PharMerica's CEO Discusses Q1 2014 Results - Earnings Call Transcript

| About: PharMerica Corporation (PMC)

PharMerica Corporation (NYSE:PMC)

Q1 2014 Earnings Conference Call

May 2, 2014 10:00 ET

Executives

Cynthia Archer - Manager, Treasury and Risk

Greg Weishar - Chief Executive Officer

David Froesel - Executive Vice President, Chief Financial Officer and Treasurer

Analysts

Glen Santangelo - Credit Suisse

Jason Gurda - KeyBanc

Brendan Strong - Barclays

Frank Morgan - RBC Capital Markets

Robert Willoughby - Bank of America/Merrill Lynch

Operator

Good day, ladies and gentlemen and welcome to the Quarter One 2014 PharMerica Corporation Earnings Conference Call. My name is Julian, and I will be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of the conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

I would now like to turn the call over to Ms. Cynthia Archer. Please proceed, ma’am.

Cynthia Archer

Good morning and thank you for joining us for the first quarter 2014 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 first quarter 2014 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 SEC filings including our annual report on Form 10-K and quarterly report on Form 10-Q. Copies of these documents maybe 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 quarterly report on Form 10-Q. We have made available to you our press release and our quarterly report on Form 10-Q 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 call over to Greg.

Greg Weishar

Thank you, Cynthia and thanks for all of you. As always, we appreciate for your attendance and your interest in PharMerica.

As you saw in this morning’s earnings release, we have reported strong results. Revenue, adjusted EBITDA and adjusted diluted earnings per share, all exceeded expectations for the first quarter. These results demonstrate the company is off to a great start towards achieving stated 2014 objectives and long-term growth and value creation.

Let me summarize the highlights. Excluding Golden Living and Kindred, we posted another sequential quarter of organic growth. This gives us confidence that we are gaining competitive strength in the core long-term care business. We anticipate achieving net organic bed growth for the year. The strategic investment in Onco360 in December 2013 gives us market entry into the large and fast growing specialty oncology pharmacy market. Growth in revenues on a year-over-year and sequential basis was in large part due to the inclusion of 100% of Onco360’s revenues in the first quarter of 2014. Amerita continues to grow according to plan. Amerita also achieved record revenues.

We continue to bring value to our clients through an industry-leading generic dispensing rate. The generic dispensing rate for the quarter was 84.5%, an improvement of 120 basis points year-over-year and 80 basis points sequentially. Looking towards the end of 2015, the generic dispensing rate is forecasted to hit 88% due to upcoming patent expirations. Nexium, Namenda and Abilify lead the list.

The investment in Onco360 coupled with the acquisition of Amerita reflects our focus on pursuing diversified growth opportunities in closely-related pharmacy markets. We believe the specialty infusion and oncology businesses will generate revenues of approximately $400 million by 2016. Complementing organic growth initiatives, we have a stated goal to complete acquisitions yearly that generate at least $100 million of annualized sales. We are targeting companies in the institutional pharmacy and specialty infusion pharmacy markets. And we are evaluating a number of acquisition opportunities and are optimistic we will achieve our yearly goal.

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

David Froesel

Thank you, Greg and good morning. I would like to spend the next several minutes discussing our results of operations for the first quarter of 2014. Revenues reported for the first quarter of 2014 were $452.2 million, which represents an increase of $12.4 million or approximately 3% versus the first quarter of 2013. In addition, on a sequential basis, revenues were slightly higher. The increase in revenues on a year-over-year basis was primarily attributable to PharMerica’s new investment in Onco360, strong branded drug inflation and growth in our specialty home infusion business, Amerita. More importantly, revenues associated with Onco360, home infusion and branded drug inflation more than offset losses in revenues associated with Kindred and Golden Living.

Gross profit for the quarter was $80 million or 17.7% of revenues as compared to $84.3 million or 19.2% of revenues in the comparable quarter of last year. The decrease in gross profit was primarily associated with the loss of Kindred and Golden Living facilities partially offset by lower cost associated with our planned restructuring program and improved drug purchasing economics. In addition, the Onco360 business contributed to gross profit dollars in the current quarter. On a gross profit dollar per script basis, Onco360 metrics are higher than PharMerica’ institutional pharmacy business, however, lower on a gross profit percentage of revenue basis.

SG&A costs in the first quarter of 2014 were $57.2 million as compared to $56.7 million in the comparable quarter of last year. The current quarter’s SG&A expense includes Onco360 and the provision for doubtful accounts is approximately $400,000 higher in the first quarter of 2014 than the first quarter of 2013, of which approximately half the increase in the provision for doubtful accounts is attributable to the inclusion of Onco360 in the quarter.

Furthermore, the days sales outstanding decreased from 41.6 days in the first quarter of 2013 to 37.7 days in the first quarter of 2014. The 37.7 days is an all-time record for the company and broke the previous record established in the fourth quarter of 2013 of 39 days. PharMerica continues to maintain the best days sales outstanding metric in the industry.

Adjusted EBITDA was $29.7 million for the first quarter of 2014 or 6.6% of revenues versus $34.6 million or 7.9% of revenues for the first quarter of 2013. The decrease in adjusted EBITDA is associated with the loss of Kindred and a portion of the Golden Living facilities. The loss of EBITDA associated with Kindred and Golden Living was partially offset by a reduction of our costs across the company associated with our restructuring program and improved drug purchasing economics. However, on a sequential basis, excluding the Onco360 business, our EBITDA margins as a percentage of revenues increased 10 basis points.

Adjusted diluted earnings per share was $0.37 for the first quarter of 2014 as compared to $0.46 for the comparable quarter of last year. Embedded in the $0.37 of adjusted diluted earnings per share is an effective tax rate of 37.4%. PharMerica’s historical effective tax rate was approximately 40% to 41%, whereas moving forward our effective tax rate will be in the range of 37% to 38%.

Cash flows provided by operations for the quarter was $4.4 million as compared to cash flows provided by operations in the first quarter of 2013 of $47.5 million. The primary reason for the change in cash flows is associated with our previously communicated plan to increase investments in selected branded drugs subject to high inflationary price trends as a means of enhancing gross margins on a go-forward basis. Our plans are to continue this strategy through the balance of the year as long as high inflationary price trends continue.

Regarding guidance for 2014, based on the solid first quarter results, we updated guidance. We are now expecting revenue to be in the range of $1.7 billion to $1.75 billion versus the previous range of $1.67 billion to $1.72 billion. Adjusted diluted earnings per share is now $1.40 to $1.50 versus the previous range of $1.35 to $1.50 and adjusted EBITDA is in the range of $117.5 million to $123 million versus the previous range of $115 million to $123 million. And last, regarding adjusted diluted earnings per share for the second quarter of 2014, we are expecting the range to be $0.34 to $0.36 per share.

So, thank you and now I would like to turn the call back over to Greg for some final remarks.

Greg Weishar

Thank you, Dave. Just before we finish and go to Q&A, I would like to talk about tailwinds a little bit. And if you look at our business, I think we are well poised to take advantage of those, but first of all, you got to look at organic growth. And as we look at the competition today, we believe we have the best client solutions in the industry. We have superior cost containment programs. We have best-in-class core pharmacy services. And we have the industry-leading generic dispensing rate. We are doing all we can to save our clients’ money help them better compete in their markets.

So, the organizational and product changes we have put in place over the past several years continue to gain traction. And this is having a favorable impact on retention and sales, as you can see from our most recent results. We also remain confident that the diversification strategy that we embarked on in 2012 is on track and will be a major contributor to shareholder value over the next several years. As I mentioned earlier, Onco360 and Amerita give us market access to the rapidly growing specialty markets.

We have also talked about the drug generic drug purchasing program and how that is favorably impacting the cost of goods sold. This program will continue to provide ongoing buy side benefits over the next several years. And as Dave indicated, the restructuring program met this quarter’s financial objectives and we are on track to achieve $50 million in annualized savings by the fourth quarter of this year. We deployed cash flow from operating activities to enhance margins through strategic purchasing and expect this strategy continue throughout the balance of the year.

So, with a solid quarter behind us, we are confident that 2014 will be a successful year of transition. We are very encouraged that the first quarter diversified revenues played a significant part in replacing the revenues lost from previously announced client losses in the institutional pharmacy business. In summary, we are confident we have a sound business strategy and that we are focused on all the key initiatives that will enhance shareholder value.

And I will turn it back to Julian for Q&A.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from the line of Glen Santangelo, Credit Suisse. Please proceed sir.

Glen Santangelo - Credit Suisse

Yes, thanks and good morning. Greg, I just wanted to sort of follow up on the revenue line. I mean, essentially it seems like the company continues to have decent organic growth momentum, and if you strip out the customer losses, I think you said you plan to be net bed positive for this year. I mean can you give us a sense for maybe what’s going on competitively in the industry, where is this market share coming from, and are you seeing more rationale behavior out of the independents?

Greg Weishar

Well, I think the independents are beginning. We have talked over the past several years how we thought that they ultimately would fade. And I think we are starting to see the beginnings of that. And I think you have heard us talk about technology in the past and the game is changing and the bar is getting raised for the client demands for technology as they compete and have to survive in the new world of Obamacare, if you will or accountable healthcare. They basically need to be able to document and to assure their clients, which are the hospitals and other discharging entities that they have the wherewithal to provide excellent service and that they can manage readmission rates at a lower rate than say some other competitors. So, we are seeing the bar raised for our clients. And I think that’s helped us in our clients’ minds anyway and as well as new sales. I understand that we are a better choice for them, because we are somebody that’s going to be around all over the long-term helping them navigate these waters with regards to the accountable care marketplace.

Glen Santangelo - Credit Suisse

So, is it fair to say that pricing, I guess, is becoming less of an issue?

Greg Weishar

Well, I don’t ever want to say pricing is not an issue, it’s always an issue. This is a very competitive market. And I think part of our value here is that we bring scale to the market as well as the other large competitor out there and we are seeing that we are able to maybe be a little more competitive than they have historically been.

Glen Santangelo - Credit Suisse

Maybe if I can just follow-up on sort of your own generic purchasing initiatives, I think on calls past we sort of talked about maybe this would be a full year ramp, in terms of buying the majority of generic pharmaceuticals on your own, is that still a fair trajectory to think about?

Greg Weishar

Correct. And we are ramping up to a target number. This year, we will buy a chunk of generics. Next year, we will buy a larger chunk. And then at the end of 2016, we will be able to reset our contract and be free to purchase up to 100% if that’s what we so choose to do.

Glen Santangelo - Credit Suisse

And maybe my last question and then I will jump off. I mean, Dave, when I sort of look at the gross margin continued sequential gross margin strengthen, you obviously you are doing more in the generic side. It kind of sounds like you are trying to take advantage of more branded price inflation and obviously the generic dispensing rate continues to pick up. I wonder if you could sort of parse out those drivers and maybe give us a little bit more color in terms of your opinion, in terms of what’s really driving that gross margin sequentially here?

David Froesel

Well, from a gross margin standpoint, I mean, you have hit basically and we have touched on what the major issues are. What’s helping us there obviously is branded to generics. What’s also helping us in a significant way, and as Greg just pointed out, will help us not only currently, but on a go-forward basis over the next several years, as we continue to buy more generic drugs directly from the manufacturers. It represents a significant tailwind or upside for the company and then we are also, from an operating standpoint, we are always looking at ways to improve our operating efficiencies within our pharmacies. So, there is a lot of positive things that I see that are going to drive gross margins over the next two to three years for Amerita and we are very pleased where we are today and it looks pretty good over the next several years.

Glen Santangelo - Credit Suisse

Okay, thanks for the comments.

Operator

Thank you. Our next question comes from the line of Jason Gurda, KeyBanc. Please proceed. Your line is now open.

Jason Gurda - KeyBanc

Hey, good morning. Thanks for taking the question. To start off, Dave, I think you guided a little bit lower for the second quarter than what you guys did in the first quarter, what do you expect in there? Is it Golden Living beds continuing to pull out?

David Froesel

No, what we did is the guidance for the first quarter was $0.33 to $0.35. And I upped the second quarter to $0.34 to $0.36. And as you well know, Jason, we are going to revisit – at the end of the second quarter, revisit our guidance on a go-forward basis, not only for the third quarter, but for the full year. But we ticked it up a little bit in terms of the second quarter over the first quarter and we are being a little bit conservative.

Jason Gurda - KeyBanc

Okay. And then if you think about the first quarter and your performance relative to like your initial guidance for the year and you guys raised the low end of your EBITDA and earnings per share guidance, what occurred in the first quarter that was maybe better than you had originally expected or ended up being not as bad as it could have been that led you to increase the guidance?

David Froesel

Well, two or three things obviously coming right out of the box in the first quarter. We want to be obviously on the conservative side. And then as the quarter finished, we were very pleased with our top line growth and we were very pleased with our strategic purchasing initiatives in terms of lowering our overall drug costs. And that gave us more confidence to raise the lower end of the previous guidance that we gave back out in late February.

Jason Gurda - KeyBanc

Okay, thank you.

Operator

Thank you. Our next question comes from the line of Brendan Strong, Barclays. Please proceed.

Brendan Strong - Barclays

Alright, good morning. So, Greg, it wouldn’t be an earnings call if I didn’t ask about specific contracts. So, I guess first I do want to ask about Kindred, because as I am sure you know, they are in the process of divesting about a third of the business that Omnicare currently has. So, I am just wondering if you think you can win some of that business back as we get into 2015?

Greg Weishar

I think it’s very possible and likely that we will get a chunk of that business back. I don’t know exactly what the timing of it will be, but we are installing some business that we lost already, I think in early June that was divested and ended up in our book back. As to how it all sorts out, I wouldn’t want to handicap it, but clearly we are keeping our eyes on it. And the folks in general who have been divested, they have indicated that they to the new owners that they liked our brand of product and services.

Brendan Strong - Barclays

Okay. And then is there any way to give us some sense for how big Onco360 was in the quarter and just so we can get a sense for the amount of scripts that it’s delivering versus the pricing it’s delivering?

David Froesel

Yes, Brendan, Dave. With respect to Onco, what I can tell you and what we previously communicated and since we didn’t break – we are not breaking Onco out into a separate segment for 10-Q or SEC reporting purposes, we expect revenues from Onco360 to be around $170 million plus. And it’s going to continue to, we see continuing to grow quarter after quarter on the top line and we also see it continuing to improve their EBITDA margins as we leverage that revenue. And as you know in that specialty business, particularly the segment or the market that Onco is playing in, the revenue per prescription is very, very high. That market typically commands revenue per prescription in the $2,500 to $3,000 of revenue per script. The gross margin as a percentage of revenue as you well know is a lot lower than some of our other businesses, but the revenue – I mean the gross margin dollar on that $2,500 to $3,000 per script is fairly healthy.

Brendan Strong - Barclays

Alright. And then maybe just two others very quickly, first on the $50 million in savings that you guys are expecting to achieve by the end of the year, how much of that did you already achieve in the first quarter versus what’s still to come?

David Froesel

Yes. The majority, I would say, was achieved in the – the way I am going to position it is the majority of it will be achieved in the first half of the year. And after we move past the first half of the year, there is going to be just a little left as we move through. But I will caution you, we are continuing – we are looking at 2014 as the transition year and we are continuing to look for other areas that we may look at in terms of improving some operating efficiencies or reduce costs, but bottom line is the majority of it will be out by June 30.

Brendan Strong - Barclays

Alright. And then just the last one I did want to ask you about was cash flow. I do understand the inventory build and that being a drag on cash flow for the year, but what I don’t understand is the impact in the quarter, because it looks like inventory came down. So, could you just explain that dynamic a little bit?

David Froesel

Yes. If you remember, Brendan, the historic – the PharMerica historical pattern with respect to the strategic drug purchasing initiatives was typically in the fourth quarter of each year, PharMerica did some strategic purchasing. And then what you saw in the immediate following quarter, meaning the first quarter of the year, the drugs that PharMerica put in, in terms of increased investment in the fourth quarter, there was a discontinuance or very little buying of those in the first quarter. And that inventory flushed out through the first quarter, and by flushing that inventory out and enhancing margins in the normal first quarters that buoyed the cash flow. So, the pattern was high cash flow in Q1, the company historically then did some strategic purchasing initiatives in the second quarter. So, the second quarter cash flow was low. Then the third quarter came back very strong as the second quarter purchases flowed through the system. And then the fourth quarter was breakeven or negative cash flow.

Brendan Strong - Barclays

Okay, alright. Thanks very much.

David Froesel

Thanks.

Operator

Thank you. (Operator Instructions) Your next question comes from the line of Frank Morgan, RBC Capital Markets. Please proceed.

Frank Morgan - RBC Capital Markets

Good morning. I wanted to ask about I guess as a follow-up to Brendan’s question on the Golden Living side, how much is left there? And then secondly, on your – the acquisition pipeline looking to pickup over $100 million of revenue, where do you really see the market today? What is the acquisition market like? And really from a strategic standpoint, what is your preference at this point? I know you mentioned issue some pharmacies, but as one possibility, but how do you kind of upgrade and evaluate, prioritize the areas that you would want to invest? Thanks.

Greg Weishar

Alright. Let’s talk Golden Living. We continue to have a sizable piece of their business. I would say that we continue to lose business as we sit here today. And we, I believe, have in our budget that we will have it all removed by November, if that’s correct. And so November, we anticipate all of it to go away. As with past years, we have taken that view, because basically that’s what Golden is telling us and – but I will say that the first quarter we anticipated more losses than we had incurred. We are seeing that pattern continue into the second quarter. But it’s very difficult when they tell us that they are going to do something and it doesn’t happen. But nevertheless, we still have in our budget I believe that November is when we anticipate most of that business planning all going away.

As far as the acquisitions, first of all, we target individual companies that are operating in our space and some of those companies are entertaining the notion of an acquisition. Other times, we get solicited by brokers or other bankers. And so we are opportunistic in that regard. But from what we, I mean, our number one view of this business is that we are essentially buying contracts and we want to buy business that is consistent, it’s not too far a field of what we are doing. And so obviously, retention of existing business that we buy is the primary, primary concern that we have when we look at businesses. So, that drives our value for the business in terms of, we have as an example a business that we think we might lose 50% of the business, it’s not going to have the same multiple as another business that’s locked in for the foreseeable future. So, I don’t know, Frank, if that addresses what you are after here.

Frank Morgan - RBC Capital Markets

Yes, but just in terms of are you buying pharmacies versus I mean obviously you have made a big push in the specialty area, but like what is your priority from a strategic standpoint, what business lines do you want to move into?

Greg Weishar

Okay. So, we have no desire at this moment to expand our oncology footprint from an acquisition standpoint. We think there is sufficient organic growth there that we have our mandate there is to build that company out and to make it highly successful and we are confident we can do that. On the infusion side, we are targeting businesses on the infusion side, because there is over 300 operators out there that are targets and we look at both from a standpoint of geographic expansion and also from the standpoint of if we can consolidate another operator in an existing market. So, we are looking at both of those opportunities, much like we do in the institutional pharmacy space.

Frank Morgan - RBC Capital Markets

Okay, thanks.

Operator

Thank you. Your next question comes from the line of Robert Willoughby, Bank of America/Merrill Lynch. Please proceed.

Robert Willoughby - Bank of America/Merrill Lynch

Hey, Greg, what was the first quarter acquisition, I see you spend $11 million. Can you remind us what that was and what that contributed to your $100 million goal for revenues?

Greg Weishar

Yes, Bob. We had some – that’s rollover from 2013 acquisitions that we paid in 2014. So, we did not close any acquisitions in the first quarter.

Robert Willoughby - Bank of America/Merrill Lynch

Okay. And then just any kind of update on the competitive landscape with some of the smaller retail pharmacies, independents accessing capital, and expanding into the institutional pharmacy market, is that getting bigger, getting lower, any change there?

Greg Weishar

In terms of people entering the business, is that your question?

Robert Willoughby - Bank of America/Merrill Lynch

Yes, some of the independent pharmacies, I had heard have been borrowing some money from some of the larger distributors out there helps some distributor pull-through some generics and helps the pharmacy increase their revenue flow if they can move into that institutional pharmacy market?

Greg Weishar

Yes. Well, I think people are looking – the wholesalers have been in some ways competing against us since the day that we were spun off. And I think you probably know we had represented a bit of a challenge as the independents in 2006 lost their cash paying customer and the wholesalers believed that they needed to prop up those independents and went about educating them on. And we are talking now not the independent institutional pharmacies, we are talking about independent retail pharmacies that entered the space in 2007, ‘08, ‘09 and ‘10 and continue to do that. So, we have made acquisitions, as an example, in the past, where a wholesaler has – where that acquisition owed wholesaler money. And we see that routinely and that’s I don’t think anything new. There maybe a renewed push on that as some of the anxiety I think is growing over their competitive position, but that’s not – that dynamic is probably not concerning.

I think the bigger question going forward is to what degree will these folks fight to stay in the business? And that’s always a little concern that you have, because they are competitors and all of these folks, it’s their livelihood. So – but I think the markets, I think Glen asked earlier about the competitiveness in the market. This market is very competitive. And we have been building products over the last five years to address some of what we consider to be gaps in needs that the clients would have as the business moved forward. And we think we are well-positioned there, because we have solutions to virtually most all of our clients’ concerns and solutions.

Robert Willoughby - Bank of America/Merrill Lynch

Okay. And just a quick one for Dave, Dave, is this disclosure going forward or do you anticipate in the Q and maybe the Q is out, I don’t know, there will be some breakouts by business line or you are going to keep everything consolidated?

David Froesel

We are going to keep everything consolidated for 2014.

Robert Willoughby - Bank of America/Merrill Lynch

Okay, thank you.

Operator

Thank you. We have no further questions. I would now like to turn the call over to Greg Weishar for closing remarks.

Greg Weishar

Thank you, Julian. Thank you for your interest. And we look forward to our next quarterly call. Thank you very much.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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