Owens & Minor Inc (OMI) 2010 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Owens & Minor's first quarter 2010 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.

Thank you, Brandy. Good morning, everyone. Welcome to the Owens & Minor first quarter 2010 conference call. We'll review our results and take your questions in a moment; but first let me introduce my colleagues on the call today: Jim Bierman our Chief Financial Officer, Charlie Colpo our Chief Operating Officer, Grace den Hartog our General Counsel, and Drew Edwards, Vice President Finance, who is the newest member of our team. Now, before we begin, Trudi Allcott our Director of Investor and Media Relations will read a statement. Trudi?

Thank you, Craig. Our comments today will be focused on the Company results for the 2010 first quarter which are included in our press release. The press release as well as the related presentation can be found on our website. When looking at our results, please keep in mind that we completed the sale of certain assets of our direct to consumer diabetes business in January of 2009. Thus it is shown as discontinued operations in our consolidated financial statements. Consequently our discussion today will focus on continuing operations. Also, in comparing to a year ago, note that we had just completed the acquisition of the Burrows Company, and during the 2009 first quarter, we were engaged in the transition of that business.

During the course of our call today, we may make forward-looking statements. These statements are subject to risks and uncertainties, that could cause actual results to differ materially from those projected. Please see our press release and our SEC filings for a full discussion of these factors. Finally, we're participating in a number of investor conferences during the second quarter. Please refer to our press release for details. We look forward to seeing you own the road in the coming week. Finally, a webcast of today's conference call will be archived on our website. Thank you. Craig?

Thank you, Trudi. Let me call on Jim to brief us on financial results. Jim?

Thank you, Craig. Good morning, everyone. When comparing the first quarter of 2010 to the prior year, we're pleased with our success in a number of areas, including earnings growth, disciplined expense control and excellent asset management. We believe that our first quarter revenue results reflect the lagging impact of the economic downturn on our hospital customers. On our call today, I will present an overview of the first quarter 2010 results, and then Craig will comment on our business, our strategic progress and the overall market. First quarter 2010 revenues were $1.97 billion. An increased $21 million or 1.1% when compared to first quarter of 2009. We experienced a $57 million increase in sales of products and services to existing customers, a growth rate of 3.2% over the first quarter of 2009. We increased, by $51 million, sales to new customers, which was offset by an $88 million decrease in sales to loss customers. We believe that revenue growth was adversely impacted by unfavorable economic conditions and the related impact on our hospital customers utilization trends.

Gross margin for the first quarter 2010 was $190 million, an increase of approximately $7 million when compared to the first quarter of the prior year. As a percentage of revenues, gross margin in the first quarter of 2010 was 9.67%, improved 25 basis points over the prior year. When comparing this year's results to last year's, keep in mind that last year's gross margin was negatively affected by 23 basis points related to the deferral of revenue for customer contracts with performance targets. In addition, last year's gross margin was 18 basis points lower than this years as a result of supplier price increases a portion of which were not eligible for supplier rebates and the resulting impact on the LIFO provision.

Turning to our discussion of expenses, for the first quarter 2010, SG&A expenses were $135 million, decreased $4 million or 3% when compared to the first quarter of 2009. As a percentage of revenues, first quarter SG&A expense decreased 29 basis points to 6.86% when compared to the same period last year. The decrease was attributable to lower expenses, for information technology outsourcing as a result of our mainframe migration project as well as lesser labor and freight costs.

The first quarter of 2009 included transition-related expenses from the Burrows acquisition. Offsetting factors in the 2010 first quarter included increases in consulting expenses and costs related to bringing online the OM health care logistics operations. Operating earnings in the first quarter of 2010 were $49 million, increased $9 million or 23% compared to a year ago. As a percentage of revenues, operating earnings were 2.50% a 45 basis point increase when compared to the first quarter of 2009. The increase resulted primarily from improved gross margin and a reduction in SG&A expenses. Interest expense, a component of net income, but not of operating earnings was approximately $3 million, unchanged when compared to the prior-year quarter.

For the first quarter this year, our affected interest rate was 6.7% on average borrowings of $200 million compared to 6% on average borrowings of $228 million for the same period last year. For the first quarter, our effective income tax rate was 39.3% compared to 38.8% a year ago. The lower effective rate in the first quarter of 2009 was due to the settlement of potential tax liabilities. Overall this year, we are targeting our tax rate for 2010 to be approximately 39%, consistent with previous guidance. Income from continuing operations for the first quarter 2010, improved by more than $5 million to $28 million when compared to prior year's first quarter. The increase in the quarterly result is primarily due to a $9 million increase in operating earnings partially offset by an increase in the income tax expense of $4 million. On a per-share basis, adjusted for our recent 3 for 2 stock split, quarterly income from continuing operations was $0.44 per diluted share compared to $0.36 per share for last year's third quarter.

As for continued operations, there was no impact on first quarter 2010 results. A year ago we recorded a loss from discontinued operations net of tax in excess of $8 million in the first quarter or $0.14 per diluted share. You'll recall the loss resulted from charges associated with exiting the direct to consumer business. As a consequence net income per diluted share was $0.44 compared to $0.22 per share last year. As for asset liability management for the first quarter, we reported cash flow from continuing operations of $140 million, compared to $83 million for the first 3 months last year. Contributions to cash flow for the quarter included increased operating earnings, decreases in accounts receivable and lower inventories when compared to the first quarter last year.

During this year's first quarter, we contributed $5 million to our pension plan, in conjunction with our Board-approved termination of that plan. We expect to make additional contributions of approximately $3 million to $8 million through final termination, which is targeted to be in late 2010 or early 2011. For the first quarter, inventory turns were 10.6 compared to turns of 10.3 a year ago. Over the course of the past year as we complete integrations of new and acquired business, our inventory levels have normalized, and, therefore, inventory turns have improved. We were pleased with our DSO result, which was very low at 20.5 days at March 31, an improvement when compared to 21.4 at year end and 23.6 days at the same time last year. For the quarter, cash used for capital expenditures was approximately $8 million primarily related to investments in our strategic and operational efficiency initiatives including our OM health care logistics initiative. Cash dividends paid were $11 million during the quarter.

Our long term debt as of the end of the quarter was approximately $200 million in senior notes. Our total available borrowing capacity under our revolving credit facility as of the end of the quarter is approximately $295 million. We are in the process of refinancing our revolver and are targeting to complete the project this year. Cash and cash equivalents increased by $50 million to $146 million at March 31, 2010.

Turning to our outlook for the year ahead, our guidance for 2010 remains unchanged. In recognition of the recent stock split, we have adjust our EPS guidance range to $1.93 to $2.03 per diluted share. As we have said before, one quarter does not a year make. So with solid EPS results, improved operating earnings and a strong as it management, we are looking forward to the rest of the year.

Now I will turn it over to Craig for his remarks.

Thank you, Jim, and now that Jim has briefed us on the financial results, I wanted to take a couple of minutes and say a few words about the quarter, the Company and the current operating environment.

Now, in looking at the quarter, we demonstrated strength in key operational areas. Our team did a very good job in controlling expenses during the quarter, showing improvement over a year ago. This helped us to improve our operating margins, which was a very important objective for us this year. We turned in another quarter of solid asset management and cash from operations. In addition, our Board expressed confidence in Owens & Minor during the quarter with a 15% increase in the dividend and a 3 for 2 stock split. However, our revenue results were not where we expected them to be even though we had anticipated somewhat of a soft start to the year. We believe our results reflect the lagging impact of the economic downturn and weaker utilization of health care services.

Now, as you all know I'm often on the road talking with customers and many of them have recently confirmed these trends for us. They're telling us they experienced lower than expected utilization of health care services in the first quarter. Recently published Wall Street surveys and tracking studies as well as some recent first quarter earnings reports also validate what we are hearing from our customers. These reports do point to lower utilization rates so far this year citing the negative impact of persistently high unemployment and extreme winter weather in certain parts of the country. Looking ahead, we believe there is an opportunity for new business growth this year. We have signed accounts in the pipeline and we are in discussions with other potential customers. Of course, once we sign a new account, the staging and timing of that transition is up to the customer. Once underway, the pace and success of the integration is up to Owens & Minor. And as you know, we are highly skilled at effective and efficient business integrations and we have proven we can handle multiple transitions at the same time.

We continue to work with the nation's best hospitals. Of the top 100 hospitals as recently identified by Thompson Reuters we serve more than half. We continue to believe that we offer the right mix of expertise, service and innovation to our customers. Already this year, we have been honored with distributor of the year awards from the Global Health Care Exchange and the University Health System Consortium. In both cases, we were recognized for providing responsive customer service and operational excellence to our customers. As we have learned from long experience, the high quality service and supply chain management solutions we provide will enable us to grow our business with existing customers and attract new customers. At the same time, we remain focused on developing new markets and opportunities for Owens & Minor.

During the quarter, we continued to pursue our strategic initiatives, including further investment in our new OM health care logistics offering, which is providing third-party logistics services to health care suppliers. In fact, next week, our health care logistics team is hosting an open house for perspective supplier customers at our Louisville facility. With initial customers up and running, we are pleased with the progress the team is making. Based on the feedback we are getting from potential customers, we believe there is strong demand for these third-party logistic services in the health care marketplace. We are also making progress with our ambulatory surgery center effort and now have a sales team in place. We are steadily moving forward with this offering to these non-acute care customers.

Since the beginning of the year we have also announced several transitions. Our very own Charlie Colpo was named Chief Operating Officer. Charlie has put his team in place and has already visited a number of our distribution centers and is placing a very high emphasis on meeting with customers and suppliers across the country. We're also saying farewell to our Controller Olwen Cape who is retiring this week. I thank Olwen for her many contributions to Owens & Minor over the last 13 years. We will truly miss her. The new head of our accounting team Drew Edwards is already on board and leading the effort. We welcome Drew and his expertise to Owens & Minor. As we look ahead to the rest of the year, we know we have work to do on growing our revenues. However, we also know that quality customer service, operational excellence, our dedicated teammates, and 128 year legacy in health care makes us a strong presence in the marketplace. Thank you. Now we will be happy to take your questions. Operator?

(Operator Instructions) Your first question comes from Richard Close with Jefferies & Company.

Yes. Thank you. Congratulations. With respect to the revenue, if we can hit upon that. I think you guys mentioned $88 million, I believe, was the number, due to lost customers. If we can have any additional details around that number and what happened there? And then if you could talk about March and April, we've been hearing in the marketplace that maybe March and April showed some improvement from January and February, and any trends, recent trends.

Richard, this is Jim Bierman. Let me address the first part of your question on maybe how to think about the net gains and losses of new business, lost business in the quarter. We would characterize the activity that we're seeing for the quarter as normalized churn that we would see over a period of time with new business and business that leaves the Company for various reasons, not the least of which is oftentimes we make decisions on where we are looking to invest in a customer relationship, and on occasion, the profitability of those customers doesn't meet our threshold requirement and the potential for increasing that isn't deemed to be significant enough that we can justify a reduced profit margin. The way we would characterize the results is really a net loss of somewhere around $30 million, the $88 less the $50 million some odd of new business. That amount, the net 37 is kind a normalized level. We would point you to the same store sales growth as being the critical issue of the quarter, and I think it does reflect lower health care utilization trends and a lack of price inflation that indicated same store sales growth was less than had been originally targeted, and I'll defer to Craig on what he's seeing in the marketplace today.

I would say, Richard, most of my travelers were through January through March, and I've seen a couple of customers last week. Primarily -- and the published reports pretty well have documented this for the for profit hospitals, and what we saw was a pretty bad January and February. So based on reports that March were better, I think that's somewhat relative to how bad January and February were. I can't really speak on April, because I just had a couple of customers last week. But I would say very much validated, January and February almost were worse, probably in some instances than last year, and March, again, from a relative standpoint was a little bit better than January and February. So I would pretty much say that the quarter overall was either pretty flat or down from what I saw anecdotally or from the published reports.

Just as a quick follow-up, I believe you guys mentioned on the fourth quarter call the decision to walk away from some of the clients, certain clients or accounts that were not necessarily efficient for you guys. You didn't quote a number necessarily. Is this $88 million essentially in line with what happened in the fourth quarter as well?

Well, we never parse out the numbers exactly, but clearly some of that $80 million plus was due to either price or profitability. We pretty well -- that was somewhat baked in the numbers for 2010. So, it was -- it was planned. We thought maybe the quarter would be a little soft anyway in the first quarter. What really probably hurt us more was the utilization trends and inflation. We try to be as transparent as possible, but I think we'd rather talk to the bigger number, and a lot of that was planned versus breaking it out.

Okay. Thank you. That's very helpful.

Okay.

Thank you, Rich.

Your next question comes from Glenn Santangelo with Credit Suisse.

Morning, Glen.

Glen, your line is open.

Hey, can you hear me?

Yes, I hear you now, Glen.

Yes, I apologize. Just to follow up on that revenue question, given that you only posted 1% this quarter, what gives you the confidence to reiterate that 4% to 6% goal, because now you have to do better than 6% for the remaining three quarters. And based on your comments, you haven't necessarily seen a huge pickup post-January, February.

Glen, this is Charlie Colpo. There is an expectation that the utilization will continue to pick up through the year. But on top of that, too, I spent all day yesterday with our field management team. There is a good pipeline of customers that we have signed that we're looking to bring on the end of June, first part of July, and then a host of customers, too, that aren't in the signed phase yet but in that very close to being signed. There's a sense of optimism around our ability to get those signed, again, that would impact us more in the second half of the year.

Then I had one quick follow-up for Jim. Jim, I wanted to talk to you about gross margins. You posted 9.67 this quarter which is right in the guidance that you laid out of 9.6 to 9.75. Each quarter feels like we have got LIFO charges or credits, and we had a couple of things last year that are kind of moving that number around. How did your margins look year over year relative to first quarter last year. Then could you give us a sense of what we can expect on a LIFO provision for the remainder of the year and what kind of moves that gross margin to the higher end of your range or to the lower end of your range?

Yes. Just to refresh everybody's memory that may have come in on -- later on the call, the gross margin we reported was at 9.67%, and the provision for LIFO came in around $8.3 million. I would point to our investor day in December when we spoke to the target amounts that we were anticipating at that particular point in time for both inflation and the component impact on LIFO. At that point, we guided people thinking to more of a normalized environment, which we would say was 2007 maybe 2006. At least LIFO as a percentage of sales activities; and what we've seen in this quarter and the early trends for the year would indicate that that is playing out. I would say that the first quarter LIFO results for this year is much more normalized than we saw last year, and we would expect, therefore, absent anything unusual coming to light that we're not aware of, we would expect a similar pattern that you would see going back to 2008, 2007, which would be more than likely a relatively small adjustment in LIFO for the next couple of quarters. And then what we've seen historically is manufacturers have price adjustments in the fourth quarter, and there could be again another potential charge in the fourth quarter. So we came in within the range that we were targeting and generally within our anticipated results.

Okay. Thanks for the details.

Your next question comes from Lisa Gill with JPMorgan.

Thanks. It's Atif Rahim for Lisa. One question on the revenue line. Is there any way you guys could break out what you're expecting the pick up in utilization to go back to in terms of same store sales growth and offer the contribution from the (inaudible) effort? And then secondly, on the SG&A line it looks like there were a number of one time items that may have skewed it. So any chance you could give us a good idea of what the run rate would be if you back out the pension contribution, the IT outsourcing that may go in next quarter. That's likely to stay, but what the run rate would have been ex those items?

Let me address, if I could, first off the question on same store sales growth and sort of put it within context. So for the quarter, as we calculate same store sales and growth, saw a utilization increase of around 3.2%, and that's with little to no inflation component, we estimate at this particular point in time. If you look and take that number within a historical context -- and let's say the last several years as being a reasonable proxy for historical context, we would say that number came in 200, maybe 250 basis points below what the historical level would have been. So quite candidly, the lower health care utilization trends, the lack of price inflation, I mean, that's negatively impacting that 250 basis point delta that we experienced in the first quarter. And again, as you'll recognize and acknowledge, that component is fundamentally out of our control.

Moving on to your second question on SG&A and sort of a normalized rate, in a normal situation, the first quarter SG&A tends to come in at a higher level than at least second and third quarters because of the various payroll related taxes and other beginning of the year expenses that we've encountered. When we saw less utilization, there was obviously some activity and efforts around reducing our spend rate, and we were able to accomplish the performance that we put forth. To a large degree, I think aspects of that are certainly sustainable as we look forward. I would point though to the fact that when we talked talked in terms of guidance for the year, we talked in terms of 6.90% to 7.05%, and that seems a reasonable target at this particular point in time. The final point I'd make is that the OM health care logistics business is ramping up and will continue continue to incur additional expenses as it does so until it reaches a breakeven status, which we're targeting that they have the revenue to break even towards the end of this particular year.

That's great. That's very helpful. One final question on the competitive environment. Are you seeing any changes there? Any color you can give on the type of hospitals you lost and the type of competitors you lost in the end chain in that environment.

I would say it's just very consistent. You can't really draw any real conclusions that any one person is doing anything different. It's a competitive market out there but also is pretty consistent.

Your next question comes from Steven Valiquette with UBS.

Hi. Thanks. First question here, I guess you mentioned the $8 million LIFO charge was in line with expectations, which I agree with, but you also mentioned a couple of times now that there was a lack of price inflation that hurt the 1-Q results, which certainly seemed to correlate with he common on LIFO provision. So I'm just trying to reconcile those two comments.

Sure. I'll take that. As prices increase to us they may not necessarily increase to the customers, because that's governed by more group purchasing organization, so increasing and pricing to our inventories does not necessarily translate to increased prices to our customers. Those are generally fixed and contracted for a period of time.

Okay. Got it. Thanks.

Your next question comes from Caroline LeCates with Thomas Weisel Partners.

Could you provide an update on growth of the MediChoice product line? Specifically, we were wondering if growth has been at all impacted by the health care utilization trends?

Sure. We're up to about 2,450 products now, and our growth rate has -- it's still in double digits. It is about 15% over where we were last year, 15% growth.

Okay. Thank you.

Your next question comes from Bob Willoughby with Banc of America.

Craig or Jim, given the cash reserves that are building here and with some of the tax laws changing in the near term, any change in your philosophy here as it relates to dividends versus share repurchases?

Good morning, Robert. We are obviously monitoring that carefully. I would reaffirm that this particular point in time we are a dividend paying Company. It is part of the philosophy of our Board of Directors. But we do understand that we need to return cash to the shareholders in a tax efficient manner and as things change, we will certainly consider what that aspect may be to us. The $146 million of cash that we have on our balance sheet at the end of March is higher than the normal amount that we have carried. I would offer that in today's environment, I think there is a bit of a changing philosophy evolving as to the amount of cash that a Company may retain on its books and have available in relation to the amount of borrowing capacity that they may have in a revolver. As I had mentioned earlier we are in the process of renegotiating our revolver agreement; and until all that is sorted out, I think it's our opinion that we would carry probably cash balances that are a bit more than we have historically.

Okay. And just refresh my memory, Jim. Do you have a share repurchase authorization out there currently?

We do not, Robert.

Okay. Thank you.

Your next question comes from [Elliot Feldman] with Barclays Capital.

Good morning, guys. Elliot Feldman filling in for Larry Marsh. Just back to that cash question, obviously it was a big cash flow quarter. I was just wondering how we should think of this pattern of cash flow generation for the remainder of the year?

Yes. It was an unusual quarter as you look at the components that contributed to near-record-breaking cash from operations. So I don't think it could reasonably be expected to replicate itself, in the other quarters of the year. That being said, we like the trending that we saw in certain major areas that are drivers to our cash from operations, specifically the accounts and notes receivable where we picked up about $18 million of cash from operations and, again, have achieved DSO levels that are really quite astounding, and then the other is we picked up about $11.6 million in cash from operations through improvement in inventories, and we remain convinced or believe that there's future opportunities that exist in that particular area. So I think there are opportunities for improvement over the course of the year, but one could not look to this quarter and expect it to replicate itself over the course of the year.

Got you. Thanks. One last quick one on third-party logistics. Wondering at this time, how many customers roughly are already taking advantage of 3PL services and what kind of demand are you seeing for those services going forward?

Well, we really haven't broken that out. If you remember, at investor day in December, I had said that we would probably start to put a little more color around that later in the year. I would say I am pleased with where we are with our progress year to date. We've got a nice open house coming up next week with a lot of perspective customers there. But I would say overall we're getting a lot of good feedback on perspective customers and RFIs that we are currently bidding on, and we do have current customers, but again, I would like to wait probably later in the year to really start to break that out and maybe put a little more color around it. Thanks, guys.

(Operator Instructions) There are no further questions at this time. I will now turn the call back over to Mr. Smith for closing remarks.

Well, thank you everyone for listening in this morning, and we'll get back with you in the second on results, and have a great day. Thank you.

And thank you for your participation in today's conference. This concludes the call. You may now disconnect. Have a good day.