PSS World Medical, Inc. (NASDAQ:PSSI)
Wall Street Analyst Forum
September 9, 2008 9:50 am ET
David Bronson - CFO
In an on-going attempt to adhere to public schedule in particular for the benefit of world class attendees that are not concerned with the logistics of a financial conference that is expected to begin and end at a certain time. I’d like to introduce the next company in this morning’s program.
It should be a reminder to those executives that are here that we are delighted to host conferences at the University Club. They adhere to a very traditional business climate, so at a certain time no cell phones in the hallway. We signed a contract, and that’s the environment here. This is an extraordinary location and an extraordinary facility. They wouldn’t build something like this these days. But they did in the 1890’s.
In any case I’d like to introduce the next company in this morning’s program, PSS World Medical. They trade on NASDAQ under the symbol of PSSI. They’re a national distributor of medical products to physicians and elder care providers for its two business units.
Since its inception in 1983 the company has become a leader in the two market segments that it serves with a focused market approach to customer service, a consultative sales force, strategic acquisitions, strong arrangements with product manufacturers, and a unique culture of performance. It’s a Fortune 1,000 company with annual revenue approaching $2 billion. PSS World Medical is a market leader serving all 50 states.
Without any further introduction I’d like to introduce the senior management of the company.
Thank you and good morning. My name is David Bronson. I’m the Chief Financial Officer of PSS World Medical. I’ve been with the company for about 6-1/2 years, almost 7 now.
As was mentioned PSS is a leader in the alternate site health care market. We primarily serve physicians, elder care customers, skilled nursing facilities and home care. The company is in its 25th year. We’ve been public for about 15 years.
The hallmark of our growth is a very consultative, well-trained, highly-professional sales force that builds long-term relationships with our customers, operations efficiency in becoming the most efficient in distribution and warehouse operations in our industry, and more recently developing a private-label brand product which is growing very fast and has the opportunity to significantly improve our margins going forward. I’ll talk a lot more about each one of those.
We serve large markets. The physician market in the US is over $11 billion. In each of these pie charts the blue represents the traditional market that PSS was built originally to serve, and the green represents new, expanding opportunities for us to continue to grow revenues.
In the physician market we see $6.8 billion of consumables and equipment. This is everything you see in a doctor’s office when you go there. You see the product in the jar; it’s on the table, on the counter, in the refrigerator. Anything that is used in a physician’s office -- literally tens of thousands of products -- distribute on a day-to-day basis to the physician market.
More recently we have expanded to include pharmaceutical products. This is not scripted drugs that you go down to the corner pharmacy to fill, but are products that the physician uses in practice to treat or diagnose the patient. Think about MMR shots for the kids, flu shots and vaccines, vitamin B shots, topical ointments, creams, and those kinds of products. That has quickly grown to almost a quarter of a billion dollars and is growing about 20% each year.
In the other care businesses, there’s overall a $16 billion market in traditional skilled nursing facilities. Nursing homes and institutions are the smaller part of that, $4 billion, and we’re currently about half a billion dollars in this market.
More recently we’ve expanded into home care. This is a much larger segment of the industry where the government reimbursement is driving patients and patient care out of institutional high-cost facilities and into being treated by family practice physicians in the home. We think this is a significant growth opportunity for us going forward.
To give you an idea of what it is that we do, here’s a chart that shows the products we sell. Branded consumables represent 34% and this is anything from gloves, band-aids, needles and syringes, cotton balls, all of the things that are used in a physician’s practice. We also sell lab diagnostics, which include rapid tests for flu and strep, as well as more complicated equipment for immuno-chemistry and bench-top analyzers that utilize re-agents and do testing. Traditionally this was done in either a reference lab or a hospital. More and more, however, the physician’s office is doing those tests, and we sell the equipment and the re-agents that do that.
I already talked about the Rx or pharmaceutical in our select offering. It’s about 11% of our mix, and this is primarily consumables. It’s all consumables, so we don’t break out the products so much. Customers in nursing homes and assisted living situations are 62% of our revenue mix. Home care is about 35%. I expect that you’ll see this chart shift over the next few years as we are growing home care in the mid-teens on an annual basis. The nursing home and assisted living market is relatively flat. We’re growing, but the market is relatively flat.
Our three-year strategic plan calls for us to increase our earnings per share by 19% over the three-year period. We plan, operate and run our business on three-year cycles. Our fiscal year 2009, of which we are in the second quarter right now – we’re in the March 31st year – is the first year of that three-year plan. In the last three-year plan we grew EPS about 19%. I’ll show you that in a minute, but our next three-year plan calls for us to grow EPS by 19%.
We also expect to grow revenues twice as fast as the underlying markets we serve are growing. We expect 8-9% growth in the physician business, and similar growth in the other care business over the three-year period. Some people ask us why we show three-year detailed plans like this, and we answer that it’s the way we get paid. All of our management incentive compensation is based on hitting these numbers, and we figure we might as well as show you how we’re going to get paid.
We are in a challenging environment. Credit is tight; capital is scarce. Energy costs are up. There is uncertainty around the presidential election, and what they’re going to do regarding health care. There’s lots of uncertainty in the market. We understand that, and we still feel very strongly that we can continue to grow and improve our profitability.
I’ll talk about how we do that. Primarily, it’s in exploiting our competitive advantages that we already enjoy – being the market leader in the industry, having the largest and best-trained sales force, having solution-based programs that address the primary and most urgent needs of our physicians, customers and elder-care customers by becoming more efficient as a distributor through managing and lowering operating costs and by strictly managing credit in this uncertain marketplace. That is how we’re going to address the current environment and still grow our earnings 19% over the three-year period.
As I mentioned, we do have the largest and best-trained sales force. This is a consultative sales force. It is not the model that you’re used to where you see a pharmaceutical rep or another kind of sales rep come in the front door of the physician’s office and wait for two or three hours for a chance to spend five minutes with the physician. Our guys come in the back door. They’re part of the practice. They manage inventory and build long-term relationships. They take care of the needs of the physician and his staff. Because of that we have very high customer loyalty and satisfaction.
We have the most comprehensive solutions-based programs, such as health care information technology to help the physician run his practice more economically and more efficiently. We have the physician laboratory where we are able to provide him with both the knowledge about reimbursement and management and the products that help him increase his revenue and provide better patient care.
Because we have the largest sales force and because we’re growing the fastest and have the highest market share, we get first pick on any new medical technology that comes to market. So we have a very robust and active product pipeline. Each year we have introduced dozens of new products.
Finally our success is due to a very stable management team – the management team has been in place for a long period of time. Our CEO has been with the company almost 20 years and has done almost every job in the company. At almost seven years I’m still the new guy on the management team. Our average tenure on our management team is about ten years.
Major initiatives for our physician business this year include expanding from four to six regions. We service the domestic United States, and that expansion along with adding some leadership in the field is going to decrease our control and increase the focus and, we think, accelerate our growth rate.
We also have new products in health care information technology through a very innovative and unique partnership with Athena Health, the Boston-based company that provides a very strong and well-accepted revenue cycle management program for the physician’s practice.
We’re returning to the flu market. We exited the flu market two years ago due to over-supply in the industry. There were 140 million doses that were prepared by manufacturers and only about 75-80 million people who actually get shots during the year. That over-supply created a lot of risk for distributors, because the inventory was dated and was only good for one season. You can’t return them to the manufacturer. It didn’t feel like the right formula for success for us or our shareholders, and we decided to exit.
Our exit from the marketplace caused the manufacturer to come back to us and offer us a better deal. The manufacturer has now offered us a risk-free deal where we don’t take inventory; we receive only an agency fee for selling and distributing the product. Ours is the only agreement like this in the industry. It allows us to share in the
the marketplace without the risk associated with it. Again, it’s because of the size and quality of our sales force and our market presence that allowed us to structure this agreement with Novartis so we’re back in the flu market as of this year: won’t have a big impact this year because of when we got back in it and signed this deal, but next year and the year beyond will have a significant impact in our growth.
I talked about select price and I’ll talk a little bit more about that private label brand and we also have some technology that expands the region and breadth and bandwidth of our sales force by helping our customers get more of the ordering and inventory management. In the other care business, we want to continue to expand in home help offerings, that is, [assisted living and hope health agencies. There are literally tens of thousands of these small companies out there that are providing products and nursing services to the home bound patient and, in many cases, they’re trying to be a distributor and a provider and we think that our offering of our distribution and logistic services can upload that from them, we’ll make sure that the product gets to the patients home or to the nurse at the right time; let them be a provider and let us be the distributor, and we think that model has a significant opportunity for us to grow our revenues in the home-health arena.
Now when we talked about our private label offering, a couple of years ago, we looked at all of the proxy we found, there’s literally probably a 100,000 SKUs from 5,000 different manufacturers, and we put it through a filter and we said that if the product is not innovated, if it doesn’t have strong brand recognition, if there’s not a high technology content, if it’s commodity in the marketplace, if the manufacturer doesn’t provide good field support, if all of those things are true, then why don’t we do the job of the manufacture contracts with foreign-source manufacturing operations to build the product force, put our name on it?
The one caveat we put on that was we wanted a product that had the same or better quality than the branded product, so this isn’t a tech-quality kind of offering; this is to increase our gross profit margin on these products, but still, keep very high quality in customer satisfaction. When we get that, about 35% of our products qualify for that out of the billion 3 sold. Our target was to –over the next few years- get to 35% mix of private label and through that last year, we were about 12% so, in the three years we got 0-12%, scoring about 20% a year and it’s accelerating, so we have now about 1,200 SKUs that have our label on them and this is an opportunity because the gross margin on these parts is anywhere from 10-15 basis points higher.
We give a little bit of that back to our customer to get them to try it and move away from the branded product. Now, you say: what about the 65%, what are you doing there? We have launched a number of initiatives to improve supplies inefficiency and marketing programs with the branded manufactures, so we’re certainly not, by any stretch , walking away from our branded manufactures. We see a significant opportunity to save money there too. Overall, you’ll see, in just a second, what the impact of that is going to be on our operating margin going forward.
We are very focused on managing our costs of operation, and this graph shows: the bars are costs to deliver; this is the warehouse GNA and freight costs that it costs to get our product store customers, and you can see that we’ve taken about 200 basis points out of our costs to deliver over the past few years, even while gas and diesel –which is a big component of that cost- has gone from $1.35 to over $4.
So we think that we have demonstrated capability of managing and reducing our operating costs, and we think that 16.5% has significant opportunity if we continue to come down, both as we grow volume and as we can become more efficient as a distributor. Now, of the 19% growth in EPS, comes primarily as a result of operating margin improvement in this fashion over the three years and this show what we think we can do there. In the past three years, from 2006 to 2008, we went from about 3% to a little over 5%. In the next three years, on a consolidated basis, we expect to go from a little over 5% to a little over 7%.
The three primary areas that drive our margin extension are the sourcing of the private label opportunity that I talked about and we looked for $20-25 million of annual benefits by the fiscal year 11, coming from increasing the breadth and scope in the success of our private label offering. There’s a simplification is the fly that I showed you about reducing our reducing our operating costs. We sold almost $2 billion of products a year. Our average order size is less than $500, so every two seconds in this company, we’re processing, we’re receiving an order, we’re picking an order, packing, shipping, and delivering it. If we can save money in any of those steps for every one of those orders, we can generate significant savings, and I think that we have opportunities and programs to do that. We expect in a three-year cycle to improve our operations efficiency through business simplification, through redesign of our processes and the advancement of some of our warehouses and other technologies to generate $20-25 million of savings per year.
Finally, just leveraging revenue growth, a few years ago, we completely rebuilt our distribution infrastructure and we overbuilt it. We have significant available capacity in our infrastructure, so every time we generate a new revenue dollar, about at least 10% of that drops through to the bottom line, so it's accretive for us to grow revenues, we can continue to grow revenues. In fact, we can probably double our revenue base with our existing distribution infrastructure, which provides an opportunity to leverage those fixed costs over much higher revenue growth, so, our goal is to get from 5-7% in the next three years.
We’re also very focused on managing credit. We have the tightest credit in our industry. All of our competitors have VSOs or data sales outstanding, which are about twice as high as ours, and then though our VSOs are very tight, we have also managed to reduce our bad debt as a percentage of sales by a significant amount over the past three years. We understand the nature of this market, we understand the risk associated with credit and we really are focused hard on this. We’ve put very professional management on top of this and we don’t do it as the expense of revenue growth, because we feel like our all of our sales force and our service model makes people want to do business with us even though we don’t offer as attractive terms as our competitors do. Our CEO likes to say that we’re never going to use our balance sheet to grow revenues. Our competitors do that and we just don’t think that we need to do that.
The strategic priorities for us are: to drive this revenue and earnings growth are sourcing on sales force bandwidth. If I can free up 30 minutes a day of my sales force's time by introducing technology, by having a customer put in the order instead of him or her doing it; anything that I can do to increase sales force band width will help us to grow revenues.
Operation simplicity; I talked about this, and these other programs. One thing I haven’t talked about is; the 19% EPS does not include any acquisitions, but there are significant opportunities for us to acquire small, Mom-and-Pop regional players, and I’ll talk a little bit more about that in just a second.
In terms of the financial outlook, this is a company that does grow revenues. Our mantra is to grow at least twice as fast as the markets that we serve. We have done that in the past; typical growth in the high single digits in a market that’s growing probably on a consolidated basis – 3 or 4%. I mentioned that we had grown EPS: 19% in the past three years, and it is our goal for the next three years as well. Coincidentally, it’s not how we got to that number, but it’s coincidence.
Operating taxes; this is a company that does generate significant amounts of cash. Our capital requirements and our working capital requirements are relatively moderate. We don’t have to invest a lot in our distribution infrastructure, in our plant and equipment, and so we do generate cash. This year we’ll generate $73-77 million. One of the primary uses of that cash has been to repurchase shares and we bought back almost 15% of our shares in the last three years. We buy them opportunistically on debts in the marketplace, and to make acquisitions, and we probably bought maybe $150 million of revenues. The past three years, I think you’ll see that significantly accelerate going forward. I've showed this slide already, we recently did a convertible of debt transaction that was primarily a refinancing opportunity.
We have $150 million of convertible bonds that we issued in 2004. The first initial redemption date of those is next March and based on where our stock price is and where we expect it to be. We would expect that we would redeem those bonds at that time, and so we went out recently and got the $230 dollars of convertible senior notes with 3 1/8% coupon, and with a call spread overlay, they get a conversion premium effectively, selling stock at a little north of $28. We did repurchase $35 million of shares in conjunction with the offering. We’ll be sitting on this capital, until March we won’t redeem the bonds early because there’s a premium if we do that, but, you can see, our balance sheet, after the offering, we did lever up a little bit up to about 45% debt-to-capital, as we will drop that back down to under 40% by next March when we pay up the bonds that are out there, and we’ll still have significant available capital.
We have a $250 million line-of-credit with our bank group, that is largely undrawn, and this new issue of convertibles; what’s left over from there. It allows us to have a war chest if you will, if you ought to do acquisitions, both strategic and fold-in type acquisitions.
Our strategy is primarily to do those fold-in type acquisitions. These are companies that would be $10-15 million of revenues, specifically client family-owned businesses in a small geography where we either haven’t got to yet, or that they’ve been there a long time. They generally have very good relationships with their customers because they have that high-service model that we like as well. It used to be a great little business to run, to have small little positions supply business, barriers to entry were really small, but not today, it’s a lot harder.
You have to have pedigree technology to track their products, you have to have the ability to handle rebates and contracts, you have to have access to HIP and other offerings, and most importantly, you have to have access to a private label offering, which, these people, because of their size, they don’t have that, they can’t develop that. This is a real challenge for people, and we think that now is the time for them to think about how much they want to be in this business. We think that we’ll see significant opportunity to buy these. We’ll pick up the sales force, pick up the customer relationships, close down their operations, and fold it into ours to accretive right away. We generally pay about half of revenues as a starting point here, so that’s our strategy there.
I’m going to summarize here: this year, 8.5% to 9.5% revenue growth, 94-96% earnings per diluted share, and I think in our first quarter, we were up to a pretty good start, and that $73-77 million of cash flow. This is a business that is the leader in its industry. We’re very focused on the two markets that we serve. We have significant opportunities to expand our margin, and to make some acquisitions that are on top of the 19% goal that we’ve laid out there. Thank you very much, I appreciate you being here.
I’ll take some questions, do you have any?
Unidentified Audience Member
That’s a great question. On the face of that, it would look like we’re.. the question was: is there any inherent conflict with our band of manufacturers by us having our own private label brand? I would say that the filter that we used, to come up with the products that we’re going to target eliminates a good chunk of that potential conflict because we’re talking about products that don’t have brand recognition, that don’t have good support, that have not been innovated. Think about a tongue blade or cotton ball. Most of those manufacturers were already manufacturing the product overseas somewhere, and had their label on it. All we’re doing is replacing them. I will tell you that for manufacturers that do innovate, that do support the products with field support, support our marketing efforts to have strong brand recondition, we’re not touching those. We’re continuing to honor those relationships because now we can focus more on them and not have to worry about some of those other products and the other manufacturers so I think it's probably not intuitive but it actually has improved our relationship and by the way, we are still growing much faster than any of our competitors with their products. Good question. Any others?
Alright, we are just finishing up our Q2 of our fiscal year '09, we will be recording results in about the third week of October.
Unidentified Audience Member
Yes... the question was, on our convertible debt structure. We have $150 million of 2004 bonds and we will be redeeming those on March 15th, at Park and so the 230, the uses of that, about $30 million was share repurchase, $150 million of existing bonds and there was some costs that the calls spread over where we had to buy and sell some options and the rest will be used for general purposes.
Unidentified Audience Member
The 230. The turns of the 230, 3 in the Nape. They are 6 year bonds so it's due in 2014. Convertible at, that's 30% up, $22.10 I think it is. But because of the call-spread overlay, existing shareholders will not see any solution until about $28.
Unidentified Audience Member
No, they are public traders and I think last time I looked, the new bonds were trading at about 104. They were issued August 12th, within the last month or so. You know, we really struggled about whether this was the right time to go and do this, based on our senses that interest rates would go up, not down; the coupons and premiums would both move away from us in the market place. I-yield was not an option because of the cost, we knew that we had a redemption available out there; we could use our band debt to do that but it would not leave us a lot of capital to take advantage of opportunities in the market place, so we thought that this was a real good time to get this done and overall we are pretty happy with the execution.
Unidentified Audience Member
I'm sorry, I didn't quite hear you. Oh, we haven't raised any equity since the public offering in '93. I think we did a secondary a couple of years later; that was before my time. No, we don’t we use cash for acquisitions. We only used stock one time, which was in '97 and '98 when we bought the other care business, also before my time. We are not a seller of stock.
Unidentified Audience Member
Great question. The question was, what are the economics around these fold-in acquisitions? I mentioned that generally we start at half of the revenue base and then as a multiple depending on how profitable they are, some of these businesses are break-even, some of these businesses have a decent margin 8-10%. So depending on the profitability once you adjust that the boats and the resorts and the vacation homes and things like that and get a normalized EBITDA. We generally pay 6, 7 or 8 times EBITDA before Synergies, and 3-5 times after Synergies and the Synergies are shutting down their operations and folding them into ours.
Unidentified Audience Member
Yes, yes that's a good rule of thumb to use. There are literally hundreds of these out there. I didn't mention this, but half of the market which we serve in both markets is still served by these small players. So us and these other two big competitors have about 40-50% of the market share and the rest are the small players. So there are lots of opportunities. Anything else? Thank you very much.
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