Owens & Minor Inc (OMI) 2012 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Owens & Minor third-quarter 2012 earnings conference call. My name is Hughie, and I will be your operator 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 of Owens & Minor. Please proceed, sir.

Thank you Hughie, and good morning everyone and welcome to the Owens & Minor third-quarter 2012 conference call. We do realize a lot of you are currently coping with Hurricane Sandy so we appreciate your participation on the call today. In advance of the storm, as we always do, we made every effort to ensure that our customers were taken care of, and that our hospitals receive their emergency orders ahead of the storm. We believe that our customers and our teammates are in good shape to weather this hurricane, and we hope that you are taking every precaution as well.

Now, we will 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 Operating Officer, Drew Edwards, our Interim Chief Financial Officer, Grace den Hartog, our General Counsel, and Brian Shotto, Vice President of Specialty Services, who is available to answer your questions. Now, before we begin, Trudi Allcott from our Investor Relations team will read a Safe Harbor statement. Trudi?

Thank you, Craig. Our comments today will be focused on financial results for the third quarter of 2012, which are included in our press release. In our discussion today, we will reference certain non-GAAP financial measures. Information about these measures and reconciliations to GAAP financial measures are included in our press release, and in the supplemental slides, which are posted on our website, where we will also archive the webcast of today's call. In the course of our discussion today, we may make forward-looking statements. These statements are subject to risk and uncertainties that could cause actual results to differ materially those projected. Please see our press release and our SEC filings for a full discussion of these risk factors.

Finally, upcoming investor events are spelled out in our press release, but as a reminder, we hold our regular investor day in New York on Thursday, November 29. You can find the registration link on our website, and we do hope you will join us. Thank you. Craig?

Thank you Trudi, and I would like to call on Drew Edwards, our Interim Chief Financial Officer, to brief us on the numbers, and Jim will provide us an operational overview. Let's start with Drew.

Thank you, Craig, and good morning, everyone. With the acquisition of Movianto, our third-quarter financial results require more explanation than in past quarters. We will now report consolidated results, along with two reporting segments, international and domestic. Our new international business segment is comprised of Movianto, while our domestic segment is comprised of existing operations.

I'll start with consolidated results and then move to a discussion of each segment. In addition, my discussion of adjusted consolidated results will exclude the after-tax acquisition-related costs of $0.10 per share for the third quarter, and $0.11 per share year-to-date. By definition, our segment operating earnings or losses exclude these acquisition-related costs. Adjusted EPS declined to $0.49 in the third quarter of 2012 from $0.53 in the third quarter of last year due to a 7.3% or $4.3 million decrease in consolidated adjusted operating earnings. This decrease resulted primarily from lower domestic gross margin of $8.2 million, and an operating loss of $626,000 for the international segment, partially offset by lower domestic segment SG&A of $6.6 million. In addition, for comparisons' sake, the third quarter of 2011 included income of $2.2 million related to the settlement of a lawsuit.

Moving onto results for the international segment, which includes only one month for Movianto since is was acquired on August 31. The Movianto operating loss of $626,000 was comprised of revenue of $49.7 million, gross margin of $19.6 million, SG&A expenses of approximately $19 million, and depreciation and amortization of $1.3 million. September is traditionally a high-volume month in preparation for the flu season. Seasonality impacts both revenue mix and margins. Accordingly, September results cannot be simply extrapolated to obtain annual amounts. For example, we explained last quarter that annual revenues for Movianto in 2011 for approximately EUR300 million.

I'd like to point out that our consolidated income tax provision is now based on separate domestic and international computations. Determining the effective tax rate on international earnings or losses is complex, as accounting rules limit the recognition of income tax benefits on losses that are only realizable in the future. For example, in September we recognized in income tax charge of $100,000 for international segment, despite a $626,000 operating loss. On a long-term basis, with all European entities generating income, we would expect the effective tax rate for the international segment to be below the US federal rate of 35%, due to lower local tax rates and structuring factors. We will provide more information on the outlook for the international segment at investor day.

Turning now to the balance sheet. The international segment had $161 million of net assets at September 30, comprised of $410 million of operating assets and $249 million of operating liabilities. Total assets include preliminary goodwill of $36 million, and intangibles of $24 million. Another impact of the international segment to our consolidated balance sheet relates to other current assets and other current liabilities. These line items include international segment financing receivables of $125 million, and related financing payables of $118 million associated with invoicing and collections services, provided to our manufacturing customers. Fees for these services are recognized in revenue. For clarity's sake, product sales and costs related to this inventory are not included in the income statement.

Moving on to domestic segment. For the third quarter, domestic operating earnings were $55.1 million, down $3.7 million versus last year. This decline resulted primarily from lower domestic segment gross margin of $8.2 million, partially offset by SG&A that was lower by $6.6 million. This quarter, the $8.2 million decline in domestic segment gross margin was predominantly due to the decline in revenue of $46.5 million, including declines of $29.5 million from existing customers, $13.7 million from net loss customers, and $3.3 million from lower fee-for-service revenue. The domestic segment gross margin percentage was 9.79% in the third quarter of 2012, a decline of 16 basis points versus last year, due mainly to lower fee-for-service revenue, including OM Healthcare Logistics, which had higher fees last year from higher costs incurred to convert a large new customer.

We continue to be pleased with our ability to manage our domestic segment SG&A. For the third quarter, domestic SG&A was 6.86% of revenue, versus 7.02% last year. On a dollar basis, domestic segment SG&A for the quarter was lower by $6.6 million. This improvement resulted from lower fee-for-service SG&A of $4.5 million and lower SG&A unrelated to fee-for-service operations of $2.1 million, which declined due to lower incentive compensation and benefit costs, and our organizational realignment in the fourth quarter of last year. The net impact of changes in domestic segment depreciation and amortization in consolidated net interest expense was insignificant for the quarter compared with last year. Substantially all of our interest cost relates to domestic debt outstanding.

The effective tax rate, excluding the international segment, and the impact of acquisition-related costs, was 38.7% for the third quarter compared with 39.4% last year. The decline relates to the recognition of tax benefits in the third quarter of this year for the exploration of the statute of limitations for the 2008 US federal income tax return. Our domestic effective tax rate, excluding special items, is expected to stay in the range of 39% to 39.5%. Domestic segment working capital ratios included DSO of 20.7, inventory turns of 10.2, and days payable outstanding of 27.1, all within the ranges that we've seen over the past four quarters. Thank you. Now, I will turn it over to Jim for his remarks.

Thank you, Drew, and good morning, everyone. With that first look at our results, I would like to provide further insight into our financial performance. Revenue growth in the domestic segment so far this year has been hampered by the combined effect of ongoing weakness in utilization, and little to no product price inflation. As we told you last quarter, we targeted that for the second half of this year, revenue growth would be flat. That is exactly what we saw this quarter with our large IDN customers. The factors contributing to the quarter's results were weaker healthcare utilization trends, little to no product price inflation, a reduced level of purchasing activity from the federal government, and ongoing rationalization of the Company's supplier base.

We would reiterate that we expect to see similar conditions with similar results in the fourth quarter of this year. As we think about revenue, we must also think about its impact on operating margin and its components. In analyzing the domestic gross margin results, we would note that we reported a sequential increase in gross margin percentage, which is certainly positive. Also, we would note that the decline in third-quarter gross margin dollars, when compared to a year ago, resulted largely from the decline in revenues, rather than customer mix. But as we've been discussing for some time, customer mix does play a role in our gross margin results.

As we look at our core distribution business, the impact of large IDNs, as well as hospital consolidation trends, have affected our gross margin percentages. One element impacting our acute care relationships are the GPOs. Let me provide an update on this year's renewals. Regarding the new Novation contract, we are pleased that we have effectively finished the sign-up phase. To a large degree, the new pricing took effect on September 1. The term of the new contract is five years, with two one-year renewal options. As for the sign-up phase, we ended up essentially where we anticipated, and look forward to serving our hospital customers under the new contract. We are satisfied that we've retained Novation customers that were of significance to us, under terms that were mutually acceptable.

We are now engaged in a somewhat similar process with Premier. We would expect to comment on the prospective effect of these contracts, when we discuss our outlook for 2013 at our annual investor day in November. As we look at our position in the market, we recognize that we are uniquely-positioned to drive efficiencies in the healthcare supply chain, benefiting hospitals and healthcare manufacturers. In recent years, we've focused on attacking the business of a number of large and influential IDNs. We believe these will be the winners in the consolidating market, and they are a natural fit for our supply chain solutions. Due to their sheer size, and purchasing power these customers have leverage in the marketplace.

In order to serve them efficiently, we are adjusting our service model to their evolving needs. For example, we are working with our acute care customers to provide supply chain solutions for their physician practices. During the third quarter, we converted three additional geographic areas of a large IDN physician business to our platform. Additional conversions for this IDN are slated to continue into the new year. For this IDN alone, we are now serving approximately 1,000 physicians. They order through our traditional platform but access a specific contract-compliant formulary. And we have just begun converting another group of physicians of another large regional IDN. This conversion entails over 300 physicians, who will be served by Owens & Minor. This group will use our proprietary ordering platform. We continue to work with our IDNs to develop ways to serve their physicians, and we believe we have the right solution for this growing supply chain challenge.

In addition to our hospital focus, we are intently working on developing services to support the suppliers and manufacturers who serve healthcare. Our efforts include taking steps to optimize our supplier relationships. We want to work with the most efficient suppliers, and those that are interested in partnering with us to deliver their products to the market in the most cost-effective manner possible. We provide a wide range of valuable services to our suppliers, including assuming credit risk, carrying inventory, managing orders and returns, and efficiently delivering next-day orders of their products with exceptional accuracy. As I said, these services are valuable and we deserve to be compensated in terms that are commensurate with the value of our services. We are well aware that there may be some suppliers who do not fit our model, and who, therefore, will choose not to work with us. For example, this summer, we parted ways with a supplier that maintained its should be receiving our logistics services for free. As common sense would tell you, this was untenable.

Turning now to our successful efforts to manage our expenses. We have been, and will remain keenly attuned to reduce spending in every area. Our teams constantly look for ways to lower operating expenses. As we demonstrated last quarter, our quarterly expense reduction efforts in the domestic segment were commendable, as we reduced SG&A dollars and SG&A as a percentage of revenues, when compared to last year. The factors that led to these solid results included reduced operating expenses in OM Healthcare Logistics, lower expenses for compensation and benefits, and ongoing benefits resulting from the organizational realignment undertaken in the fourth quarter of 2011.

We're all pleased that domestic operating earnings margins improved on a sequential basis this quarter. This was no small accomplishment in a year was so many challenges. Consequently, as we reflect on the third-quarter 2012 results, we are targeting the fourth-quarter 2012 adjusted operating results to be similar to those reported this quarter. As our outlook further evolves we will provide additional details at our annual investor day. Thank you, and I'll turn it over to Craig for his remarks.

Thank you Jim, and now that we have provided a very in-depth look at our results in operations, I'd like to take a step back and give you a look at the bigger picture. This is been a very challenging year in healthcare, with many health care companies facing greater softness in utilization than anticipated. Consequently, many companies, healthcare companies, are focusing on improved efficiencies while looking for new opportunities, just as we are. Even in a challenging environment, we are pleased that our teams have turned in a steady performance, and made solid headways on many fronts. Under Jim's leadership, our operations teams have made significant progress in adapting to changes in our markets.

The realignments we undertook nearly a year ago have helped lower our expenses in 2012. Our customers increasingly seek our help with emerging supply chain challenges, and of course, we are excited about the opportunities presented by the Movianto acquisition to expand our global reach and our third-party logistics services. Now even with these pressures in today's economy and in the healthcare industry, we are providing supply chain solutions that can deliver a tangible difference for our hospital and our supplier customers. One of the ways we serve suppliers is through our third-party logistics offering, and during the quarter we completed the Movianto transaction, our first overseas acquisition. Movianto is one of only two pan-European healthcare 3PLs, and it gives us an experienced team and well-run logistics facilities throughout Europe.

After we closed the transaction, our teams quickly began to transition Movianto from the parent company to Owens & Minor. The transition team is focused on ramping up services previously provided by the parent company, such as certain corporate support functions, marketing efforts, and information technology systems. As we said last quarter, this is a strategic platform acquisition of a leading 3PL company that we believe will create a widening path of opportunity for us. Before investing in Movianto, the parent company had made strategic capital investments in the network, so there is plenty of capacity for growth. Our near-term focus is building our client base and putting more volume through this network.

We believe that our 3PL services, both domestic and international, offer manufacturers a streamlined cost-effective solution. We also believe that our legacy relationships with 4,000 hospitals and 1,200 manufacturers in the US give us a competitive advantage that general 3PL providers do not enjoy. We also know that 74% of the global healthcare spend occurs in North America and Europe. With our new platform, we are now well-positioned to leverage this concentration of healthcare spending. Since completing the acquisition, we have had an increasing number of calls from suppliers who want to talk to us about third-party logistics.

We are very encouraged by the heightened level of interest in working with us. For example, we signed an agreement with an existing legacy supplier to provide 3PL services in Europe through Movianto, and we have signed a letter of intent with another US supplier to become a Movianto client. In recent days, we have also signed a new customer for OM Healthcare Logistics, our domestic 3PL service, and exchanged a letter of intent with a second manufacturer. The old [METL] customer is a medical device manufacturer that is working with us to bring its new spinal implant device to market. This physician preference item is the type of product that typically does not go through traditional distribution, but is a perfect fit for our 3PL services.

At the end of the day, we aim to create long-term shareholder value, which is key to our mission, vision and values. Accordingly, our Board just declared a fourth quarter dividend at $0.22 per share, our 3% dividend yield is among the strongest in our sector, and dividends remain a priority for our Board. During the first nine months of this year, we returned more than $53 million to our shareholders, almost $42 million in dividends and another $11 million from the Board-approved share repurchase program. By allocating cash to strategic acquisitions and investment in our infrastructure, while also paying for dividends and repurchasing shares, we believe we are using a balanced approach to strengthen our foundation for future growth.

Before we take your questions, I would like to say a final word about our results this quarter. We saw sequential improvement in domestic operating margins, gross margin, and SG&A. We completed the Movianto acquisition, we signed new customers for our domestic and international 3PL services and we implemented a physician service model with two large IDN customers. Looking ahead, we will continue to maintain our focus on operating as efficiently as possible, while positioning ourselves for future growth. Thank you, and we would be happy to take your questions. Operator, you can open the line for questions.

(Operator Instructions)

Our first question in the phone queue comes from the line of Joel Ray with Davenport. Please go ahead, your line is open.

Could you possibly elaborate a little bit on the revenues that were generated in the quarter? They seemed to be a fair bit light, and you had mentioned not only volume but pricing. I was wondering if you could give us a little bit more detail on that? How much do you think was related to each component, where was this coming from, and so on. If anything has changed on the outlook on that effort.

I would be happy to. This is Jim Bierman. So as we commented, there were several factors at play this quarter. As we looked at the revenue for the third quarter of 2012, compared to the revenue for the third quarter of 2011. As Drew mentioned in his remarks, one of the factors in play was that there was one less sales day between the two periods. That being said, there were other factors that came into play. One was the fact that we have continued to see, and we mentioned this during last quarter's call, we continued to see softness in healthcare utilization in the United States. When you take the softness in utilization and you couple it with the lack of really any product price inflation, we are seeing results that are flatter than we were thinking a year ago when we talked in terms of our outlook for 2012.

Other factors in play were that last year in the third and also the fourth quarter, the Department of Defense, which is one of our top customers, had significant activity, and so the comparables between the third quarter of this year, fourth quarter this year and last year, as it relates to that particular customer, are high. And then the final point is, as is normal and customary, and you might expect, we are constantly looking and working with our suppliers and bringing on suppliers that haven't traditionally used distribution services, or whose line of product may not have gone through distribution services, and add them to the mix. But also, quite candidly, looking at opportunities where economically it doesn't make sense for us to continue to handle product, where we are not receiving fair financial consideration for the efforts we are putting forth. And again in this quarter, there was an impact with the decision that we made there that I mentioned. So those factors combined explain the variance that we saw in the third quarter, and as I said, I think we will see those factors in a similar fashion coming to play in the fourth quarter of this year.

And I presume that the culling of one or more suppliers is probably one of the key drivers to the improvement in gross margins?

It certainly would be a factor improving gross margin, particularly in instances where that supplier was virtually receiving the service for free. So no question about that, yes.

Okay, and you had mentioned you are in process with the Premier renewal. Could you update us as far as what you think the timing is on getting all of that pulled together?

Yes, I would think that by the time the year ends, or even really by the time we meet with the investor community at our investor day at the end of November, that we had a pretty good outlook as to what the sign-up impact may be as it relates to 2013.

Okay. And finally, with the addition of the 3PL capability in Europe, are we starting to see some cross-selling opportunity, bringing some of those products to the US also, in addition to the domestic organizations you are talking to, possibly shipping over there?

Let me hand it off to my colleague, Brian Shotto, to answer that.

The short answer to that is yes. It was certainly one of the things that we put some immediate resources on, to see if we can leverage work that's being done both here in the US and Europe. I look for commonality amongst the customer basis. And we have had some successes coming right out of the gate. Nothing that we're ready to announce today, but certainly some successes, and we anticipate that to continue going forward.

Very good, thank you very much.

Our next question comes from Evan Stover with Robert W. Baird.

This is Evan in for Eric. I just had a quick question on, a little point of clarification on the guidance. You had spoken to similar performance in the fourth quarter. I just wanted to clarify, is that on an absolute basis sequentially, or should we be thinking about similar year-over-year growth rates versus the prior year? Just wanted to clarify there?

Yes and not to parse technical terminology but really the comment had to do with our outlook for fourth-quarter operating results that would say that the results should be similar to what we reported this quarter. I think if one was to take my other comments relative to revenue, in the context, there I think it is more of a relative rather than absolute thought. And in large part because there is an additional sales day in the fourth quarter, when compared to the third quarter of this year. Yes.

Okay that's helpful. And as we think about Movianto, we have one month now of the business incorporated into the results. Obviously, understand the comment that we cannot take that business and run rate it, given the September month was a higher run-rate month. But as a step back and think about EUR300 million at the time of acquisition, call it $400 million, does that estimate still hold, or are you seeing anything in the first month that gives you a little more confidence that it will contribute at a higher level?

Well I'd like to answer that question, Evan, really from an earnings perspective. Our guidance for the impact of Movianto for the year is probably in the neighborhood of $0.15 a share, and that includes the acquisition-related costs. So a negative impact of $0.15 per year. As you look forward to 2013, consistent with what we said in the second quarter, we expect that to be neutral on earnings and then it to be accretive thereafter beginning in 2014.

All right, that's helpful. My final one. I think there were some comments to the effect that the US 3PL business last quarter was running at breakeven or just above. Can you verify that business -- did it achieve breakeven this quarter? And any other color on the trajectory there is helpful.

This is Drew again. It has achieved a breakeven level.

All right, thank you all. I'll step back in queue.

Our next question comes from the line of Robert Jones with Goldman Sachs. Please go ahead. One moment please. Your line is now open.

This is Stephan Stewart, calling in for Bob. I wanted to follow up on the fee-for-service businesses. It's still break even or achieved breakeven this quarter. How much did that contribute to the sequential improvement in gross margin?

This is Drew again. Stephan. And the contribution had a negative impact, not sequential, I'm talking year-over-year, of 14 basis points overall to gross margin.

Okay. And anything on sequential? I'm assuming given the relative change in revenue sequentially versus the rest of the distribution business, that there was some positive impact?

I don't have that calculation with me, Stephan, on a sequential basis of the impact.

Got it. And this is a follow-up on SG&A. A couple quarters of impressive cost control. How much benefit is there left out of the realignment you announced last fourth quarter, do you think, and is there further room to improve efficiency fee-for-service businesses? I guess moving forward is the 6.8% of revenue a good run rate to think about for your combined business ex-Movianto?

That's a great question and probably deserves a more fulsome answer that we can provide at investor day, as we think about 2013. But let me answer it directly now, with limited time. I think we are at near-record levels of performance, presently. So the challenge we have going forward is not lost on us. That being said, we also acknowledge that we've seen gross margin compression that exists, particularly as a result of the consolidation that's going on with our customers in the industry. So I think we are vigilantly looking for opportunities to continue to set the SG&A bar at record levels. And we think that we have some strategies and some tactics that will accomplish that, some of which we will share when we get together in November. But we think it's of paramount importance that we continue to demonstrate our ability to lead in the area of SG&A.

Great thanks, and one last follow-up if I may. On the $0.10 to $0.15 dilution from Movianto for this year's guidance, I know we got $0.10 in acquisition-related costs this quarter. Is there an estimate for acquisition-related costs next quarter?

Stephan, our estimate is that the overall adverse impact of Movianto for the year is probably going to be closer to $0.15. We already have $0.10 associated with acquisition-related that was in the third quarter, so the $0.15 would include the acquisition related for the whole year, as well as the impact of operating results.

Got it. Thanks for the questions, guys.

Thank you, sir. At this time there appears to be no additional questioners, and I like to turn the program back over to Mr. Smith for his closing remarks.

Thank you, Hughie. I know we are all struggling with Hurricane Sandy here in either personal or professional mode, in terms of taking care of our patients and taking care of the hospitals, and I know it's been very challenging in the Northeast, so I appreciate those of you who phoned in. I think we tried to put a lot of information in our comments, so I would encourage you as you go to the website, to review this to look at the comments. I think we went into more detail than we normally do, and we are looking forward to all seeing you at Investor Day at the end of November. Thank you.

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