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Omnicare Inc. (NYSE:OCR)

JPMorgan Chase & Co.'s Global High Yield & Leveraged Finance Conference

February 25, 2013 9:00 am ET

Executives

Robert O. Kraft - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Patrick C. Lee - Vice President of Investor Relations

Unknown Analyst

So folks I think -- are we right on time? Okay, I see the countdown clock. So we're very happy to have Omnicare with us today. Presenting from the company will be Robert Kraft, Chief Financial Officer; and Patrick Lee from Investor Relations. So gentlemen, thanks again for being here.

Robert O. Kraft

Thanks, David. It's a pleasure for Omnicare again to participate this year in the JPMorgan High Yield Conference. To those in the room and those on the webcast, I want to thank you for your interest.

First, let me put up our forward-looking statements disclosure. A lot of the comments that I'll make today will be forward-looking and involve risk.

Omnicare today operates in 2 distinct primary platforms. Although they're different, both are key to improving patient care. In our Long-Term Care Group, we're the largest provider of pharmaceuticals to institutional settings in the U.S., providing over 110 million prescriptions per year.

Our Specialty Care Group operates in 5 platforms, most of which are focused on providing commercialization services to our biopharma clients. Although we have multiple platforms in Specialty Care, we believe we have a unique, integrated approach that differentiates us in the marketplace.

Turning to slide 4. From a size perspective, our Long-Term Care Group today is 80% of the revenues and adjusted operating income of the company, although our Specialty Care Group is growing at a much more rapid pace.

When we think about Omnicare and our priorities for the future, they're relatively simple and they're threefold. First, we want to have long-term growth in our Long-Term Care business that sustain on an organic basis. Secondly, we want to continue the momentum we've achieved over the last 2 years in our Specialty Care Group. And finally, we want to efficiently allocate capital based upon our robust cash flows.

Before I talk about each of our businesses in more detail, I wanted to speak about a couple of market trends that we believe are very beneficial to our businesses.

First, the aging of the population. The aging of the population results in higher utilization of health care, particularly in the markets we serve. As you can see on the chart on Slide 7, the highest growth -- compounded annual growth is in the 85 plus sector of the population. The interesting thing about that group of seniors is that they're the most likely to be in institutional settings and served by our Long-Term Care Group. Another interesting statistic, the geriatric market uses 3x the pharmaceuticals than the general population.

On the Specialty Care side, we've seen significant increases in the shift to specially molecule drugs over the last several years, and that will continue through 2016 and into the future. If you look today's pipeline, there's a saturation of traditional drugs in the marketplace, but we see continued increases in the pipeline of specialty drugs. Today, there are more than 900 specialty products in the current pipeline. We believe our Specialty Care Group is well-positioned to capitalize on this shift.

All right, let me now spend a couple of minutes talking about each of our businesses in detail. First, our Long-Term Care Group. There's first -- certain aspects of long term care pharmacy that are common to all the providors and common to our industry. They're shown in this chart on Slide 11. However, we believe we differentiate ourselves in 3 primary areas: first, our Clinical Services; next, our operating platform; and then, finally, the technology that we bring to bear with our customers. Let me spend a minute to talk about each.

First, on the Clinical Services side. We go well beyond the traditional services of our competitors. As you can see on Slide 12, we have a broad -- we have broad offerings designed to improve outcomes of our seniors. This is going to be even more essential as health care moves to quality base reimbursement. Inside our toolkit, there are a lot of specific redesigned programs, one of which I'll speak about is generic efficiencies.

As you know, as many of you have heard, our -- we move generics to our customers in a matter of days once a generic is launched. That's compared to months with our competitors. This provides our customers with immediate savings. Our Clinical Services are based on the foundation of a proprietary clinical-based formulary. That formulary is supported by University of Sciences, Philadelphia. This provides credibility with our patients, our payors and the medical community.

Next, let me talk about our pharmacy operations. We have a robust hub-and-spoke network that provides for nationwide coverage. As you can see on the chart, we've laid out, on Slide 13, the hubs across the country. This makes us the natural partner for our national accounts in the skilled nursing space. This network also allows us to have enhanced resource deployment. It allows for standardization across the country. It also allows for the deployment of our proprietary automation inside our pharmacies, which provides us with what we believe, is the lowest cost to dispense in the industry. It also allows us to leverage acquisitions, wherever they might be in the U.S.. Finally, as we've seen recently, this -- our network allows us to effectively respond when issues arise in the country, such as natural disasters, such as Superstorm Sandy or Nemo.

Finally, let me talk about our customer-facing technology for a minute. It's based upon our Omniview platform, which provides a huge value proposition and resonates with our users, while improving our retention with our customers. This is a sticky product. What we found over the last several years is while our product is good, it can be better, and we continue to enhance it. We've also found that our pitch of this product in the marketplace was very inconsistent, and so we spent a greater effort with our sales and service organizations to increase its utilization.

As many of you know, in June of this year, we had a management change. When we made that change, one of the primary aspects was Nitin Sahney became our president and chief operating officer. Prior thereto, Nitin just ran our Specialty Care Group. Nitin has brought a multifaceted approach to our Long-Term Care Group with the primary focus of sustained organic growth.

We've left Phase 1 of that approach, which was to make an assessment around what we had in the Long-Term Care. What we found there is we needed to improve our sales and our retention efforts.

On the retention side, we made progress over the last several years. Over the last 8 quarters, our retention rates have been in the low- to mid-90% range. That's significantly improved over the 80 percentile we saw in 2010, that we've seen that through enhanced customer focus, although we believe there's more to do in that space. The other thing we found was that sales was behind and not nearly as far along as retention was in our Long-Term Care Group. We're gaining ground quickly there. Let me spend a minute more on each of those.

On the retention side, one of the things we found is that we had areas that were performing very well. If you look at Slide 17, you can see that most of our regional service areas were performing at or above the 93% retention rate. The issue: Several very poor performers that were negatively impacting our overall statistics. What we also found that a lot of those losses were self-inflicted. Poor service is an example, and so we're working to fix that.

The other thing that we found in retention is that, in our business, there are what we call controllable and uncontrollable losses. An uncontrollable loss is a bankruptcy, it's a sale, another example is a customer that we don't want to do business with because of compliance issues. We've determined that those aren't the real areas to focus. What we need to focus is on the controllable losses; losses due to service or other areas that we can influence. And that's what we're doing with all of our service areas, particularly those that are underperforming.

On the sales side, it's a little more difficult, because we did find that we were behind. We found that we had structural issues in our sales force. We were deployed in the wrong markets and we had the wrong roles around the sales leadership. We also found that many of the tools we had in place weren't being used effectively. What we did in that area is to put a seasoned professional, Amit Jain, in charge of our sales force. He's now the -- our Senior Vice President of Sales for LTC. Prior thereto is with our Specialty Care Group. As Amit discussed in our Investor Day in December, he went through a detailed plan around what we're going to do to increase our sales and we've made big improvements in that area. There's a lot of work still to do, but we're on our way to where we believe we'll see sustained sales growth in the future. Ultimately, the changes in sales and the enhancement in our retention, we believe, will lead to sustained, long-term growth in our Long-Term Care business.

Before I move off to Long-Term Care, I want everyone to focus here just for a minute on Slide 20. What we've seen over the last several years, since the downturn in 2008, is that Long-Term Care is a flat to declining business on the skilled side. But our Long-Term Care business isn't just about skilled nursing facilities, there's also assisted living and independent living facilities. And what we've seen is over the same period, these businesses are growing at a 3% to 5% rate.

Although we're the largest player in the assisted living space, we continue to believe that it's been under focused in the last several years. We currently are about to launch a pilot in the assisted living space that we believe will be a differentiated, scalable approach to serving assisted living facilities in our market.

The positive point around assisted living is there's really a 3-pronged approach for Omnicare, and it's shown on this slide, on Slide 21. First, we can -- we have -- we can increase our penetration at our existing customers, where our penetration is much less than we see in our skilled nursing space. Second, we can add new customers. And then finally, we can grow with a growing industry. We believe this is a potential area for significant growth for Omnicare in the future.

Let me now spend a minute or 2 on our Specialty Care Group. As I said before, Specialty Care operates in 5 platforms, 4 of which are focused on commercialization for biopharma products. Our objective, increase access to our clients' products. And we do that through Brand Support Services, third party logistics and multiple pharmacy platforms. We believe we're the only person in the industry who's integrated these platforms under one leadership team. We believe this is unique and is very enticing to our biopharma clients.

Our Specialty Care Group was formed in late 2010. At that point, we laid a foundation for significant growth. We invested on our operations and our infrastructure, including building a new sales force. For the last 8 quarters, we've seen this performance show itself in double-digit revenue and EBITDA growth.

Now while I'll tell you that we don't believe that we can continue to grow at the 20% to 30% rates we've seen over the last 1.5 years, we do believe that this is a double-digit, long-term growth story. The reasons being: First, the industry grows in the high single-digits; secondly, the number of drugs that we have included in our model that we do business with today are very small, relative to the number of drugs in the marketplace and the growth that's coming, as we showed on previous slides. In addition, we focus primarily on multiple sclerosis, RA and oncology today. There are additional disease states that we believe would fit well with our platforms.

Having talked about our business, now let me spend a couple of minutes on the financial overview. Slide 28 includes our 8-quarter trends on operating -- on our operating performance. The prescriptions dispensed were about 30 million per quarter and -- over the entire period on a slightly lower-bed base. As you can see in the upper right quartile, our generic dispensing rate has increased over the period, nearly 84% at the end of 2012. Revenue has seen a modest decline from the increased generic utilizations, and that's been offset by the growth on our Specialty Care Group. And as you can see in the bottom right quartile, we've seen very strong EPS growth.

Now let me move on to one -- what we believe is one of the more compelling aspects of Omnicare cash flow generation. For 2012, we generated $545 million of operating cash flow. If you exclude the $50 million payment we made to the DEA in early 2012, we generated almost $600 million of operating cash flow. We believe we have a high quality earnings, and as shown on sleep this chart on Slide 29, our EBITDA turns into cash flow, and that cash flow provides us with flexibility around capital allocation.

I'm going to spend the next few slides talking about our capital allocation program. First, let me talk about acquisitions. What you've seen with the new management team is a very disciplined approach to acquisitions. We've greatly reduced the deals we've done, although we look at as many, in 2012, we only completed one acquisition in the Long-Term Care space, and it was relatively minor.

While we're still interested in doing acquisitions, because our platforms our leverageable, there are certain factors that we look at before we'll even consider a transaction. First, it can't be disruptions to any of our businesses. In the Long-Term Care space, we're not going to buy beds anymore, we're more focused on organic growth. That means, if we do deals, it's going to be acquisitions where we have strong operators, there are no compliance issues and the businesses are making money.

In the Specialty Care side, that's means realistic valuations. It means businesses that add to our existing platforms while not slowing down our current growth rates. And it also means that the businesses are generating cash. The results of reducing the amount of acquisitions we've done means that we have more uses of cash today than we have in the past.

First, returning to shareholders. On the dividend front, we've significantly enhanced our dividend since 2010. We've increased the dividend 4x, from a $0.02 per share dividend to $0.14 per share. That's currently 140 basis point yield on our common stock price, although still very minor when you think about the amount of cash that we're distributing for dividends. Our overall objective of over dividend program is to provide a reasonable, long-term yield to our shareholders.

Next, let me talk about share repurchases. You've seen a significant increase in our share repurchases since 2010. We've reduced our share count by approximately 10% since that time. Part of our decision here of returning capital to shareholders through share repurchase is directly tied to the acquisition strategy. When you do acquisitions, you can increase your EPS for a short period of time, but if those are bad deals, you'll lose that EPS over time. We believe by buying back shares, you return capital and you create EPS growth for the long-term.

Late in 2012, we entered into an accelerated share repurchase for $250 million, that accelerated share repurchase will complete in the first half of 2013. After consideration of the share -- of the accelerated share repurchase, we have approximately $220 million dollars remaining on our authorized repurchase program.

Next is debt repayment and our capital structure. As you've seen, since 2010, we've done, in our view, a very terrific job of stretching out our debt maturities and reducing our borrowing costs. As you can see in the chart, the yellow lines are where we were in the end of 2009. Today, the purple lines are where our debt maturities are. At any point in time, we could use our existing cash flow to pay down debt, if necessary.

Today, because of our cash flow and our capital structure, we're very flexible around our uses of cash. We have the ability to invest in our business, be in automation or other such technology. We could do minor step-out acquisitions or significant acquisitions if the opportunity arose. We're going to be opportunistic about -- around debt reduction, and then we'll continue to return capital to our shareholders.

On Slide 34, we've laid out our credit profile in a 3-year trend. I will tell you that we're very comfortable today with our current leverage, given our cash flows. You see a slight uptick in our ratios at the end of 2012, all driven by the accelerated share repurchase and the $250 million payment that was made. We believe that our leverage ratios will continue to improve with cash flow and EBITDA growth.

Let me conclude by talking about our 2013 guidance that we released last week on our year-end earnings call. First, from a revenue perspective, $6.1 billion to $6.2 billion, adjusted cash-based EPS of $3.47 to $3.57, and cash flows from operations of $450 million to $500 million. This mid-point of our EPS guidance is a 5% increase over 2012. And I'll tell you, it includes higher depreciation costs from investments we've made in our Oracle-based ERP system and automation, and also includes a $4 million headwind from cash tax adjustments. This guidance also includes a full -- an assumption for FUL-based pricing under AMP for a large portion of the year.

With that, we'll open it up for questions.

Question-and-Answer Session

Unknown Analyst

Just curious about the assisted living opportunity. What percentage of -- I mean, in your pharmacy business, what percentage is assisted living now? And just how does -- I mean, I guess, I understand how pharmacy feeds the skilled nursing bed, but how does the model differ for assisted living?

Robert O. Kraft

Yes, let me -- can you hear? I think I'll have Patrick Lee answer this question. Patrick is, in addition to being our Investor Relations person, also the strategy for our company. And one of the areas that he's been intimately involved with is the pilot around assisted living.

Patrick C. Lee

Yes, so I think the company, historically, has spent most of its efforts focusing on skilled nursing and assisted living has been more of an afterthought. But it is a very differentiated model to your point and a market that really -- you can't really take the same skilled nursing approach and apply it to assisted living. I think that's what most of our competitors and Omnicare has done historically in the market and it just hasn't worked. You're dealing with a different skill level at the staff of the communities. In skilled nursing, you've got very sophisticated nurses, you have medical directors. You don't have that same kind of infrastructure in assisted living. To your first question about the size and the percentage of our business, assisted living is probably about 15% or so, plus or minus, a little -- of our scripts or beds, either way you look at it. When you look at just the number of scripts per resident, it's very similar. And historically -- I mean, you probably wouldn't think that, but what happens is in skilled nursing, you don't really have as much over-the-counter medications. But in assisted living, you typically have 2 to 3 over-the-counter medications per resident. So the net number is pretty similar. But what we're doing is, again, as Rocky mentioned a little bit in the presentation, we're trying to take a little bit of a differentiated approach. We've kind of identified some of our historical weaknesses, some of the gaps in the market. And then we're trying to fill those through this pilot.

Robert O. Kraft

Yes, the other important piece, as we talked about in the presentation, is penetration. As Patrick said, even with existing clients today, in a skilled nursing facility, we'll serve 98% or 99% of the patients that are inside the skilled nursing facility with which we have a relationship. On the assisted living side, it's a much, much lower penetration level, more like 50% or even lower. And so there's a big opportunity even without growing new patients to just grow the penetration we have with our existing clients.

Patrick C. Lee

I would also say the health of these customers are a lot different than skilled nursing. With skilled nursing, you have roughly 1/4 of their revenues that are -- they're directly being reimbursed by the government. Assisted living really doesn't have any government reimbursement. There's a very small amount of Medicaid, but that's it. I mean, most of it is just private pay where they're getting fees directly from the residents. So we like to think that that's an environment where it's a little bit healthier from a reimbursement perspective as well.

Unknown Analyst

I just wanted to talk a bit about your leverage strategy and your balance sheet. I guess, with the management changes that happened, and you talked a bit about it that during the presentation. But do you have a specific target that you're looking to? And also kind of a mix of debt financing, historically, there's been a lot of converts previously.

Robert O. Kraft

Yes, I think -- we do not have a target that we're looking for from -- example, from a leverage ratio perspective. We're comfortable with where we are today. We think, naturally, because of our cash flow generation or EBITDA, that, that number will come down if we don't do anything significant from an acquisition perspective. And so we're comfortable where we are. We will be comfortable, quite frankly, with this business even as cash flow characteristics being more highly leveraged. That being said, the second question you asked was around our debt structure. I think as you us looking -- going forward, I don't think you would see us probably originating any convertible-type securities. I mean, particularly today, if we had a need to borrow money, that the rates in the marketplace, as you all know, are very favorable, and we think we could borrow at very favorable terms at pretty long range. So I think if and when we decide to do something, it'll be more conventional than what you've seen historically.

Unknown Analyst

I'd like to ask about to your -- the barriers to entry in your business. They've never been, I don't think, particularly high with respect to capital needs or perhaps even technology. But how would you say that has changed over the last several years? Are the barriers going up or are the barriers coming down? And I have a follow-on.

Patrick C. Lee

Yes, I mean, I would say that -- I'll start and then Rocky can add do it. I'd say the barriers have probably increased from the standpoint that reimbursement has gone down over the last 10 years. Medicaid rates have gone down. Part D reimbursement has gone down. So it's a tougher environment. I think that's part of the reason why you don't see as many skilled nursing facilities owning their own pharmacies, as we saw 10, 15 years ago. I think the other thing is you have other regulatory changes, like short-cycle dispensing -- it's something that started on January 1, which is a requirement to dispense branded drugs under Part D every 2 weeks, instead of every 30 days. And just operationally, I mean, we kind of have been preparing that for 1.5 year, so we have talked to that as something that really wasn't much of an issue for us. But keep in mind, we have automation, we have scale. Most of our competitors don't have any of that stuff. So it's very challenging for them to actually take on that additional labor to implement a rule change like that. So I think, to answer your question, it's just the way the environment has progressed over the years. It has become a little bit more challenging for the smaller players to compete in this market.

Unknown Analyst

Okay. And the follow-on, also relating to competitive landscape. The retention slide you put up was, I think, interesting. The centers that stood out as not particularly performing well in 2012. Were they -- did you look at whether they were the same centers in 2010 and '11? Does it sort of jump around from year to year? Or was that a multiyear theme of centers?

Robert O. Kraft

Yes, I think the centers that you see are multiyear themes, that just from an operational perspective, weren't fixed. And so, again, as we said, a lot of those were self-inflicted wounds. A lot of -- I don't want to over simplify our business, but most of our customers -- if you get the right drugs to the right patient on time, they're pretty happy with customer service. And so what we saw is pharmacies that, operationally, weren't performing well and weren't doing a good job getting the drugs out on time to the right customers, and that was longer-term.

Unknown Analyst

Okay. And then, finally, I jotted down, but I'm not sure I got this right. Did you say that acquisitions of beds not going to be done anymore? Or just not as much of a focus anymore?

Robert O. Kraft

I think what you'll see is a much more disciplined approach that you've seen over the last year, you'll continue to see that. So if they are good operators, they're in the right geographies that don't have compliance issues, we'd be interested in buying those beds. We're not going to buy beds that have compliance issues or bad operators or people who aren't making money. So I think -- I don't want to call it de-emphasis, because I will tell you the pipeline is still robust, and we continue to look at a lot of acquisitions. But I think you're going to see a much more disciplined approach than you've seen historically.

Unknown Analyst

So those criteria actually do represent a more discriminating approach?

Robert O. Kraft

Yes, absolutely.

Patrick C. Lee

Correct.

Unknown Analyst

If we x-ed out acquisitions, I think there's been, for years and years, organic bed loss. Is -- is that a reflection of market share? Or the flat to shrinking SNF bed base? And is it possible to -- is that ever going to reverse?

Robert O. Kraft

Yes, I mean, I think as I talked about it more, we believe that we will reverse. We believe we can. I think: A, you are fighting a little bit of an upstream in that it is a declining-to-flat business, and we aren't going to grow in the skilled nursing space through just growth in the industry. There may be some in some of the other markets, but not in skilled. What we've seen is the retention -- if we can get our retention and our controllable losses to a reasonable level -- again, the ones that we influence, we believe that our sales force that we've put in place today can make that up and get us to organic bed growth. But it's going to time. As we've said publicly, we believe that in the second half of 2013, you'll see us move to net organic growth or to a positive from a beds perspective.

Patrick C. Lee

And to say it in a different -- I mean, we've -- saying in a little bit of a different way, we think we can grow our market share in skilled nursing. So even though the market is somewhat flat, I don't think it's going to be flat forever. I mean, you've got skilled nursing that's been kind of going through this evolution of going after post-acute instead of their traditional long-term residents. And until that evolution is complete, I think the growth is going to be flattish. But then, that emphasizes the importance of going after these other markets like assisted living, independent living, and some other areas, which are growing.

Unknown Analyst

Are there -- what percentage of the market -- are there SNF operators that have their own pharmacies? Because you mentioned one of the uncontrollable losses was acquisition. I kind of thought all the big -- a lot of the big nursing homes were outsourcing that already. So if there was an acquisition, you'd either continue to do it or...

Robert O. Kraft

Yes, I think when you talk about acquisitions, this is -- it's more smaller players, quite frankly. I mean, when you look at across the continuum of the large national accounts, we service virtually all of them. There's one that our primary competitor services and then there's one that has publicly said they're bringing their pharmacy in-house. But other than that, we serve all of those. So as acquisitions happen in that space, we should be in that winner. It's more in the smaller space where -- when a regional player or even a local player will go out and buy a pharmacy that -- or buy a nursing home that we service, where we'll lose those beds potentially.

Patrick C. Lee

It's more nursing homes buying other nursing homes, where we don't have the relationship with the acquirer, but we did with the target. That's where we kind of lose the business.

Unknown Analyst

Now, are the small nursing home operators more likely to have their own pharmacy than the larger ones?

Robert O. Kraft

I don't think so.

Patrick C. Lee

Yes, no, it's been -- I'd say, it's been a decreasing trend in general. There is one large skilled nursing chain, Golden Living, which is in the process of -- and we don't serve this customer, it's served by one of our competitors. But they're in the process of taking it in-house. I'd say that they're more of an anomaly compared to the rest of the market. We just -- again, that was a trend we saw a lot 10, 15 years ago. But it's a lot more difficult, there's more regulations today. The reimbursement is a lot different. The clinical demands are significantly different. So it's just, it's a different space. We don't really see that developing as we did some time ago.

Robert O. Kraft

It's good. Thanks, David.

Patrick C. Lee

Thanks.

Robert O. Kraft

Thanks, everyone.

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