or lose it purchasing behavior.

Consequently Access had its strongest sales month ever in December and then lighter volume in January and February. March, however, has been our biggest second month in the history of the time that we have had Access. The team at Access also changed its sales process during the first quarter, which allows us a higher percentage of orders on the first call. These factors together resulted in a small operating loss in the first quarter for Access. However, customer orders were very strong in March and looked very strong in April. This is a high-growth division in a very promising market, and we are building our infrastructure for future growth. We continue to seek acquisitions to supplement the growth of this business.

This year we will continue to work our long-term plan to become a fully integrated health care provider from the manufacturer directly to the patient. We will continue to provide best debris distribution, offering advanced supply chain solutions and building out our direct to consumer pipeline to follow the patient from the hospital to the home.

And finally, I want to recognize Jeff and his finance team for a great effort on refinancing our bonds. This move gives us increased flexibility and strength. We are well positioned both financially and operationally for the year ahead and poised to take advantage of opportunities in a growing health care market. And as always, I would like to thank our teammates in the field and at the home office for their hard work this quarter. Their efforts make the difference for us everyday.

Thank you and we would be happy to take your questions.

(OPERATOR INSTRUCTIONS). Eric Coldwell, RW Baird.

The first question, I was hoping you could give us just a little more color on the hq relocation expense in Virginia, and then kind of pare out for us what the magnitude of that was specifically? And then also, if you could give us an update on the Access facility relocations and how those are going?

Okay. Let me first cover the first part of the question. In regard to the headquarter, the home office relocation expenses incurred in the first quarter we indicated in the press release. The relocation costs and the effect of FAS 123R were $1.3 million. The breakup there is about $900,000 associated with the home office move. That includes double rent, things like that and the actual cost of the physical move, and those expenses are complete. We are in our new facility. The remaining part was the additional equity-based compensation expenses associated with that new accounting standard.

For the first quarter, that is about $250,000. That is something that is expected to increase throughout the year and particularly in the second quarter.

What is it about the second quarter before we go to Access? What is it about the second quarter that you're looking at in terms of increasing? Could you quantify that?

I think what you would see is historically it has been our practice to work the equity compensation during the second quarter. So there is accounting implications there related to those who have reached retirement age and so forth.

And could you quantify are we looking 600,000, 700,000, that kind of magnitude?

I believe the guidance we provided was it would have an impact of about $0.05 per share for the year.

For the year. Okay. And then Access, if we could get an update on those facility moves? And if I could add onto that, I know national advertising was going to be part of your strategy in calendar '06. I'm curious have you launched a natural ad campaign and if so what traction are you getting there?

Eric, this is Dick. On the relocation, the first part of that relocation is completed. The team is well-established. It seems to be operating well. As we go forward in the year, some additional space will become available in the building, and we will move some additional teammates accordingly. So the majority of the move, however, is settled, and we are on target as to where we want to be going into '06.

And national advertising?

We entered -- we did some -- well, we are doing some advertising in specific markets such as New York, which are producing some very good results for us in that market. So we will continue to roll that out through the year across the country into different markets. But the New York market was particularly attractive for us, and we did that with some TV ads.

That was a test market, Eric, that went fairly well. Actually I have personally seen some ads here in Virginia that are very good ads. So we will start to roll that out throughout the country over the year.

That is great. Then final question looking at the core business, recently one of your -- your largest competitor made some comments to us that they are seeing pricing opportunities start to pop up in the channel both on the manufacturer's side with maybe some slight price increases and then also even to a lesser extent on the GPO side with a little less pushback. So I'm curious if you can give us an update in acute care distribution and general hospital supply what you're seeing in terms of pricing on both upstream and downstream relationships?

Yes, well, I was really very pleased with the first-quarter performance of the core. Obviously from an operating expense standpoint, we did a very very good job of driving our expenses down.

As I also said, our programs and services across the board are doing very well, which obviously all add to a higher margin for us throughout the core. We did see from a manufacturing standpoint some slight increases in the fourth quarter. Personally I don't think it was as much as we expected. I think actually there was some pushback from the GPOs on the resin prices and the transportation.

So where we really have seen the improvement for us would be across the board on our programs and services, and we are very very happy with that. We are going to continue to work on our expenses. That has been probably one of the highlights for us over the last two or three years is to continue to really drive the core expense down. We have our Six Sigma in place now, and we are going to continue to focus on that and improve margins. That has been a priority for the Company also for the last two or three years is profitable sales, and that is a key for us in 2006.

Lisa Gill, JPMorgan.

Jeff, I was wondering if we could just talk a little bit about the refinancing. I'm figuring that the interest savings on this is going to be about $0.04 in 2006. I'm just wondering I think on the last call you said that any benefit that you receive from this was not in your current guidance. Is that correct?

Yes, it is correct that we did not include the effect of the bond deal in terms of our guidance provided at the end of the year. Certainly we are very excited about the bond deal. It is something that will be favorable to us this year and for the next 10 years. However, Lisa, we feel it is quite early in the year. The range of our EPS guidance is $0.05, so call us cautious, but we don't think it is necessary at this point in time to adjust the guidance.

Great. And then secondly, maybe we could just talk a little bit about the acceleration in the revenue growth obviously coming in just below 6% for this quarter and then the expectation of having 6 to 8% for the year. As we look at the hospital market, we continue to see companies like HCA having problems on the volume side. I'm just wondering what you're seeing in the overall marketplace that gives you the confidence that you will be able to continue to grow substantially faster than the market?

We look at obviously -- as you know, I am an old sales guy, so I'm still very active in the sales cycle. I see a lot of customers on a regular basis. I probably see customers almost every week. The three customers that we had coming on in the first quarter, two of them were fairly complicated, and we chose to conservatively move them to the second quarter to just make sure they are both low unit of measure that we did everything right. We could have pushed it forward, but I think to the benefit of the customer we waited until the second quarter. The third customer was a government customer that needs to get some things squared away with their state legislator.

We beyond those three had a lot already in the pipeline for the second quarter that is starting to ramp up. So we validate that topline number on a monthly basis. We have Friday conference calls with all of senior management. We look at all of the programs and services. We look at the sales, we look at the operations, and we are still very comfortable with the guidance of 6 to 8% for the year. We think despite with the three customers that did not quite come on in the first quarter, that we still had a very strong revenue growth in the first quarter.

So was it fair then to characterize that you're taking market share in the marketplace, as well as continuing to sell through your products and services to existing customers, therefore increasing your penetration? Is that the way I should be looking at it?

That is correct. The three obviously that are coming on are competitive customers, and we have another competitive customer coming on in the second quarter that is a nice size. But we are also, if you look at OMSolutions, we are now up on cross-sells. I believe we quoted 135 million in the fourth quarter. We are up to about 156 million in cross-selling on OMSolutions. So we are able to leverage our programs and services with some of our larger customers also.

Great. And then just a last question. Craig, I was wondering if you could talk -- obviously Access Health has been a great acquisition for you. What other areas do you think potentially you could move towards from a direct to consumer type relationship (technical difficulty)--?

I knew you were going to ask that because you asked that last quarter.

I know, and I keep asking it. I figure if I ask it enough times, maybe one of these times you will give me an answer.

And I said, we better have an answer for Lisa this quarter. We are aggressively looking at other platforms. Obviously the diabetes basis -- unfortunately I am kind of going to give you the same answer I gave you, but I ask the same question every week -- where are we? So we are aggressively in acquisitions looking for other platforms to add to the diabetes basis, the foundation.

Now one of the things we wanted to do last year was really build up our customer base, and about at 124 we would like to get it up even a little bit bigger than that. So we have a good foundation to cross-sell across those 150,000 customers. But we are actively looking to add other platforms.

One, we are looking at strategic partners from a manufacturing standpoint. We are looking at acquisitions. We could build some things out, but I don't think it would have as fast an impact if we could do an acquisition or bring a manufacturing partner on quickly.

So we are working on this thing everyday. We are still looking for diabetes acquisitions, but now we are also very aggressively looking for some platforms to add.

Great. Thank you very much for the comment.

Glen Santangelo, Credit Suisse.

Just two quick questions. Craig, you talked earlier on the call about the ability to drive maybe further productivity improvements and drive margins. It seems like the business has clearly reached some level of maturity. I'm trying to figure out how do you go about improving the margins from this point? Is there something you can do along the productivity lines, or is it really going to come from maybe business mix changes, your own solutions strategy? If you can just kind of give us a sense of that, that would be helpful.

Well, I think we have done an outstanding job in the core of leveraging the sales against the current group of teammates we have today. One, we continue to invest in our systems. So we are on our seventh or eighth version of Manugistics. We are on our sixth or seventh version of our client/server warehouse. We continue to upgrade.

I think the second key that we really have not talked about publicly and we would love to have you all come down for the next investor day is the investments we have made in OMU and our people. I believe we have one of the best trained workforces in the industry today. You know, our warehouse people have an opportunity to have a career here where we had very high turnover three or four years ago on the warehouse. It is tremendously down. We work on our people being cross functional. We have spent a lot of money on OMU. We run ROIs. I was just with our head person of training the other day, and we were walking through the ROI on the programs.

So we will continue to leverage through technology, through training, through productivity the current workforce that we have today, and I think there is still some opportunity there. Once we start to put some Six Sigma processes on some of the key functions we do, I think there is still some opportunity there.

The other place is we have the sales force now selling programs and services. It has taken us about two years to really get them turned around and starting to focus on MediChoice and SurgiTrack and PANDAC. We are seeing some good leverage in the first quarter. I think we actually mentioned in the fourth-quarter conference call that we had seen some good progress in December, so we have about four months behind us of some good positive traction on that.

Then we will continue to use OMSolutions to get higher margin engagements. A lot of those engagements now are actually in competitive accounts where we don't have the distribution business. So we do see what we have been working on over the last three years really starting to take hold over the last four or five months.

Just one follow-up question, Craig, if I could. Just to follow-up on Lisa's question, clearly you moved into Access Diabetic, and that was kind of a strategic change going more into a direct to consumer business. But is there anything else along the acquisition lines that maybe looks interesting to you as you look out over the next couple of years? Maybe not even along the direct to consumer avenue, but maybe anything else that might help improve the productivity of your business? Just what do you think about more broadly from an acquisition standpoint?

Well, I think I have had the opportunity to be at a lot of conferences over the last two or three months. As we all know, 65% of what we sell is consumed in the operating room. That continues to migrate out of the traditional hospital into the surgery centers, into doctor's offices. So you will see us continuing to look at supporting either our acute care customer. What I'm saying hearing from a lot of hospital CEOs is I have to find other ways of revenue than just in-patient services. So we have CEOs looking at rehab centers, outpatient surgery, specialty hospitals. So we think there is an opportunity for us with our distribution model and the distribution centers we have, the ability to go to low unit of measure, to be able to support that.

The other context that we want to try to do is many of the products that we sell are used in other markets. And as products become more commoditized in what we distribute, we will continue to look at other areas outside of the hospital to either be able to use MediChoice products, focus or emphasis products in what we traditionally would not sell our products in. So that is a key area for us that we are looking at also.

Robert Willoughby, Banc of America Securities.

Actually it is Matt Jackson for Bob. Actually all of my acquisition questions have been addressed, so I will leave it at that. Thanks.

Larry Marsh, Lehman Brothers.

Craig, Dick and Jeff, good morning. If you guys can predict Lisa's questions, my are going to be a lay-up. I don't even have to ask them, right?

We have got three of them that we know you are going to ask.

All right. Let's see, shall we start with Dick?

Sure.

What do you think, revenues? Can you talk about diabetes revenues and then maybe elaborate a little bit on the comment about the seasonal operating loss that just has to do with January and February being weaker months as you expected? Should we expect to see the operating profit ramp-up for the rest of the year, is that the message?

Yes, you know, I think when you look at going through the operating profit situation, when you look at it on a cumulative basis, Access has been very accretive. It is a very, as we all know, a very high-growth market.

In our 10-K filing at the end of the year, we showed that we had 5.9 million in operating earnings. So, for the first quarter, we did show a small operating loss of 300,000. But we need to keep in mind that Access is a young high-growth company, and we are building the infrastructure to support that business growth as we go forward.

I think it is important to point out that when you look at the operating loss it includes 2.5 million in non-cash D&A. So the fact that, as Craig pointed out, the customer base has doubled, etc., we're seeing a lot of positive signs.

What is really encouraging is that we saw the month of March was very strong, one of the strongest months we have had so far. I think Craig stated very well with the customers having the use it or lose it on their deductibles they wanted to get their orders in December, and that was our best month thus far. So it all seems to make a lot of sense. We have been looking around the industry at some of the other companies, and it does look like this is a normal type of event. So we are learning how to plan for these things as we go forward and we will do that.

Craig also mentioned that we made some changes in our sales process which were very productive for us and that again was reflected in the numbers in March. So we see a lot of positive things as we go forward.

To Lisa's point strategically, we feel like this acquisition has been a real success for us, and we are learning to create a platform for the future. We are working very hard to find a nice acquisition to add to the platform as we go forward. We have had discussions with a number of companies, and we will continue to do that. It is a real focus for us. We think there is a huge amount of value to be derived by expanding that platform into the other disease states, and that is one of our high strategic goals as we go forward.

Larry, we were not going to use this as an excuse, but I think there is some gut feeling that perhaps -- and this goes back aways -- that perhaps we may have lost some sales through the hurricane and that we are making up for that. But primarily really it was around a very heavy December, and then it picked right up in March, and through the first two weeks of April, we are clipping right along. So we are feeling very comfortable with their progress, and we think it is going to just continue to grow.

There is only one other issue that may have had some impact. There has been a lot written about the confusion surrounding Part D, and some people surmise that because of that confusion the seniors may have assumed that it was going to be under Part D, which it is not, and that may have impacted to some small degree.

Okay. Do you have a revenue number for the business in the first quarter?

Yes, sir. We knew that was going to be one. That was 17.8.

Okay and rough estimate of customers?

124,000.

Okay. Got it. Thank you. The second question, I just want to confirm, Jeff, you are saying that the refinancing is now incorporated in your 175 to 180?

Yes, it is Larry, and that is excluding the $11.5 million charge that you will see in the second quarter.

Yes, Larry. We are a little conservative here, but I think that plays well for us. But we have just gone through the FAS 123. We have just moved into the new home office. We moved pretty quickly on the (indiscernible) because we felt it would be favorable for us. At the end of last year, we were not exactly sure what we were going to do.

So we would kind of like to have a little breather. You have followed us a long time. The range on EPS was usually $0.03 spread, and we went to $0.05 this year kind of figuring that we had a lot of moving parts early in the year. And we are going to continue to look at that. But for right now we are going to take the conservative posture and stay where we are and then just keep a close watch on that.

I see, okay. I understand. So the message is it is a little early to perhaps readjust guidance with the refinancing given it just took place?

Yes.

Okay. And I just want to clarify I think a point, Eric. So the moving expenses are roughly 900,000, so that is a little less than what you thought it might be when you talked about it back in February?

That is correct.

Okay. And then finally, on the gross margin side, is it fair to say if we back out direct to consumer, it was down slightly year-over-year? Is that the case, and did you get hurt by inbound freight costs in the first quarter?

We really don't provide that. There will be additional disclosures that we think are appropriate related to Access in the 10-Q, but we're not to the point of segmenting it yet. Quite frankly, we're looking at the company as a whole, and we are quite pleased with where the margins are heading.

Well and again I'm pleased where the core is for the first quarter. I mean you don't hear us talking a lot about making up backside money as we have in the last few quarters. So we feel we have turned the corner around on that.

On inbound transportation, Larry, we have made some adjustments over the first quarter and the end of last year. We will continue to look at fuel and fuel costs and when appropriate take that up with our customers.

Okay. And then finally, Craig, I think I got brain freeze, which is not unusual, but you said three customers or some delay in the first quarter. You will see them coming on in Q2. You mentioned one government customer. I know in the past you mentioned Premier and CHI coming on. Were those the other two customers you mentioned or somebody else?

Those are pretty well built out. I think there are still some opportunities with them. These were -- the government customer was actually a state customer that will probably come on later in the year just because a lot of those agreements now have to go before a state legislature to be approved.

The other two I'm trying to remember. One is a Premier customer, and I believe the other one is a Novation customer. But one started April 1, one will start May 1, and then the other one will probably be in the third quarter. But we have a lot of other new business other than that coming on across the board. So we feel the pipeline is really moving along right now.

Okay. I will stop there, and I will look forward to seeing the new facility here. It is very nice.

We would love to have you. It has been great.

(OPERATOR INSTRUCTIONS). At this time, there are no further questions. I would like to turn the conference back to Mr. Craig Smith, President and CEO, for closing remarks.

Alright. Well, thank you for joining us, everyone. We would love to have you come to the new home office. We're thrilled to be here. We're thrilled to have everybody in one building, and we look forward to seeing you all over the year. Thank you for calling in.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.