Owens & Minor Inc (OMI) 2016 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Owens & Minor third-quarter 2016 financial results conference call. My name is Kevin 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, Ms. Trudi Allcott. You may proceed

Thank you, operator. Good morning, everyone, and welcome to the Owens & Minor third-quarter 2016 earnings call. I am Trudi Allcott and on behalf of the team I would like to read a Safe Harbor statement before we begin.

Our comments today will be focused on financial results for the third quarter 2016 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 also included in our press release and in the supplemental information posted 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.

Participating on our call this morning are Cody Phipps, our President and CEO, who will provide an overview of the business and the progress we are making on our transformation initiatives; Randy Meier, Executive Vice President and Chief Financial Officer and President of International, who will give an update on our results and insight into the performance of our three segments; and Nick Pace, our General Counsel, is also on the call today.

Now I'd like to turn the call over to Cody Phipps, our President and CEO, who will start things off this morning. Cody?

Thank you, Trudi, and good morning, everyone; thank you for joining us on the call today. As you saw in our earnings announcement yesterday, we achieve solid earnings per share for the quarter and the year-to-date period. We made progress on a number of fronts across the enterprise.

We successfully managed the exit of the large customer that we mentioned earlier in the year. Due to the size of this customer we knew that this would be a challenging transition for our business. Our teams have done a good job working through this transition and we will continue to take steps to adjust our cost structure.

During the quarter the International segment had another profitable quarter helping us to shift our focus to growing revenues and engaging in strategic discussions with a number of important new customers.

On the leadership front we onboarded our new Chief Information Officer, Steve Olive. He joins us from Philips, a $33 billion global company, where he most recently served as their Global CIO in Amsterdam leading an IT organization across 100 countries.

Steve is a strategic thinker who has solid experience in business transformations both in the US and abroad. Steve has already impressed us with his energy and vision for the future and he and his team will play in an increasingly important role in our go-forward strategies.

Finally during the quarter our teams made continued progress in managing costs and improving productivity, staying focused on delivering our plan and helping us to strengthen our foundation for the future.

Now I would like to spend a few moments on our new enterprise strategy. Our provider customers continue to experience significant cost pressures driven by new reimbursement guidelines which are increasingly linked to patient outcomes. This evolving healthcare model is also changing the competitive dynamics in our industry.

While the progress we have made in managing costs and improving efficiency is helping to drive positive results, these actions alone are not enough. We will have to take bolder steps to reposition Owens & Minor for the future.

To address this changing market we've been developing future strategies for long-term success and we are near the end of that planning process. Our management team and Board have aligned on our new strategy and we are starting to take action in some areas while we continue to refine our detailed execution plans. We will spend more time on our new strategy at our Investor Day in February, but I would like to introduce the components at a high level today.

Building on our legacy as a leading logistics player, we are evolving into a global healthcare services company. In this role we will connect the world of medical products to the point of care, attack complexity and unlock efficiency at every step of the healthcare value chain and become the indispensable partner for both manufacturers and providers delivering exceptional value.

To accomplish this, our new strategy has three key elements: one, strengthen our core logistics platform; two, unlock new growth platforms; and three, transform to accelerate our move into services.

As for strengthening our core, our industry is at a crossroads with unprecedented cost pressures and rising complexities. The healthcare industry is behind almost every other industry in driving continuous improvement in productivity. Our industry has to become more efficient and productive and we are in a strong position to lead this charge and to attack system-wide complexity for both providers and manufacturers.

To accomplish this we will invest in our core business from driving lean practices into our operations to creating greater standardization to improving our data connectivity and supplier services. Our goal is to build the most efficient and intelligent route to market from the point of manufacture all the way to the point of care.

As for growth we have exciting prospects ahead. I will highlight three of these areas.

First, our newest segment, CPS, has great potential for the future. Our customers want us in this business and they value our procedure-based solutions that create efficiencies while enhancing patient safety. They also want our help in creating transparency and unlocking efficiency in their networks, operating rooms and expanding sites of care.

A second area of growth for us is with our manufacturing customers, both Domestic and abroad. Our customers want us to bring new approaches and technologies to existing problems, scale and outsourcing for their non-core activities and enhance data and connectivity to help them navigate the increasingly complex quality and regulatory environment.

Our international customers also want a simplified pan-European approach for their operations. Domestically Owens & Minor has always been the trusted partner to branded [manufacturing], providing them with exceptional value. We can build on this position bringing new capabilities and outsourcing services to unlock value.

A third area for greater growth involves expanding our reach and services along the full continuum of care as our IDN customers advance into more and more settings outside of the hospital.

Finally, our strategy is also about transformation. No Company these days can succeed by standing still. Indeed, across our 134 years in healthcare we have a history of reinventing ourselves. Today we sit squarely in the middle of the flow of goods, funds and information.

We believe a critical component of our value is embedded in the tremendous amount of data and information that we maintain, analyze and deliver every day to providers, manufacturers and [EPOs]. And we believe there is more we can do this area to create value for our stakeholders.

Clearly aspects of our strategy are centered on the creation of significant and sustained value for our healthcare customers. We remain focused on achieving our goals for 2016 while we lay the groundwork for the future.

Thank you. Now Randy will review our financial results and provide an overview for international operations. Randy?

Thank you, Cody, and good morning, everyone. Today I will review our consolidated results and provide an update on our segment. The adjustments we have made to reported results and the reconciliations to GAAP are outlined in our press release.

Before I review our results, I am sure you saw our Board has authorized another $100 million in share repurchases over the next three years. At the same time the Board also approved a fourth-quarter dividend payment of $0.255 per share. Both of these actions are aimed at returning value to our shareholders.

Turning to the quarter, we successfully completed the transition of a large customer primarily from our West Coast facilities. The transition, which started in August and was completed prior to the end of the quarter, affected quarterly revenue by about $60 million.

Even without the benefit of the full-quarter contribution from this customer we are pleased that we achieved quarterly GAAP earnings per share of $0.48 for the quarter and adjusted EPS of $0.51, in line with expectations. Year to date GAAP results were $1.32 and adjusted year-to-date earnings were $1.53.

Consolidated revenues for the quarter declined 2.3% to $2.42 billion when compared to last year. On a year-to-date basis consolidated revenues improved 1% to $7.36 billion. Compared to last your revenue improvement from the year-to-date results was from solid performance in our Domestic segment and from one extra selling day in the first quarter.

Consolidated operating earnings were $53.6 million for the quarter, essentially unchanged compared to last year. On an adjusted basis operating earnings for the quarter declined $3.4 million to $56.3 million. For the year-to-date period GAAP operating earnings were $151 million while adjusted operating earnings were $171 million, representing increases and $8.2 million and $6.4 million respectively when compared to 2015.

For the year-to-date period the effective tax rate was 37.3% compared to 41.6% in the same period last year. On an adjusted basis the effective tax rate was 36.7% compared to 37.3% last year.

Asset management metrics included DSO of 21.1 days and inventory turns of 8.9 times. Operating cash flow for the first nine months was $144 million compared to $206 million last year. The primary cause of the decrease with timing changes in working capital in the prior year and our customer transition this year.

Turning to a discussion of our three segments. Domestic segment revenues for the quarter decreased 1.5% to $2.29 billion, largely as a result of the customer exit during the quarter. For the year-to-date period revenues improved 1.5% to $6.95 billion with growth coming primarily from large provider customers as well as contributions from an extra selling day in the first quarter.

For the quarter Domestic segment operating earnings were $41 million, declined 2.3% when compared to last year. For the first nine months of the year Domestic segment operating earnings improved 6.5% to $126 million. Quarterly results reflected a customer exit and lower income from product price changes when compared to last year. These declines were partially offset by reduced operating expenses. Improvement in the year-to-date results came in the first half revenue growth and expense control initiatives.

As for the International segment, quarterly International segment revenues decreased $9 million or 9.7% to $84 million. For the year-to-date period, International segment revenues declined $25 million or 9% to $256 million. Excluding the negative impact of foreign currency, quarterly revenues declined $1.4 million while year-to-date revenues declined $12.4 million. This decline is primarily due to the exit of a UK customer last year.

Looking ahead, we know our pipeline of new business is robust and there is growing interest in our pan-European services. The International segment had operating earnings of $1.4 million for the third quarter, decreased slightly when compared to the prior year.

For the first nine months operating earnings improved nearly $1 million to $3.4 million driven by improvement in cost controls and operating efficiency. The International team has done a great job in turning around their operations and achieving and maintaining profitability.

As for the CPS segment, revenues for the third quarter were $133 million, a decline of 7.8% when compared to last year. For the year-to-date period revenues were $409 million, unchanged from the prior year.

Operating earnings for CPS were $14.3 million for the quarter and $41.9 million year to date. Both periods experienced a decline in operating earnings of about $2 million largely resulting from the third-quarter revenue shortfall.

During the quarter we experienced greater than expected demand for our kitting services and solutions which in turn created production challenges in capacity and workforce availability. Our teams are systematically working through these challenges in order to meet the needs of our customers as quickly as possible.

We are excited about the potential for this new business and we are taking positive steps toward the future and we are making the right investments to scale the business.

As Cody mentioned we executed the transition of a large customer during the quarter. We are making adjustments to our cost structure and platform and we remain focused on delivering our 2016 goals.

However, with increasing provider cost pressures and the resulting competitive dynamics in our industry, we believe that we will continue to experience gross margin pressure in the fourth quarter and we expect this trend to continue into next year.

That said, based on our year-to-date results and our expectations for the fourth quarter, we are affirming our 2016 financial outlook of adjusted earnings per share in the range of $2.00 to $2.05.

We will discuss the changes in our market and our new strategic plan more fully at our Investor Day in February. At the meeting our intention is to provide a longer range financial outlook associated with our new enterprise strategy.

Thank you. And with that we will turn the call over to the operator for questions. Operator?

(Operator Instructions). Lisa Gill, JPMorgan.

Thanks very much and thank you for the details. I just want to go back to your Domestic business. You talked about growth in large provider customers, but I am wondering what you are seeing in the marketplace right now as far as just core underlying growth in the market? Number one, what are you seeing around utilization trends?

And then secondly, when you talked about cost pressure and the pressure on the providers, is this because of the fact that you are seeing consolidation of the bigger players and therefore you have more larger players that have more scale? Or is there something else going on in the industry from a pricing pressure competitive standpoint?

Hi, Lisa, this is Randy. Let me take your sort of utilization question, then I will let Cody sort of address some of the broader cost pressures going on in the marketplace right now.

We have always taken the approach in the last year or two and through most of this year that utilization rates will continue to be positive. We continue to see that in the market and would expect that going forward. But we are seeing a sort of very low-single-digit kind of utilization rate growth.

So again, sort of a positive incremental growth as we are moving forward and we see that continuing to be a relative benefit driving volumes and continuing to support the market. But geographically it is a bit choppy.

And as you have probably seen in some of the results over the last week, the urban environment versus the rural environment in some of the hospital systems are different right now. But broadly speaking we continue to expect sort of a positive albeit low utilization rate growth going forward.

Lisa, it is Cody, I will take the second part of your question on cost pressures. What we are seeing out there is just the projected decline in reimbursements is resulting, from our perspective, in kind of a big cost pressure wave that is working its way up the system kind of starting with the large IDNs, hitting the distributors, hitting the manufacturers. That is really the challenge.

I think in some ways consolidation is one of the reactions to that. And again, from our perspective what we want to do is help our large customers, both manufacturers and providers, attack system-wide complexity.

What we believe is that the industry is very inefficient, the price lever has been pulled and pulled very hard. And so what we see is the opportunity to help them reduce their cost structures.

I was out in the last month or so talking to large IDNs and every one of them has got a $50 million, $100 million cost challenge that they are chasing. And we are trying to position ourselves to help them as well as the manufacturers.

Can you just help us maybe just understand though a little bit on the competitive landscape side? So you are out there with your offering in the marketplace, obviously Cardinal has a big offering. But do you still view this as an opportunity to take market share from some of the smaller players that are in the market?

How do we think about the competitive landscape? Or is it just more of it is you and another large competitor kind of battling it out to continue to serve some of the larger IDNs? And I will stop there.

Well first, I think we do see it as kind of a zero-sum game where everybody is chasing the same share, so that creates a very competitive bidding process and that is what we are alluding to in our comments.

That said, the customers that are choosing us believe what I just said, that there is a lot of system-wide complexity that they need to unlock and we are well positioned to help them do that.

We have our service offerings around that, so when our customers look at this versus others they are asking themselves the question, who can help them get at the significant sustained value that is tied up in their networks.

And, Lisa, as you know, our core business has really been focused on the larger IDNs over the past couple of years. And that has served us well and is still serving as well in a consolidating market.

So again, I think we are well-positioned as we move to the future. A lot of these larger IDNs have some financial challenges. But a lot of them are looking to sort of the longer-term sustainable profitability model and that plays right into our strength. So we still feel fairly confident that we can continue to go out, capture market share and be very competitive in the marketplace.

Great, thank you.

Steven Valiquette, Bank of America.

So a couple more things just on the pricing or the gross margin pressure you are talking about. I just want to confirm whether or not that is tied to any major GPO renewals or is it just maybe other factors that are driving your view on that margin pressure?

And also the other one kind of bigger picture, it does seem like you always hear about your other major players in this sort of hospital distribution space, just finding ways to continue to lower their COGS as they seem to be making bigger strides to increase self manufacturing of some of the more commoditized products, more private label.

So, just curious to get your latest thoughts on that component of the market and whether you think it makes sense to try to accelerate some of your presence in that arena as well. Thanks.

Hi, Steve, thanks for the question. Regarding the margin pressure, where we see the current margin pressure today is really a reflection of just the loss of our large customer.

And we kind of wanted to remind you as we moved into next year that, as we said early on, this was going to be -- there are two areas, one we'd addressed pretty quickly are variable costs which I think we have done pretty well over the last two months.

But then is the fixed costs that are going to somewhat linger over time. And it was more just -- those pressures going to be there in the fourth quarter and linger on into 2017.

With the second half of your sort of margin question related to GPOs, we are actually in pretty good shape. We have just re-signed -- extended Vizient for I think it was about another three-year extension. And we also have completed our renewal process with Premier another five years.

And I think it was a pretty reasonable step forward. We don't really share a lot of comments about the pricing of those, but we were pretty pleased with how they worked out going forward.

And as you know, HPG we signed up at the end of 2015, so we have a little more time before we need to address that. So we are in good shape with regard to the GPOs. On the competitive side let me toss it over to Cody to give you his thoughts on that.

Yes, Steve, I think the second part of your question was around private label products and the role that they can play in our business. We have chosen a partnership path with branded manufacturers. And so, we tend to lean toward stressing our partnership with them.

And one of the things we did during this quarter was we introduced a new value-based funding model with our branded manufacturers. And what that's designed to do is to recognize that distribution is changing in this industry.

We are no longer just delivering to the back of the hospital, we are increasingly kitting products, we are bundling products, we are taking them into the operating rooms, the cath labs, we are delivering all the way to the point of care. And we expect to get paid for that value.

So, we introduced that component and we do have -- we have at our disposal private label products and we think that will be a meaningful contributor to our margin profile going forward, but we will err on the side of a brand centric approach through this value-based model going forward.

Okay, that is great. Thanks.

Michael Cherny, UBS.

I want to dive in -- you obviously focused on service, the differentiation you guys are thinking about providing relative to service. And I don't want to get too far ahead in terms of the February Analyst Day. But as you think particularly your capabilities now around CPS, obviously it's still pretty early in the build out there. Where do you think the build out has been strongest?

And then from an incremental perspective, what areas around service do you think are the most important that clients are telling you they'd love to see you have sooner rather than later?

I will take that, Mike. First, as we go out to both IDNs and manufacturers, again, what strikes me is the enormous complexity in the industry and the recognition that with the declining reimbursements and the cost pressures we have got to reinvent how this industry goes to market and how we get at this what I call system-wide complexity.

So some of the areas on the IDN side that they are very excited about, they are operating rooms. There is a lot of cost tied up in the operating room and that is why we are in the CPS business. We can bring procedural-based solutions to that part of their business where we can help them standardize products, go after the waste, obsolescence, overuse of products and the efficiencies around that.

There is also a lot of supply chain time that is impacting the clinician's time. And we think we can help streamline that through better processes, better data, better services and in some cases all the way to outsourcing functions for them on the IDN side.

Another big area for them that is increasingly complex is as they expand into more and more points of care non-acute they expect us to be there with both logistics solutions and value added services. That is on the IDN side.

On the manufacturing side there is a number of areas. First, a lot of our manufacturing partners do some sort of kitting and bundling, it is not really core to them. We think we can bring scale to that, so they are excited about us helping them with that. We also believe we can bring scale and reach to small to midsize manufacturers both domestically and abroad in delivering their products.

But our goal there again is to become the indispensable partner to them, to take on non-core activities, to reduce their cost structure, and in some cases all the way to fully outsourcing services for them.

Great, thanks.

Sean Dodge, Jefferies.

Cody, maybe staying on the kitting, you mentioned positioning CPS as a growth opportunity. Can you give us an idea of how much runway is left there for you guys? Maybe how penetrated you are into your current client base? Or even more broadly how we should think about the total market opportunity?

Yes, Sean, I don't want to frustrate you with a lack of numbers, but let me take a shot at that. First, we believe we are highly underpenetrated in this market. You we have a pretty sizable share on the core logistics business and our share in the CPS market is considerably lower than that.

And the solution we want to bring is kind of what I would characterize as a procedural-based solution versus a product-based solution. And what that means is we are going to work with the IDNs and the manufacturers to really come up with the leanest most efficient procedural-based solution for them. And from what I have seen out in the marketplace that is what they want.

And what we commented on is we had more demand than we expected and that resulted in kind of some production challenges and some labor challenges for us. But we remain very excited about this business. And we put new leadership in place, we are investing in it, and for putting in place the steps to scale that business. So we see quite a bit of upside here and we see quite a bit of demand for the business.

Okay, and then on that last point you made, the uptick in demand you saw during the quarter. Does that relate to the big deal, the 47 hospitals you signed last quarter? Or is that still kind of in the process of being implemented?

No, it was partially related to that and also some other wins that were smaller than that. But that was certainly a contributor.

Okay, thank you.

Robert Jones, Goldman Sachs.

Cody, I know you guys are going to talk more about the investments you see needed to adhere to some of the changing dynamics that you are talking about here today at the Analyst Day. But I was hoping just -- you could give us some sense, order of magnitude as far as what we are thinking about as far as the internal investments.

I mean is this -- are you guys thinking about this more as like a real overhaul of the way you are investing in the business and to those three platforms or those three areas that you highlighted? Or is this really more of a tinkering and refocusing some of the internal investments in the way that they had been invested previously?

Yes, I don't, I am going to probably come somewhere in between overhaul and tinkering, Bob. I think first and foremost we think we have a fantastic core logistics platform. And we think that platform can be made even better with investments in better data connectivity and transparency.

So we're -- and one of the reasons you saw me call out the addition of Steve Olive, our new CIO. We see great potential to bring better connectivity, transparency and data around our core logistics platforms. That is the first point I would make.

The second point is we think that same platform can help power our growth initiatives in CPS and International. So we see it as an opportunity to kind of bring -- the way we think about it is people, process, and technology. So we are adding new leadership, we are building better processes, but we are going to invest in some new technologies to create greater connectivity and data transparency.

And part of that is a recognition of we're in the middle of all of that today. We are touching these products, we are ensuring that they get billed correctly, we're ensuring they get returned properly. We are providing data to just about everybody.

And we want to connect that story and turn that into services that go at this system-wide complexity that we keep talking about. So it will be a different focus on investments, but that is what we are going to outline at our Investor Day in February.

Great, look forward to it. Thanks so much.

Evan Stover, Robert W. Baird.

CPS has been asked on a couple of times, but I wanted to try to dig a little bit deeper. The commentary that I have heard probably for the last two or three quarters is related to pretty exceptional market demand in that segment, pretty upbeat outlook by you. But the revenue kind of continues -- the declines are accelerating there and you brought up some production challenges today.

I just wanted to know: A, what is the exact nature of the challenges that you are seeing in execution in that unit? And are we still dealing with any challenges from integrating medical action in ArcRoyal?

Yes, Evan, I will take the first part of that and then I will ask Randy to chime in. And let me say right at the get-go, we are not pleased or satisfied with the results there yet. So what we have done is we have rebuilt the management team, we brought in a new leader, we formed a global business unit.

So we have got a long-term view on this and we are making the right investments to scale this business because we see great demand. That said, what we saw is better than expected demand. And as we started to ramp up the business that exposed, what I would call kind of some production challenges for us, some labor challenges.

And so one of the things that team is doing right now is laying out the overall plan for scaling that business. So that is what we referred to. We still see great demand, we think there is great value here for our customers, both providers and manufacturers. But we have got some work to do to put in place the right resources and, again, around the whole people, process, technology to scale this business. Randy.

Yes, sure. Evan, probably just to give you a little bit more granularity, with the integration of these businesses over the past year and [bring them in]. We have three primary locations, two of them are running fairly well and up and meeting some of the demand. And one is just [experiencing] mostly some workforce issues as we look to take on incremental capacity here.

So we are doing a pretty good job, but we knew this when we acquired it, that the location would require some extra effort around scaling this business. And with the increased demand coming on fairly quickly, which is very pleasing to us, we are just struggling a little bit with some of the workforce requirements and scale in that business.

All right. I had one -- thank you for that. I had one clarification on a comment I just heard about your GPO renewals. I want to figure out what is actually incremental, what has happened in the last three months there.

So, you said Vizient was extended for another three years. I assume that includes both Novation and MedAssets. And it sounds like that one was done early because I remember a September 2017 date on that.

And on Premier, I thought we were kind of in like a one-year option period. So can you clarify on both of those? And is that something that just happened in the last couple of months and therefore may be a cause of the near-term pressure particularly in 4Q?

Just to sort of clarify, you are absolutely correct in that these have been ongoing discussions and we had some interim arrangements in place on both of the agreements. Vizient had been sort of toying with the idea of whether to extend individual contracts or just go to a consolidated contract.

And quite frankly, we were pleased that they opted to go to a consolidated contract and extend the arrangement so that has been done just recently. So we are real pleased that we have got that behind us.

And then similarly with Premier, we have taken the opportunity during the interim phase to take on and we have extended I believe it is a five-year contract that gets kicked off with the beginning of the year. So, again, both of these are pretty recent situations that we have been able to conclude. So we are pretty pleased with the outcome of both of these.

Great, thank you.

David Larsen, Leerink.

There had been some talk in the past about potentially entering into some new markets like perhaps I think maybe the post-acute space. Cody, is there any update there, any thoughts there?

Yes, Dave, what we have outlined is that we need to follow our large IDN customers to their points of care. So we have concluded through the strategic planning process that I outlined we will be there. And we are right now going through the planning process for that, exploring both organic and partnership approaches to meet those demands. So that is an area that we are going to talk more about at our Investor Day in February. But certainly an area of focus for us.

Okay, great. And then in terms of these large customers that are rolling off, I think you have Kaiser that will start rolling off in 2017, that is obviously not in the numbers yet.

That one is actually done, Dave. That is the one we called out that it is fully out and we saw the first full month impact at the end of the third quarter and it is now -- that one has transitioned out.

Okay. And then was that a full impact for the quarter or was it a month -- will there be incremental impact next quarter?

It was not a full impact for the quarter, but by the end of the quarter it was fully executed.

Yes, we had started the transition August 1, they were out by mid-September and that was the call out about the $60 million revenue impact for the quarter. That is not a full quarter impact, which is part of the reason, again, we have highlighted some of the margin pressure in the fourth quarter and into 2017.

Yes, I didn't mean to interrupt you, Dave, but I wanted to clarify that.

No, no, glad to did. So, thanks very much. I appreciate it.

(Operator Instructions). Lisa Gill, JPMorgan.

Lisa? Yeah, we can't hear the question if you are there, Lisa.

If your phone line is muted could you please unmute the phone?

Operator, we might as well go to the next question because we can't hear Lisa's question.

And I'm actually not showing any further questions at this time.

Okay. Thank you for participating in our call today. We had a solid third-quarter and we look forward to sharing more detail on our new enterprise strategy at our Investor Day in February. Thank you and have a good day. Operator?

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect. And have a wonderful day.