Omnicare's CEO Discusses F2Q12 Earnings Results - Earnings Call Transcript

| About: Omnicare Inc. (OCR)

Omnicare, Inc. (NYSE:OCR)

F2Q12 Earnings Call

July 25, 2012 9:00 am ET

Executives

Patrick C. Lee – Vice President of Investor Relations

John L. Workman – President, Interim Executive Officer & Chief Financial Officer

Nitin Sahney – Chief Operating Officer, Executive Vice President & President Specialty Care Group

Robert Kraft – Senior Vice President of Finance

Analyst

Lawrence Marsh – Barclays Capital

Lisa Gill – JP Morgan

Glen Santangelo – Credit Suisse

Charles Rhyee – Cowen & Co.

Robert Jones – Goldman Sachs

Steven Valiquette – UBS

Frank Morgan – RBC Capital Markets

Operator

At this time I would like to welcome everyone to Omnicare’s second quarter 2012 conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question and answer session. (Operator Instructions) 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 C. Lee

With me on the call are John Workman, President, Interim Chief Executive Officer; Nitin Sahney, Chief Operating Officer; and Rocky Kraft, Senior Vice President of Finance. 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 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 from all periods in our discussions today. The reconciliation of this non-GAAP information has been attached to our earnings release and is also available on our website.

Also on our website you will find second quarter supplemental slides which we will follow during our discussion today. Before turning the call over to John, I’d like to remind the analyst to limit themselves to one question and one follow up during our question and answer session so others may ask their questions. With that, it is my pleasure to turn the call over to John Workman.

John L. Workman

As you know, I was named the interim chief executive officer in early June 2012 and Nitin Sahney was named the chief operating officer. Nitin and I view this as a partnership and we remain focused on improving the operations of the company particularly in long [inaudible]. In a short while Nitin is going to provide you some perspective six weeks into his new role.

Before we discuss the quarter I want to provide you with an update on the CEO search on behalf of the board of directors. The board of directors has retained a national search firm. The process is underway including meetings with senior management of the company. As you know, I am a candidate and as such am engaged in the process myself. The board expects to complete the process by the end of the third quarter 2012. While that process is underway, Nitin and I are working together to execute the company’s strategy including making refinements as appropriate.

Now, turning to the quarter’s financial results; we are pleased with our second quarter results. Adjusted cash based earnings per diluted share from continuing operations was $0.83 for the quarter compared to $0.69 a year ago and $0.81 in the first quarter of 2012. These strong results benefitted from generic drug efficiencies and in other strong specialty care performance. Cash flow from operations was $120 million for the quarter which included a $50 million payment under the DEA settlement announced earlier in the second quarter.

Long term care’s adjusted operating income from continuing operations of $150.8 million was a 16% improvement over the same quarter a year ago. Specialty care group’s adjusted operating income of $31.9 million was a 30% improvement over the second quarter of 2011, a continued exceptionally solid performance.

Next, turning to metrics, our retention rate for the quarter in long term care was 92.3% returning to the 92% to 94% range we saw in 2011. Importantly, service related losses were 38% lower as compared to the second quarter 2011. Our net organic bed activity for the quarter in long term care was a net loss of 8,637 beds. While an improvement over the first quarter 2012 we are disappointed in our progress particularly as it relates to new beds added. We have commented on the fact that new beds have been lagging in our expectations on past calls.

Consequently, we do not currently expect net organic bed growth in our patient related beds for the full year 2012 though we do expect to see continued improvement over the prior year as we move through the third and fourth quarters 2012. Nitin will discuss some specific strategies about how we plan to address this situation and restore organic bed growth.

Our total scripts dispensed in the second quarter were 30.1 million scripts down approximately 650,000 scripts from the first quarter of 2012. We saw a similar seasonal decline from the first to second quarter in 2011 also. I’ll remind everybody that while we discuss beds our revenue is driven by scripts.

Finally, a few additional highlights before I turn it over to Nitin for his observations and then to Rocky Kraft for a more detailed review of our financial results. During the second quarter of 2012 we concluded the exchange offer described on our first quarter 2012 earnings call which further strengthened our capital structure. Subsequent to the end of the second quarter we agreed to purchase the pharmacy operations of Five Star. This acquisition will allow us to pick up the rest of the Five Star beds we do not serve today and also add customers that were served by the Five Star pharmacy operations. We expect the acquisition to close in the second half of the year.

We purchased approximately 1.8 million shares in the second quarter 2012. Consequently, between dividends and share repurchases we are pleased to have returned 55% of our cash flow from operations to shareholders.

Let me now turn the call over to Nitin Sahney, our chief operating officer.

Nitin Sahney

Before I offer my perspectives six weeks into my new role as COO I would like to reemphasize John’s comments regarding our specialty care group. Since the fourth quarter of 2010 when we integrated five separate operating businesses under a single management structure, we have increased revenues by 49% and operating income by 34%. Our specialty care group has continued to perform very well and I believe this is driven by the operating structure and clear business strategy we have put in place.

I expect we will take a similar approach with our long term care group to ensure that we make further progress towards our goal of operational excellence. This does not mean a change in strategy but rather a shift in approach. Our new approach will be uniform across both businesses. It will emphasize accountability, urgency, and operating discipline. We expect this new system will improve upon the progress we have made to date.

Over the past two years we have increased customer satisfaction levels and we believe we can enhance the customer experience even further. E believe a key factor to our future success will be how effective we are at increasing utilization of our key advantages our technology offering and our clinical programs. Similarly we believe we have further opportunity with sales. With our compelling value proposition we believe we should be [inaudible] more regularly into the marketplace.

Just as we have installed a methodical approach to sales in our specialty care group that has proven successful, we intend to implement a similar system in long term care. We believe the critical elements to this structure will revolve around creating a standard sales process for each customer type and size, having the structure based on collaboration and clearly defined roles and ensuring that sales objectives and incentives are appropriately aligned. With some refinement and an intense focus we believe we will improve our effectiveness in the marketplace.

While most of our efforts have been on instilling the right system to drive customer growth we are also exploring ways to optimize our network. Our hub and spoke infrastructure provides for a scalable platform to support growth and we will consider additional needs for standardizing our operations.

John and I have worked very closely these past six weeks and we share the same perspectives on the company as well as a mutual respect for each other. While we have made nice progress during these past two years we believe there are still opportunities to enhance our operations and sales functions. Now, I’d like to turn it over to Rocky Kraft who will cover our second quarter financial results.

Robert Kraft

As mentioned earlier we have filed supplemental slides along with our press release and I will refer to these slides throughout my presentation. We have also revised our presentation of special items under the reconciliation schedules on our website. We hope you find this new approach simpler and more convenient.

I’d like to start my discussion with second quarter special items which were larger in number and magnitude as compared to the same period in 2011. In total second quarter special items amounted to $85.3 million and were driven primarily by three items. First, loss on debt repurchases and related redemption costs of $39.2 million primarily associated with our convertible debenture private exchange that closed in the quarter. Second, separate costs of $13 million related to former executives. Finally, special litigation and other related charges of $26.1 million.

This increase in special litigation and related expenses is unrelated to our previously announced settlement with the DEA. That amount was fully reserved in prior periods. Additionally, the increase in special litigation is unrelated to the Johnston & Johnston risperdol case as we settled this matter multiple years ago. We do not believe we have any additional exposure as it relates to this issue. As we have mentioned before we believe there may be additional matters that may arise against the company but we believe those we are aware of are manageable given the company’s financial position and cash flow characteristics.

Now turning to our operating metrics which can be found on Slide Six. Second quarter scripts dispensed were 30.1 million down slightly from the 30.4 million scripts we dispensed in the same period last year. Within our long term care group where script volumes are more directly correlated to revenue than in our specialty care group, second quarter script volumes were lower on a year-over-year basis by approximately 100 basis points to 28.4 million. This change in scripts was driven primarily by a lower average number of beds served.

With respect to beds served, which again relates wholly to our long term care group, we ended the second quarter serving approximately 977,000 beds which is 9,000 beds lower sequentially and 26,000 lower than the second quarter of 2011. Within the patient related beds category which generally has a higher level of acuity and is more closely tied to patients served, we experienced an 8,000 bed sequential reduction to 924,000 beds served. The beds served numbers do not include those at Five Star’s institutional pharmacy asset which as John noted, we recently agreed to purchase. We expect to close this transaction in the second half of the year adding approximately 16,000 licensed beds at that time.

Turning next to the income statement, I’ll first cover net sales and adjusted gross profit both of which can be found on Slide Seven. Our net sales were $1.563 billion in the second quarter of 2012 reflecting a 1.3% decrease from the $1.556 billion we generated in the comparable prior year period. This change was driven principally by the introduction of low cost generic drugs coupled with the reduction in scripts dispensed.

Second quarter adjusted gross profit increased approximately $31 million to $367.3 million due to a $50.8 million reduction in cost of sales. These lower costs which were also driven by the impact of lower cost generic drug introductions contributed to our 230 basis point year-over-year increase in gross margin to 23.9%.

Next, I’ll turn to SG&A expenses and a provision for doubtful accounts, both of which can be found on Slide Seven. Our second quarter SG&A expense was $9.4 million higher in 2012 reflecting the investments we have made in our people and in our systems. As a percentage of sales, SG&A expenses were 77 basis points higher reflecting the aforementioned investments coupled with the lower sales impact for new generics.

It’s also important to note that our second quarter results include the full quarter’s effect of our annual employee merit increase. This occurred late in the first quarter. As a reminder, these additional labor costs are classified both in SG&A and cost of sales. We also granted our annual equity awards to our employees in the second quarter. This added approximately $1 million of amortization to Q2.

Our provision for doubtful accounts was 1.57% of revenue for the second quarter of 2012 even with the comparable prior year period. Second quarter days sales outstanding of 55.2 was lower by 3.4 days as compared with the second quarter of 2011. Of note, we’ve revised the methodology in which we calculate DSOs to be more consistent with how other companies report this metric. We believe this new methodology which is detailed on Slide 16 and has been applied to all periods is more closely aligned with our quarterly results.

Interest expense of $25.6 million was $2.1 million lower than in the second quarter of 2011 primarily related to our debt refinancing and reduction initiatives. Excluding the impact of special items our effective income tax rate was 38.7%. As a reminder, our cash tax rate is much lower generally reflecting the goodwill we amortize for tax purposes and the comparable yields we deduct relating to the contingent interest on our outstanding convertible debentures. These items are added back to the adjusted income tax line and arriving at adjusted cash based EPS and have a weighted average life that exceeds nine years.

Adjusted income from continuing operations for the second quarter of 2012 was $71.1 million or 4.6% of net sales. This represents a 23.4% increase from the $57.6 million we reported for the second quarter of 2011. For the second quarter of 2012 we generated adjusted cash earnings per diluted share from continuing operations of $0.83 or a 20.3% increase over the $0.69 for the second quarter of 2011.

Next, let’s turn to our segment results which can be found on Slide Nine. Our long term care group generated a 16.1% second quarter adjusted operating profit increase to $150.8 million on a 6.7% decrease in net sales that was primarily due to the impact of new generic introductions. As a result, we expanded second quarter operating margin in this segment by 247 basis points to 12.54%. The improved performance in long term care was driven principally by the benefits of new generic drug introductions which also have a favorable impact on our customers, payers, and the national healthcare system as a whole.

We also experienced a very strong performance in our specialty care group. For the second quarter of 2012 our specialty care group generated approximately 26% and 30% increases in net sales and adjusted operating income respectively over the comparable prior year periods. All five specialty operating platforms generated double digit adjusted operating income increases during the second quarter.

Next, I’ll turn to the balance sheet. We believe we again improved our financial position during the quarter ending the period with $567.4 million cash on hand including our restricted cash. Our accounts receivable were approximately $61 million lower sequentially and relatively even with where we exited 2011. As discussed last quarter we had a few key timing issues that we suggested would reverse themselves in the second quarter and that largely occurred as expected.

Second quarter inventories of $350.9 million were lower from where we exited both the first quarter of 2012 and the fourth quarter of 2011. These improvements were driven largely by an increase in generic drug penetration. These working capital benefits improved our cash flows and you can find details on Slide 10.

Cash flows from continuing operations for the second quarter of 2012 were approximately $120 million including the DEA settlement of $50 million which we have previously stated is excluded from our 2012 cash flow guidance. The second quarter cash flows also include our semiannual interest payments of approximately $37 million which were lower than expected due to the timing of the private exchange we completed during the quarter. Semiannual interest payments will not recur until the fourth quarter of 2012. For detail regarding deployment of these cash flows, please refer to Slide 11.

While our capital expenditures continue to be relatively modest when compared to our cash flows we have increased our spending from the $30 to $40 million we would generally expect for maintenance cap ex. This increase level of capital expenditure reflects largely technology investments that are expected to improve the efficiencies of our operations and to enhance customer service while providing an attractive return for our shareholders. Our second quarter cap ex of $26.2 million reflects this increased level of investment.

As discussed during our first quarter earnings call, we made an important change to our capital structure by completing a private exchange of approximately one half of our 3 ¾ convertible debt due 2025 for a new 3 ¾ issued that matures in 2042, replacing $257 million of 13 senior convertible debentures with $390 million of 30 year debentures. We believe this exchange is attractive to our shareholders due to certain attributes of the new debentures including the 30 year maturity schedule, a call feature at par beginning April 2016, a contingent interest component that provides a tax deduction at 7.11%, a higher conversion price of $41.50 as compared with the retired notes adjusted conversion price of $27.39, and a series of capped calls that effectively provide an economic hedge up to an average share price of $61.25 for the four years through 2016 which corresponds with the timing of our first call option.

We made further improvements to our capital structure during the second quarter of 2012 by retiring $25 million of our 3 ¼ convertible debentures due 2035. As you recall these have a put feature in 2015. As John mentioned earlier, we also continued to exceed our objective of returning at least 25% of our operating cash flows to shareholders through dividends and share repurchases. During the second quarter of 2012 we paid dividends of $0.07 per share or $7.7 million which is 71.1% higher than our dividends paid in the comparable prior year period.

Additionally, we repurchased approximately 1.8 million shares for nearly $58 million in the aggregate. We have a total of $178.6 million remaining on our existing share repurchase authorization. Collectively, our second quarter dividends paid and share repurchases represented approximately 55% of our operating cash flows which is one of the highest percentages of operating cash flows that we’ve returned to shareholders within our history.

With that, I’d like to turn the call back over to John.

John L. Workman

I believe the message you heard today conveys our confidence about the future of Omnicare. With all operations now under Nitin’s leadership we believe we’ll believe we’ll be able to cross pollinate our long term and specialty care group executives to further strengthen our performance. We also have added a capable group of executives in the last two years who can assist in operations and we’re in the process of leveraging their talents. We remain very focused on the elements that drive success both now and in the future including elimination of activities not directly related to that objective. One of our key areas of focus will clearly be net organic bed growth which we believe is achievable with the right discipline and focused approach.

Because of our strong first half performance we are raising our guidance for adjusted cash EPS and our cash flow from operations excluding settlement payments as follows: we now believe adjusted cash EPS per diluted share will be in the range of $3.22 to $3.28 per share compared to the $3.10 to $3.20 per share in our original guidance. We also believe cash flow from operations will now be at $425 to $525 million for the year again, excluding settlement payments which compares to our previous guidance of $400 million to $500 million per year.

The midpoint of our revised EPS guidance is 12% above the 2011 reported amount. This guidance includes an assumption for federal upper limit pricing that is based on average manufactures price or AMP. Regarding FULs we have moved a number of contracts off this benchmark eliminating our exposure to 3% to 4% of revenues. We continue to have concerns with the draft pricing data and variability from one month to the next in that it is inconsistent with our own cost trends.

We also have concerns with the implementation in that the dispensing fees may not be enough to cover the cost which the higher margin on the ingredient side covers today under Medicaid. Therefore, if the ingredient reimbursement is reduced near costs, we believe it is essential for CMS to establish some form of mechanism to ensure state’s increase dispensing fees to adequately reimburse pharmacies for their costs.

Next turning to some previous comments we’ve made about longer term guidance, many of you have asked about these comments related to double digit adjusted EPS growth for the period 2010 to 2013. This statement was made before we moved to an adjusted cash based EPS calculation. We’ve modified this in our subsequent presentations to high single digit cash based EPS growth for the two year period ending in 2013 to reflect the change of the cash based reporting. We are also still comfortable with this statement despite our net organic growth below our expectations.

Before opening up the line for questions I’d like to make a few comments related to capital allocation. We remain focused on returning value to shareholders as evidenced by the 55% of our cash flow from operations we returned to shareholders in the quarter. We also recognize the cash we have accumulated and our expectations for continued strong cash flow generation. The topic is one of our board of director’s regularly monitors and discusses and it will be assessing the allocation at its next scheduled board meeting.

With that operator, we’d now like to open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Lawrence Marsh – Barclays Capital.

Lawrence Marsh – Barclays Capital

My question really for you John is on payer mix and pricing. As you think about year ’11 it looked like about 47% of your payment came from Medicare Part D and B I believe. Is that still about the case? And, how do you think about concentration of PDPs within that mix? I guess along with that are you seeing any change in strategies around their pricing with you or do you feel good about your ability to negotiate effectively given your scale?

John L. Workman

The mix has remained about the same. If anything our Part D mix is growing slightly. Obviously, there’s negotiations with the Part D plans. We work very effectively to, I think, create good relationships with the Part D plans but I don’t want to mislead you there are negotiations and you raised a key issue is, that Omnicare has scale. What we’re trying to make certain the Part D plans understand is what Omnicare brings to that equation.

We can provide a complete network to cover the United States for the Part D plans. We can do it so that there’s one administrative place that they can go to in terms of questions or needed information. Lastly, we provide a lot of supplemental information. As you’re probably aware, CMS is requiring some additional reporting information as time progresses and we’re able to provide that for the Part D plans. So I think our relationships are sound but there are negotiations.

When we look at guidance both for the remainder of 2012 and even in forward years, we expect a declining reimbursement picture because that’s what’s happened, but that’s also part of our guidance that we’ve provided.

Lawrence Marsh – Barclays Capital

A follow up there I guess would really be on the generic scripts and dispensing rate. It looks like generic scripts were up 5% year-over-year, maybe slightly below what we were thinking, but I guess the question is around your generic dispensing rate expectations. I know you guys have said you had hoped to get to 83.5% in ’12, 86% in ’13, is that still your expectation and if not what might be changing?

John L. Workman

We’ve seen a steady increase in our generic penetration over the years. We still believe we’re at a higher generic penetration rate than any of the competition and we would expect that to achieve 85% by around 2014 so I think we’re on track to get to that level.

Operator

Your next question comes from Lisa Gill – JP Morgan.

Lisa Gill – JP Morgan

John and Nitin maybe the two of you can talk to us a little bit around your plan for net organic bed growth. I know this has been a goal of the company for some time. The results in the quarter were great and overall it seems like you’re achieving a lot of the objectives that you’ve talked about but this is one that has lagged a little bit. Can you maybe talk about the competitive landscape and some of the newer programs that you’re thinking about? I know we’ve talked in the past about OmniView and some of the other differentiators that you have on the technology side but are you taking a different approach now around trying to regain that organic bed growth?

John L. Workman

Let me make a couple of opening comments and then I’ll turn it over to Nitin so he can speak in a little more detail about some of the changes we’ve made in the last six weeks and that will continue. One is clearly the OmniView, OmniView Doctor, those are all competitive advantages for Omnicare. We want to make certain that we’re consistent in the way we go to market to present those. I would say the competitive landscape has not really changed. We know we’re in a competitive marketplace and as you said, we’re a little bit disappointed in our results.

Now one thing I could caveat is I’d remind everybody that when we report losses those also include losses that may have come about through acquisitions of other pharmacies and when we build our business case we always expect to lose some of those beds. We don’t call that out but that is part of the loss number. I think the thing that we believe is that the company can still get to net organic bed growth and with the assets that you mentioned we should be able to grow share. But with that, I’ll turn it over to Nitin for a few other comments that he can make about some of the changes that we’ve made and are making.

Nitin Sahney

As you know, over the last two years we have made a number of investments in our operating structure in the long term care group and also on the sales structure. You know, strategically we have a very compelling story to tell to our customers when it comes to customer facing technology and automation and I think when it comes to the retention on the operating side what we are doing is we are revaluating and making sure our focus stays on a weekly basis when it comes to making sure we can leverage the investments we already made.

The second part more importantly the sales side of it. Our sales structure is about two years young and has made a lot of progress but we’re taking a fresh look at how to enhance and frankly market our advantages that I think we can do a much better job of. I think those are the two things. The third thing is more qualitative which is every week on a daily basis these three of four things we are talking about is going to be a focus just like we did with the specialty care group where there was no sales structure and frankly very lean operating structure and we were able to bring it all together with a clear vision, clear number, all our operators, all our sales function people on a weekly basis and are talking about the same language. Those are the things we’re going to be focusing on going forward.

Lisa Gill – JP Morgan

Just as a follow up to that, if I think about the business model and what you’ve been able to do I mean, the margins this quarter were exceptional on both side of your business exceeding ours and the street’s expectations, but is it the true opportunity of the story going forward is to have that growth and continue to grow specialty so you can leverage those costs and continue to drive margins? Is that the right way to think about it? In order to continue to have growth you really do need to get back to net organic bed growth?

John L. Workman

But again growing scripts is what’s important. One of the other dynamics that is occurring a little bit is you see more Med A type business coming into the facilities which can have a little higher acuity patients. So we’re really focused on scripts, beds are a proxy for that so clearly we’re focused on beds but we’re also not letting up on the operating efficiencies in the company. So continuing to invest in automation, better ways of doing business to keep our cost down are the other elements that are there to protect margin.

Lisa Gill – JP Morgan

Just one last comment would just be around the CEO search. I’m just wondering if maybe you can give us any insights as to why it’s taking so long? To be honest with you I had anticipated that they would have named you CEO for this quarterly call so maybe any insights you could give would be great.

John L. Workman

Again, that’s on the board. The board is doing the right thing, they’re doing a search and a search takes a little time one as you hire a firm and secondly you start a process to work through. I think they’re working through that pretty efficiently pretty quickly and again, I am a candidate I am engaged in the process and we would expect that clearly by the end of the third quarter to be finalized so it’s only a couple of months away.

Operator

Your next question comes from Glen Santangelo – Credit Suisse.

Glen Santangelo – Credit Suisse

I just wanted to ask a quick question on the specialty business. This quarter we saw scripts up less than 4% but we continue to see this revenue growth again 26% this quarter and I understand there’s a lot of moving parts out there with respect to mix and price inflation but can you please explain in a little more detail maybe how the revenue growth is so strong and how you expect the profit margins to evolve given the disconnect between beds and scripts?

Nitin Sahney

Actually, as you know, we brought five different operating platforms out of which only one of them which is our specialty pharmacy is more scripts driven. What I can tell you is even though inflation is a part of that increased revenue, the majority of that comes from our organic growth year-to-year when it comes to the number of patients and frankly new [inaudible], being part of new specialty distribution networks, etc. so solid organic growth.

When it comes to the EBITDA and operating margin it is coming now also as expected from a fee for service platform that we have invested in and frankly focused on in terms of sales for the last six to seven months. Overall, when you look at our revenue growth it is coming a lot from our organic net growth when it comes to scripts and new patients on the specialty side and our fee for service platforms are contributing mainly on the EBITDA line.

Glen Santangelo – Credit Suisse

John, I did want to ask you a follow up question, within your slides you talk very specifically about the fact that generic drugs as well as price inflation as well as specialty all more than offset the pricing and reimbursement reductions. You’ve included that in your supplemental slides. I’m kind of curious if you can discuss a little bit what you’re seeing in terms of pricing and reimbursement reductions to just kind of lay that back on to your bed retention comments, it’s not that 9,000 beds is a big deal I think what we all want to know is what you’re seeing with respect to the pricing environment because you’ve all consistently made the case that the key to bed retention is going to be around customer service, and your operating structure, and your technology but could it simply be as simple as there’s a fair amount of independents that are willing to price more aggressively and that’s what contributes to the bed loss?

John L. Workman

No, I mean clearly there can always be people who undercut us on price and we see that. I think the important thing that we’re selling at Omnicare is not just about price. Look, we can be compared on price obviously, we buy direct and you know our margins are far in excess of what others have even including the independents. But, we’re focused on the other value equations and the total cost to the company so what we try to emphasize with our customers is not just the pricing of the drugs, the other services we provide whether it be OmniView or the other tools and things like we’ve talked about on prior calls where if you use those tools effectively you yourself as an operator can be much more profitable. So we’re emphasizing a lot of those things.

Relative to reimbursement the comment about minimizing our exposure to [MAC] and FUL, sometimes that’s a competitive pricing that you might see from the independents. Again, we’ve worked pretty effectively not only with the Part D plans but also with the facilities so that we have an AWP minus model which we believe is better for them and better for us. It gives a lot more predictability, it keeps people aligned, it keeps transparency in the equation and we’ve been very successful in looking at that total basically value equation to the customer and that’s our focus.

Again, there can be circumstances of price I mean one of the things that we clearly still have in the pilot stage is the other element about that customer service issues and as we see more patients migrating to Med A which means they’re going to be short stay patients admitted at different times of the day clearly getting to that first dose and once we are through the pilot and make that work effectively I think that will be a tool that helps also with the smaller independents because that is one of the things we still need to put in place.

The good news is again, that’s in a pilot. We don’t want to oversell that so we need to validate the case but that also will give us opportunity to look at other parts of our overall infrastructure in our hub and spoke network.

Operator

Your next question comes from Charles Rhyee – Cowen & Co.

Charles Rhyee – Cowen & Co.

Maybe getting back to talking about how we’re going to improve your organic net bed growth if I recall correctly when John you came on board a couple of years ago and we started this transition to turn this into more of an operating company, if I recall correctly you had kind of streamlined sort of the regional segments from something like 11 down to, correct me if I’m wrong, five or so. So it seemed like a lot of things were being done at sort of the organizational and sales level but today Nitin you’re kind of saying we still need a lot more standardization and process. Can you maybe talk about what processes were in place and maybe indicate where you think we are maybe in terms of innings, are we sort of half way there do you think to get to the right structure in which case we can drive organic bed adds?

John L. Workman

I’ll make a couple comments and then kind of turn it over to Nitin. You’re right, we made a lot of organizational changes and again, the strategy is the same let’s retain the customers we have and let’s get new business. I think as you recall, we’ve commented on prior calls that while we thought we were making progress on retention and we have made progress on retention, that the sales piece has been lagging. Part of that was tied into getting the right plans and getting the right people.

Part of what Nitin brings and what Nitin is focused on is one a more sense of urgency. He mentioned more weekly calls. But I would just look overall I mean, if you think about the situation when Nitin came into specialty and revitalized that and reorganized it and basically it’s doing about the basics in a sales function and that’s what we’re instituting. We think that will generate the net organic bed growth that we believe the company can achieve. Both Nitin and I concur there’s no reason we shouldn’t be growing organically in long term care and expanding share. With that, I’ll let Nitin add in any comments he wants.

Nitin Sahney

As you know, our investments have been already made when it comes to our sales structure and operating structure. When it comes to sales a lot of improvements have happened. Historically Omnicare was more an acquisitions driven company but over the last few years the sales functions frankly were only two years ago in place. Since then improvements have been made. I feel strategically you have to also look in other additional markets within the long term care space.

So we are approaching it with an enhancement of the business plan on sales looking at strategically additional marketplaces that we’ve talked about but we frankly haven’t as of yet leveraged those markets. Secondly, we’re looking at the basics as John has mentioned what’s working what’s not working so we’re having a fresh look is what I’d say. It’s the basic day-to-day tackling and blocking that has to go on in sales, we intend to be on a weekly basis, and frankly it’s not rocket science. I mean, you just have to do the basics on a day-to-day basis and also realizing the right people in the right places, etc. So that’s really what we are evaluating as we speak.

Charles Rhyee – Cowen & Co.

Maybe as a follow up questions, if you look at your annualized retention rate sort of in this low 90% range and it sounds like you were kind of saying in the slides your service related bed loss was down 30% plus, if you can just maintain that rate should we kind of just get to more flattish organic beds just on the math or are we going to really need sort of a really bigger push in sales itself?

John L. Workman

I think two things, one is we need both. I mean, we want to ramp up the retention rate from where it is today. Again, we’re focused on those that are customer service losses and as we’ve said before those are looked at every month in terms of why are we losing for service related issues and we want to make that number go away or get as close to zero as possible. That should allow us to have a stronger retention rate.

But then as we spent time talking and again, this is something we’ve commented on in prior calls, that we’ve been lacking we believe on the sales side. We believe the number of beds that are added from a sales perspective can be increased and we’re putting in place the mechanisms to allow us to do that. It’s a combination of the two.

Operator

Your next question comes from Robert Jones – Goldman Sachs.

Robert Jones – Goldman Sachs

I just wanted to stick with the bed conversation here. On the revised organic bed expectation for the year, maybe could you delve a little deeper into what types of beds you are losing relative to your original expectations that would cause you to miss your original goal? I know all beds aren’t the same on a profit level so as we think about the full year I mean, are the beds we’re losing more along the lines of what we saw last quarter with the lower margin correctional facility beds losses? Just any commentary around kind of as you look at the full year where those losses are really coming from would be helpful.

John L. Workman

It’s not necessarily a change in mix. I mean, yes there were the prison beds or correctional institutions losses in the first quarter, the second quarter would be a blend across all categories of losses. I do emphasize again some of those were coming out of an acquisition. As you all know we made a fairly large acquisition in late ’11 and planned to lose beds and lo and behold some of those are coming to fruition so I don’t think that was unexpected.

I think the thing I want to emphasize is we do believe we will return to net organic bed growth. We’re putting in place the proper processes to do that and while we’re disappointed that we’re not going to have net organic growth for the full year that doesn’t mean we’re not making progress towards that goal. More importantly is when we gave the revised guidance that was all part of our anticipation so from a profitability standpoint it’s not as big of an impact as one might thing. It’s clearly important but the fact that we’re able to and with recognition to that increase guidance for 2012 and also tell you that we’re still comfortable with what we thought was ’12 and ’13, I think demonstrates the foundation of the company and our ability to grow very profitably.

Robert Jones – Goldman Sachs

John I just wanted to go back to your final comment in the prepared remarks around capital allocation, you now have $179 million left on the authorization, any sense you can give us about how you’re thinking about the buybacks in the near term? Then more importantly, looking out longer term, with the maturities now more spread out, still solid cash position, obviously solid cash flow generation, I’m just wondering how you’re thinking about implementing a more consistent buyback program relative to where we are today?

John L. Workman

That’s a great question. Again, I think if you look back where this started with this group in 2010 we’ve put in place a goal, is to return 25% of that value to shareholders. Now, I think what I said in my closing comments is this is something we continue to talk about with our board. Clearly, we have accumulated cash, we have strong cash flow from operations and we will revisit that with our board at the next regularly scheduled board meeting.

If we don’t have a lot of opportunities for acquisitions, and the acquisitions we’re seeing right now of what I would describe as a little bit smaller in nature, nice add on acquisitions but as we look obviously we want to spend money on those, cap ex, some debt reduction, but that leaves a larger pool. We’re going to discuss that with the board again, and we have $179 million left in the existing program. Strong purchasing in the quarter, that was done through a 10b5 plan so not only are we taking advantage of the open market but we’re putting in place mechanism that when we’re not in an open market situation that will allow us to purchase back shares.

But I think the idea of purchasing back shares regularly that we instituted in 2010 would continue and we’ll reassess those levels with the board and they’re very open to those conversations. I don’t want to say one way or the other but clearly we’re signaling to you that that has got likelihood of increasing versus staying the same or getting lower.

Operator

Your next question comes from Steven Valiquette – UBS.

Steven Valiquette – UBS

I just want to make sure I understand just on the messaging for 2013, just curious is there any change in your view for next year? I guess if you talk about this two year CAGR high single digits if we’re talking about at the midpoint of 2012 guidance is roughly 12% growth so that would imply something around mid single digit EPS growth for 2013, just trying to figure out there’s something about the amortization schedule that restricts the growth next year or is there something operational where you’re just taking a more conservative stance for 2013? Without obviously giving detailed guidance, but I’m just trying to understand the messaging for today.

John L. Workman

We don’t want to get locked into specifying by year. Again, we said we’re comfortable with the high single digit for the two year period and as you just did the math Steve, clearly the ’12 right now is at 12% above which would signal, depending on what percent you’re using, something a little bit less. Now, we’d remind everybody we’ve had a nice benefit from branded generics in 2012, probably one of the biggest years. Now, as we look at 2013 still a good branded generics year but it’s not going to be as strong as the 2012 event. I would say that’s kind of the one element that’s being recognized over that two year horizon.

But, I think it’s important that we believe we can achieve that over that two year horizon. I wish I could sit here perfectly and tell you when all the branded generic conversions were going to occur but unfortunately those have a little variability in them. We have put in our guidance, as we said at the end of 2012, some AMP impact and so that would carry on into 2013 also.

Steven Valiquette – UBS

So it sounds like mainly it’s just sort of tough generic comps is kind of the main variable just in terms of the conservative stance and obviously we’ll just have to see how it plays out over the next 12 to 18 months I guess is what it sounds like?

John L. Workman

I think that clearly is one of the things. We’ve always said ’12 was going to be a very strong year, not that ’13 is a bad year, we don’t want to imply that at all, but again, we’ve factored AMP some small hit for that in 2012 and that would annualize in 2013 and we’re also going to continue to provide merit increases as we move into 2013 and beyond.

Operator

Your final question comes from Frank Morgan – RBC Capital Markets.

Frank Morgan – RBC Capital Markets

You touched on this, you were talking about some of the testing of technology in your buildings and could you talk about some specifics on timing and where you will get the results necessary to make a call on whether or not you really expand this first dose dispensing technology on a greater basis?

John L. Workman

Right now we’re piloting the first dose technology. We have what we would describe as a proprietary pretty innovative solution but we are testing that pilot. Part of the reasons we’re testing the pilot is to make certain we understand what the business case is both to Omnicare and to our customers because we think it has benefit to both. So we’re a little hesitant to speak too much about those until we get through the pilot. We’re still very optimistic about that being a solution. We’re also very excited about OmniView Doctor but again, these are pilots and what we would rather do is have a little bit more information about them as we start to share those with you in terms of a going forward basis.

Let me just leave it to say that Omnicare believes in investing and we believe our scale allows us to have that opportunity to invest in technology whether that be automation or customer facing technology. We’re still looking at automation to make our operations more efficient. That we have a little better history both with some of the equipment we’ve used plus modifications. There’s some modified equipment we’ll be using in the future but we’ll continue to look for new concepts that are beneficial to both us and to our customers. We just like to be a little hesitant about saying too much about it until we get through the pilot.

Frank Morgan – RBC Capital Markets

The issue of the bed loss have you seen any change in the type of customers? I mean obviously, someone asked the question earlier about prisons which are low margin beds, but say like in the bed loss you experienced in the quarter would you characterize those losses or those beds that are more of those high intensity Medicare Part A focused kind of [snip] providers or is it more the low tech more residential kind of long term care type of asset?

John L. Workman

I think it’s more of the later. I think we’re focused on obviously a lot of things to service those that have more intensity. There could be some of your larger players too in the Med A business. One comment I would make is that the losses and stuff are not across the board geographically either, that we do see some concentrations in some markets and where the loss could be a little bit greater than in other markets. I mean, look we have some divisions, we have five divisions today in long term care, we have some of those quite frankly that are at 95% retention rate and growing beds. We clearly expect to have net organic growth it’s just not across all divisions and some of that requires some people changes and we also recognize that.

We’re in the process of making the appropriate corrections. It’s nothing foundationally changing. From a retention standpoint a little more structural change as Nitin talked about in terms of the sense of urgency but again, I want to just emphasize the stuff that we’re doing is just the basics it’s not something that’s unique on the sales perspective. We just want to apply the basics and we think that will win out but that also means having the right people in the right spots.

Frank Morgan – RBC Capital Markets

This is jumping back over, understanding that you mentioned some new initiatives to kind of standardize and have a more uniform approach across both the long term care and specialty business, understanding that is there any reason you still couldn’t look at splitting or spinning off this segment? And if so, how big do you think it might need to be before it will be worthy of trying to accomplish a spin off?

Nitin Sahney

We cannot comment on any spin offs and strategies like that. All I can tell you is that the plan we had made two years ago on how to grow specialty we are ahead of plan and I think that is very strategically right and important to Omnicare. So, I’ll leave it at that.

John L. Workman

Look, we’re going to be focused on the things that improve shareholder value we’re not shutting out any alternatives but we’re also not pursuing something I guess is another way to say it.

Operator

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

John L. Workman

I’d just like to say thank you all for your interest in Omnicare, for joining our call, and we look forward to talking with you in the future. Thank you.

Operator

Ladies and gentlemen this does conclude today’s conference call. Thank you for participating. At this time you may now disconnect.

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