Owens & Minor Inc (OMI) 2011 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Owens & Minor's first quarter 2011 earnings conference call. My name is Regina and I will be your operator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this 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 for Owens & Minor. Please proceed, sir.

Thank you, Regina, and good morning, everyone. And welcome to the Owens & Minor first quarter 2011 conference call. We're going to review our results and then take your questions in a moment, but first let me introduce my colleagues that are here with me today. Jim Bierman, our Chief Financial Officer; Charlie Colpo, our Chief Operating Officer; Grace den Hartog, our general counsel and Drew Edwards, our Controller and Chief Accounting Officer. Before we begin Trudi Allcott, our Director of Investor and Media Relations, will read a Safe Harbor statement. Trudi?

Thank you, Craig. Our comments today will be focused on Company results for the 2011 first quarter, which are included in our press release. The press release, as well as the supplemental slide presentation, can be found at our website at Owens-Minor.com, where we will also archive the webcast of today's conference call. In the course our discussion today we may make forward-looking statements. These statements are subject to risk and uncertainty 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 risk factors. As for our investor calendar, we're participating in four investor conferences in the second quarter, which are outlined in our press release. We look forward to seeing you on the road in the coming weeks.

Thank you. Craig?

Thank you, Trudi, and I'm going to have Jim now brief us on our financial results. Jim?

Thank you, Craig, and good morning, everyone. In reviewing the first quarter of 2011, we are pleased with our revenue growth when compared to the prior year. While revenue growth exceeded our outlook, significant commodity price increases in materials, such as cotton, resins and fuel offset some of the benefits one would expect from the increased sales activity. Craig and I will discuss these factors within the context of our review of the first quarter 2011 results and current market trends.

Net revenues increased 7.8% to $2.12 billion for the first quarter of 2011 from $1.97 billion for the first quarter of 2010. The increase in net revenue resulted primarily from greater sales of products to existing customers of $134 million, representing 6.8%, or almost 90% of our sales growth. In addition, sales to new customers contributed $103 million to the increase in net revenues and were partially offset by a decrease in sales to lost customers of $84 million for a net increase of $19 million. As I mentioned at the outset, this quarterly revenue growth exceeded our 3% to 5% outlook for the year. We've analyzed the results and offer the following observations.

Growth rates for the quarter were affected by an additional selling day, which could translate into approximately 170-basis points of the growth in revenue. Obviously, we factored this extra day into our outlook for the year. However, it does have a disproportional impact on our first quarter growth rate. Adjusting for this factor, results of the revenue growth rate of 6.1% for the quarter. In segmenting our customer database, we observed that revenue from our largest customers grew at a rate of over 8% while revenue growth of our smallest customers actually declined when compared to the prior year. Some of this shift is attributable to industry consolidation, as larger providers are acquiring smaller hospitals, which does tend to skew our analysis. Finally, while our existing customer growth rates demonstrated an increase when compared to the rates we experienced last year, we are still at the early stages of this improvement and it is unclear if these trends are sustainable.

Turning now to gross margin. For the first quarter, gross margin dollars increased 7%, or $14 million, to $211 million, largely as a result of increased revenues. As a percentage of revenues, gross margin was 9.92%, a decline of 8-basis points when compared to last year's first quarter. The decline resulted primarily from an 11-basis point increase in the LIFO provision, due to inventory purchase price inflation and a decrease in supplier incentives of 8-basis points. You may recall at our investor day last December, we identified commodity pricing as a variable in 2011, noting that we cannot predict global price fluctuations. At the same time, we also said that we were targeting a lower level of supplier incentives this year. These negative factors were partially offset by a net increase in fee-for-service revenues of 6-basis points.

Turning to our discussion of expenses. For the quarter, SG&A expense as a percentage of revenues improved slightly to 7.14% when compared to the first quarter of 2010. On a dollar basis, SG&A expense increased $10.6 million, or 7.5%, to $152 million. The $10.6 million increase can be attributed to greater labor expenses for salaries, incentive compensation, and benefits. Strong business growth and higher fuel costs also drove up our delivery expenses for the quarter, which had an adverse affect on SG&A. Finally, expenses associated with serving new third-party logistics business also increased SG&A in the first quarter by approximately $1.8 million.

Sequentially, SG&A increased from the fourth quarter 2010 to the first quarter 2011, primarily as a result of seasonal expenses associated with payroll taxes and certain compensation benefits in the first quarter. Depreciation and amortization expense for the first quarter increased 29% to $8.8 million from $6.8 million in the same quarter last year. The increase is due primarily to amortization of leasehold improvements for both relocated and expanded distribution centers and our two OM Healthcare Logistics facilities, as well as amortization of voice pick systems and computer software.

Operating earnings in the first quarter of 2011 were $51 million, increased $2 million, or 3.8%, from a year ago. The increase resulted primarily from greater distribution and fee-for-service revenues partially offset by additional expenses to serve business growth and increases in the LIFO provision and delivery costs. As a percentage of revenues, operating earnings were 2.4%, a 10-basis point decrease when compared to the first quarter of 2010. Net income for the first quarter of 2011 improved by approximately $1 million, or 3.3% to $29 million when compared to the same period last year. Net income per diluted common share for the quarter was $0.45 compared to $0.44 per share.

For the first three months of the year, interest expense was approximately $3.7 million. Our effective interest rate was 7.2% on average borrowings of $211 million for the first quarter this year, compared to 6.4% on average borrowings of $210 million at the same time a year ago. In June 2010, we replaced our revolving credit facility with a new $350 million facility, which expires in June 2013. The increased effective interest rate for the first quarter of 2011 is due to greater commitment fees on the new facility and increased amortization of deferred financing costs. As of the end of the first quarter, this facility remained fully undrawn.

For the first quarter our effective income tax rate was 39.2%, essentially unchanged when compared to a year ago. Overall, we are targeting our tax rate for 2011 to be approximately 39%, consistent with our previous discussions. As for asset liability management, cash and cash equivalents increased by approximately $27 million to $186 million as of March 31, 2011. We reported cash from operations of approximately $50 million for the first three months of the year. Cash from operations was positively affected by operating earnings and an increase in accounts payable, but negatively affected by increases in accounts and notes receivable and merchandise inventories. For this year's first quarter, inventory turns were 10.7 compared to turns of 10.6 a year ago. And our receivable days sales outstanding were 21.1 days compared to 20.5 days at the same time last year.

For the quarter cash used for capital expenditures was approximately $7 million, used primarily for strategic and operational efficiency initiatives. These expenditures included warehouse equipment and technology for both our distribution centers and OM Healthcare Logistics, as well as investments in certain customer-facing technology. Cash dividends paid were $12.8 million during the quarter.

Turning now to our outlook for the remainder of the year. At this time our guidance remains unchanged. As we first outlined at our investor meeting in December, we continue to target revenue growth in the range of 3% to 5% and net income per diluted share in the range of a $1.95 to $2.10.

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

Thank you, Jim, and let's turn to an update of our business. We are pleased with our financial results for the quarter, especially the strong revenue growth. With Jim's analysis you should have a better understanding of the factors that drove our results, I believe, including the strong improvement in our quarterly revenues. As we have explained, there was more than one external factor affecting the revenue mix during the quarter. Recently published reports from analysts and healthcare companies indicate that hospitals experienced modest first quarter increases in outpatient, inpatient and emergency room volumes. However, I would caution that even with these positive signs at this early stage, we would hesitate to say, definitively, that utilization of healthcare services by our customers is on a steady path to levels we are accustomed to at Owens & Minor.

In looking more closely at our customer segmentation data, as Jim explained, we experienced strong growth trends with our large provider customers, while we experienced weak, or even negative growth with the smaller customers during the quarter. We continue to believe these trends validate our strategy of partnering with the large integrated healthcare systems. These large systems are aligned with our approach to managing the healthcare supply chain, which focuses on process improvement, innovative supply chain management and operational excellence. Our goal is to partner with the providers that are demonstrating the greatest potential for growth in a very changing markets.

And we believe we are well positioned in that regard. As for our abilities in the field we continue to set the standard for operational excellence. We believe that our warehouse investments, including automation and voice pick, are enabling our teammates to serve a larger book of business with greater accuracy at a faster pace. In the first quarter, out of 20 key performance indicators that we track, we improved in 15 categories. For a Company that's been in operation for 129 years, these results reflect our culture of continuous improvement.

At Owens & Minor, we also have a reputation for skillful management of customer conversions, including those of complex, large IDNs. In the first quarter we completed the conversion of a large new customer and began to service its numerous facilities spread over many states and from 17 of our distribution centers. Our conversion team did a great job with this large scale project and we are very pleased with the new partnership. We also achieved an important milestone with OM Healthcare Logistics. In April we began handling third-party logistics for the initial CareFusion divisions. As you will recall, the conversion of the various product lines is estimated to occur over 18 months in a phased process.

As you think about the rest of the year, there are a few items that we often get questions about, so I'd like to bring you up to date on those. Novation has extended our existing contract for another year with a new expiration date set for August of 2012. Consequently, consider our relationship with Novation to be business as usual for another year. We also heard from the Defense Department, which has awarded the new Generation IV medical-surgical contract that will take effect in the first quarter of 2012. We are pleased to extend this long-standing relationship, and we are already preparing for how we can best serve the military under the new contract.

As we look ahead to the rest of the year, we will continue to monitor utilization trends in our market, as well as fluctuations in commodity prices. We will aggressively market our value to the large IDNs. We will seek ways to improve operations and gain efficiencies in our network. We will continue to market our 3PL services to the medical supply and device market. And finally, we will do we do best; serve our healthcare provider customers with innovative supply chain management services. In order to accomplish our goals, we will continue to invest in developing and educating our teammates, who are the key to our long-term success. We were once again named to Fortune's Most Admired Companies List, which I believe is a direct reflection of these outstanding work of every single teammate at Owens & Minor. I would like to thank our teammates for another strong performance in the first quarter. We have a very full investor calendar this year and we look forward to seeing you on the road in the months to come.

Thank you and we would be happy to take your questions. Regina, you may open the line for questions.

(Operator Instructions).

Your first question comes line of Matt Galati with UBS.

Good morning. Just had a question related to some of the strength selling into the existing customer base, so I was just wondering how much more opportunity exists is there? And, secondly, within that smaller client or customer demographic has it been just a little bit slower to recover, or is there more of a significant trend or change going on there? Thank you.

Sure, Matt. As we look at the segmentation of our customer base, we saw a trend that had begun last year that we had commented on, where we saw larger hospitals increasing market share at the expense of smaller hospitals. And, if you think about the strategy that Craig has laid out in numerous occasions, not the least of which was Investor day, that is a strategy of ours to concentrate on those larger IDNs, as we see them increasing market share. So, I think, to a degree, we would expect if that phenomenon increases into the marketplace that there would continue to be some level of expansion. Also along those lines, we have seen, as we went into this year and had expected, a level of expansion of product that had traditionally gone direct now being use -- placed with distributors, and that is a factor that is contributing also to the experience that we've seen at the beginning of the year.

And, let me put a little color on the second part of your question, Matt. I think utilization is somewhat mixed still. If you were to look across several of the systems in the country -- and, as you know, I'm on the road quite a bit -- so I do think there are some hospitals in recovery, there are still some hospitals flat, but I think the overall feelings right now of large systems is, they're not going to wait to be told how they're going to operate. They are going out and cutting costs and looking for services and products where they can drive their cost down. So, I do see a higher level of business as usual in the last, probably, six months. And, I think part of that, also, is this a consolidation strategy that the hospitals are taking as they're going to move forward and they're going to continue to consolidate and get bigger so they're a bigger player in the marketplace.

Great, thank you.

Our next question comes from the line of Eric Coldwell with Baird.

Thanks, guys. I don't even know where to begin this morning, a lot of good detail here. I'm still wanting to stick on the same topic of near 7% growth with existing clients, yet you're -- Craig, you're really not calling for a recovery in utilization, or saying that you're not convinced that we have a sustainable trend yet. How would you define that 7% growth with your existing accounts? It's just a very, very -- obviously a good number. We expected a good number, but that's a very big number.

Well, Eric, I think you have to go back and look at what happened last year going into this year. So, I think we were relatively flat last year. We did talk about this larger customer that was coming on late in the fourth quarter, so a lot of that came on in the first quarter. But, we've also been talking consistently about these larger systems acquiring hospitals and then I think the ability to pick up some of this direct business, so I think it was a combination of two or three things that came together. Now, I think the easy thing would be to change your forecast, but we're going to take a look at this and we're going to cautiously look at it again this next quarter and watch very closely. But, we were working very hard last year to get the sales going and I think we're also seeing some success from that.

I would also offer though, Eric, a cautious reminder that the additional sales day did have the effect of -- in this particular quarter of having a disproportional effect, and, so, the actual revenue growth on a per-sales-day basis is closer to 6.1% than the 7% that you'd spoken of.

Right, right. And, the 7% that I quoted was your growth with existing clients. But, again, to your point probably 6% or so backing out the sales day. Jim, you also made a comment in your response to the last question that was intriguing. You said you're seeing more product that had gone direct now go through distributors. Could you add a little more color on what type of product or more details on this?

Eric, we've seen a good movement on the suture and endo lines moving more through distribution primarily. We were fairly successful in the first quarter of obviously working with Ethicon and Covidien to start to move some more product through our distribution network, and, so, it was primarily a lot of those two lines. But, we have seen fairly consistent growth in the direct from manufacturers' lines and that really has been part of our strategy over the past two or three years. So, we were pleased that we were able to pick up a significant amount of the harmonic sales, which Ethicon has done very well in that marketplace, and then to pick up some suture and endo products through Covidien.

Is -- I know that, historically, the suture market was either direct, or it was dominated by specialized niche players. Are you taking share from some of the specialized players, or is this manufacturer direct sales that have come out to another distributor? How would you characterize that?

Well, I would say it's mostly direct. I would also say though, Eric, I go back to this large IDNs strategy, which -- and you know the market as well as anybody. These systems are getting bigger, they're really working at process improvement efficiency, they're really working trying to fill the truck up as much as possible. If they've got a truck that's three quarters full, they're trying to cube that truck out. And, so, I think our strategy has played very well for us that we are working in partnership with a lot of our larger systems that are trying to move more and more product through us in an efficient and productive manner.

Craig, if I know the market as well as anybody, we are all in a lot of trouble. (laughter)

Oh, don't say that.

But, let me just ask one or two more quick ones. D&A was significantly higher than I had modeled, about almost $1 million higher in the quarter. Jim, you gave us the reasons the behind that the new distribution centers, the relocations, software, voice pick, et cetera. Is there anything else I should be thinking of with the HCL business, the CareFusion business going live in April? Should we be taking another stab at our D&A model going forward to a higher level?

No. I think most of the significant investment in that area was done towards the end of the fourth quarter. I think the remainder of the CapEx that we would anticipate incurring during 2011 or even going into 2012 would tend to be oriented towards specific customer conversions and tied to specific customer signings. So, stated another way, I think once we've established the California logistics center and outfitted it and have the systems to support it that generally for that business we've incurred the major bulk of the CapEx expenditures at this point in time.

Got it. I'll leave the podium here to some others and thanks for the answers.

Thank you.

Your next question comes line of Lisa Gill with JPMorgan.

Morning, this is Gavin Weiss in for Lisa Gill. I'm just wondering if you could give us some more color on the impact from commodity prices in the quarter and whether the manufacturers really were able to pass along these prices to customers? And just given where commodity prices have gone over the past month, is this a risk to your guidance going forward?

Sure. We have a different profile than manufacturers or even distributors that do a great deal of manufacturing in that our prices to the end customer tend to be contracted, and, so, therefore, there isn't really the same issue regarding price increases squeezing the margin per se. Where commodity price increases or decreases impact us is in, as I've characterized before, the more arcane area of accounting for inventory. And, we are on the LIFO method of accounting and, consequently, as the price of the product changes for inventory purposes, there is an adjustment that's required in the valuation of inventory and that flows through in the provision for LIFO. You'll note that this quarter, compared to last quarter, there was an approximately $3 million increase in that LIFO provision. But, I think a way to think about this is that this tends to be a non-cash event and is accounting-driven event, in contrast to others in the manufacturing space that have a more true economic cash exposure to these fluctuations.

Okay, great. Thanks for the clarity. But, then, on the SG&A you also mentioned impact from higher fuel cost, is that negligible going forward?

No. Excellent question. So, let me address that. Because we saw year over year, an increase in delivery cost of $1.7 million. The components of that are twofold, though. A portion of the increase in delivery cost is going to be due to the fact that we saw an increase in the product delivered. You'll recall that the $154 million increase in revenues, which is a component of that increase. But, quite candidly, we are, to a degree, exposed to the increases on fuel cost, and so a component of that $1.7 million also represents the increase in fuel. And, to the extent fuel prices continue to increase over the course of the year, we will have a degree of exposure to that.

Okay, but it's not significant, you'd say?

It's $1.7 million increase in delivery cost for the quarter.

Okay, great. Thank you for the clarity.

Our next question comes line of Elliot Feldman with Barclays Capital.

Good morning, guys, this is Elliot Feldman filling in for Larry Marsh. Thanks for all the details this morning. Just a quick question on capital allocation, if I could for a moment. I know you guys have over $185 million on the balance sheet. I know you guys are committed to the dividend payout, capital investment, debt reduction, but with the discussion of some of the success of Burrows and McKesson you mentioned Analyst day, just wondering if you can comment on the M&A environment, potential targets, what you guys may be looking at over here over the next 12 to 18 months?

Yes, I think the best I can do on that, Elliot, is to probably restate what we said in December and that is really to -- there are four areas that we're looking at. And, of course, the first one is to look at regional distribution and as you have probably heard me say probably ten times is we will take that on an individual basis and look at the customer list, as well as the profitability that distribution business. Second piece is our initiative and our drive on our sourcing to improve our private label growth, which I think Jim was pretty specific about at Investor day, is we are pleased where we are with MediChoice but we want to take that to the next level. The third piece is to continue to look at technology and do bolt-ons for our customers and we do have a new small technology that we've added for our 0M solutions group in the first quarter, and not go into too much detail but we'll continue to look for small bolt-ons.

And, then, the fourth is to really to look at partnering, and that could be partnering with a customer, partnering with a manufacturer partnering, with a GPO, anything that's going to help us in terms of continuing to drive productivity and efficiency with the individual customers. So, those four are still the priority for this year. As all companies, we're very active in that space and looking. And, we're moving along as fast as we can and anytime you're in M&A for every 50 you look at there's one or two that either finalize or get close to. So, I would say we're very actively in the marketplace in those four categories.

Got it, thanks for the detail. And, then, one final question, if I could, on the competitive environment. Just wondering if you guys are seeing any broad changes out there? I believe, Jim, you mentioned I think it is $103 million from new customers partially offset by the $84 million hit from some lost customers. Is there any color you can give on the type of customers you want and also the type of customers that you've lost, the type of competitors you might have lost them and any broad changes in the competitive environment?

Well, I think it's been pretty consistent. Let's -- we all know that our customers are under a tremendous price pressures, and the real challenge right now is for all of these systems to try and get down to Medicare reimbursement as quickly as they possibly can. I hear that every week. And, clearly, as I've said probably the last three or four quarters here, our price customers -- unit price customers, which typically are those smaller or medium-sized hospitals that are really trying to survive. And, then, there are the larger systems that really, they want a low price but it's not about price, it's about taking $5 million or $10 million or $15 million or $20 million out of the supply chain.

So, the systems that we have been going after -- and it's a little bit more of a complicated sell, it's a little bit longer of a sell cycle, but we let want these larger systems that going to then turn around and acquire these smaller and medium-sized hospitals. So, I would say that really the last 15 months we've seen price customers and we've seen process and efficiency customers, and, obviously, we have been very clear about we're going after the process efficient customers that are the larger ones. It's a little bit larger sell cycle but we think ultimately some of these smaller and medium-sized hospitals will end up being either affiliated or owned by these larger systems. So, it's been -- we've been pretty consistent about what we've said on that for probably the last 15 to 18 months.

Okay, got it. Thanks, guys.

(Operator Instructions).

Your next question comes from the line of Robert Jones with Goldman Sachs.

Thanks for the questions. Just to go back to the sales growth and just to marry a few of the comments here. Craig, you mentioned that some of the industry reports have pointed to patient volumes only having increased modestly and then obviously really strong growth with your large customers. Even if you back the extra selling day, it sounds like it was a little over 6%. Is that really all coming from just market share consolidation from the large players from the small players? I guess I'm just trying to get a better understanding of how patient volumes across the industry might not have increased that much, but yet, clearly, some stronger with your big accounts.

Yes. Again, I wish I had a magic mirror to -- every week I go out, I'm meeting with hospital systems and it is not consistently across the board that everybody -- that their revenues are increasing. So, what I would say is there's -- and I wish I could be specific. I think a portion of it is, is this direct sales that we picked up. I think, secondly, hospitals, to some degree, last year were holding back, or really not making any changes trying to figure out what they were going to do. And, I think they have picked up moving forward, maybe they even trimmed inventories back a little bit. It's ready hard to segment that out and tell you exactly what it is, but I do think it's a combination of a new sales, direct sales. I think it's also the fact that there are -- all you have to do is every week, we do a business intelligence weekly. There's hospitals being acquired almost every week by larger systems. And, I will say we have been fairly fortunate that most of those smaller hospitals are being acquired by current customers that we have today.

So to try to look at 1,000 or 4,000 customers, it's a lot of work to do that on a daily or weekly basis. So to really dive as deep as you're probably asking would be -- would probably take us a month-and-a-half to do that. But, I think we're very comfortable with the combination of what we said was -- is that I think our strength has always been in existing customers. Secondly, we're getting these direct sales. And, then third of all, we are seeing -- and I'll give you a customer. I won't say their name, but they hadn't acquired a hospital probably in 25 years, they bought three hospitals last year that they're now converting to us, that I would have never probably guessed they would've done that. So, there is a lot of movement in the marketplace from that standpoint.

Okay, that's fair. And I guess Jim, if we think about the offsets to the strong top line, so the things that negatively impacted margins, a couple moving pieces here, I was wondering maybe if you could just share with us all those moving pieces, what items were not fully contemplated in the original guidance?

Sure, Robert. I think the biggest piece -- and this does have an element of risk of oversimplifying, but the biggest piece certainly is the LIFO provision. If you go back to Investor day, when we spoke about our outlook for 2011, we referred back to 2010 as being a relatively normal year in terms of our LIFO experience, and we contrasted of that to 2009 where we saw some pretty significant fluctuations due to commodity price increases and decreases later in the year. So, as we thought about 2011, we thought 2010 was a pretty good proxy. And, what we saw in the first quarter -- and as I've said before -- was approximately a $3 million increase over where we had originally anticipated. So, I think that's the biggest issue. There are various and a sundry other offsetting type variances, but I think, if you had to look at one, that would be it.

Okay, that's helpful. Thanks for the questions.

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

Thank you, Regina. We appreciate you listening in today and those were great questions. And, we're looking forward to getting out and seeing everybody. As I say, we have a very heavy investor schedule so I'm sure we will see a lot of you on the road over the next three to six months. Thanks for dialing in.

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