Omnicare's CEO Discusses Q1 2012 Results - Earnings Call Transcript

Apr.27.12 | About: Omnicare Inc. (OCR)

Omnicare (NYSE:OCR)

Q1 2012 Earnings Call

April 26, 2012 9:00 am ET

Executives

Patrick Lee -

John G. Figueroa - Chief Executive Officer and Director

John L. Workman - President and Chief Financial Officer

Nitin Sahney - Executive Vice President and President of Specialty Care Group

Jeffrey M. Stamps - Executive Vice President and President of Long-Term Care Operations

Analysts

Lisa C. Gill - JP Morgan Chase & Co, Research Division

Charles Rhyee - Cowen and Company, LLC, Research Division

Glen J. Santangelo - Crédit Suisse AG, Research Division

Frank G. Morgan - RBC Capital Markets, LLC, Research Division

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Robert P. Jones - Goldman Sachs Group Inc., Research Division

Brendan Strong - Barclays Capital, Research Division

Steven Valiquette - UBS Investment Bank, Research Division

Operator

Good morning. My name is Theresa, and I will be your conference operator today. At this time, I would like to welcome everyone to Omnicare's First Quarter 2012 Earnings Call. [Operator Instructions] Thank you. I would now like to turn the call over to Patrick Lee, Omnicare's Vice President of Investor Relations. Mr. Lee, you may begin your conference.

Patrick Lee

Thanks, Theresa. Good morning, ladies and gentlemen, and thank you for joining us today. With me on the call are John Figueroa, Chief Executive Officer; and John Workman, President and Chief Financial Officer.

Before we begin, let me remind you that during this call, we will make remarks that constitute forward-looking statements. Actual results may differ as a result of a variety of factors, including those identified in our earnings release and in our various filings with the SEC. You are also cautioned that any forward-looking statements reflect management's current views only, and that the company undertakes no obligation to revise or update such statements in the future. For simplicity's sake and to focus on what we believe are the best indicators of our operating performance, we will discuss results from continuing operations, and we'll also exclude special items for all periods in our discussion today.

A reconciliation of this non-GAAP information has been attached to our earnings release and is also available on our newly redesigned website. Also on our website, you will find first quarter supplemental slides and the historical data behind our adjusted cash-based EPS reporting methodology, which we'll follow during our discussion today.

[Operator Instructions] With that, it is my pleasure to turn the call over to John Figueroa.

John G. Figueroa

Thanks, Patrick. Good morning, everyone, and thank you for joining us. During today's call, I'd like to share with you some of the drivers behind our first quarter performance, as well as provide an update on the status of our core operating initiatives. John will then review our first quarter financial results and current outlook for the year. Following our remarks, we'll be happy to answer your questions.

We are pleased with our solid first quarter financial results, which reflect the continuation of our recently established earnings momentum. Our focus on becoming more operationally driven and customer focused has enabled us to become more efficient as an organization, while concurrently benefiting from the pharmaceutical market trends. I believe we have begun a successful 2012 by elevating Omnicare's growth profile and positioning our shareholders for value enhancement.

For the quarter, we generated adjusted cash EPS of $0.81, which represents a 17% increase over the first quarter of 2011. This robust earnings growth was driven largely by our ability to leverage a sales increase. With sales 4% higher on a year-over-year basis, we increased our gross profit by 10%, as we benefited from the introduction of new low-cost generic drug alternatives, while also driving more operational efficiency.

As a result, we expanded our gross margin by 115 basis points, to 23.1% and we created further leverage at the operating income line as gross profit dollar growth outpaced the year-over-year increase in SG&A dollars, driving adjusted operating profit 19% higher. With SG&A expense remaining relatively even sequentially, we expanded our adjusted operating margin by 40 basis points, to 9%.

We also continued to generate solid cash flow, with first quarter cash flow from continuing operations of $100 million, or nearly 84% of our adjusted income before income taxes. And while John will discuss how that cash was allocated during the quarter, I believe we've been consistent in returning at least 25% of our cash flows to shareholders, while also looking at ways to improve our capital structure and generate attractive returns through acquisitions. We believe this disciplined approach to capital allocation, coupled with the robust cash flow characteristics of our company, provides for a compelling opportunity for our shareholders.

Turning now to our operating performance, a few items stand out. We continue to benefit from certain pharmaceutical market dynamics: further improvements in efficiency and standardization; a decline for the quarter in the number of beds served, as we had expected; and a robust growth within our specialty care group.

With respect to the pharmaceutical market dynamics, we have seen a number of high-volume branded products convert to generic form during the past 6 months, and we have been effective in driving rapid conversion to these low-cost alternatives. In fact, our generic dispensing rate expanded 80 basis points during the quarter, to 80.1%. And because we believe there are still a number of significant generic drugs yet to be introduced into the market and other exclusive generic drugs are soon to become multi- sourced, there is still opportunity for Omnicare, our customers and payers to capture additional savings.

I believe Omnicare's generic drug efficiencies, coupled with our unique clinical programs, enable us to generate savings that provide a tremendous amount of value for our customers. In fact, we recently met with a new regional customer and evaluated their savings attributed to our therapeutic interchange programs and a brand-to-generic efficiency program, and this new customer was pleased to see we saved them over $250,000 in the fourth quarter alone. When we benefit from our clinical expertise and generic drug efficiencies, our customers do, too. And that is why we believe Omnicare and our customers are uniquely positioned to benefit from this generic wave we are currently riding.

Moving on to our improvements in efficiency and standardization, we continue to benefit from recent initiatives designed to streamline dispensing activities in Long-Term Care, especially in the area of automation. During the quarter, we increased the percentage of our scripts dispensed through our proprietary auto label verify machines, or ALV, to approximately 100 basis points, to 19.7%. We are excited about this progress, but I believe we have only scratched the surface here. By 2015, I expect we will be utilizing our ALV and our new universal label verify technology, or ULV, to handle approximately 70% of our scripts, which we believe will be a key driver for efficiency improvement.

We also believe the Six Sigma level automated processes have a favorable impact on the customer experience by improving the accuracy of our prescriptions dispensed. With respect to the customer experience, service levels continue to be higher than historic levels, with our first quarter service-related losses 30% lower than a year ago. While service-related losses were well contained, we did see a reversal of our fourth quarter net organic bed growth, as expected, to a net organic bed loss of 24,000, although I think it is important that you understand the factors that contributed to this. The majority of our net organic bed loss was attributed to 2 business determinations made after a cost-benefit analysis: first, the exit of a large correctional facility, where the competing bid was at a price point that we had no interest in matching; and second, the termination of several legacy accounts for collections and related issues.

Regarding the correctional facility, we are still very keen on this market, and we have several of these facilities in our pipeline. But because this is typically a lower-margin business, we will be disciplined in how we price our services to these accounts.

Suffice it to say, we remain focused on establishing net organic bed growth in Long-Term Care. And I believe we have a number of new service enhancements to help us attain this, including our OmniviewDr e-prescribing module, which is the first of its kind in the institutional pharmacy space to also provide a secure interface for physicians to prescribe all products, even controlled substances; and our medication availability unit, which is our proprietary in-facility machine that solves for lack of medication events, while significantly shortening the time in which residents receive urgent meds, including controlled substances.

We continue to look at new ways to bring value to our customers, while ensuring they're heavy users of our services and remain loyal to the Omnicare offering. We remain very encouraged by organizations' commitment to serving our customers, and we have made a number of recent investments in our sales and marketing components that keep us focused on attaining our goal of net organic bed growth in 2012.

And just as service levels remain high in Long-Term Care, we have been similarly effective with our Specialty Care group. This segment generated a 41% year-over-year increase in operating profit, with double-digit increases generated across all operating platforms.

Our Specialty Pharmacy platform experienced tremendous growth during the quarter, driven largely by a very strong performance from our physician sales team. Additionally, we believe our manufacturer-focused, fee-for-service platforms are demonstrating momentum and beginning to appeal to the biopharmaceutical community. As many of you well know, only recently have we organized our manufacturer-focused sales organization, but we have been pleased with the early results from this group. Despite what is generally a longer, more consultative sales cycle, this team began to generate results in the second half of 2011. And we are even more excited about their prospects for 2012. I believe this team will be increasingly effective as the year progresses, and we will exit the year supporting several new products for all of our fee-for-service operating platforms. We are using a differentiated position in Specialty to appeal to pharmaceutical companies. I believe we are the purest, fully integrated pharmaceutical-support company for key commercialization services without inherent conflicts in our relationships with our clients.

And with that, I'll turn it over to John, who will cover our first quarter financial results in greater detail, as well as provide some comments on our full year outlook. John?

John L. Workman

Thanks, John. As John stated, we are pleased with our first quarter results. As also mentioned, we have filed supplementary schedules with our press release, providing additional information, which we hope helps with your analysis.

Our special items were lower this quarter than a year ago and were primarily related to: one, litigation and other settlement issues; two, acquisition-related costs; and three, debt-related charges. We also had an impairment charge on an asset held outside the United States. I will cover these later, but I want to start by covering our adjusted continuing quarterly operating results.

Looking at our quarterly performance and starting with operating statistics, which can be found on Slides 5 and 6. First quarter scripts dispensed at 30.8 million were higher by 40 basis points than the scripts dispensed in the comparable year earlier-year period. On a sequential basis, scripts were 50 basis points higher than the 30.6 million scripts dispensed in the fourth quarter of 2011. Due to leap year, the current quarter had one more day than a year ago but one less day in the fourth quarter of 2011. As we have stated before, scripts are the most meaningful measure as a driver of revenue and gross profit our generic dispensing rate has continued to increase. It was at 80.1% for the quarter. We believe this continued to help lower overall health care costs.

With respect to beds served, we ended the first quarter with 986,000 beds in our Long-Term Care segment. As we mentioned in our year-end call, we no longer report specialty care beds as they are not relevant to this segment. We have tried to provide more insight into the beds included in our Long-Term Care segment by breaking out those at parallel script performance and those with less correlation. The first category labeled Patient-Related Beds includes SNFs, ALs and similar venues. The second category labeled Other is where the number of beds that are disproportionately higher than the scripts dispensed. An example would be correctional institutions.

Our retention rate in patient-related beds was 92.1% for the quarter, generally consistent with our full year 2011 rate. We have indicated organic bed growth will not necessarily be linear by quarter, and we expect negative organic growth in some quarters in 2012. The fact we have losses reported in the first quarter is consistent with our expectations mentioned in our year-end call. Certain of the bed losses categorized as patient-related beds are related historical accounts receivable issues. The net bed loss in the Other category was primarily attributable to the loss of a 12,000-bed correctional facility with low per-diem rates and 3,000 beds serviced by our nuclear pharmacy in the northeast that we divested during the quarter.

Turning to the income statement and consistent with past practice, we believe the most appropriate comparison for the quarter is on a sequential basis, excluding special items. Looking first at net sales and gross profit, which can be found on Slide 8. Net sales were $1.593 billion in the first quarter of 2012, a 2.3% improvement over the fourth quarter 2011 results. Compared to the first quarter of 2011, sales increased $67.5 million, or a 4.4% increase. Adjusted consolidated gross profit increased $8.4 million in the first quarter over fourth quarter of 2011, with a generally flat margin rate as a percent of sales. Compared to the first quarter a year ago, gross margin improved $33.1 million, representing 115 basis points increase as a percent of sales.

Next turning to SG&A expenses and provision for doubtful accounts, also found on Slide 8. SG&A expense was flat in the first quarter of 2012 versus the fourth quarter of 2011, despite our continued investments in our employee base and systems. As a percent of sales, SG&A expenses improved 28 basis points. Omnicare awarded merit increases late in the first quarter. These will impact labor costs in the remaining quarters of the year.

As a reminder, our labor costs are included under Cost of Sales as well as the SG&A expenses. The provision for doubtful accounts is 1.5% of revenue for the quarter, slightly improved from the fourth quarter rate. Receivable day sales outstanding, or DSO, were flat compared to the fourth quarter of 2011.

Finally, in looking at interest income taxes, net income and earnings per share, which can be found on Slide 9, interest expense was $1.1 million lower in the first quarter, principally related to our debt refinancing and reduction initiatives.

Our income tax rate for the quarter, excluding the impact of special items, is 38.3%. Income from continuing operations, excluding special items, was $73.4 million for the quarter, or 4.6% of revenue. Adjusted cash earnings per share for the quarter equates to $0.81 per share, a $0.03 per share improvement over the fourth quarter of 2011 and a $0.12 per share improvement over the first quarter of 2011.

As a reminder, the long-term items we are adding back to arrive at adjusted cash earnings per share are: one, amortization of intangibles and the tax benefits of goodwill amortization; and the benefit of our contingent interest debt obligations, where we are allowed to deduct interest at a higher rate while only paying 3.25% or 3.75%. As we have stated previously, these items have a life of 9 years or more.

Next turning to our segments. First, looking at Long-Term Care, which can be found on Slide 7. For the quarter, Long-Term Care on a sequential basis reflected an improvement of $7.9 million in adjusted operating income on higher sales. Operating income, as a percent of sales, improved 45 basis points. Compared to a year ago, operating income in Long-Term Care improved $23.8 million, an improvement of 179 basis points. The increase is a result of the benefits of branded generics, as well as improved operating efficiencies.

In looking at the Specialty Care group, also found on Slide 7, on a sequential basis, the Specialty Care group's revenue increased 6.2% and operating income, 10.3%. Compared to the first quarter of 2011, the Specialty Care group experienced significant growth, with a 26.8% growth in revenues and a 41.3% growth in adjusted operating income. The growth was across all operating platforms.

We have been stating that this is a growth segment, and we think the first quarter results reinforce that point. Going forward, we expect strong double-digit growth in revenue and growing operating income.

In addressing special items, in the quarter they were fewer in number and amount than the fourth quarter of 2011. Consistent with prior quarters, the amortization of our debt discount was $6 million in the quarter. We incurred $3 million related to merger and acquisition expenses, down from $15 million in the previous quarter. We had been assessing our prospects for an asset held outside the United States, and as a consequence, recorded an impairment of goodwill of $6 million in the quarter. We also incurred $3 million related to separation costs for 3 former executives in the first quarter of 2012.

The largest special item in the quarter was litigation-related settlements, which totaled $7 million, down from $23 million in the fourth quarter of 2011. The provision considers the state of discussions on various regulatory and other matters that have previously been mentioned in our disclosures, including the DEA investigation. There were about $1.5 million related to our attempt to acquire PharMerica, including special items in the quarter. As we have mentioned before, we believe there will likely be some additional matters that may arise against the company in the future, but we feel that the large ones are behind us.

Next and turning to the balance sheet. We continue to show strength in the quarter. Cash on hand was $624 million, including restricted cash. The cash receivable were $61 million higher than the fourth quarter of 2011 impacted by: one, a seasonal build on the Specialty Care group; two, the impact of a Part D provider being required by another plan, which has 15-day longer terms; and three, slow pay by certain state Medicaid plans, for example, Illinois. These items should be timing items.

As mentioned earlier, days sales outstanding was flat compared to the fourth quarter of 2011. Inventory was lower than the end of the fourth quarter by $65 million, based on our purchasing patterns as we saw the impacts of generics moving through the system and the timing of our deliveries. This benefit did not entirely flow through our cash flow in the first quarter since the payments for the year-end inventory levels were made in the first quarter.

Next in turning -- looking at cash flow, which can be found on Slide 10. Cash flow from continuing operations in the first quarter of 2012 was approximately $100 million. The first quarter was a little lighter due to some of the working capital items mentioned earlier. We believe the company also has less modest maintenance capital requirements on an ongoing basis. We believe our maintenance CapEx to be approximately $30 million to $40 million annually. The amount that is maintenance CapEx is increasing, as we maintain the 2 segments including expenditures to support growth in Specialty Care, some of which is billable revenue.

For the first quarter of 2012, capital expenditures totaled approximately $20 million, a little below the level spent in the fourth quarter of 2011. The first quarter was higher than normal due to moneys being spent on information technology and automation, and we would expect additional funds for information technology and nursing home automation in 2012, as we increase our investments in the business to improve operations and customer service. As discussed in our previous calls, the company plans to continue to assess the use of cash flow in 2012 and deploy that cash in the best fashion to create value for shareholders in addition to acquisitions and debt repayments.

In this slide, we have returned $30 million of our cash flow from operations to our shareholders in the first quarter through dividends and share repurchases. As a reminder, the dividend was a 75% increase over the prior level. The total amount returned to shareholders at $30 million was higher than our 25% target. We have $237 million remaining on our share repurchase

[Audio Gap]

in our capital structure, which can be found on Slide 12.

Immediately after the end of the first quarter, we completed an exchange done on a private basis of approximately 1/2 our 2025 3.75% convertible debt for a new 3.75% issued that matures in 2042, giving Omnicare access to 30-year funds. The key elements of the exchange were: one, we issued $390 million of new 30-year convertibles and retired $257 million of the 15-year convert. The new issue has no put rights but is callable at par beginning April 2016; two, the new issue includes a contingent interest debt component, that will provide a tax deduction at an equivalent rate of 7.11%. The new notes have a conversion price of $41.50 per share versus the original $27.44 conversion in the old notes.

We also entered into a capped call arrangement that effectively provides an economic hedge up to an average share price of $61.25 for 4 years through 2016, which corresponds to our first call option. We paid approximately $44 million for that hedge. As a result of the exchange, we estimate we will incur a non-cash charge of approximately $40 million in the second quarter, which represents the difference between the values of the 2 issues net of discounts.

Next, I'd like to address the regulatory items. We have previously discussed the CMS short-cycle rule. This should only impact about 2% of our total scripts when implemented on January 1, 2013, and not have any significant impact on our operating results. We are well positioned to absorb the impact with our proprietary automation. Related to FUL pricing, commonly referred to as AMP, CMS has published multiple preliminary guidelines. We have been moving our contracts away from FUL pricing, thus limiting our exposure to approximately 3% to 4% of revenues, including Medicaid. We believe there are several errors in the amounts published and are providing appropriate comments. Based on the knowledge we have at this time and what we believe will be the outcome based on changes to the FUL formula, we have included the expected negative impact in our 2012 guidance.

CMS also included comments in its report on part D, considering proposing that consultant pharmacists be independent of the dispensing pharmacy. We had indicated we do not believe a separation will be good for patients and would likely increase health care costs to our customers. Recently, CMS has indicated they are not moving forward with this potential change. Somewhat related, CMS has mentioned an initiative to reduce the use of antipsychotics in nursing homes. These types of drugs account for approximately 30% of our scripts. Further, our consultant pharmacists' recommendations are consistent with the theme of reduced usage.

There has been much in the press about state Medicaid departments looking at integrated models for dual eligibles with managed-care companies potentially reducing the expected rate of increase for skilled nursing facility admissions in the future. While we continue to monitor the activity in selected states, we remind you that: one, many of the patients require around-the-clock care provided in institutionalized setting; two, SNFs are generally moving to more short-stay rehab patients, increasing the number of higher-acuity patients; and three, the population growth of the over 85 group, which are generally in a nursing home, will significantly increase in the coming years. However, we also believe our Omnicare-at-home initiative is well positioned to serve those patients, who remain at home or in a community setting.

Finally, in addressing the 2012 outlook. We are continuing to transform the company into a customer-focused and operations-driven company to build a strong foundation for the future. It will be characterized by: one, investment in people and internal technology to improve customer service and improve efficiency; and two, disciplined use of cash.

Relative to the full year 2012, we reaffirm our guidance as follows: revenues of $6.1 billion to $6.2 billion, remember branded generics will cause a revenue drop; adjusted cash-based earnings per share of $3.10 to $3.20 per share; cash flow from operations of $400 million to $500 million, excluding settlement payments. While we believe we had a strong first quarter, we believe it not appropriate to consider changing guidance after one quarter. Accordingly, we will reassess our guidance after the second quarter performance.

At the beginning of 2011, we indicated we expected conventional double-digit EPS growth that is not on a cash basis over 3-year horizon ending at 2013. We are still on track to achieve this rate. We will continue to stay focused on our capital structure and creating value for shareholders, which will include returning cash from operations to our shareholders.

With that, I'd like to turn it back over to John Figueroa.

John G. Figueroa

Thanks, John. As evidenced by our solid first quarter financial results, I believe we have begun to benefit from our recent investment, while capitalizing on the various market opportunities. Both of our 2 primary core businesses generated strong double-digit growth to begin the year. And I believe these businesses will continue to perform, as we continue our operationally driven and customer-centric focus. Fundamental to our organization's success is our team's unrelenting pursuit of our 3 core operating objectives: establishing organic growth in our Long-Term Care group, repositioning our Specialty Care group for an elevated level of growth and creating more standardization across the company. These core objectives are fully aligned with our customers, payers, patients, employees and shareholders. As we are successful, we believe those constituents will succeed as well.

And with that, operator, please open the line up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from Lisa Gill with JPMorgan.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

My first question is just really around the guidance. So, John Workman, I know you talked about the fact that it's only the first quarter, but with these very strong results, how should we think about how things are going to line up over the next couple of quarters? And is there potential headwinds that you would expect over the next few quarters? Or do you think that what we saw in the first quarter will continue to carry through the rest of the year? That will be my first question. And then secondly, John Figueroa, maybe you can just give us an update on the Omnicare following the patient home and where you are on that?

John L. Workman

I'll start with the guidance. Yes, obviously, Lisa, we think we had strong first quarter. I think, as you look at the remaining part of the year, it's still early in the year. Clearly, as I mentioned, we're going to have some merit increases that start to impact us in the subsequent quarters. And we're not always in complete knowledge base of when the brand-to-generics switches will occur, which can cause a little bit of volatility. So I would just say we're being a little bit cautious, and it's been our practice to kind of get to the first half under our belt before be readdress guidance but again, nothing on the forefront. Clearly, we have some expectations for AMP. That hasn't happened yet. It's another negative that will impact later in the year. So that's why we reaffirmed the existing guidance, but we'll reassess again after the second quarter.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

What is the merit raise that you gave here, please?

John L. Workman

It's an inflationary increase. I mean, in the mid-2 percentage range is what I would characterize it.

John G. Figueroa

Yes, Lisa, I'll add on to at-home, but I also want to talk about guidance. I think we had a very strong first quarter and I think, to your point, the remainder of the year looks good. But it is our philosophy, and specifically mine, not to change guidance after the first quarter simply because I think it's just too soon. But I really am optimistic for the remainder of the year as well. I know the rest of the team feels the same way. Regarding at-home, we continue to be very pleased with the progress that we're making in this area. And just to give you an update, we have about 350 patients who have been on our at-home pilot program for getting close to 6 months now. So we have some great data. We have, I think, perfected the program from a service perspective. The packaging is fantastic and the customers are -- the patients are very pleased. Where we're at is perfecting the automation. The proprietary automation that we have in packaging the product is almost done. It's probably at a 95% efficiency rate and accuracy rate, and we need to get that to 99.999%. It's got to be a Six Sigma-type quality operation. We think we're on our timeline. We indicated that by the end of this year, we should have that program in full operation from an automation perspective. And we feel that we're still on track to get that done. We'll also tell you that we have picked a location, a primary location for the at-home pharmaceuticals to be shipped out of. We're building that location now. It's about 80% complete. And again, I think the timeline looks good to be in full operation by the end of the year and have full impact of this operation in 2013.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

So are there costs associated with this today, John? Is it not at breakeven today?

John G. Figueroa

It is not at breakeven. It's very minimal. It doesn't affect our financials at all. It's really been a cost center that doesn't move the dial at all.

John L. Workman

I'm just going to comp add to that, but we really expected to lose money in 2012, and that was part of our guidance.

Operator

And your next question comes from the line of Charles Rhyee with Cowen and Company.

Charles Rhyee - Cowen and Company, LLC, Research Division

Maybe just following up on the beds here. You're looking, if I understand correctly, John Workman, you kind of said you signed a letter of intent here to sell a Canadian pharmacy so you took a write-down of goodwill. Can you talk about how many beds are related to that pharmacy? Is that something we should expect then to come out in the second quarter as well?

John L. Workman

It's a few thousand beds, Charles. And it's not a lot of expected proceeds, but it's a reasonable price and it's just -- it's the one operation we have there that as we strategically look, we're not certain makes sense. And it's consistent with what we said in the past. We'll look at some smaller assets and decide if they fit within the portfolio.

Charles Rhyee - Cowen and Company, LLC, Research Division

Okay. Can you just remind us what is your overall presence in Canada or...

John L. Workman

One pharmacy.

Charles Rhyee - Cowen and Company, LLC, Research Division

One pharmacy. So you're effectively saying we're going to be out of the Canadian business?

John L. Workman

Correct.

Charles Rhyee - Cowen and Company, LLC, Research Division

Okay. And on the correctional facility business, if I assume some majority of the 24 in this last quarter was some percent and most were saying 2% of total beds, but the profitability's a lot less. I mean, is it fair to think half of your typical profitability or is it -- can correctional facilities be even lower than that?

John L. Workman

It's even lower than that, Charles. I think we -- the reason we try to provide a little bit more transparency -- and that the correctional institution is about 12,000 loss in beds is -- the challenge here is you always count licensed beds, and in a prison, that's all the beds. That's not necessarily the patients that come through the infirmary, which is a smaller number. So you can see what some of the correlation is, but it's a much less profit impact than our normal business.

Charles Rhyee - Cowen and Company, LLC, Research Division

That's helpful. Can -- and maybe just one last question on that. We know your main competitor kind of talks about that business not as that attractive, and clearly, as you discuss it here it's -- the profitability relative to the -- your traditional businesses is a lot less. Can you talk about strategically what interests you about the correctional business?

John G. Figueroa

I'll take that one. What's exciting about that business is it's contained. I mean, certainly like a nursing home, you have patients in a population that are contained. I think what we're looking at here and what we're talking about with a number of these facilities is the fact that the majority of these patients are aging pretty darn quickly. And so they're actually getting into more of a geriatric care than they ever have in the past and they're looking for additional services, some unique services that they have not been looking for in the past. And they're coming to Omnicare and we're going to them, I think, with some custom programs to help with that aging population. So I think you're right that historically this population hasn't been very exciting because it's low margin and it is not consistent. But as you're seeing the population age, it is becoming a little bit more attractive. And as long as we can maintain the discipline around price points and getting paid for additional services, it does become an attractive market to look at. Next quarter, we actually have a facility that will be coming on that meets all of that criteria. They're paying for additional services. It is a bed count that we like and in a margin that we like. So as long as we stay disciplined, provide differentiated services and get paid for it, it's a decent market.

Operator

And your next question comes from the line of Glen Santangelo with Credit Suisse.

Glen J. Santangelo - Crédit Suisse AG, Research Division

Just 2 quick questions. First, I want to talk about the competitive landscape. I know you guys clearly telegraphed last quarter that your net debts were going to be down this quarter, so I'm guessing you anticipated terminating the contracts -- or some of the contracts that you didn't. John, you sort of suggested in your prepared remarks the correctional facility was a competitive bidding process and you just didn't want to go to the price that was in the marketplace. I mean, could you give us an assessment in terms of what you're seeing out of the independents? And are you at all nervous about the competitive landscape from that perspective? And then secondly, my other question is, I wanted to talk about Specialty. Can you help us -- can you elaborate maybe on some of the more recent internal developments that you think are helping to drive that growth? Because I'm trying to assess the opportunity and the sustainability of that growth rate so any sort of elaboration will be helpful.

John G. Figueroa

I'll start it off, and I'll ask John to add. But from a competitive standpoint, I think the key characteristics of the quarter that I'm particularly excited about is the fact that we have reduced our service-oriented losses by another 30% year-over-year. Anytime you get better at service and as you continue to get more customer-focused and reduce that service-level loss, we become a pretty darn good competitor everywhere in the country, including to the independents. Now that being said, there's still very good competition out there and they still continue to move business in their direction. But we have been great at defending the business that we currently have and actually beginning to pick up more volume from all of our competitors. So very, very competitive, but I feel very good about our opportunity to move market share, especially when you look at the differentiated value and some of the unique automation that we will be providing here soon. And as I explained to the one customer that is brand new to us, we are tracking the benchmark of what they used to gain and what they gain from us today. And when we can demonstrate savings like $250,000 a quarter and continue to demonstrate that type of value, you then tend to, I think, gain some momentum and move some market share at a much faster rate. So we're excited about that. The second piece around correctional, again, we're not going to provide services that just -- that we don't get paid for. But there are a number of correctional facilities that are looking for those services, and as long as there's an economic benefit to both parties, we'll continue to move in that market. So I do think that even though we walked away from this one, we will continue to gain some share in the correctional facility piece. And then to your third question around Specialty, the reason we are growing at such a faster pace than market, and first of all, let me emphasize that this is a market that grows at 15% to 20% organically, so it's a great market and we're growing at a much faster pace than that. I would attribute that to 2 things: I mean, the first is that we are well-organized around this business. Prior to Nitin Sahney joining the company, these were disparate businesses that were run on their own. Today, they are run together under one leadership team. I would tell you 90% of that leadership team is new and they are focused on one thing, and that's the customer in the space. And that's -- whether that's the patient, the payers or ultimately the manufacturers, we have concentrated sales team and management team specifically calling on those entities. And we have a unique platform in that we are working with manufacturers on an exclusive basis. There is no conflict whatsoever when we're dealing with those manufacturers, and they seem excited about that and we're actually moving molecules to our Specialty group for the first time in 4 years. I think this team has closed 4 or 5 new accounts in the last 8, 9 months. So we are moving market share, we're focused, we're energized, we are providing a unique service and I think the customer base is responding.

Operator

And your next question comes from the line of Frank Morgan with RBC Capital Markets.

Frank G. Morgan - RBC Capital Markets, LLC, Research Division

A couple of questions here. First, I think you alluded to exiting Canada. But in terms of just other small pharmacy divestitures, like the one in Maine, are there any others out there that are contemplated and perhaps built into guidance? And I'm just curious about the -- was this impact part of the contributor to some of the EBITDA growth you saw in the quarter as a result of this divestiture? That'd be my first question.

John L. Workman

I'll take that one, Frank. The -- both of these are marginally kind of towards a breakeven standpoint. And they're not -- the nuclear thing was kind of a one-off, not our core business. And we just kind of look at these, can we make that into an opportunity? And what are going to be the cost to convert it to make it more profitable? And as we look at allocating our resources and focused on the bigger piece of the core, that kind of led to our decisions. But these things didn't significantly improve the EBITDA one way or the other with what we've either done or contemplated and I'll turn it over to John to see if he's got some added comments.

John G. Figueroa

I think that's right, Frank. I mean these weren't core. A nuclear pharmacy, you either have to grow with great scale. One pharmacy in Maine just isn't going to do it for us, and to John's point, the financial certainly didn't look that attractive and valuable for us to continue to invest in. Canada, the same thing. We have one small pharmacy in Canada. I think we made a nice run through the years to see if there was any opportunity for growth there and I think the reality is that's just not our core.

Frank G. Morgan - RBC Capital Markets, LLC, Research Division

I got you. But no other divestitures contemplated at this point in terms of your guidance for '12?

John G. Figueroa

I think that's very safe to say, that anything within the pharmacy area, we feel pretty good that over the past 16 months, we've done a nice evaluation of the core assets that make sense for us, and those that don't, to move out of the organization. And I would tell you, I think we're just about done with that exercise.

Frank G. Morgan - RBC Capital Markets, LLC, Research Division

I got you. And on the termination of some of those legacy contracts, is that one of the drivers for the improvement you saw in the bad debt expense coming down, did that impact the results in the quarter? And then finally, just any comments about -- you mentioned this net availability unit for first dose dispensing. Just it sounds like you're talking more about that, maybe just some more details on how the work timing of the roll out there, and I'll hop off.

John G. Figueroa

I'll ask John to talk about the bad debt and I'll cover the automation piece. We have been driving to a solution for that first dose for quite some time. As I've indicated in the past, we have come up with a proprietary machine that we believe hits all of the criteria that we needed to penetrate the market. We actually have that in a few sites today. We have customers who are kicking it, beating it, doing everything they possibly can to ensure that it services all of their needs. We feel pretty good about the data that we're getting, but we're only -- gosh, we're not even 2 months into gathering the data on the technology. And as you can imagine, with the pilot, when you get the data back, you got to make a few more tweaks to the product. We still believe that this will be into the market by the end of the year, and again, will have some impact for us in 2013.

John L. Workman

And on the bad debt, Frank, I mean, we inherited some legacy accounts that we've been steadily working through, I would say, for the last 18 months and we're getting near the end. I don't want to say those are all behind us totally, but we're clearly getting near the end. And we're also getting better at our processes, if you will, to make certain that we have improved processes, all of which grow up a little bit, a slight, slight improvement, don't get too excited about the drop -- in the 0.1%. Just kind of stay focused on the dollars. And there was a little improvement in the dollar, but not a great deal.

Operator

And your next question comes from Bob Willoughby with Bank of America Merrill Lynch.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

News on the fully diluted share base post the debt refinancing that you just did, the exchange of the converts. I assume that base comes down a bit?

John L. Workman

You cut at the -- I don't think the first part of your question came across. Do you mind repeating it?

John G. Figueroa

He was talking about the shares, the anti-dilutive impact of the new...

John L. Workman

Well, clearly, the new issue will take out some of the dilutive impact of the old convert because of the higher strike price. And so if you think of it, there was a few million share counts on average added by the older convert for the quarter, and we took out half of that. So that's kind of the right way to think about it. Did that help?

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Yes, I would assume them down sequentially, a couple of million shares potentially.

John L. Workman

Yes, I would say that. Just I always remind people that there are constantly shares that in terms of coming up on executive grants, this is the time of year when those start to occur so there can be some shares and certain options that may be legacy options that get into the money. There also can be some added parts. So there are some pressures on the other side, just not to lose sight of those.

Operator

And your next question comes from the line of Robert Jones with Goldman Sachs.

Robert P. Jones - Goldman Sachs Group Inc., Research Division

Just on the Specialty businesses, specifically the operating margins. I know last quarter you mentioned the expectation to see margin degradation because the growth in the lower margin pharmacy business there. Based on this quarter's results, has that mix changed and is there anything we should be thinking about as far as the margin progression for the balance of the year?

John G. Figueroa

I'll take that. The -- I think what you saw in the first quarter was some success in the fee-for-service business and some new contracts that we picked up. I think as you see the Specialty pharmacy business continue to grow with market and probably faster than market, you still may see some margin degradation through the remainder of the year, some slight margin degradation. But as long as we continue to be effective in the fee-for-service area, there is potential to maintain, and in some quarters, actually increase margin. But, John, let me throw that back to you.

John L. Workman

Yes, I think, our original view is still fairly consistent. It is driven somewhat by the mix of the business that we have. I'm clearly pleased with the first quarter results and those were an improvement on our rate over the fourth quarter. It was also quite the leverage of getting stronger revenue base that translated into that, so I still think our overall view of Specialty is that. And we actually have Nitin Sahney here with us as well as Jeff Stamps in Long-Term Care and I'm just going to pause and see if Nitin wants to add something about Specialty.

Nitin Sahney

We are getting into near-therapeutic state, and frankly, our sales function has come together in the last 6 months, which is reflected in Q1. And I think that trend will continue in Q2 to Q4. But it's really the whole operating team coming together, getting into new areas, developing new services and strong organic growth.

Robert P. Jones - Goldman Sachs Group Inc., Research Division

Understood, that's helpful. And then just one big picture question, and then -- John Workman, you touched on this, but on the regulatory front, earlier this month, we got word from CMS that they will not require a long-term care pharmacies to hire independent pharmacists. But in that decision, the agency did state that they think the industry does need to take steps to curb the overutilization. And I know you touched on this briefly in the prepared remarks, but I was wondering what changes could you envision that would get after this perceived issue? And what role or impact should we think about Omnicare relative to that?

John L. Workman

Well, I will address that first and then see if Jeff Stamps, whose the President of Long-Term Care, wants to add to it. I think as we stated before that there's no impact, Robert, from a consultant pharmacist, a part of Omnicare or not part of Omnicare, did not really have a financial impact, even though, again, we thought it was the wrong decision to try to separate those. We'll remind you that the thing that the initiative that CMS has mentioned is about the -- trying to reduce the use of antipsychotics, and that's consistent with all of our consultant pharmacists' recommendations. If we quoted a statistic that we went back and looked at I think 700,000 recommendations and in the high-90 percentile, those were either reduce or take a patient off or revisit the use of those antipsychotics. But I'll pause there and see if Jeff wants to add something.

Jeffrey M. Stamps

Thanks, John. One of the things, as John mentioned, is our consultant pharmacists remain vigilant and have been vigilant for quite some time around the use of all psychoactive medications. It's been a priority for our consultants and will remain so through not only this year, but as we move into the future. In addition to that, Omnicare continues to remain focused on being fair market value related to our consultant pharmacies' services so that there's absolutely no conflict whatsoever between what our consultancy we're doing while they're there. Acting on behalf, frankly, of the resident and facility, that's what their responsibilities are.

John G. Figueroa

I guess I'll add something there as well. I mean, we have, we believe, established, we believe, a pretty good relationships with CMS. And I think to answer the core of the question on what happens from here on out, I believe we'll continue to share information and data that CMS is looking for and requesting, and as they see more and more data on this industry, I think together, both the industry and CMS, will modify and do things that are best for our patient population.

Operator

And your next question comes from the line of Brendan Strong with Barclays.

Brendan Strong - Barclays Capital, Research Division

So I guess as I think about the improvement in gross profit dollars and EBITDA dollars, I kind of break it down into 3 categories: brand-to-generic conversions, Specialty growth and then cost management. I don't know if you'd be willing to maybe kind of put some numbers around that as we think about the improvement of gross profits, either sequentially or year-over-year?

John L. Workman

Well, I'll start with that. I mean, those are the 3 key drivers, Brendan, and you got them right, and those are the 3 key things that we're focused on. We're focused on getting the branded drug to convert as quickly as possible. Cost management and fueling growth and Specialty care. I'll be a little bit careful about trying to put even percentages because I think those will be the drivers, and quarter-to-quarter, some of those may be a little stronger than others. So -- but those are the 3 key drivers from our perspective. And, John Figueroa, you want to -- maybe you want to add something.

John G. Figueroa

No, I mean, I think that's absolutely right. And the good news about those 3 categories, are those are the 3 key categories within health care. If you do generics well, you do Specialty well, both growth areas within health care and you can become an efficient operator. I think that's a good recipe for short- and long-term success. 2012 is a very good generics year. 2013, '14, '15 and beyond are pretty darn good generic years as well and we all know the demographics of what Specialty looks like over the next 10, 15, 20 years. And as we continue to bring more automation and, I think, the statistics that I get extremely excited about is getting better than 70% of our scripts through an automated process within -- over the next few years. Those are the 3 absolute right categories for us to focus on and those will continue to deliver results.

John L. Workman

Just let me add one other thing on the cost side. We are very focused and especially in Long-Term Care, we have a standardization initiative. We've also talked about migrating from 2 systems to 1. Those are also going to be things that will gain momentum. And as we've stated before, also key drivers that John Figueroa mentioned in 2013 and the out-years, that will probably be a little bit larger proportion than the brand-to-generics that we're seeing in 2012.

Brendan Strong - Barclays Capital, Research Division

Okay. And just, John Figueroa, the follow up on what you mentioned about pumping more scripts through ALV and ULV. Is there any benchmark that we can think about on a -- on maybe a per script basis in terms of the cost that comes out because of that technology?

John G. Figueroa

We haven't shared that. It is -- each piece in technology really is unique. And in some states, you can cross state lines and get even more effective in cost savings. In other states, you still have to have pharmacists verifying things. So it varies across the board. I will tell you, though, every time we move it from a manual process to an automated process, there are savings. We have not quantified that publicly yet, though.

Brendan Strong - Barclays Capital, Research Division

Okay. And then just last question, if I may. As I look at what I think is a further ramp-up in profitability into the second quarter with Lexapro and Seroquel, do you think it's more important to focus on the number of scripts that are going generic, which is up a lot versus what happened in the fourth quarter? Was it more important to focus on the brand-to-generic or the branded revenue, which is kind of similar to Zyprexa, at least as I look at it? I'm just trying to get a sense for how much numbers move up sequentially into the second quarter.

John G. Figueroa

Yes, John, you want to handle that one?

John L. Workman

Well, I'm not sure I understood the question. So maybe we'll start by repeating the question, Brendan.

Brendan Strong - Barclays Capital, Research Division

Sure. I think you guys had about 1 million scripts annually on Zyprexa. I think it's close to 3 million annually on Lexapro and Seroquel. But the branded revenue, I think, on Lexapro plus Seroquel is kind of similar to Zyprexa. So I'm just trying to understand, is it more important as we think about further gross profitability improvement in the second quarter to think about more scripts going generic or the branded -- the amount of branded revenue that goes generic?

John L. Workman

It varies by drugs. We have to be, number one, careful because there are different arrangements. Not every drug is the same on the branded side relative to the post purchase discount element. And again, as you know very well in terms of how long the exclusivity period for a generic drug versus when it goes multi-sourced. But clearly, script growth is key and as we stated before, generics are always -- are more profitable to us than branded drugs in the long run. So that's going to continue to be our focus.

Operator

Your next question comes from the line of Steven Valiquette with UBS.

Steven Valiquette - UBS Investment Bank, Research Division

So my question, a little more general, just on that revenue per script. I'm just kind of curious. If you think about it just by your 2 segments, it was up year-over-year and LTC. Is that sustainable for the rest of the year or could that dip down with more generics? And then in Specialty, you're seeing about a 20% growth year-over-year in revenue per script in that category. Is that just mix or is there other things going on there and, again, is that type of growth rate sustainable for the full year there as well?

John L. Workman

I'll start with that then let that John Figueroa add on. We actually think the revenue per script in long-term care was slightly down in Q1 versus Q4. But we focused not so much on the revenue as gross profit per script. So the one thing that I would encourage you to look at is gross profit per script, and that definitely is on the uptick and we would expect a similar level as we look at that particular dynamic in the out-quarters in Long-Term Care. It will be influenced a little bit, these merit increases that we talked about, do impact cost of sales. So there is a slight impact in gross profit, but I would expect that to have some similar level as we saw in the first quarter.

John G. Figueroa

Yes, I'll add to that. I mean, as you look at gross profit per script, I think that best reflects the other thing that we talk about consistently, which is we almost always get more gross profit from a generic than a brand through the entire life of the generic. So as revenue per script may modify based on how quickly generics come to market in one particular quarter, that gross profit per script, I think, is a better indicator. So that's, I think, all I'll say about that. In the Specialty piece, I think John's answer was right on.

John L. Workman

Yes, I mean, in Specialty we did grow -- scripts and Specialty over Q4 grew 1.8%, so we had a 6.2% growth and I think that's consistent. With the one platform on Specialty pharmacy, where we're seeing a lot of the revenue growth, I think that's going to be -- we'd expect that to continue. I'll remind you, that's our lowest profit margin.

Steven Valiquette - UBS Investment Bank, Research Division

Yes, but the revenue per script is in Specialty, though. Could that be volatile from quarter-to-quarter, just given the mix of drugs or could the -- should we assume that'll stay fairly consistent just on the -- I know you want to focus more on gross profit, but just on the revenue piece, just curious on that.

John L. Workman

We'll let Nitin Sahney comment on Specialty.

Nitin Sahney

Thank you, John. Just an additional comment. In our Specialty platforms, our Specialty pharmacies runs out of 5 platforms that we measure ourselves. And frankly, significant growth is coming on EBITDA levels from a fee for service, while revenue per script is not a metric that would be relevant. It's only on the scripts is on our Specialty pharmacy where revenue is coming from. So our growth has been consistent, between our Specialty pharmacy and fee-for-service on the EBITDA level, and frankly a little higher on the EBITDA level from fee-for-service where the script count is not really the only measurement.

Operator

That is all the time we have for questions today. I would like to turn the call back over to our speakers for any closing remarks.

John G. Figueroa

Well, thank you all for joining us today. We sincerely appreciate your interest in Omnicare, and again, thank you very much for joining us. I hope you have a pleasant day.

John L. Workman

Thank you.

Operator

That concludes today's conference call. You may now disconnect.

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