Owens & Minor Inc (OMI) 2006 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Owens & Minor fourth quarter 2006 year=end earnings conference call. My name is Carrisa, and I will be your coordinator today. [OPERATOR INSTRUCTIONS]

I would 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. Welcome to the Owens & Minor fourth quarter 2006 conference call. We'll 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, Charlie Colpo, our Senior Vice President, operations and technology, Dick Bozard, our Vice President and treasurer, Olwen Cape, our Vice President and controller, and Grace den Hartog, our Senior Vice President and general counsel. Before we begin, I'd ask Trudi Allcott, our communications director, to read a Safe Harbor Statement. Trudi?

Thank you, Craig. Except for any hysterical information, material discussed today may constitute forward-looking statements that involve risks 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 personal; intense competitor 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 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 call today, and also the call will be archived on our website for the next three weeks.

Thank you. Craig?

Thanks, Trudi. Jeff is going to give us a look at the numbers. I'll make a few comments on 2006 and what's ahead for 2007 before we take your questions. Jeff?

Thank you. Good morning, everyone. Before we begin, one housekeeping item. I'd like to point out that we have added a brief supplemental presentation to our website that you might want to refer to. You can find these slides at owens-minor.com. Now turning to our results, 2006 was a very busy year for us, and looking back on what we accomplished we're confident that we've positioned our Company very well for years to come. Refinancing our $200 million in bonds and completing the McKesson acquisition were major milestones for Owens & Minor. We also re-signed a great deal of business with our new Novation and Broadlane agreements. But we also faced a few challenges as we worked to put our direct-to-consumer business on firmer footing. Our fourth quarter does reflect the unexpected items we reported last week, plus the effect of the McKesson acquisition and transition, so let's start with the fourth quarter results.

Revenues for the quarter were very strong at $1.7 billion, up 35.9%. This includes approximately $282 million of revenue associated with the McKesson acquisition. But what's even more impressive is that, if we exclude the McKesson contribution, revenue grew at 12.7% and that's on the heels of the 9.8% growth last quarter, which we mentioned was our highest quarterly growth rate in five years. Congratulations to our sales team who further enhanced our leadership position by finishing off a strong year with a great fourth quarter.

Now taking a look at net income and diluted earnings per share. Remember as we announced last week, these fourth quarter results were negatively affected by a couple of items. First, we increased our allowance for doubtful accounts by $4.7 million and recorded about $500,000 in other adjustments in our direct-to-consumer business. This had a negative impact of $0.08 per share. And secondly, the impact of delusion from the McKesson transition was approximately $15 million or $0.22 per share. These two items together had about a $0.30 impact on earnings per share this quarter. Reported net income for the quarter was $7.3 million compared to $15.7 million in last year's fourth quarter. Consequently, diluted earnings per share for the quarter was $0.18 compared with $0.39 last year. Our gross margin for the quarter was 10.6% of revenues, down from 10.8% last year. SG&A was 9.1% of revenues. And this, of course, is affected by the unexpected direct-to-consumer items in the McKesson transition expenses. Excluding these items core business SG&A was favorable compared to last year.

Now turning to total year results, revenues for the year grew 14.8% to $5.5 billion including contributions from McKesson in the fourth quarter. Excluding the McKesson contribution yearly revenue grew at a pace of 8.9%. This strong organic revenue growth came from healthy dose of penetration with existing customers as well as new customers. Reported net income for the year was $48.8 million, while diluted earnings per share for the year was $1.20. These results were effected by three significant items, two of which were done for very positive reasons. First, delusion of approximately $16 million at $0.24 per share associated with the transition of the McKesson business. Second, our bond refinancing, which resulted in a charge of $11.4 million or $0.17 for the early retirement of debt. And finally pre-tax charges of $9.3 million to increase our allowance for doubtful accounts in our direct-to-consumer business, as well as $500,000 of other adjustments, for a total impact of $0.15 per share. Our gross margin for the year was 10.8%, improved slightly from last year, while SG&A was 8.5%. SG&A, of course, includes the impact of the McKesson transition and the DTC adjustments. Core business SG&A percent was improved from last year excluding those items.

Turning to asset management, inventory turns were 9.2 for the fourth quarter and DSO was 30.5 days at the end of the fourth quarter. Both measurements were less efficient than our normal asset management performance, but were temporarily affected by the McKesson conversion. As we mentioned last quarter, we historically use cash in the fourth quarter and we expected to use more cash this year due to the McKesson transition. We did have negative operating cash flow of approximately $105 million in the fourth quarter, and $74 million for the year. This is largely due to the fourth quarter buildup in inventory to ensure high fill rates for transitioning customers, as well as growth in the receivables associated with the new business. On top of that, the strong organic revenue growth of more than 12% contributed to the use of cash. As we are using more working capital than normal to fund the transition, as well as the fund the high levels of organic growth in our core business, we have increased our revolver by $100 million, providing us additional borrowing capacity. Of course we do expect to generate cash after the transition is complete.

Turning to our guidance for 2007, the Company anticipates it will report revenue growth in the 15% to 20% range and diluted earnings per share in a range of $1.85 to $1.95, including the impact of the acquired McKesson business. Due to the timing of the McKesson acquisition, revenue growth will be stronger in the first three quarters of 2007, while earnings growth will accelerate in the second half of the year. The dilutive effect of the McKesson transition in the first quarter of 2007 is expected to be between $9 million and $12 million. I'd also like to point out that we will have one additional sales day in 2007 in the fourth quarter compared to 2006, while other quarters have the num -- same number of sales days.

So in summary, we had quite a busy year, one that I think sets the stage for years to come. Top-line growth, with and without McKesson, was very strong. The McKesson acquisition and new agreements with Broadlane and Novation have secured a great deal of business and established us as the clear leader in the acute care distribution market. We refinanced our bonds at a more favorable rate and achieved another investment grade credit rating. We had a few unusual items, but we have a solid outlook for 2007 and expect to begin realizing the benefits of the McKesson acquisition after the transition is completed.

Thank you. Now I'll turn it back to Craig.

Thank you, Jeff. As you just heard, this really indeed was a very busy year for us. Our organic revenue grew at a very good pace. thanks to our strong and great relationships with our customers and the hard work of our teams in the field. We made a significant acquisition that will benefit Owens & Minor for years to come, and really brings us some great new customers, markets and teammates. And we did weather a few storms in our direct-to-consumer business. Since we had a conference call last week, I'll just touch on 2006 and then talk a little bit about the progress of the transition business of the McKesson business and the impact that that acquisition will have on 2002. And in reflection of 2006, we really did accomplish a lot. We moved our home office teammates into a new building, putting them all under one roof. We took advantage of favorable market conditions and refinanced our $200 million in bonds. Our teams in the field worked with our customers to produce very strong revenue growth. In fact, fourth quarter's double-digit growth marks the first time in five years we have crossed that threshold. And in 2006, we renewed agreements with Novation and Broadlane, both for five years, and this represents more than half of our business. We negotiated a long-term contract with our IT out-sourcing partner, Perot Systems, which has played a significant role in transitioning the McKesson business. They've been right there with us every step of the way. And we've taken steps to put our direct-to-consumer business really on a firmer footing by putting in financial and operational expertise, and by focusing on the daily blocking and tackling that distinguishes Owens & Minor. And of course, finally, we acquired the McKesson acute care business, which is expected to add in excess of $900 million in revenue. All in all, we are in a strong position for the years ahead.

Now let me talk a little bit about the short term. We were focused on completing the transition of the McKesson business. To date we were on target for the conversion and actually a little bit ahead of target. We have transitioned 50% of the business, and to date we have closed three of the acquired distribution centers. There was questions on the call last week and I promised you that I would give you that number this week. At the end the day we expect to retain four of the acquired distribution centers, and we have opened a new facility in Chicago to service our new customers and existing customers in Chicago. We are very pleased with the conversions to date, and we are on track to finish this three weeks early.

Looking at 2007, we intend to introduce our new customers to our value-added programs and services, such as MediChoice®, PANDAC®, SurgiTrack, CostTrack, and I happen to know for a fact we have several PANDAC® surveys lined up and some SurgiTrack surveys. So even with only half the business converted over, we already have our new sales force out selling programs and services to our new customers. We have a big opportunity with the new McKesson business and we plan to make the most of it. Once the conversion's over, we will concentrate on completing any necessary cleanup and we'll get to work to serving these new customers. Daily blocking and tackling makes a difference in distribution and that's what we do best. Looking ahead, we intend to build on our solid platform to grow our core business, pursue or follow the patient strategy and capitalize on the excitement that is all of us feel at Owens & Minor about our future.

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

[OPERATOR INSTRUCTIONS] And your first question comes from the line of Steven Postal of Lehman Brothers. Please proceed.

Thanks a lot and good morning.

Hi, Steven.

Jeff and Craig, can you talk about -- obviously with the strong revenue growth, especially in the second half of '06, it looks to me like your guidance for '07 is implying pretty meaningful deceleration in organic sales growth. Can you just clarify that and elaborate why that may or may not be the case?

Let me take that, Steven. First of all, as we have talked, if you look at the McKesson business in the fourth quarter, it's about $280 million, and really we're only half way through the conversion, and we have been very fortunate to date that we have not lost any customers due to the conversion. Now we have a small number of McKesson customers who have not chosen to come with us. Also we are in the middle of our conversion. And again, it's gone very well, but we still have half the business to move over, and so we are being optimistically cautious about that. And third of all, we are really continuing -- as you know asset management is one of our strongest -- strongest things that we do. It's the core of our Company, and we are really reviewing the credit strength of the McKesson customers, and some of those potentially may not come over. So, although that number was pretty high on the McKesson piece, there is probably some potential that that number would be a little bit lower once we converted the business.

Okay. Craig, can you maybe talk about what drove the top line in 4Q?. I know you've mentioned on the DOD piece of business and increased penetration, but maybe could you elaborate there?

Sure, let me break it out there for you. About 8% was on sales penetration and what we're seeing is, as we talked over the last year to 18 months we have been focused on the direct manufacturer that ship traditionally direct to our hospital customers. We are continuing to see growth in what we call our non-traditional categories. And then we had about 4% new business that I talked about that was -- that started a little bit late in 2006. We had anticipated first or second quarter of 2006 that business coming on and it really fully ramped up in the fourth quarter, so about 4% of that is new business.

Okay. And then want to -- LIFO, it looked to me that there was a change in LIFO, perhaps a LIFO credit, could you maybe provide context for why that would be the case?

Steve, this is Olwen. LIFO is -- last year was unusually high and it was really driven by higher price increases on the inventory that we had on hand. Where we are this year is probably a little bit more normal, if you go back to look it for the last three or four years.

Did you have deflation -- price deflation in the quarter?

No, it's pretty much -- LIFO is a calculation you can really only do completely at year end. The quarterly calculation's estimated. So we're are seeing relatively little inflation this year as a whole, and at the end of the year it was just simply a true-up.

Okay, fair enough. And then just one final question for me. In terms of cash flow, can you maybe provide a little bit of help in how cash flow was trending throughout the year? You mentioned that when the transition is complete I think you said that you'd expect to generate cash flow, but do you still anticipate to be cash user in maybe the first quarter or first half of the year?

Well, Steven, we don't provide guidance on cash flow, neither for the year or for the quarter. I did -- it is true that I mentioned that -- that after the transition is complete, we expect the contribution from the McKesson transition to be positive from a cash flow perspective. Obviously, the build-up in inventories and receivables associated with McKesson had contributed to the cash usage in the fourth quarter, and normally we use cash in our core business regardless of that. We still will be transitioning through the first quarter, and I'd expect to see the effects of that on our cash flow. But following that, as the business is normalized and we enter the second quarter and then particularly the second half of the year, you should see similar characteristics that you've seen with our core business in the past.

So, Jeff, is it fair to think about in terms of the guidance for the delusion in earnings that that should be the same for cash flows of -- as you transition it'll be somewhat dilutive to cash flow, and then when the transition is complete then you see a more normalized cash flow trend?

I think that's a very reasonable assumption, and, of course, the cash usage and the higher debt levels associated with that, and the interest expense, contributed to the delusion that we've seen thus far in the fourth quarter and expect to see in the first quarter.

Okay. Thanks a lot, guys.

Thank you.

Your next question comes from the line of Glen Santangelo of Credit Suisse. Please proceed.

Yes, thanks. Craig, could you just talk a little bit more about the facility closures? It sounds like you have five more facilities you're looking to close. Could you kind of maybe give us a time frame around that? And then maybe if you could talk about the three that you already did close, could you give us a rough idea on how much annual expense you'll be saving as a result of those closures?

[LAUGHTER] Good question, Glen. It is in the guidance, and --

Five is in the guidance?

The closures are in the guidance for 2007 and the headcount reduction in 2007. So what we will do is, the majority of the centers will be closed by March, and there will be a little bit of carry over with one operating unit that had a lot of specialized distribution in it that might take us a couple of extra months to move that over to one center. Everything will be pretty much done by the end of the first quarter, and we will have a little carry over with one unit that we just need to make sure that we take care of that cus -- well, there's two customers in that building that, as you know, we still do a lot of stockless, we do a lot of outsourcing. And these are two pretty big customers we want to make sure that we take care of in the transition.

Okay, and then just one other follow up here in gross margins. You stated in the press release that it was -- the gross margins were slightly impacted by the transition of the large volume. Could you talk about how quickly we'd expect those gross margins to normalize once we get past the transition and give us a sense for how much it impacted the quarter or is that --?

Glen, Charlie Colpo. You know, in any of these transitions where you're converting large amounts of business you have a syncing up and a cleaning process of the price files and matching the prices. We feel very, very comfortable that this book of business is going to be comparable to ours. In fact, Craig mentioned already selling -- or having surveys on PANDAC® and SurgiTrack, We have nine PANDAC® surg -- excuse me -- nine PANDAC® surveys scheduled, and that's just on the half of business that we've transitioned already. In general terms, it'll clean up. We are going through the clean-up process [staffs] and that's built into our guidance.

Okay. Thanks for the comments.

Thank you, Glen.

Your next question comes from the line of Lisa Gil of JPMorgan. Please proceed.

Hi, thanks. It's Atif Rahim in for Lisa. I just want to elaborate on the margin question, if possible, and you touched on this briefly last week. When -- if I recall correctly, you said you expect margins to be in line with -- somewhat where your overall margins are, be it close to acquisition -- close to closure of the acquisition. So is it fair to assume that post-1Q we're not going to see a major progression in EBIT margins if you -- and say gross margins are going to be fairly in line with the rest of the business and SG&A is just exactly in line, too, or do you expect some progression there?

Atif, as Charlie mentioned, again we feel ultimately this book of business is very, very, very comparable. It takes a little bit of time to get there. What we had indicated in the last call was we will complete the transition process in the first quarter. There'll be some remaining clean-up that probably occurs in all avenues in terms of the SG&A, of the margin, and so forth in the second quarter. And where we really see the acceleration is in the second half of the year, and that's why we provided that input in the guidance section.

[Could you perhaps in the terms of basis points acceleration and margins --?]

[LAUGHTER] No, we can't get down to that --

Okay.

-- level of detail.

All right.

You know, Atif, I think what we are very comfortable in saying is that next year our margins will normalize to where they ordinarily are on the Owens &Minor platform. There was also a little bit of degradation in the access margin in the fourth quarter, but we are very comfortable that margins will retur -- normalize in 2007.

Okay, that's great. Thank you.

Thank you.

And there are no further questions. I would like to turn the call back over to Mr. Craig Smith, President and CEO, for closing remarks.

Well, thank you again for listening. Again, 2006 was a very busy year for us. We were able to get a lot accomplished. We are halfway through our McKesson conversion. We are well on our way on the access business of cleaning that up and moving forward with our follow the patient strategy. And we really feel that we have positioned the Company that over the next several years we will be very successful in our accomplishment and actually implementing our strategy. I do want to thank all of our teammates. This year with McKesson and everything that we have done would not be possible without the people that work for our Company every day to serve our customers throughout the country. Thank you, and have a good day.

Thank you for your participation in today's conference. This concludes the call and you may now disconnect. Good day.