Owens & Minor Inc (OMI) 2016 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Owens & Minor's fourth-quarter and full-year 2016 financial results conference call. My name is Kaylee 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. Please proceed, ma'am.

Thank you, operator. Good morning, everyone, and welcome to the Owens & Minor fourth-quarter and full-year 2016 earnings call. I am Trudi Alcott 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 fourth quarter and full year 2016, which are included in our press release. In our discussion today we will reference to certain non-GAAP financial measures. Information about these measures and reconciliations to the most comparable GAAP financial measures are 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 uncertainties 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 new strategy, and Randy Meier, EVP and Chief Financial Officer, and President, International, who will give an update on our results and insight into the performance of our three segments. Now I would like to turn the call over to Cody Phipps, 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. We were pleased that we achieved adjusted earnings per share of $2.05 for the year, given the backdrop of challenging industry dynamics. This result is a testament to our teammates, their dedication, and their hard work.

Our industry is going through a period of great change, driven in large part by the significant cost pressures and enormous complexities in today's health system. Owens & Minor has built 135-year legacy of partnering with its customers, both hospitals and manufacturers, to help them solve their problems. And they need our help now more than ever. Our focus on solving complexity will continue to make us a trusted and valued partner.

So while there are many challenges in our markets, we also see significant opportunities that we are well-positioned to pursue. Last year we aligned with our Board on our new strategy, which we will share with you in greater detail at our investor day in March. Today I would like to share with you the four main elements of this strategy so you understand where we are headed and why I believe this new strategy will create value for our shareholders.

First, we are building the most intelligent route to market by investing in our supply chain to bring scale, efficiency, and enhanced connectivity to the flow of medical products from the point of manufacture to the point of care. Going forward, we will be making investments in lean operations and productivity tools to make this a reality. We will also invest in new technologies and data connectivity to unlock new forms of value.

As you have seen, we are developing a track record of continuous operations improvement, which played a critical role in our results this year. We will continue to pursue this culture of improvement and we will invest to drive further efficiencies. Our goal is to have the lowest cost and most intelligent route to market for medical products.

Our second strategy will have us expand our services along the continuum of care to non-acute settings to help our provider customers follow their patients. This part of the market is growing faster than the acute setting and our customers are asking for our help in managing this increasingly complex part of their networks. We are focused this year on gaining important new capabilities and on building a new business platform to serve the expanding continuum of care. We believe this will represent an opportunity for growth and will enhance how we serve our manufacturer and provider customers.

The third part of our strategy is to become the preferred outsourcer for leading manufacturers. Our manufacturing partners are also facing significant cost pressures and we remain their trusted partner. They are looking for us to partner with them to drive new efficiencies and to facilitate new growth opportunities.

With our efficient network, broad channel access, and ability to deliver all the way to the point of care, we are in a unique position to create value for manufacturers. As an example, we are seeing enthusiastic interest from ortho and cardio device makers and, in fact, we have recently signed an agreement with a large manufacturer to provide value-added services across our US network. Additionally, we are having regular conversations with small and midsize manufacturers who want our help in getting their products to the market and to the point of care.

Finally, our fourth strategy is to drive value through data, analytics, and services. Our business places us squarely in the middle of the flow of goods, funds, and information from the point of manufacture to the point of care.

In the coming year we intend to invest in driving connectivity, transparency, and improved analytics. We believe this will create new service growth opportunities and important new capabilities for our customers. Our goal is to build data, information, and service platforms that will connect our solutions so that we can attack complexity up and down the healthcare value chain.

While 2017 will be a challenging year, it will also be a year of investment and transformation to reposition our business for long-term success, and we are excited about our future.

Before we move on to Randy's comments, I would like to recognize two changes to our Board. Last week we welcomed a new director, Barbara Hill, to our Board. Barbara is a healthcare executive with deep management experience and insight earned from many years in the healthcare industry. She has both strategic and operational expertise and we look forward to leveraging her experience and knowledge of the industry.

Finally, I want to say word of thanks to Craig Smith, who will retire as Board Chairman at our annual shareholders meeting in May. Craig has defined the heart and soul of Owens & Minor for nearly 30 years. He was instrumental in growing the Company, and extending our reach into new businesses and markets.

Craig is a mentor and leader to many, but most importantly, he was a friend to countless Owens & Minor teammates. On behalf of all of us at Owens & Minor, I want to thank Craig for his service and wish him the best in retirement.

With that, Randy will review our financial results and provide an overview of our segment results. Randy?

Thank you, Cody, and good morning, everyone. I will use my time today to brief you on the 2016 results and to provide an update on the performance of our three business segments and the positive contributions from our transformation agenda initiatives.

A combination of solid operating performance and improvements derived from transformation initiatives led to positive earnings results for the year and the quarter. We hit or exceeded many of our goals while managing through the loss of a major customer and the rapidly-changing healthcare landscape. Overall, we are pleased with our performance in 2016.

For the year, consolidated GAAP results reflect EPS of $1.76, while our adjusted EPS was $2.05. We realized meaningful benefits from operating efficiency, cost control efforts, and our commitment to return capital to shareholders. For the quarter, we reported GAAP earnings of $0.45 per share and adjusted GAAP earnings of $0.52 per share.

Consolidated revenues for the year were $9.72 billion compared to $9.77 billion last year. For the quarter, revenues were $2.37 billion in comparison to last year of $2.49 billion.

GAAP operating earnings for the year were $200 million, in line with last year. On an adjusted basis, operating earnings for the year were $224 million. The out-performance in achieving our transformation agenda through the course of the year helped us offset the fourth-quarter impact of a large customer transition. As for the quarter, operating earnings were $49 million, while adjusted operating earnings were $53.7 million.

In other results, the effective tax rate for 2016 was 37%. The adjusted effective tax rate was 35.8% and was improved when compared to last year due to the progress with our global-sourcing strategy and increased income from lower tax jurisdictions. Asset management metrics include DSO of 23.1 days and inventory turns of 9.2 times.

For the year, operating cash flow was $187 million, demonstrating a high quality of earnings. Last year's operating cash flow was $270 million, benefiting from certain timing differences in working capital between the fourth quarter of 2014 and the first quarter of 2015 that abnormally affected operating cash flow in 2015. However, we consider 2016 operating cash flow to be on the stronger side of our historical trends.

Looking at the segments, for the full year domestic revenues increased slightly to $9.19 billion. For the fourth quarter, revenues were $2.24 billion from $2.33 billion in the fourth quarter of 2015. Revenues were affected by the previously discussed transition of a large customer, which was completed in the third quarter. Growth from the large provider customers during the year helped to offset this customer transition.

In addition, there was one less sales in the fourth quarter of 2016 than in the year before. Domestic operating earnings were $165 million for the year, reflecting an increase of $2.6 million as compared to 2015. For the quarter, operating earnings were $39.3 million compared to $44.5 million, reflecting the impact of lower income from manufacturer price changes and revenue shortfalls and offset somewhat by positive results from the transformation initiatives.

Turning to the international segment, for the year international segment revenues were $344 million compared to $373 million in 2015, while quarterly revenues came in at $88 million versus $91 million last year. It is important to note that excluding this unfavorable effect of foreign currency and the previously discussed loss of a customer, international segment revenues increased by nearly 1%.

International operating earnings for the year were $5.6 million, improved by $2.4 million when compared to the prior year. For the quarter international operating earnings were $2.2 million, an improvement of $1.5 million. The international team remains focused on growing the business with new and existing customers throughout the European market.

As for the CPS segment, revenues for the year were $540 million and quarterly revenues were $131 million compared to $562 million and $153 million in the comparable periods last year. Annual CPS operating earnings were $53.8 million for the year versus $61.9 million last year, while quarterly CPS operating earnings were $11.9 million compared to $18.3 million in last year's fourth quarter.

As we mentioned last quarter, CPS business faces challenges in capacity and the workforce availability that adversely impacted results and lower sourcing revenues resulting from a large domestic customer transition. Also, the CPS segment had revenues from a one-time customer contract in the second half of 2015.

As for shareholder return, we provided a total of $134 million to shareholders last year through a combination of dividends and share repurchases. I am pleased to report that our Board has approved a 1% increase in our first-quarter dividend. This year will mark Owens & Minor's 87th consecutive year of paying dividends to shareholders.

Our teams executed at a high level in 2016. The transmission agenda, which included a variety of margin and expense initiatives, enabled us to largely mitigate the loss of a large customer. We are also making plans to invest in our global platform and in systems to support it and position us for the changing healthcare landscape for years to come.

Based on the ongoing challenges that we are facing in our domestic business, including the loss of a large domestic customer, as well as ongoing margin pressures resulting from the changing market dynamics, we expect 2017 adjusted earnings to be in the range of $1.75 to $1.85. However, based on our expected progress of our new strategic plan, we are targeting guidance for 2018 adjusted EPS to be in the range of $2.05 to $2.20. We believe our strategic plan and the investments we are making will enable us to achieve high single-digit EPS growth rates in the subsequent years.

We look forward to providing additional detail regarding our three-year strategic plan at our investor day on March 16 in New York.

Thank you, and with that, I will turn the call over to the operator for questions.

(Operator Instructions) Sean Dodge, Jefferies.

Cody, you mentioned the changing and challenging market dynamics and how it's weighing on your margins. Can you elaborate on those? What specifically are you experiencing out in the market that's different now? Is it coming from competitors or is out of the GPOs or the manufacturers or from somewhere else entirely?

Sean, thanks for the question. What we are seeing out in the marketplace is just a lot of cost pressure on the part of providers. They are under enormous cost pressure. When I talk to our customers, most of them have very significant cost-reduction goals.

I think that, plus the general market dynamics, just leads to a very competitive marketplace. And so we are seeing that show up in RFPs. I think we announced on our last call that we re-signed with the three major GPOs, so that's behind us, but again those re-signs come with some margin pressure.

Okay. Then in the CPS business, Randy, you mentioned continued workforce challenges and a domestic client transition. Is the client transition the same one that transitioned off the domestic buy/sell business in the third quarter? Is this a different one?

Then can you talk about the extent to which the large CPS contract you signed in the second quarter has ramped or is contributing revenue at this point?

Sure, Sean. I think what we alluded to in the third quarter was in the end of 2015 we got a singular contract that contributed to the tail end of the third quarter and fairly significantly in the fourth quarter of 2015. So the year-over-year comparison is a bit difficult as a result of that.

Putting that aside, though, with the acquisition of a fairly significant customer in the first half of last year, we have been experiencing a little bit of capacity problems related to some of the labor issues we've had at one of the facilities. We are beginning to see some of our efforts begin to take hold and we are starting to see capacity ramp up and starting to meet customer demand. So I think we are pretty much on track.

First half of the year is going to continue to have a bit of struggling there in terms of some of the margin pressure as we have tried to make sure that we can meet demand and less focused on the profitably side. But as we move into the second half of the year, I think we will have that back under control and be able to start to see some meaningful benefits to that. So hopefully that gives you a little bit of color.

It does, thanks. We will talk to you guys soon.

Steven Valiquette, Bank of America.

Thanks. Good morning, Cody and Randy. I guess I apologize if I missed this; we're kind of toggling between a bunch of different calls here. But for the guidance for 2017, just curious if that factors in any other customer losses besides the Kaiser loss.

I guess I would couch that by saying this could be other losses that may have already occurred or it could just be ones that maybe you're factoring in just to be conservative. I'm just trying to get a sense for either potential customer losses or other ones that may have already occurred. Thanks.

Steve, thanks. The guidance for 2017 was really factoring in three major factors. One is the exit of the large customer that we talked about. We're still working through the fixed cost issue with that exit. That's the primary piece of that.

The second thing is, as I mentioned, the margin pressure that we've seen and re-signing business and maintaining our market share. And the third is the investments we're making consistent with our strategy, so those are the three factors that we layered into the guidance for 2017.

Specifically to your question about other accounts, what we have said is, net of that large customer loss, we are holding our own out in the marketplace in terms of wins and losses. And what we see this year is we are going to have that business coming out in the first half of the year and bringing on new business in the back half of the year that we've already won. So that's what we factored into the guidance for 2017.

Again, probably a little bit more color for the first half of the year. As Cody alluded to, obviously the large customer we shared with you had a pretty big fixed cost impact and we suggested that would take us some time to work through. But remember, when we go through customer transitions, bringing on new customers, transitioning some other customer losses, there are some upfront costs to those things and we expect that to be more of a first-half-of-the-year impact.

Again, first half of the year going to be a little bit more challenging on that side of the fence than we've seen in the past, but we expect to work through that and we begin to see the benefits of those on-boarding efforts in the second half of the year.

Okay, that's helpful. Thanks.

Stephanie Davis, JPMorgan.

Good morning, thank you for taking my questions. Could you talk to the initiatives you are undertaking to address challenges to the domestic business and how you see your growth trajectory for that business going forward?

Stephanie, as we outlined in the remarks, we've got really a four-part strategy that we will be spending more time on in our investor day in March. But one key element of that is what we call building the most intelligent route to market, and underneath that, what we see is a very significant operational improvement agenda.

We are really good at supply chain and logistics in the healthcare space. We want to be even better, but that implies operational improvement and data and connectivity to strengthen our core business.

The second part of our strategy is, as we outlined, to expand into the continuum of care. Our customers want us there; we see opportunities to service them and to provide a growth platform for our business.

And the third that we are excited about is the demand and discussions that we are having with our manufacturing partners. They're under the same cost pressures that we see the providers facing. And they are looking for a partner, a trusted partner, like Owens & Minor, who can help them reduce complexity and their cost, but also help them facilitate growth. So it's kind of a combination of core opportunities we see to strengthen the domestic acute business, but also these other areas that I've outlined.

Thank you. One follow-up to that just from your answer, you talked a little about the demand environment. Just given the healthcare changes we are seeing in the new administration, have you seen any changes to utilization?

Stephanie, this is Randy. We see utilization being fairly consistent with the tail end of 2016. Anything that might go on with the administration, I think our view is it's probably going to take some time and we have got to take a little bit of a wait-and-see attitude. So, for 2017, we think positive but low utilization rate as we get through there.

And probably just to your prior question with Cody, I think one of the things that we have suggested is that as we begin to implement the strategic agenda that Cody has outlined, we expect a lot of those investments to begin to yield the results towards the second half of the year and that is going to drive growth into 2018, which is really why we gave the two-year guidance. We want everyone to understand that this is a year that we are going to position ourselves to really change the direction of the Company and move us in a direction, and that's what we're going to give color on at our investor day.

All right, guys. Thanks for the color.

Robert Jones, Goldman Sachs.

This is actually [Jason Jacoby] calling in for Bob. I want to ask one on the 2018 guidance without getting too far ahead of ourselves. Just generally, guidance is obviously calling for a pretty steep ramp, so what's the expectations for margin recovery? Especially with customer pressure, which you've discussed as bringing down margin in 2017, is that something that really transitions and turns around in 2018? Thanks

Jason, thanks for the question. We see margin pressure in the acute setting as kind of here to stay and again driven by the cost pressures that customers are facing up and down the value chain. So the guidance that we gave for 2018 really factors in a combination of things.

One, the operational improvement agenda that we've outlined -- that we are outlining, and we will go into more detail on that in March. That same agenda, not only is it an operational improvement agenda, we think that strengthens our role in the supply chain and allows us to serve our customers in new and different ways. So certainly some of that is baked into our guidance for 2018.

The second thing that is in there is, as Randy alluded to, the investments we are making this year in new areas such as the continuum of care and in the manufacturing services area. So it's kind of those factors that we -- that will contribute to our 2018 guidance.

Again, specifically around margin. As we have been alluding to for some time, and clearly as Cody has indicated with our strategy, as we move into 2018 we expect a lot of our fee-for-service business to really begin to ramp up. We've got a variety of initiatives domestically that we see improving throughout 2017 and into 2018: certainly the recovery of our CPS business in the second half of this year into 2018 and the ongoing improvement of international.

All of which create a lot of fee-for-service, which drives gross margin, which is why we have always suggested to people not just to look at revenue growth, but look at the gross profit growth as well. So that mix shift as we move through 2017 and into 2018 should have meaningful impact in 2018 on our gross margin.

Thanks, that's helpful. A quick one, a quick follow-up on just international margins; seems like they were pretty strong in the quarter, 2.5%. So can you just talk about what drove the strong margins and whether you think 2.5% or around there is sustainable going forward?

Sure. I think this is -- as we've talked about over the last couple of years, the continued improvement in the business as we move forward. I think what really drove the quarterly results is we finally put what we've been talking up for a while, the exit of our large customer behind us, so you had, relatively speaking, a fairly clean quarter.

We've also seen the benefits of a lot of the price increases on our retained customer that we began to implement at the end of 2015 and in 2016, and the ongoing cost management that we've had over there. So the focus in 2017 is going to be a lot on growth and trying to continue to finish out and fill up the capacity over there. But I think all of the efforts of the past couple of years are starting to yield some benefits.

All right, cool. Thanks.

(Operator Instructions) Michael Cherny, UBS.

This is Allen in for Mike. Thanks for taking the question. Moving back to 2018, does that guidance contemplate any impact from a repeal of the ACA? And if so, can you quantify what is embedded at the low and high end of that range?

Yes, it does not factor in any repeal of the ACA at this point. I think as Randy pointed out, we think it's too premature to -- we haven't baked that into our plans. We are still, I think as many are, trying to get a more definitive read on that so that guidance does not bake in a repeal of the ACA.

And the second part of your question?

That was just contingent on if it was. Then a follow-up to that. You mentioned investments in lean operation, product tools, and data connectivity. How should we think about how these -- or I guess these investments versus the cost reduction initiatives and the trajectory of SG&A in 2017 and 2018? Then are these investments going to be mostly capitalized?

First, the way to think about it is we're going to have a multiyear operational improvement agenda and so we are investing in 2017. As I pointed out, that's one of the factors in our lower guidance.

What you find is -- what you've seen from us in the last year and a half is the beginnings of a consistent track record for continuous operations improvement. As you get further into that agenda, what you find is the low-hanging fruit has been picked up and now you have to do more.

Some of those investments include resources toward lean operations, some technology. A good example would be pick-to-voice technology, which drives productivity in our distribution centers. We are investing in a new client engagement center as part of our shared services platform to help us provide both a better customer experience, but also drive down overhead costs. So what you are seeing in our guidance for 2017 are those investments and they help us get at additional cost savings and efficiencies throughout our network.

I think -- just to give you some color on whether a lot of these costs may be expensed or capitalized; I think as we get to investor day we will probably give you a little bit more color on what our CapEx and that will look like. But I think -- as we move forward here, I think you're going to see a combination of just longer-term investments that will be either depreciated or amortized over a period of time versus adding just some costs. But that will be offset by productivity improvements going forward.

So I think you will see it evenly invested between the expense side and the capital side moving forward. But I think it does lead to giving us the opportunity to move into much more clinically relevant areas and improvements in our regulatory affairs and some of the quality areas that we'll need to improve on as we move into some of these higher margin, more value-added services.

Got it. Thank you very much.

(Operator Instructions) I am showing no further questions at this time. I would like to turn the call back to Mr. Phipps for closing remarks.

Thank you for participating on our call today. We had a solid year in 2016 and we look forward to sharing more detail on our new strategy at our investor day in March. Thank you again. Have a good day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a wonderful day.