Owens & Minor Inc (OMI) 2022 Q3 法說會逐字稿

Good day, and thank you for standing by. Welcome to the Owens & Minor Third Quarter 2022 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, to Alex Jost, Director, Investor Relations.

Thank you. Hello, everyone, and welcome to the Owens & Minor Third Quarter 2022 Earnings Call. Our comments on the call will be focused on the financial results for the third quarter of 2022 as well as our outlook for 2022, both of which are included in today's press release. The press release along with the supplemental slides are posted on the Investor Relations section of our website.

Please note that during this call, we will make forward-looking statements. The matters addressed in these statements are subject to risks and uncertainties, which could cause actual results to differ materially from those projected or implied here today. Please refer to our SEC filings for a full description of these risks and uncertainties, including the Risk Factors section of our annual report on Form 10-K and quarterly reports on Form 10-Q.

In our discussion today, we will reference certain non-GAAP financial measures, and information about these measures and reconciliations to the most comparable GAAP financial measures are included in our press release.

Today, I'm joined by Ed Pesicka, President and Chief Executive Officer; and Alex Bruni, Executive Vice President and Chief Financial Officer. And Andy Long, Executive Vice President and Chief Executive Officer of Products & Healthcare Services, will be joining us for the Q&A section.

With that, I'll turn the call over to Ed. Ed?

Thank you. Good morning, everyone, and thank you for joining us on the call today. I'd like to start this call by addressing the factors that were in line with our expectations as well as the unanticipated factors that drove the recent change in our outlook.

While there were some new challenges, combined with the continuation and acceleration of existing challenges, many key aspects of the third quarter occurred as expected.

Starting with one, we continued gaining momentum in our Patient Direct segment, growing organically in the mid- to high teens across all major categories. We also continued to see improvement in our ability to access equipment, which allowed us to meaningfully reduce our overall backlog of orders in our sleep product line.

Two, as planned, we successfully onboarded new acute care customers in our Product & Healthcare Services segment with the investments made in Q3 and Q4, providing benefits in the future.

Three, as a result of our investments in predictive analytics, AI and inventory optimization we continued to improve our already market-leading service levels.

And four, as expected and discussed last quarter, procedural volumes in Q3 were soft and well below the 2019 pre-pandemic levels.

Now let me discuss the unanticipated factors in Q3 that drove our recent change in our outlook. One, as the third quarter progressed, we saw more and more of our acute care customers delay reorders, choosing to deplete their stockpiled items, including our higher-margin S&IP products. Simply put, our previous guidance did not factor in.

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Hello. This is Ed Pesicka. I apologize about the connectivity issues, but let me continue back to where I left off at. So now let me discuss the unanticipated factors in Q3 that drove the recent changes in our outlook.

First, as the quarter progressed, we saw more and more of our acute care customers delay reorders, choosing to deplete their stockpiled items, including our higher margin S&IP products. Simply put, our previous guidance did not factor this in as an assumption.

Second, from a macroeconomic standpoint, the Federal Reserve actions were more aggressive than expected. The U.S. dollar strengthened and fuel prices reversed course and began to increase towards the end of Q3.

Three, as we ended the third quarter, we concluded that the execution and velocity of the actions we were taking in our Product & Healthcare Services segment were insufficient to offset the future impact of macroeconomic headwinds as we successfully had done in the past.

And finally, while we were beginning to see slight improvements in procedural volume, we did not see the extent of the ramp-up of procedural volumes we expected at the end of the third quarter and into Q4.

Accordingly, we have made changes to address these shortfalls. And the good news here is that there are numerous short-term and long-term opportunities in this segment that will allow us to operate more efficiently and more cost effectively.

Here are just a few of them. One, we will continue to leverage our industry-leading service levels. This has helped retain existing customers and win new business with attractive customers. This is an important distinction since as we have said in Q1 and Q2 not every customer is going to make financial and operational sense for us. We remain focused on profitable growth.

Two, we are refocused on expanding our portfolio of products, which provide longer-term benefits.

Three, we are implementing changes in the way we incentivize our sales team to drive proprietary product penetration and conversion, along with supporting our key supplier partners.

And finally, going forward, we will more aggressively implement the Owens & Minor Business System into this segment.

Simply put, we must execute better and faster.

Moving on to the Patient Direct segment. The effectiveness of our business system is readily apparent in our Patient Direct segment. We have experienced many of the same macroeconomic pressures on this side of the business as well, but have been able to offset some of these same challenges. The difference is simply in the execution.

In the third quarter, our Patient Direct segment achieved organic revenue growth in the mid- to high teens across sleep, diabetes urology, ostomy, incontinence and wound care. On a pro forma basis, this segment grew at 11.4% year-over-year.

Also, our ability to procure sleep equipment was better than expected, which enabled us to grow our census of sleep patients and meaningfully reduce our backlog of orders. This highly recurring revenue base will compound nicely as we head into 2023.

With the backlog of sleep patients clearing and the patient census growing, we will see more sleep supply sold in the future, and this will benefit the bottom line.

Finally, from an integration and synergy perspective, we are ahead of our internal targets. Overall, the Patient Direct segment will continue to be a larger and larger portion of the total company earnings and cash flow. We believe that the attractiveness of this faster-growing, higher-margin segment is overlooked by the market and the near-term and long-term perspectives of this segment is very exciting.

Before I turn the call over to Alex to take you through the quarterly financials and our recently revised outlook, I want to emphasize a few points. First, our commitment to the hospital customer and our industry-leading service is paying off in new wins. Again, we will remain selective in pursuing the share gains that are most impactful to the bottom line.

Next, the use of stockpiled items for current activities by our customers is temporary. And as these stockpiles are depleted, demand for our S&IP products should return to normal.

Three, you will see a more rapid and fulsome deployment of the Owens & Minor Business System in the Product & Healthcare Services segment.

Four, I believe there will be an even greater appreciation for the strength and steadiness of our Patient Direct business. More and more of our earnings and EBITDA will be coming from our Patient Direct segment, and I believe the recurring revenue nature and growth rates of this segment will become properly valued.

And finally, I am confident that our core business fundamentals remain strong, and we have the correct strategy across both business segments.

With that, I will turn the call over to Alex for a discussion of our financial results. Alex?

Thank you, Ed. Good morning, everyone. It's my pleasure to be with you today, and I look forward to meeting many of you in the weeks and months ahead. Today, I'll review our financial results and key drivers for our performance in the third quarter and then discuss our revised expectations and assumptions related to the full year outlook.

First, let me start with our third quarter results. Our revenue in the quarter was $2.5 billion, virtually flat from the prior year, driven by the contribution of Apria and strong organic growth within the Patient Direct segment offset by lower revenues within the Products & Healthcare Services segment.

Gross margin of $513 million or 20.6% of revenue was up 740 basis points from prior year. This growth was driven by Patient Direct and reflected the contribution of Apria's sales and sales mix within that segment. Year-over-year for Q3, foreign currency negatively impacted revenue by $12 million, gross margin by $6 million and adjusted operating income by $5 million.

Distribution, selling and administrative expense was $445 million, driven higher primarily from the addition of Apria expenses and ongoing inflationary pressures, partially offset by operating efficiencies and productivity gains derived from the Owens & Minor Business System.

Interest expense was $40 million in the quarter, which was $28 million higher than prior year, driven by the debt financing of the Apria acquisition in late March. As a reminder, floating rate debt represents approximately 1/3 of our overall borrowings inclusive of our interest rate swaps.

The GAAP effective tax rate this quarter was 36.2% compared to 12.6% in last year's third quarter. The change in rates resulted primarily from the mixture of income and losses in jurisdictions in which we operate as well as the prior year's utilization of foreign tax benefits.

Our GAAP net income for the quarter was $12 million or $0.16 a share. Adjusted net income for the quarter was $31 million or $0.41 a share.

Third quarter adjusted EBITDA was $127 million, with a margin of 5.1%, up 140 basis points versus the prior year.

On a segment basis, Products & Healthcare Services third quarter revenue was $1.9 billion versus approximately $2.3 billion last year. This change was driven by approximately $110 million of lower glove cost pass-through as well as reduced hospital demand and customers' reliance on existing stockpiles. Products & Healthcare Services adjusted operating income for the quarter was $24 million compared to $64 million last year, and this change was attributable to the factors just discussed along with accelerating inflationary pressures.

Turning to Patient Direct. This segment had an excellent quarter. Net revenue in the quarter was $594 million, an increase of 142% year-over-year, growing 11.4% on a pro forma basis with strong double-digit growth across key product categories and aided by our better-than-expected ability to procure sleep equipment.

Adjusted operating income for the quarter was $60 million compared to last year's third quarter of $15 million.

The synergies we are generating within our Patient Direct business are tracking ahead of expectations. And we continue to expect Apria to add over $900 million of revenue and over $180 million of adjusted EBITDA for its 9 months of contribution in 2022.

In the next few years, we continue to expect deal synergies to add incremental annual revenue of $80 million to $100 million and incremental annual adjusted EBITDA in the range of $40 million to $50 million.

Moving now to cash flow, the balance sheet and capital structure. This quarter, we generated $69 million of cash from operations. And on a year-to-date basis, we have generated $238 million.

Free cash flow, defined as adjusted EBITDA less net capital expenditures, was $84 million in the quarter and just under $300 million through the first 9 months of 2022.

During the quarter, we further reduced net debt by $35 million, and we were comfortably within all debt covenant requirements. Leverage reduction remains a top priority, and there is no change in our target net leverage ratio of 2 to 3x.

Now let's look at our current guidance. For the full year 2022, we expect net revenue to be in the range of $9.8 billion to $10 billion, adjusted EBITDA in a range of $527 million to $537 million and adjusted EPS in the range of $2.50 to $2.60.

As we look at the key drivers of this revised outlook versus the previous guidance, there are a few items to note. First, we have reduced our revenue assumption by $50 million at the midpoint. This decrease reflects our new assumptions on softer Q4 procedural volumes and factors in the recent trends in customer reordering. As we mentioned, over the quarter, we saw more of our acute care customers delay reorders choosing instead to deplete their product stockpiles.

Given this, we are expecting a much different sales mix in Q4 than we had previously projected. This is driving the majority of the $0.45 reduction in the midpoint of the adjusted EPS guidance for the year.

Expected interest expense for the year is slightly reduced to a range of $128 million to $130 million due to ongoing debt management and continuing to lower average daily debt levels partially offset by higher interest rate assumptions.

For a complete summarized list of modeling assumptions, please refer to the supplemental slides filed with the SEC on Form 8-K earlier today, which we've also posted to the Investor Relations section of our website.

Looking further ahead, we are in the midst of our normal budgeting cycle, which has put us in a position to discuss our outlook for 2023 in the first quarter. As we've discussed, the changes to our outlook for this year came as a result of some unanticipated challenges, and without question, we are very focused and have a renewed urgency to address these issues.

There were also many positive takeaways from the quarter. We are very proud of our service quality and new wins and successful onboardings within the Products & Healthcare Services segment. And we remain very excited about the performance and outlook for the Patient Direct segment.

Thank you. At this point, I'll turn the call back over to the operator to begin Q&A. Operator?

(Operator Instructions) And I show our first question comes from the line of Kevin Caliendo from UBS.

It's actually Andrea Alfonso for Kevin. I guess if we could just get a little bit more granularity around your expectations for the run rate of margin and products in 2023.

And if I could just slip one in. Would appreciate a little bit more color on your thoughts around sort of the sleep apnea backlog and how we should think about that manifesting in the numbers due to next year?

Sure. I'll start -- this is Ed. I'll start with the second part of the question and have Alex talk a little bit about the projection going forward.

And I think the way to think about the sleep product is we had a very strong quarter in sleep. We were able to basically get access to additional products. The team executed extremely well on it. And frankly, we took our backlog down to back to almost close to where we're sitting now today, closer to normal levels of what we'd anticipate. So while we had anticipated the depletion of that backlog to lead us into Q1 of next year and early part of 2023, we actually were able to capture most of that business now because of the additional capacity that we received, additional volume we received, and frankly, incredible execution on the team's part to get those products out.

So how does that manifest into the future is obviously placing the equipment is one thing. It's now that, that recurring revenue will start to occur in Q4 or late in Q4 because generally they get a 90-day supply with the initial deployment of the product. And then that recurring revenue will start to continue to flow throughout all of 2023 versus where we originally thought we would fill those -- that equipment orders into '23 and then start to gain it.

So it's really been strong execution of the Patient Direct team, focused on partnering with those sleep manufacturers, getting the product out to get us ahead of the curve and really get our back orders and backlog on that back down to what we would see as a normal rate where we sit today.

And then I'll let Alex cover a little bit on the first part of the question and kind of standard run rates on where we are in the process.

Thanks, Ed. So within PHS, the trends that we've seen here in Q3, we do expect to continue at least in the short term through Q4, and I think that's reflected in our guidance. And as I mentioned, we are in the middle of our budget process and we do expect to have greater visibility in the first quarter.

The markets continue to be very dynamic, and we'll work through that over the next month or so.

And I show our next question comes from the line of Daniel Grosslight from Citi.

It seems like most of the pressures you're facing are macro in nature. But you mentioned that there are specific actions you didn't take quickly enough and you're going to begin implementing. I'm wondering if you could put just a bit of a finer point on what specifically you can do in the near term given these macro pressures don't seem to be abating anytime soon?

And how quickly that will manifest in more normalized margins for the Products & Solutions business.

Sure. Yes, I'll take that. So really, it's both a mix of macro as well as some of the industry specific that we're seeing. So I talked a little bit about the destocking that's having a material impact on us here in Q3 and then extending into Q4. And that's really the fact that hospitals are under financial constraints. They have a tremendous amount of stock on hand of PPE, which historically they haven't had. They're electing to utilize that versus restocking. So they're using their "safety stock" to bleed down inventory, which is having a material impact on us.

I think on the macroeconomic side, there are several different things that we're in the process of doing. Some of those things offset the macro impact. One is route optimization. As fuel prices continue to go up, there's still tremendous opportunities for us to maximize and optimize our route optimization within the customers. And that's going to take a period of time to work with our customers from a delivery standpoint.

There's additional -- really embedding the Owens & Minor Business System within our Product & Healthcare Services segment. There's an ability for us to continue to take cost out of that business aggressively by driving continuous improvement.

And I think the way to really look at it is compare and contrast the two segments. Many of the same macroeconomic pressures impact Patient Direct that impact our Product & Healthcare Services segment. Our Patient Direct through the embedding of the Owens & Minor Business System have been able to quickly take cost out of that system to be more effective. That same implementation has to happen on the other side of our business on the Product & Healthcare Services segment.

The other thing I would talk about to really continue to look at offsetting some of the macroeconomic is looking at the labor force. One of the things we had anticipated coming into Q3 and going into Q4 was a stabilization of the labor. We didn't see that in Q3 and Q4. However, we actually believe as the economy continues to tighten, the labor force will create opportunities for us to have a better labor force and then keep our employees and teammates for a longer period of time and reduce that turnover.

So that's another aspect of it. Continuing to look at ways where we've identified of how do we reduce the turnover of our teammates in our distribution centers, so that way we can have well-trained teammates that are much more effective than new hires. That's another aspect of how we're thinking about it.

Appreciate the color. And if I could slip one more in here. You mentioned a lot of the margin pressure within Products & Solutions is due to product mix as well. The higher margin products just haven't come back as much as you expected.

Given you had generally seen higher margins within your product -- proprietary products business, does this mean you're really seeing most of the pressure within proprietary products rather than the core distribution segment?

Yes, I think that's the right way to think about it. And really, it comes down to this is while we're winning customers, we're continuing to grow in our general distribution business, the one area we're seeing today, primarily our proprietary S&IP products, we're seeing less and less demand. We're not seeing utilization go down in the hospital of the product. We're actually seeing hospitals reduce their purchasing of those products because they have a stockpile.

And that's one of the things that's fundamentally changed is during COVID over the last few years, many of our customers went out and bought product from us, from other manufacturers and then directly anywhere they could find the product. They built those products up in a stockpile. And now they're electing to actually utilize those products that are in their stockpile, deplete those down to a lower level. And then we -- that's when the recurring revenue will start to happen and increase again in our Products business, specifically the PPE-based products.

And I show our next question comes from the line of John Stansel from JPMorgan.

This is John on for Lisa. I just want to dig in a little bit on the synergies that you're seeing. I think you called out kind of ahead of schedule, but I was hearing kind of the commentary correct, about the same amount, that $40 million to $50 million of EBITDA contribution.

So I guess my question is, are you seeing a more than expected just synergies from your overall integration? And I guess, how should we think about that going forward?

Yes. The answer to that question is absolutely, we are. Again, I've watched the Patient Direct business come together, Apria and Byram. I watched them both collectively embrace and embed the Owens & Minor Business System. We've watched them continue to grow. If you think about the growth rate. I think Q2 pro forma growth rate was approximately 10%. Q3 pro forma growth rate is 11.4%.

So just think about that, the ability to cross-sell, the ability to identify opportunities. I would say there are synergies on both sides and the fact that we've embraced the fact that Byram has learned from Apria. And Apria has learned from Byram. Byram has effectively done some of the things that have made Apria successful and Apria has done many of the things that has made Byram successful. Again, you're seeing that in growth that, again, pro forma last quarter, this quarter was 10% up to 11.4%. You're seeing that in operating income.

Overall, I believe it went from 9.1% to 10% adjusted operating income as a percentage so you're seeing margin expansion. And again, that is driven by cost elimination, that has been driven by better operational effectiveness, that is driven by top line growth.

And I think it's also important that with the synergies, we're seeing growth not just in one category or two categories, but virtually all major categories grew at double digits. So those are the quantitative examples that are validating the synergies and continuing to drive the adjusted operating income margin expansion as well as the accelerated top line growth.

And I show our next question comes from the line of Charlotte Kolb from Bank of America.

This is Charlotte on for Mike. Can you talk a little bit about the competitive environment and any impacts that you're seeing from a share perspective versus peers?

Yes. From a competitive environment, I mean, all the businesses are different. Obviously, we've got a manufacturing business, we've got a distribution business, we've got a Patient Direct business. I would like to -- I believe that if I take those in the other order, our product -- our Patient Direct business continues to grow. Again and again I said at 11.4% of pro forma and really in the high teens or double digits across the board, I should say, within all major categories.

I'd like to believe that in those markets we're playing, we are continuing to grow at or above market.

I would say also within our medical distribution, we continue to see new meaningful wins come into our business. But I'll also qualify that as in the fact that we're continuing to look at the right wins and retaining the right business. We look at it as is there meaningful losses and can we gain meaningful wins. And across the board, I would say we're gaining some very meaningful wins with the opportunities for those to continue to grow.

We're also doing -- putting together programs within our medical distribution business that will win customers. A great example of that is one of the recent announcements we had in WVU. That's not just an opportunity to win there. It's to grow in the entire state with the footprint we're adding and then the geographic states around that.

So that's where I say there's great success on that. I would say in the PPE space in our proprietary products, I think the destocking isn't just affecting us, it's affecting many others in the market, too, that are in this space. And as we look at our contracts across our customer base, we continue to maintain those. We continue to have expansions of new customers coming on to our PPE, coming on to our contracts with our PP. So I think across the board, we're doing extremely well for us.

I'm showing no further questions in the queue. At this time, I'd like to turn the call back over to Mr. Pesicka for closing remarks.

Thank you. Well, firstly, I just want to thank everyone for joining us on the call today. But before I end the call, I want to reiterate a few key points that I want to make sure we all take away from today's conversation.

First, at Owens & Minor, we are completely committed to our hospital customers and continuing to provide leading industry -- or industry-leading services. That service level we're providing continues to deliver on new wins for us. And we're going to continue to focus on, as I just stated in the previous question, the right growth going forward.

Second, really, the stockpile issue. We've got customers that have a tremendous amount of products stockpiled. We're seeing customers utilize that stockpile. I met with a customer most recently that had been burning through their stockpile and now he's completely through it. Met with other customers that validated, yes, we're utilizing some of our stockpiles to offset some of the financial lows.

As those things are -- is that stockpile is depleted, and it's not going to last forever, that demand for our product exists. It still exists, and they're using those products today.

Next, you're going to see really an increased intensity around the Owens & Minor Business System in our Product & Healthcare Services segment.

Finally, we've talked about this back in Q1, Q2 and in various open communications, you're going to continue to see a mix shift at Owens & Minor, where more and more of our earnings and EBITDA are going to come from the Patient Direct segment. And I really believe as people understand that segment, it has tremendous recurring revenue nature as well as it has higher growth and it's a more profitable segment than our patient -- our Product & Healthcare Services segment. And you're going to continue to see that mix shift as we go forward.

And finally, over the long term, I am completely confident that our core business fundamentals remain strong, and we have the correct strategies across both segments.

So I want to thank everyone, and I look forward to sharing our progress when we report on our fourth quarter results in early 2023. Thank you.

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