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PharMerica Corporation (NYSE:PMC)

Q4 2013 Earnings Conference Call

February 28, 2014 10:00 AM ET

Executives

Cynthia Archer - Manager, Treasury and Risk

Gregory Weishar - CEO

David Froesel, Jr. - EVP, CFO and Treasurer

Analysts

Steven Valiquette - UBS

Brendan Strong - Barclays Capital

Robert Willoughby - Bank of America Merrill Lynch

Diego Hernandez - Credit Suisse

Operator

Good day ladies and gentlemen and welcome to the Fourth Quarter 2013 PharMerica Corporation Earnings Conference Call. My name is Dominique, and I'll be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions].

I would now like to turn the conference over to Ms. Cynthia Archer, Manager of Treasury and Risk. Please proceed.

Cynthia Archer

Good morning and thank you for joining us for the fourth quarter and 2013 year end conference call. On the call with me today are Greg Weishar, Chief Executive Officer; and David Froesel, Executive Vice President, Chief Financial Officer and Treasurer.

Before beginning our remarks regarding the fourth quarter and 2013 year-end results, I would like to make a cautionary statement. During the call today, we will make forward-looking statements about our business prospects and financial expectations. We want to remind you that there are many risks and uncertainties that could cause our actual results to differ materially from our current expectations.

In addition to the risks and uncertainties discussed on this morning's press release and in the comments made during this conference call, more detailed information about the additional risks and uncertainties may be found in our annual reports on Form 10-K. Copies of our annual report on Form 10-K may be obtained from the SEC or by visiting the Investor Relations section of our website. PharMerica assumes no obligation to update the matters discussed on this call.

During this call, we will be referring to non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is available in our press release and in our annual report on Form 10-K. We have made available to you our press release and our annual report on Form 10-K filed with the SEC. In addition, this webcast will be on our website along with the transcript from this call.

And now at this time, I would like to turn the presentation over to Greg.

Gregory Weishar

Thank you, Cynthia and thank you all for attending. We appreciate your interest in PharMerica. As you saw this morning's earnings release, we reported strong results across the board. Revenue, adjusted diluted earnings per share and cash flow from operations all exceeded expectations. Furthermore, with respect to earnings and cash flow from operations, 2013 was a record year for the company. Dave will provide additional details regarding the fourth quarter, and the full year's financial performance.

Let me summarize the highlights. We strengthened our competitive position in the core long term care segment growing both organically and through acquisitions. We made a strategic investment in Onco360. Onco360 gives us market entry into the large and fast growing oncology pharmacy market. We met our first year business goals with Amerita, a specialty home infusion company we purchased in December of 2012. We developed a strategic partnership with Innovatix, to lower the cost of goods sold and to help us position for changes that are occurring in the healthcare delivery system, and we successfully implemented a direct generic drug purchasing program, and this will provide ongoing buy side benefits over the next several years.

In the institutional pharmacy business, excluding Golden Living and Kindred, we achieved organic bed growth in the fourth quarter. Moreover, we anticipate excluding the impacts from Golden Living in 2014, we will achieve in net organic bed growth in 2014 as well. We are generating sales and retention momentum, as the organizational and product changes we put in place over the past several years, are getting increased traction.

Today, we have the best client solutions in the industry, we have superior cost containment programs, best in class core pharmacy services and an industry-leading generic dispensing rate. We are doing all we can to save our clients' money, and help them better compete in their markets.

Generics play a big role in our strategy to save clients' money and drive margins. Generics have been and will continue to be a big win for our clients and the company. The improvement we saw in the fourth quarter, where in the generic dispensing rate improved from 83.3% in the third quarter to 83.7%, as a prelude to further improvements that will distance us from the competition.

Looking towards the end of 2014, and 2015, given scheduled brand patent expirations, we estimate the generic dispensing rate will likely surpass 85% of all prescriptions dispensed, and could go as high as 88%. Drugs such as Namenda, Abilify, Procrit and others are all slated to lose patent protection. So driving generics is a central go-to-market strategy for us.

Finally, we completed several acquisitions in 2013 that will partially offset client losses. I will talk more on acquisitions later. The strategic investment in Onco360 gives us market access to the rapidly growing pharmacy oncology market. With Onco360, we are creating a unique national oncology pharmacy and care management platform. We believe Onco360's revenues will grow rapidly over the next several years.

Let me give you an example; Onco360 recently announced it is participating in an exclusive distribution network for Pharmacyclics' recently approved drug Imbruvica. As one of only five specialty pharmacy distributors in the United States, we believe Onco360 can gain its fair share of a blockbuster size market that could exceed $1 billion by 2016. This is just one of many drugs Onco360 has limited distribution rights to. The investment in Onco360 and last year's acquisition of Amerita reflects our focus on pursuing diversified growth opportunities and closely related pharmacy markets.

Now let me touch on Amerita; Amerita revenues and earnings for the fourth quarter of 2013 achieved new records. We continue to believe the home infusion market has attractive fundamentals, and we are optimistic, that the current business will continue to post organic growth, and serve as a platform for national expansion.

As I mentioned last quarter, we are working to establish pilot operations to determine the feasibility of leveraging PharMerica's pharmacies, in order to strategically expand Amerita's platform, nationally. Much progress is being made and we have begun pilots in several markets. If successful, we will roll out nationally. Combined annual revenues, Onco360 and Amerita are estimated to grow organically to grow approximately $400 million by 2016.

The agreement with Innovatix, a full service Group Purchasing Organization will assist us in several ways. The partnership with Innovatix positions us to assist clients and partnering with ACOs, hospitals and physicians. We want to assure clients that PharMerica can assist them in reducing hospital readmissions and make them more competitive in their markets. We are expecting the Innovatix partnership will also advance PharMerica's position in the home infusion and oncology markets.

Now let me update you on our purchasing initiatives; we previously mentioned we commenced buying generic drugs from the manufacturer effective October 1, 2013. Buying generics direct improves the overall purchasing economics in 2014, and we will see improvement in each of the following years, to the point where we expect to be borrowing a vast majority of generic drugs on a direct basis by 2016. In addition, in 2014, we intend to deploy cash flow from operating activities, as a means to further enhance margins, for strategic purchasing.

Complementing organic growth initiatives, we continue to see measurable opportunities for acquisitions, both in the institutional pharmacy and the specialty pharmacy segments. Going forward, we will make targeted acquisitions that are consistent with our strategic blueprint and strict financial criteria. We are committed to pursuing opportunities in an aggressive manner, while continuing to be disciplined and opportunistic. We seek to add yearly on a yearly run rate $100 million in annual revenues through acquisitions.

Before I turn it over to Dave, let me update you on the restructuring program. Following the loss of Kindred at the beginning of 2014, we have taken immediate steps to right size the company's cost structure. As we move through 2014, we will continue to adjust the workforce and pharmacy plans to reflect anticipated business needs. We have been mindful to not jeopardize the progress in core operations that we have made over the past several years.

Serving our customers and clients remain the number one priority. The restructuring program is expected to generate approximately $50 million of savings on an annualized basis, and it will be fully implemented by the end of 2014.

So with that, I will turn it over to Dave to walk you through the financials.

David Froesel, Jr.

Thank you, Greg, and good morning. I would like to spend the next several minutes discussing our results of operations for the fourth quarter and full year 2013.

Adjusted diluted earnings per share for the fourth quarter of 2013 was $0.44 compared to $0.36 in the fourth quarter of 2012. Included in the fourth quarter of 2013 adjusted diluted earnings per share of $0.44, are several items worth noting.

The fourth quarter includes a $1.3 million non-taxable gain or $0.04 diluted earnings per share related to a bargain purchase gain on an acquisition completed in the fourth quarter. In addition, the fourth quarter was unfavorably impacted by approximately $3 million of revenue adjustments, associated with customer and third party pair settlements and a provision for doubtful accounts was approximately $1.4 million higher in the fourth quarter than the prior 2013 three quarters' run rate associated with customer settlements reached in the fourth quarter.

However, it is very important to note, both the $3 million impacting revenues and the $1.4 million higher in the provision for bad debt, should not; I repeat, should not be considered as an indicator of any future run rates. The improvement in adjusted diluted earnings per share on a full year-over-year basis of approximately 30% was attributable to the improvement in gross profit tied to the company's purchasing strategies, Amerita's 2013 full year contribution, and a lower effective tax rate for 2013 of 37% as compared to the historical average effective tax rate of approximately 40%. On a forward-looking basis, we will be bringing down our effective tax rate from the historical average rate of approximately 40% to a lower rate in the 38% range.

Revenues for the fourth quarter of 2013 were $450.5 million; however, excluding the $3 million of adjustments in the third quarter of 2013 associated with customer and third party payor settlements, revenues increased approximately 5% as compared to the fourth quarter of 2012. The 5% increase in revenue is primarily associated with institutional pharmacy acquisitions consummated in 2013, acquisition of a controlling interest in Onco360 and brand drug price inflation.

On a sequential quarterly basis, excluding the impact of the $3 million in adjustments recorded in the fourth quarter, and similarly $2.9 million recorded in the third quarter of 2013 associated with California Medicaid legislation discussed in our third quarter conference call, revenues increased approximately 3% associated with institutional pharmacy acquisitions completed in the fourth quarter, and the investment in Onco360.

The fourth quarter 2013 gross profit margin, excluding the $3 million in adjustments was 18.5%, which was 100 basis points higher than the gross profit margin in the fourth quarter of 2012 of 17.5%.

The improvement in gross profit margin for the fourth quarter of 2013 versus the fourth quarter of 2012, was largely attributable to the company's purchasing strategies. On a sequential basis, excluding the impact of the $3 million related to customer and third party settlements in the fourth quarter of 2013 and $2.9 million associated with the previously mentioned California Medicaid issue, the gross profit margin in the fourth quarter of 2013 was 18.5% versus 18.7% in the third quarter of 2013.

SG&A costs in the fourth quarter of 2013 were $57.6 million compared to $52.9 million in the fourth quarter of 2012. The increase in SG&A is primarily attributable to the acquisition of Amerita in December of 2012, and an increase in the provision for doubtful accounts. On a sequential basis, excluding the $1.6 million increase in the provision for doubtful accounts, SG&A costs were flat. Provisions for doubtful accounts in the fourth quarter of 2013 were $6.8 million or 1.5% of revenues and $5.5 million or 1.3% of revenues in the fourth quarter of 2012. The increase in the provision for doubtful accounts versus the fourth quarter of 2012, was due to customer settlements. On a sequential quarterly basis, the provision for doubtful accounts increased $1.6 million from 1.2% of revenues to 1.5% of revenues.

Furthermore, the company's DSOs improved in the fourth quarter 2013 to an all time new company record of slightly less than 39 days, versus 42.8 days in the comparable quarter of last year, and improved on a sequential basis, from 39.8 days attained in the third quarter of 2013. PharMerica's DSOs are the best in the industry.

Adjusted EBITDA for the fourth quarter of 2013, excluding the impact of the aforementioned $3 million revenue adjustments was $33.6 million compared to $28.9 million for the fourth quarter of 2012. On this basis, the EBITDA margin percent improves 70 basis points from 6.7% in the fourth quarter of 2012 to 7.4% in the fourth quarter of 2013. The year-over-year improvement in adjusted EBITDA margins is primarily attributable to the company's strategic purchasing initiatives.

Cash flows provided by operations for 2013 was a record $155.7 million, or 82% higher than the cash flows provided by operations in 2012 of $85.7 million. Furthermore, cash flows from operations of $155.7 million represents the sum of cash flows generated by the company for all of 2012, all of 2011 and approximately half of 2010. The improvement in cash flows from operations is associated with a significant improvement in net working capital, primarily associated with a reduction in inventories and higher year-over-year adjusted EBITDA.

One additional comment I would make regarding cash flows, which I have mentioned in prior calls. PharMerica has approximately $128 million in tax deductible goodwill, which simply represents a future cash flow benefit of approximately $45 million, which is an asset and an important asset that should be factored into the value of the company.

Now, regarding guidance for 2014, we are reaffirming our preliminary guidance released on January 10. We are expecting revenue to be in the range of $1.67 billion to $1.72 billion and adjusted diluted earnings per share of $1.35 to $1.50. Furthermore, we are providing adjusted EBITDA in a range of $115 million to $123 million; and last, regarding adjusted diluted earnings per share for the first quarter of 2014, we are expecting the range to be $0.33 to $0.35 per share. This range reflects the fact that payroll taxes are higher in the first quarter than subsequent quarters.

Now with that, I'd like to say thank you and now I will turn the call back over to Greg, for some final remarks.

Gregory Weishar

Thanks Dave. We enter 2014 coming off a strongest performance in the company's history, and more importantly, we are carrying the momentum from 2013 into 2014 across many fronts.

We are and remain focused on positioning PharMerica to grow and compete aggressively for market share, through organic growth and acquisitions. We will continue to improve the purchasing economics, right size the structure and deploy innovative cost savings, products and services. We anticipate tailwinds associated with brand patent expirations and demographic trends as well.

Finally, as we have previously indicated, 2014 is a transitional year for the company. However, we remain confident that 2015 financial results will be in line or better than the company's 2013 financial results; and we expect this growth trend will continue over the long term. We are confident the business strategy is sound and we are executing our initiatives that drive shareholder value.

I will turn it now back to Dominique for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions). And your first question comes from the line of Steven Valiquette of UBS.

Steven Valiquette - UBS

Thanks. Good morning. Just a quick follow-up on the guidance call back in January. You said it was preliminary, there could be some adjustments based on how Golden Living might roll off throughout the year. You have the Medicare Part D enrolment, Chicago is in the customer base. Just curious if you can update on those three topics and how they were a couple of months into 2014? Thanks.

Gregory Weishar

Steven, on the Golden Living piece, we have taken a pretty conservative view. It continues to be liquid. Sometimes, we think they are going to leave certain chunks of business on the payroll, sometimes they don't, sometimes they do. I can't read their mind, we continue to be flexible with them and at the end of the day, we think that there is probably a little bit of upside there. Could you restate your Med Part D question? Were you talking about pricing or, I had trouble following what your question was there, Steven?

Steven Valiquette - UBS

Yeah sure. You mentioned that when you gave the initial 2014 guidance back in January that was preliminary, but it could be adjusted, depending on how the Medicare Part D enrolment trends and Chicago, which they got within your customer base. I was curious how that may have progressed, now that we see the January [indiscernible]?

Gregory Weishar

We didn't see anything that really alarmed us, and we have some adjustments to some MAC pricing like we always do. But generally speaking, it was in line with what our expectations were.

Steven Valiquette - UBS

Okay. Got it. All right. Thanks.

Operator

Your next question comes from the line of Brendan Strong of Barclays Capital.

Brendan Strong - Barclays Capital

Good morning. Actually, just to follow-up may be first on Steve's question. I mean, Omnicare talked about seeing some negative PDT reassignment, so I would think that that might benefit you guys. So I am just curious if you are understating the benefit to 2014, or if you don't see a benefit from mix?

Gregory Weishar

I think the issue here is that, there is a mix and everybody has their own mix, of patience with regards to the location of their facilities and the payors that they do business with. I can't comment on what Omni's situation is, but I can tell you that, there were no major surprises here. We always seem to take a little bit of -- and there is always going to be an impact year-to-year, based on what Part D plans do with regards to pricing. But at the end of the day, there is nothing that we saw that was overly alarming, that's where we are.

Brendan Strong - Barclays Capital

Okay, great. Then Dave, I wanted to follow-up, may be a few questions. One is on, there is $3 million in the quarter. I am guessing this, a bunch of this really is for prior periods, can you give us some sense for, the periods that actually the settlement relates to?

David Froesel, Jr.

Put this in perspective, I joined the company as the permanent CFO in August of 2013, and when I came in and during the last five months of the year, wanted to get my arm around, any issues that were lingering out there, associated with -- that were kind of influx, we needed to reach some sort of settlement on. And bottom line is Brendan, we took a hard look at everything in the fourth quarter with respect to some of these customer and payor settlements that kind of had been lingering out there and the same thing on the bad debt or provision for doubtful account side, and we made some decisions to reach some settlements on those, put them behind us and we didn't want them continuing linger on or move into 2014, and decided to clean it up.

Brendan Strong - Barclays Capital

Okay. A follow-up question on that, there was some news back in the fall about pricing disputes between you and Brookdale. Does this resolve that as well; because I mean, that'd be good if you did?

David Froesel, Jr.

What I would say is, I am not going to call out any specific customer names. These customer and our payor settlements, there were several or more, and they were not confined, as you pointed out rightly so, that the fourth quarter of 2013, there were issues that rose in the past. But I don't want to really call it out for specific customers.

Brendan Strong - Barclays Capital

Okay. So I am sure you were quite aggressive in the first week of January about taking costs out. I guess, is there any sense you can give us about, how much of that $50 million you already achieved in January and February versus what you still need to deliver on throughout the course of the year?

David Froesel, Jr.

What I can say there, we took out a little bit of costs in the third and the fourth quarter of 2013, and then as you know, we lost Kindred effective January 1 of 2014. So prior to January 1, 2014, we aggressively took out labor costs and/or downsized some of our facilities associated with that. Then as we move through the first quarter and the subsequent quarters, we will continue to right-size our cost structure associated with the loss of the Golden Living facilities and other initiatives that we have underway. So yeah, a good part of it came out associated with Kindred, but there is more to come in the subsequent quarters, as we have not only right-sized our pharmacy operating structures, but as we continue simultaneously to right-size our overhead or back office functions.

Brendan Strong - Barclays Capital

Okay great. Thanks a lot.

Operator

Your next question comes from the line of Bob Willoughby of Bank of America.

Robert Willoughby - Bank of America Merrill Lynch

Hey Dave, just a question. What is the bargain purchase gain that's there in the fourth quarter? You may have said it, I jumped on late, but does the commentary about 2015 being in line with 2013 include that $0.04 contributions?

David Froesel, Jr.

What the bargain purchase gain was, is we consummated an acquisition late in the fourth quarter, and I am going to simplify you for it -- simplify this for you. When you simply -- if you look at the aggregate of the values that we assigned to that acquisition in terms of identifiable assets acquired in the liabilities assumed, if they exceed the consideration transferred by the acquirer being us, and in this particular case, it pertained to some federal NOLs that was a benefit of this acquisition, and the accounting roles after net of repaying out in terms of the assets and liabilities you inherited, combined with the federal NOLs. We were the beneficiary of about a $0.04 bargain purchase gain, that was isolated solely to the fourth quarter of 2013, that has got nothing to do -- I am sorry, 2013, got nothing to do with 2014 or beyond.

Robert Willoughby - Bank of America Merrill Lynch

That's right. But the comment hat 2015 would be at least in line with 2013, that does contemplate the $0.04, not backing that out for comparison purposes?

David Froesel, Jr.

I am backing that $0.04 out, since it was very unique.

Robert Willoughby - Bank of America Merrill Lynch

Okay. Okay. And just then a question, given that you have got other businesses now growing at some pretty exciting cliffs, are you contemplating any type of revenue disclosure here, to show us that oncology business and infusion business on a standalone basis?

David Froesel, Jr.

We are still in the process of evaluating, what we are going to do, with respect to our first quarter 2014 10-Q in terms of business segments, and we are going through that study right now with our auditors. So it's premature at this point in time to say anything on that.

Robert Willoughby - Bank of America Merrill Lynch

Okay. That's it. Thank you.

Operator

(Operator Instructions). And your next question comes from the line of Glen Santangelo of Credit Suisse.

Diego Hernandez - Credit Suisse

Hey guys, this is actually Diego filling in for Glen. Maybe trying to get at that question a little bit differently is, if you're saying that the specialty business is going to grow to $400 million in 2016, what sort of run rate base are we looking at here?

David Froesel, Jr.

In order for us to get to that number, we have to show growth rates of greater than 20% over the next couple of three years.

Diego Hernandez - Credit Suisse

All right, perfect. That's really helpful. Then, just in terms of the margins that these transactions that you are hoping to accomplish every year; I mean, I know you've talked about the specialty acquisitions coming in, maybe somewhere between 3% and 5%, I am just kind of curious on the long term care side, what kind of margins you guys are seeing for the potential acquisitions?

David Froesel, Jr.

In terms of the margins on those acquisitions?

Diego Hernandez - Credit Suisse

Right.

David Froesel, Jr.

Well I think margins can be all over the board, but depending on the health of the business that we look at. We typically see 8% margin, somewhere in that ballpark, give or take a few points. So that's a good planning number. That takes you to the operating margin. You also got to recognize too, that those businesses that we buy, typically have very limited overhead. So that's their margin now.

Diego Hernandez - Credit Suisse

Great. Thank you.

Operator

With there being no additional questions, I'd like to hand the call back to Mr. Greg Weishar, Chief Executive Officer for closing remarks.

Gregory Weishar

Thank you all again for joining us and hope you have a nice weekend, get out in the cold and have fun. Thank you.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a wonderful day.

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