Owens & Minor Inc (OMI) 2014 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Owens & Minor's first-quarter 2014 financial results conference call. My name is LaToya and I will be your operator for today.

(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, Chairman and Chief Executive Officer of Owens & Minor. Please proceed, sir.

Thank you, LaToya, and good morning, everyone. Welcome to the Owens & Minor first-quarter 2014 conference call. After I introduce my colleagues on the call today, we will review our results, and then take your questions.

Here with me this morning are Jim Bierman, our President and Chief Operating Officer; Randy Meier, our Chief Financial Officer; and Grace den Hartog, our General Counsel. So, before we begin, I'm going to ask Trudi Allcott, from our Investor Relations team, to read a Safe Harbor statement. Trudi?

Thank you, Craig. Our comments today will be focused on financial results for the first quarter of 2014, which are included in our press release. In our discussion today, we will reference certain non-GAAP financial measures. Information about these measures and reconciliation to GAAP financial measures are included in our press release and in the first-quarter supplemental slide presentation, both of which are posted on our website. Also, our call today will be archived on our website.

In the course of 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.

And, finally, during the first quarter we will be participating in the following healthcare conferences: Bank America Merrill Lynch; UBS; Jefferies; and Goldman Sachs. And, this week, we will hold our annual shareholders meeting at our home office, and we look forward to seeing you on the road.

Thank you. Craig?

Thank you, Trudi. I would like to call on Jim Bierman for an operational overview and a closer look at our Domestic results. Then, we'll turn it over to Randy to brief us on the financial results, and then he'll give us an update on our International segment. And then, finally, I'll have a few comments before we start to take your questions. Jim?

Thank you, Craig, and good morning, everyone. Last quarter, we outlined some of the investments we are making in our Domestic segment to address the changing needs of our US market. While we have not yet achieved all of the efficiencies planned for this year, we continue to make progress. And we are encouraged that our offerings are gaining traction in the marketplace.

For example, after redesigning our sales and service model to meet the needs of the larger, more sophisticated provider customers, we are seeing positive results as it relates to revenue growth and expansion of our service offerings, resulting in improved margin for these customers. Our strategy is being validated in the continuing growth in our larger customer accounts.

This quarter, we continued to see a trend we have been experiencing for some time. Revenues from the larger customer accounts grew nicely, while revenues with the smallest customers declined. As we mentioned last quarter, we have signed a very large for-profit healthcare system as a new customer, as a part of last year's GPO renewal cycle. We are now targeting the transition of the majority of this customer to begin in the third quarter of 2014. This is a somewhat-later start than we had originally anticipated, when we held our December Investor Day meeting.

As with all large customer conversions, we will incur a transition-related cost in advance of the new revenues coming on. Due to this customer conversion shifting to later in the year, we are carrying incremental costs in advance of the on-boarding process, thereby helping to ensure a smooth conversion for this significant account. We are very optimistic about the potential with this new customer, as they consist of both acute and non-acute points of care.

During the first quarter, our gross margin results reflect the customer profitability ranges consistent with our expectations at this time of the year. In addition, we continue to believe we will have opportunities to enhance customer profitability, as our relationships mature over the terms of these contracts. As for expenses this quarter, Domestic segment spending on a dollar basis -- and as a percent of revenues -- decreased when compared to the prior-year quarter. We continue to streamline and standardize our processes nationwide, which enables us to be more efficient in serving our customers.

During the quarter, we were affected somewhat by the severe winter weather in the United States, as we have seen with certain other healthcare companies. As a byproduct of the weather, we incurred expenses estimated to be in excess of $1 million due to greater transportation and overtime costs, which we absorbed on behalf of our provider customers.

As we discussed last quarter, there are three areas of focus in the Domestic segment for 2014. First, we continue to evolve our physical network to meet the changing needs of our provider and manufacturer customers. Now that we've established our first regional distribution center, we continue to work on other opportunities to optimize operations around the country.

The second area of focus is on technology. We are now in the third year of a three-year, $50-million investment plan. We continue to work on creating a single platform capable of serving both manufacturers and providers.

As for the third area of focus, we are expanding our capabilities in the marketplace to help our customers achieve efficiencies in the supply chains. As we have explained, we are using our centers for excellence to provide these services for our customers. We anticipate that the work they do today will help our customers reduce their expenses, while improving service to their patients.

We remain excited about our positioning in the marketplace as the only pure-play healthcare logistics company, and we look forward to driving change in our business, so that we are able to produce sustainable, profitable growth.

Thank you. And with that, I'll ask Randy to share his observations and insights. Randy?

Thanks, Jim, and good morning, everyone. As Craig indicated, I will provide an update on our financial results, but first I'd like to take a few moments to talk about our European operation. During the quarter, we decided to take the next step in our longer-term international strategy. We have created a small group of experienced Owens & Minor operations experts to form a leadership team in Europe.

This group is tasked with providing operational expertise to simplify, align, standardize process, and continue the integration of our European platform, while at the same time identifying future expansion growth opportunities in Europe. This structure will enable us to move quickly to optimize our existing platform, and to evaluate and integrate other expansion opportunities.

In the first quarter, the UK division experienced an acute challenge, with lower-than-expected activity from existing customers with -- and higher expenses resulting from on-boarding of a large new customer. We have already taken steps in the UK to get operations back on track, including adjustments to the management structure. And we are asking the Owens & Minor operations team to focus immediately on improving operations in the UK. Because this team is very experienced in our business, we believe it will be an invaluable as we grow our platform in Europe, develop new customer relations, and seek other opportunities for expansion.

With that, let's turn to the first-quarter results. Consolidated revenues in the first quarter was $2.26 billion, up slightly compared to the same period last year. This increase in quarterly revenues resulted primarily from strong business growth on a quarter-over-quarter basis in the International segment.

On a segment basis, first-quarter Domestic revenues were $2.15 billion, a slight decline when compared to last year. Domestic segment revenues were affected by ongoing market trends, including lower overall healthcare utilization rates. As Jim mentioned, we also continue to see revenue growth with our larger customers, and declines in our smaller customer accounts.

International segment revenues improved by approximately 17%. This increase was due primarily to the increase in fee-for-service revenues and the positive impact of foreign currency. As we have seen in past quarters, about two-thirds of Movianto's business is fee for service.

For the quarter, consolidated gross margins were approximately $281 million, or 12.46% of revenues. This is a $2-million improvement over last year. The improvement resulted primarily from an increase in the International segment gross margin of $11.4 million over the prior year, as a result of growth in the international fee-for-service business.

Offsetting this increase was a decline in our Domestic segment gross margin, due primarily to lower benefits from supplier price changing this quarter compared to last year's first quarter. Domestic results, as we had anticipated, also reflected lower margins on new and renewed contracts with healthcare provider customers.

As for the quarterly operating expenses, consolidated SG&A expenses were $225.6 million, or 10% of revenues. This is an increase of nearly $8 million, compared to last year at the same time. The comparative increase was driven by increased expenses in the International segment of approximately $10.6 million, primarily due to increased fee-for-service business, and the cost of on-boarding a new significant customer in the Movianto UK division. This increase was partially offset by lower domestic expenses, due to cost benefits derived from our ongoing strategic initiatives, as well as improvements in worker compensation claims experience.

During the quarter, we reported other operating income of $7.8 million. This included the recovery of $5.3 million from the settlement of a direct purchaser, anti-trust class-action lawsuit associated with the recovery of costs related to the purchase of certain medical devices.

Consolidated operating earnings -- adjusted for $3.3 million in acquisition-related and exit and realignment charges for the quarter -- were $49.5 million, or 2.2% of revenues, decreased only slightly when compared to the $49.9 million, or 2.22% of revenues, in the prior-year quarter. Quarterly results were affected by an operating loss of $3.2 million in the International segment. As I explained earlier, this operating loss was almost entirely related to our UK operation, which experienced reduced activity with certain existing customers, as well as greater on-boarding expenses to accommodate a significant new customer.

For the first quarter, Domestic segment operating earnings was $52.7 million, or 2.45% of segment revenues, and were affected by the factors outlined by Jim. As for the International segment, while our immediate focus is to bring the UK division back to profitability, we believe it is important to note that, if we were to exclude the results of the UK business, the broader network did produce an operating profit for the quarter. That said, we continue to focus on further improving the cost structure across the platform, while we work to optimize capacity in the network.

For the quarter, interest expense was $3.2 million, while our tax rate was 40.8% compared to last year's 41.6%, largely reflecting the impact of foreign taxes. For the first quarter, operating cash flow was $93 million, compared to $155 million for the same period last year. The Company continues to report strong consolidated asset management -- excuse me, metrics, such as DSOs of 20.5 days and inventory turns of 10.4 times.

So, for the first quarter of 2014, adjusted consolidated net income, excluding the after-tax charges of $2.2 million for the acquisition-related and exit and realignment activities, was $27.7 million, or $0.44 per diluted share. Included in these results was the previously mentioned pretax quarterly operating loss for the International segment of $3.2 million, as well as the positive contribution of the Domestic segment of $5.3 million that I have described.

Considering our first-quarter results and looking towards the rest of the year, our guidance for 2014 remains unchanged, with most of the upside coming in the second half of the year. As a reminder, we are targeting revenue growth of up to 2%, and adjusted net income per diluted share of $1.95 to $2.05 for the year, which excludes exit and realignment costs, as well as the acquisition-related costs.

While we recognize we have our work cut out for us in the coming months, we remain comfortable with our guidance for the year. Achieving further efficiencies in our network, on-boarding new domestic customers in the second half, and growing our business in Europe will all contribute to our ability to reach our goals this year.

Thank you. And with that, I'd like to turn the call back over to Craig.

Thank you, Randy, for the update on the quarter, and I would like to add a few thoughts. As I reflect on the first quarter, there are several positive points that I would like to point out. The first is that the total revenues improved in what continues to be a tough market. International sales were up strongly; consolidated gross margin improved; asset management, as always, was solid; operating cash flow continues to be positive, with more than $90 million for the quarter; and we are on-boarding significant new business this year, in both the Domestic and International platforms.

As for the challenges this quarter, we did see an increase in expenses, largely as a result of our International platform. On the Domestic side, I am pleased with the progress on expenses -- overall expenses. So, as we look at the year ahead, we see an opportunity with expense management, in particular with our International platform. While we experienced challenges in our UK operation throughout 2013, these issues were heightened in the first quarter due to the on-boarding of a new customer. Randy and I had the opportunity to travel to Europe in April to meet with the leadership team, and they are actively working to get the UK unit back on track.

We are also taking the next step in our strategic development by enhancing the Owens & Minor team in Europe. In fact, we have asked several of our most experienced operators to lead this effort, and they will relocate to Europe in the near term. This step will enable us to move more aggressively in building out the International platform, and identifying and capturing opportunities for future growth. As Randy said, obviously, their first assignment is to work with the UK team to reposition the division for profitable growth.

Turning to the Domestic front, as Jim said, we are working on a number of areas that will ensure a strong future for our Domestic business. During the quarter, the team did a great job in a tough environment, making progress on sales and managing expenses. We have identified the areas we need to focus on, and our teams are actively executing on our plans. All in all, we are encouraged by the revenue development in both segments, and we believe we are better positioned than ever before for growth.

I would also want to take a moment to thank all of our teammates that through a very tough -- a very tough quarter, from a weather standpoint from the West Coast to the East Coast -- every one of our teammates stepped up and made sure that deliveries were made, and that we didn't miss a beat on our service as we continue focusing on customer excellence, and making sure that our customers can operate during any tough times that they face.

And with that, we'd be happy to take your questions. Operator?

Thank you.

(Operator Instructions)

And our first question comes from Glen Santangelo of Credit Suisse. Your line is now open.

Yes, thanks, and good morning. Craig and Randy, just want to follow up on some of the comments that you made, with respect to gross margins. It kind of sounds like that you called out a number of things that impacted your profitability, whether it be supplier price changes, or renewing some of the contracts, or doing more business with bigger customers, which I traditionally think about having lower margin. But yet, your gross margins came in above your range. Now, even if I sort of back out the litigation settlement, you are still kind of at the upper end of the range. So maybe could you just give us a little bit of clarity, in terms of what you are thinking about in gross margins, relative to that initial guidance that you provided at Analyst Day?

Sure, Glen. I think overall, when we look at our gross margins, I think where we came in at 12.46% is largely a function of just the continued evolution of our international business, and the impact it's having on the overall gross margin. We still feel fairly comfortable where the modeling guidance was. As you know, back on Investor Day, Jim indicated we would be onboarding a number of larger customers throughout this year, which will have a little bit of an impact on the overall gross margin as we move through. So I think really just seeing some seasonality with sort of the balance between our international margins and our domestic margins.

Randy, just to follow-up on that guidance a bit more. I mean, obviously, you had a $0.05 benefit this quarter from the litigation settlement. Was that part of your original thinking with respect your guidance or is that new?

Well, we always model out a variety of opportunities that we may have on other incomes. And while this one was not part of the overall forecast, this is part of our longer-term operating strategy to pursue a lot of these recoveries. Our General Counsel's office certainly has been doing during this over the last decade or so. So as we see some of these things that we have had historically, a little bit of volatility in our other operating income, and I would expect that to continue. But all in all, we just called this out because of the magnitude of it in terms of materiality. But we consider this part of our normal operating performance.

Maybe if I could just squeeze one last one in. When I look at the quarter, and the $0.44 reported, if I were to back out that -- the settlement for a second, it looks like you earned about $0.39 from operations. Which kind of looks like it steepens in the ramp as we head to the back half of the year to make your full-year numbers then. Randy, in your prepared remarks, you seem to suggest that we are expecting a lift in the second half. I wonder if you could elaborate a little bit more on what those primary drivers will be in the second half, to kind of get you to the range for the full year?

Hello, Glen, this is Jim Bierman. Yes, I think as we reflect on the story for 2014, we definitely have several opportunities that will come to fruition in the second half of the year. The big one internationally is the rationalization of resources to align with the business in the UK, and then furthermore the servicing of the larger customer that Randy referred to that is coming on in the UK.

In the United States, it really revolves around onboarding a very large customer in the second half of the year, and the opportunities to then rationalize resources aligned with the business that comes on. So, I think you're right, it is a second half of the year story. I think when we, where with everyone and talking about 2014 initially in the December time frame at our Investor Day in New York, it was our expectation that these events would be more staged throughout the year, and maybe a little more front-end loaded. But as things are evolving, clearly they're going to compress into the second half of the year.

Okay, Jim. Thanks for those comments.

Thank you. And the next question is from Robert Willoughby of Bank of America. Your line is open.

Just to follow on with Glen's question on the EPS ramp. I am not sure how you are actually thinking about the international profit ramp. On the bigger revenue base, do you swing the profitability in the second quarter, or is that, to Jim's comments, more the back half phenomena?

I think as we look at our international business, we would expect again for the full year to be solidly profitable for the year. Certainly, the loss in the first quarter is almost entirely due to the operating shortfall in the UK. The balance of the network was solidly profitable. We think, as we successfully onboard this customer and continue to onboard other customers throughout the year, that we will swing to a profitable year.

Okay. Perfect. And just could you flesh out anecdotally in the UK, you characterized a reduced level of activity, but what products aren't going out the door that you might have expected to happen? What exactly is the weakness around?

Well, as you may recall, we operate more of a 3PL business. So it is not our products, it is our customers' product and their activity. Broadly speaking, we had a few customers that just experienced some softness in the first quarter. So the level of activity going through our warehouses was down slightly sequentially.

The other areas that we have, was just the onboarding of this particular large customer, that was a little bit more complex than we anticipated, so it required some incremental expenses throughout that period. Both of those incidences, we feel comfortable have begun to turn themselves around in the second quarter, and should see some benefits in the second half of the year.

So, I guess, Randy, the question is more, were -- what kind of products were these? Were these band-aids or were they some higher tech products? I mean, how would you characterize the softness?

Sure. Most of the products that we -- pass through our warehouse are pharmaceutical in nature.

Okay. So it was a drug use. Okay, perfect. Thank you. (Multiple speakers).

Yes, Bob, this is Craig. It was really in particular to two manufacturers that just had a slow quarter. And as we have also said, historically in this business the first quarter is all little bit slower, and has a tendency to ramp up to the flu season towards the end of the year. But in retrospect, it was two manufacturers that were a little light on the pallets in and pallets out, primarily pharmaceutical.

Perfect. Thank you.

Thank you. And the next question comes from Lisa Gill of JPMorgan. Your line is open. Lisa, please check to see if your line is on mute. Okay. We will take our next question from Robert Jones of Goldman Sachs. Your line is open.

Thanks. So just going to the domestic side, domestic segment operating profit and margin in the quarter were down compared to the first quarter last year, if you adjust out the one-time settlement that you called out. I know you called out areas, Craig, that you sounded like you were pleased with on the expense control side, yet operating margins were down. Can you talk about how gross margin in the domestic business is tracking compared to your expectations?

Sure, Robert. This is Jim Bierman again. Let me start by saying that, I think when one looks at the first quarter of 2013, we had always known that we had a difficult comp when -- as we went into this quarter. So last year saw the benefit of manufacturer price changes that impacted the quarter. And so on a dollar basis, we are down domestically gross margin year-over-year about $9.3 million, and the vast majority of that relates to manufacturer price increases.

When you relate that though to our expectations and our thinking for the first quarter of this year, obviously we were able to factor that into our thinking. And the gap between where we end up in the first quarter of 2014, and sort of the amounts we were targeting, is really quite small. If I had to summarize where the areas are that we will remain focused on for the remainder of 2014, a little bit of softness on the manufacturer services revenue is what we saw. And in terms of complexity of the ability to close a gap, that is one of the areas that -- none of it is easy, but that's one of the areas that a little bit more within our control to try to fix in the shorter-term.

Okay. Got it. And then, I guess, just a bigger picture question, the revenue from larger customers, you described it as growing faster than smaller, I think, as a phenomenon, you know, we've seen going on for some time right now. I was just -- and clearly, it does seem like it has a drag on profitability in this mix shift. Can you maybe just talk about where we are in your mind, as far as this transition or this mix shift from the medium to smaller customer provider base towards the larger IDN base?

Yes, that is a great question, Robert, and we have spent a fair amount of time posing that ourselves. I think, again, within expectations, and what we were targeting for the quarter as we reflected on all of 2014 -- we, because of the timing of the new business that we will be bringing on, we actually generated more revenue in the first quarter of 2014 than we were targeting. So in that sense, we were pleased, very pleased. It is down a relatively small amount from the prior year, but it is ahead of where we were targeting.

When we look at where in our components of our targets we were off, and therefore the good news, the fact that the big continue to get bigger and -- is again the phenomenon that we are experiencing, and we underestimated their growth in our projections, and how we thought about the quarter, which is all good. When this begins to level out and we get a little better feel for this, the ability to predict this -- I am not sure if that is ever going to occur. I think this is a transformation within the healthcare industry, and I think your guess is as good as mine as to sort of how it plays out in total. We do think, though, that we have placed the resources in the appropriate -- with the appropriate customers, and we are constantly being validated in the marketplace that is in fact the case.

Got it. Appreciate your thoughts, Jim.

Thank you. And the next question is from Lisa Gill of JPMorgan. Your line is open.

Hello. It is Gavin Weiss. Sorry for the silence earlier. We were having some technical issues on my end.

I apologize if this has been asked already, but in terms of your large new customer now coming on later in the year than you had originally anticipated, and keeping the revenue outlook the same, are there any tailwinds that may be helping you to achieve that 2% target? Are you seeing any benefit from ACA-related volumes?

No, Gavin, I wouldn't characterize it as being ACA-driven. I think it really ties pretty directly into the question Robert asked, which was, it is a function of our larger customers growing at a rate that is faster than we had originally projected.

Okay. And then in the past, you have talked about the opportunity with medical device manufacturers. Have you seen any increased level there, and is that something that you think will benefit 2014?

We hope it benefits 2014 to some degree. But we have seen a significant amount of interest in our offerings, and how we might help the medical device manufacturers reduce costs, and really improve the service within the four walls of the hospital. So again, we are encouraged by the level of activity and discussions that are going on. But at this point, the amount of revenue or margin that is being created is relatively small.

Okay. Thank you very much. That's helpful.

Thank you. And the next question is from David Larson of Leerink. Your line is open.

Hello. With respect to the international operations, can you give us a sense for what those costs were for that large customer you were bringing on board? Was it $1 million, $2 million, can you give us some sense?

The onboarding costs were approximately about $1.5 million in the first quarter.

Okay.

And we expect that to continue somewhat early in the second quarter, and diminish as we get late in the quarter, and then into the third quarter.

Okay. And then, the international revenue actually I think looked pretty good. It was a pretty good sequential increase there. Was it just sort of a mix shift that caused the operating loss, and what portion of that business is UK-related? Thanks.

I think we saw a pretty nice increase throughout the network in the first quarter, when you look year-over-year. We had a couple of new customers come onboard in the first quarter. Most of the costs, though, related to the loss was the UK-based costs. But a lot of the revenue was fairly evenly spread throughout the network.

We onboarded the large customer in the UK effective March 1. So while we had pretty much a full quarter of costs associated with that customer, we really only had about 30 days of revenue, as it came up to speed. So again, we think that will have a very different perspective in the second quarter. But otherwise, we saw some nice balanced revenue growth throughout the network.

Okay. Great. Thanks very much.

(Operator Instructions)

The next question is from Steven Valiquette of UBS. Your line is open.

Thanks, and good morning. Also a couple questions on the international. I guess, I am just curious, you did a pretty good job explaining some of the things that happened in the first quarter, but I guess in a normal year going forward, is there any seasonality in this business, or should we assume that the profitability in this business generally speaking, will be fairly consistent across the four quarters of the given calendar year?

Nice question, Steve. As we have indicated in the past, there is a certain amount of seasonality in both the business that we operate in, due to the flu season that Craig alluded to earlier, so that is kind of an end of the third quarter, fourth quarter event, and then the normal seasonality of Europe that usually sees softness in the first and third quarters, and we would expect that to continue throughout this year. Offsetting some of that though, we do expect as we continue to improve capacity utilization year-over-year, we will start to see the benefit of that, as we get into the second half of the year.

Okay. And also I guess, near-term, should we expect that as you onboard additional customers, that there always could be a little bit of lumpiness in the earnings as well, until the business gets more mature? That we -- unfortunately the start-up costs to reach a new customer might be material enough to kind of cause some of these swings? Just curious to get your thoughts around those start-up costs for future customers?

That is actually a great question, and it really depends on the nature of the customer, and the nature of the service that we are providing. This particular customer in the UK is a fairly complex customer, one that involves a lot of deliveries to local customers. And so, as part of that I think, we just -- our own team over there underestimated some of the integration hurdles that we would have and the complexity of that particular customer.

On the flip side of that, another customer that we onboarded in the first quarter was more of a buy-sell in nature, and had very low costs coming in, and actually could onboard within about 30 days. So it really depends on the nature of the business, what services we are providing, and the related complexity of the services to the end markets.

Okay. Got it. Okay. Thanks.

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

Thank you, LaToya. And I want to thank everybody for listening in this morning, and for their questions. And as you can tell, we are going to be out talking to a lot of folks over the next several months. So we are looking forward to seeing you, hopefully over the next quarter or two. And if you have any questions, we will answer them at the different meetings. But I appreciate your participation today. Thank you.

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