Owens & Minor Inc (OMI) 2014 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Owens & Minor's fourth-quarter and full-year 2014 financial results conference call. My name is Samantha and I will be the 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. James Bierman, President and Chief Executive Officer of Owens & Minor. Please proceed, sir.

Thank you, Samantha. Good morning, everyone. Welcome to the Owens & Minor fourth-quarter and full-year 2014 financial results conference call.

With me this morning are Randy Meier, our Chief Financial Officer; and Grace den Hartog, our General Counsel. This morning Randy will review our financial results and I will then provide some observations on 2014 and the year to come. But before we begin, Trudi Allcott will read a Safe Harbor statement. Trudi?

Thank you, Jim. Our comments today will be focused on financial results for the fourth-quarter and full-year 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 reconciliations to GAAP financial measures are included in the press release and in the 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.

Finally, we will be participating in the 2015 Barclays Capital Global Healthcare Conference in Miami on March 11. Thank you. Jim?

Thanks, Trudi. I'd like to call on Randy Meier for his presentation of the financial results. Randy?

Thank you, Jim, and good morning everyone. I'd like to use my time this morning to review the fourth-quarter and full-year results for 2014 and to bring you up to speed on our operations in Europe. As we think about the year, please remember that we completed the acquisitions of Medical Action and ArcRoyal in the fourth quarter.

Let's start with revenues. Fourth-quarter consolidated revenues improved 7.5% to $2.49 billion when compared to last year. The quarterly improvement was driven by solid growth of 6.3% in our Domestic segment and growth of 32% in our International segment.

For the full year, consolidated revenues increased 4.1% to $9.44 billion. The International segment grew 27% while the Domestic segment revenue increased by 3%.

Domestic revenue gains resulted largely from the growth of our large customers as well as one quarter's contribution from Medical Action. In the International segment, revenue growth benefited from gains in the UK and the Netherlands, as well as two months of revenue contributions from ArcRoyal. Excluding the impact of foreign exchange, the International segment revenue increased 24% compared to the prior year.

Turning to operating earnings. Consolidated fourth-quarter operating earnings were $40.8 million. On an adjusted basis, quarterly operating earnings improved slightly to $59 million, or 2.37% of revenues.

Included in our press release is a reconciliation of the items that were excluded to arrive at our adjusted earnings results. Of the $18 million in pretax exclusions, I'd like to touch on a few items that were either unique or were represented in the progress we made during the quarter.

We recorded a gain of $6.7 million in other operating income that resulted from a fair value adjustment related to the 2012 Movianto acquisition. This gain was partially offset by the incremental charge of a cost of goods sold of $3 million, which related to the sale of inventory acquired from the two fourth-quarter acquisitions.

We also recorded a loss of $3.9 million in other operating income related to the accrual for the proposed settlement of a breach of contract claim asserted by a UK customer. This proposed settlement, which would include termination of the existing contract, would resolve all outstanding issues with this customer.

In addition, three significant items specific to the International segment were included in the exit and realignment charges for the quarter. These were as follows: severance payments for several executives, the termination of a warehouse lease in the UK and the acceleration of the amortization of certain information systems in the UK which are being replaced. A full discussion of these pretax items is included in our press release financial tables.

For the full year, consolidated operating earnings were $160 million, and adjusted operating earnings were $203 million or 2.15% of revenues, a decline of $8 million compared to the prior year before. The adjustments to these annual results of $43 million are fully described in our press release.

On a segment basis, quarterly Domestic segment operating earnings improved slightly to more than $57 million. The quarterly improvement was derived primarily from revenue growth.

For the year, Domestic segment operating earnings were $209 million, or 2.34% of segment revenues, representing a decline of $2.7 million compared to the prior year. The decline resulted primarily from lower margins on new and renewed customer contracts in 2014 and higher SG&A costs to support sales growth. And while the Domestic segment benefited from $5.3 million settlement of a direct purchaser antitrust class action lawsuit, this benefit was largely offset by increased legal bills for ongoing litigation.

As for the International segment, quarterly operating earnings were positive at $1.5 million, improved slightly over the same period last year. For the year, International segment operating losses were $6.7 million compared to the loss of $1.4 million in the prior year. Factors affecting performance in the International segment consisted of items we discussed last quarter, including lost business in the UK and expenses associated with on-boarding a large customer in the UK, both of which occurred early in 2014.

However, I'm pleased to report that a number of our European operating units, including Germany, France and Spain, achieved improvement in business growth and expense reductions. And while performance in the UK fell short of our expectations, the team achieved sequential improvements in revenue and expense control and they are recognizing the benefits of a significantly streamlined management and cost structure.

As for the ArcRoyal acquisition, the team is highly effective and very eager to integrate with Owens & Minor and our logistics platform, as well as our consolidated global sourcing efforts. All in all, we are very pleased and excited about the potential of this new business combination and about the efforts of our teams across Europe. We are focused intently on achieving our goals and together we are making progress on a variety of fronts.

Now turning back to consolidated results. Depreciation and amortization was $16 million for the quarter, and $57 million for the year. The quarterly increase resulted primarily from the assets acquired from Medical Action and ArcRoyal.

Interest expense was $7.3 million for the quarter and $18 million for the year. The increased interest expense resulted from the new senior notes issued in September.

The effective tax rate was 58% for the fourth quarter and 47% for the year, reflecting the impact of foreign taxes and certain non-deductible acquisition-related costs. However, the effective tax rate for the quarter and the year on an adjusted net income was 40.3%.

As for operating cash flow, we used $3.8 million in cash from operations in 2014 compared to cash provided by operations of $141 million in the prior year. The timing of vendor payments and increased inventory and receivables required to support solid domestic sales growth contributed to the increase in net working capital for the year.

On a consolidated basis, asset management metrics were fairly stable throughout the year, including DSOs of 22.1 and inventory turns of 10.1 times. Turning to our bottom line, fourth-quarter adjusted net income was $30.9 million, or $0.49 per diluted share compared to $0.52 for the prior-year period. For the full year, adjusted net income was $110 million or $1.76 per diluted share, compared with $1.90 for the prior year.

Finally, recapping our financial guidance for 2015, which we originally discussed at our December Investor Day, the Company is targeting adjusted net income per diluted share of $1.90 to $1.95, which is consistent with our stated goal of 10% EPS growth for 2015.

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

Thank you, Randy. This morning I'd like to reflect on our performance in 2014, the investments we made last year, and the progress we made towards our goals. From there, I'll share a few thoughts on how these accomplishments have positioned us for success in the coming year and then we'll take your questions.

Five years ago, we embarked on a strategic path, leading us to invest in certain key areas, including network automation, new capabilities and technology, and the expansion of our service offerings to manufacturers. In 2014 we continued on this path, making investments in our network in key areas of the United States and Europe.

We now have more than 60 logistic centers located in more than 15 countries, from which over 8,000 teammates serve our customers. Our ability to influence the healthcare supply chain has never been greater.

Last year we continued to build out our service portfolios for both providers and manufacturers, acquiring two kitting companies, Medical Action in the United States and ArcRoyal in Europe. Combined with our existing packaging services, we now support more than 4 million surgical procedures annually. With new capabilities and expanded geographic reach, we occupy a one-of-a-kind position in healthcare logistics services, where we can manage the supply chain all the way from the manufacturer to the patient.

The investments we made over the last year are producing results. Our regional distribution center in Chicago is operational, enabling us to more efficiently leverage our network.

In 2014, we began the work of establishing our new Southern California regional distribution center. We are pleased to report that in January we brought this California facility online. Throughout last year, we made additional enhancements to our domestic network by expanding and modernizing our capabilities in areas such as Cleveland, Memphis and Boston.

During 2014, we on-boarded a large national IDN in the second half of the year, a substantial project that involved many of our facilities and teammates. As we move forward this year, we continue to refine and grow this important customer relationship.

As we have said, we will continue to seek affiliations with the innovative IDNs in healthcare. These are the institutions that are seeking strategic partnerships aimed at achieving real supply chain improvement.

As we look ahead, we recognize that we provide the greatest value to the customers that seek the advanced supply chain management services that we offer. These customers, both the providers and manufacturers, will choose to partner closely with Owens & Minor to achieve an improved supply chain function, and will rely on us to contribute the solutions, the talent and the techniques that achieve sustainable results.

Last year we saw manufacturer consolidation in the market. But even as that occurs, we continue to see significant interest from manufacturers who want to leverage our global logistics network.

Also last year, we made significant changes in Europe that were designed to streamline management and operations. We invested in our UK operations even as we managed through customer losses and working through the resolution of a challenging new customer. We restructured the operations and replaced the management team and collectively we're working to bring the UK to profitability.

In Europe, our existing and prospective customers span a range of healthcare manufacturers, who are seeking a diverse array of logistics services. We are pleased with the increasing interest in our European logistics platform, and in the coming year we're focused on achieving sustainable profitability.

In 2014, we focused on investments that we believe would support our progress along the strategic path that we embarked upon several years ago. Looking ahead at 2015, we see this as a year focused on the execution of our strategic vision as we leverage the series of investments we've made in recent years.

We are very pleased that the new teammates from ArcRoyal and Medical Action are excited about the opportunities they see in our new combination. We welcome their energy and their enthusiasm as we leverage their expertise to add depth to our healthcare market offerings.

We remain excited about the potential that our new packaging services will offer to our healthcare customers. In 2015, we will continue integrating the acquisitions and achieving the cost synergies we targeted for the year.

Let me take a brief moment to comment about the status of our management succession plan. Craig Smith and I have long recognized the value of succession planning as part of good corporate governance.

In reflecting on my own retirement horizon, I realized it would be appropriate to formally initiate the succession planning process to ensure a seamless and advantageous search for Owens & Minor. I asked the Board to commence a search for my successor even though there is no specific timetable for its conclusion. I am prepared to continue to serve the Company as CEO and fully support the Company's goals as we embark on this succession process.

In summary, I believe strongly that the strategy and the investments we've made over the last five years are being validated in the marketplace today. With our organizational realignment and significant investments in place, I truly believe we are well positioned for sustainable and profitable growth.

Thank you, and with that, I will now take your questions. Samantha?

(Operator Instructions)

Our first question is from Lisa Gill with JPMorgan. Your line is open.

Hi, it's actually Gavin Weiss in for Lisa. First, Jim, obviously we'll be sorry to see you go, but glad you'll be around while this process is going on.

And I just wanted to touch on Medical Action and ArcRoyal. You've had these both for several months now. Can you talk about the performance relative to your expectations?

And, Randy, can you talk about the performance in ArcRoyal in the International segment? We saw profitability improve there. What was from ArcRoyal versus the core business?

Let me start, Gavin, and thank you for your kind comments. Let me start with just an overview of how these two entities are transitioning into the Owens & Minor family.

I think that the first 90 days the of transition, as we all know, are really the critical ones as to the ability to begin momentum around a new relationship. And I think all of us feel very good about the transition efforts, in both Ireland and then here in the United States, with both of these new entities.

Our existing teammates have gone out of their way to help ease that transition. I think the marketplace reaction to our offering, and it's in the beginning stages, I don't want to overstate this. But the marketplace reaction has truly been overwhelming.

We think the offering that we have is differentiated. We think it's well positioned. And we think that these two assets, by leveraging our sales force and our broader capabilities, we will be able to optimize these assets over time.

Now, that being said, there's a thousand things to do sequentially and we're working our way through it. But I can clearly say both strategically and operationally, we're on schedule and proceeding as we had expected. Randy?

Hi, Gavin. I'd echo Jim's -- all the things that Jim said. I think we're well on our way with the integration of Medical Action, as well as ArcRoyal.

With regard to ArcRoyal's contribution in the fourth quarter, it was fairly negligible. It's a fairly small business, relative to the broader size of the consolidated entity, even as well as the European operation. And we only had about two months of contribution go through the income statement.

However, I would point out aligning the teams over there, the focus on our manufacturing customers and the influence that ArcRoyal has brought with their customer relationships on the medical device and medical technology side has reinvigorated an already energized team over there to continue to grow and expand their business. So I think as Jim indicated, we're seeing some nice successes early on but we still have a lot of work to do.

Okay. Another one for you, Randy. I may have missed this in your prepared comments, but obviously the cash flow trends were a little bit different in 2014. How should I think about cash from operations in 2015? Will that be returning to a more normalized rate?

I couldn't have characterized it better. I think we have every expectation that we'll be back on our normalized trend of the last few years. We closed out the year with the significant revenue growth that we saw in the fourth quarter.

We had some significant changes in terms of some inventory builds, receivables with the increased business. And certainly continue to take advantage on our payable side of some of the benefits of continuing to pay on time.

But that all resulted in some timing issues near the end, so we ended up with a bit of a use of cash. I think this was more of an anomaly and we would expect to be back on track as we go into 2015.

Okay, thank you very much.

Thank you. Our next question comes from Glen Santangelo with Credit Suisse. Your line is open.

Thanks and good morning. Just two quick questions, if I could. First on the revenue growth, it seemed like in the US 6.3% was a nice number, and even 4.5% if you exclude Medical Action.

But Jim, in your prepared remarks you talked about the on-boarding of the large IDN in the second half. Could you give us a sense for what revenue growth might have looked like ex that customer? I'm really trying to get a sense for where organic revenues are at this point.

Yes, Glen, great question. Don't have the specific number right in front of me, but I can give you directionally. Fundamentally, what we saw in the latter two quarters of 2014 was an increase in utilization, at least in our customer base, that created a same-store sales kind -- think of it in those terms -- same-store sales kind of a lift that was probably, I would estimate, 100 to 200 basis points better than we have seen for a good number of quarters. So that's generally directionally what we saw.

And I think as you reflect on the outlook that Randy and I both had at the Investor Day and our outlook for 2015, that was a pretty pivotal point in time to decide whether or not that trend was an anomaly of just one or two quarters, or it was something that we thought had a degree of consistency to it. And we spoke in terms of our outlook for 2015 seeing that continue.

I think the fourth quarter results validated that early call. We'll see how the rest of 2015 goes.

If that's the case, then Jim, maybe you feel comfortable with that 3% to 5% revenue growth range that you have out there, given the acquisitions. And maybe a slight uptick in the market makes you feel pretty confident with that range. Is that fair?

Well, we're sitting here in February and I think we're all appropriately cautious. But, yes, I think as we sit here today, we feel pretty good about the conversations we had with you all in December, which set the outlook for 2015.

Maybe if I just followed one last question for Randy on the margin side. Randy, I'm looking at the margin guidance that you provided at Analyst Day and it seems like, given the results that you had for the full year of 2014, you're modeling gross margin expansion and flat SG&A, which is a little surprising, given that you brought on this large IDN customer.

Is that uptick in gross margin something organic? Or maybe being driven by the acquisitions? Because traditionally when I think about Owens & Minor, it's obviously a lot harder to grow your gross margin and a lot easier to reduce that SG&A, due to the leverage. So if you help us think about that dynamic, that would be great.

Sure, Glen. I think the one thing that I would remind everyone is the guidance that we gave was on a consolidated basis. And as we continue to improve our business outside the United States, given it's predominantly a fee-for-service business, you're going to certainly see an impact and a continued expansion of our gross profit margin.

So I think as we continue to look at our domestic business, we continue to pursue more fee-for-service business as well. So I think you can't look at it in the context of two, three years ago, of purely the distribution business and relate that in a linear fashion to our gross profit margin. And again, looking back at our guidance, we feel very comfortable with where we sit this year, even though it is February, with our top line projections and continuing to see some nice expansion in our gross profit margin.

Okay, thanks very much.

Thank you. Our next question comes from Sean Dodge with Jefferies. Your line is open.

Thanks, good morning, Jim. Congratulations and good luck.

Thank you, Sean.

Can you start by talking a little bit more about the bounds of the successor search. Are you looking both internally and externally? What kind of candidate are you targeting? Is there a certain type of experience or professional background you're specifically looking for?

Yes, Sean, I think some of that probably isn't appropriate for this kind of forum. But let me talk a little broader, if I could, for just a minute on this.

I think if you put the whole succession issue in context, the Company has been working through succession planning for well over three years now, and it's been a series of events. It began with Gil Minor handing over Chairmanship of the Board of Directors to Craig. And it then moved on to Craig handing over the CEO role to me.

And if you look at it within that time frame and those components, this is a natural next step. One could say more than likely the last next step of the process.

I think in each of these moves the transition's been handled thoughtfully, carefully, and quite prudently. And I think as we look into this next move, that was the motivation behind initiating and disclosing what we were going forth with.

One of the reasons to disclose now is to ensure that the search is broad enough and transparent enough that we don't accidentally miss candidates that could be potentially a perfect fit. So I think by going public the way we have, and we will look at some internal candidates, but Heidrick & Struggles has been engaged and they will conduct the search on a broad scale.

I think that assures the investor community, as well as the teammates here, that it's a very thoughtful and prudent process. I have great comfort and confidence in the search committee of the Board of Directors as we embark upon this.

Okay, makes sense, thanks. Randy, you brought the International segment back to profitability in the fourth quarter, so congratulations on that.

Is the focus now going forward more of a cost one? Or there are still more that need to be taken out? Or is consistent profitability going forward more a function of continue to push revenue higher?

I think as we look at our international business, there's a couple of things that come to mind to remind folks. We still have a bit of a seasonal business over there where you have a somewhat stronger fourth quarter. And as typical in Europe, we began the year with a little bit softer projections.

But I think a lot of what I'd characterize as the real heavy lifting is behind us in Europe. And I think looking at our exit and realignment and the significance of the charges in the third and the fourth quarter would be indicative of that.

Going forward, I think we've got an opportunity with some of the initiatives to continue to expand the business and add to the top line. But as is customary here at Owens & Minor, we are going to watch the cost side of the fence very intently. And if we need to take incremental steps to ensure profitability going forward, we'll certainly do that.

So I'd say we're probably back to a little bit of a more normal operating pattern there. And certainly it goes without saying that we're going to watch the cost side, and if we begin to be short, we'll take the necessary actions to keep moving in the right direction. But a lot of focus is being made on what we're going to do to continue to expand the platform, work with global customers, and continue to pursue the strategic initiatives that Jim and Craig have outlined as they added the international side of our business.

Very good, thanks again.

Thanks, Sean.

Thank you. Our next question comes from Steven Valiquette with UBS. Your line is open.

Thanks, good morning.

Good morning.

So also Jim, congrats on the upcoming retirement. I think unfortunately the tough question that we're still getting from some investors is why announce this so shortly after getting the CEO position? It's been asked a little bit, but any additional color? I think investors want to make sure nothing else has changed operationally within the Company to prompt this. Then I have just one follow-up afterwards.

Yes, so I was trying to stay away from this one part, but the reality is I'm 62 years old and the Company needs to have someone with a horizon, a runway that's longer than that. And there's nothing more to this than that as an issue. I think if my runway was longer, this wouldn't even be a factor.

I have nothing but true love for the Company, for the teammates that work with us at Owens & Minor. And I feel strongly about how we are positioned in the marketplace and positioned for success.

And I truly believe that as we are positioned for success, that it's a time like now that is the best time to begin to bring a successor on in order to ensure that continuity of strategy and management. So I truly believe it's for the good of the Company that we do this at this particular point.

Okay. And just a couple of quick financials for Randy. The interest expense of $7 million in the quarter, it was a little messy to try to sort through all the one-time charges. But is that a little higher than what the quarterly run rate will be for interest expense going forward? Or is that the actual run rate to use now going forward?

Yes, I think that may be slightly higher than it would be, given some of the interim borrowings that we did as we started to see some upside in the top-line growth. But I think generally speaking, with the recapitalization that we did at the end of the third quarter, you're going to see higher interest rates going -- or higher interest expense going forward.

Okay. Then quickly, the ArcRoyal acquisition, would you guys disclose the approximate revenue run rate of those acquired assets? Just to help us out a little bit for modeling purposes?

I'd have to go back and look. I know we didn't disclose a significant amount of financial information. It is a much smaller entity than Medical Action.

I think when we looked at it there was some technical expertise that they brought to the table and a service model that we thought was very leverageable going forward. So it's a fairly modest business.

In general, the run rate that they brought to the table in dollar terms was probably about $65 million a year on an annualized basis. So that just gives you some color on it.

Okay, perfect, thanks.

Thank you.

(Operator Instructions)

And I am showing no further questions at this time. I'll turn the call back over to Mr. Bierman for his closing remarks.

Thank you, Samantha. And thank you all for taking time to listen to our earnings call. We appreciate and value your interest in Owens & Minor. Have a good day.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.