Owens & Minor, Inc. (NYSE:OMI) Q1 2019 Earnings Conference Call May 7, 2019 8:30 AM ET
Chuck Graves - Director-Finance & Investor Relations
Ed Pesicka - President & Chief Executive Officer
Robert Snead - Executive Vice President & Chief Financial Officer
Conference Call Participants
Steven Valiquette - Barclays
Kevin Caliendo - UBS
Good morning, ladies and gentlemen, and welcome to the Owens & Minor's First Quarter 2019 Financial Results Conference Call. My name is Amanda, and I'll be your operator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference call. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes.
I would now like to turn the presentation over to your host for today's call, Mr. Chuck Graves. Please proceed, Mr. Graves.
Thank you, operator. Good morning, everyone, and welcome to the Owens & Minor first quarter 2019 earnings call. I'm Chuck Graves, and on behalf of the team, I'd like to read a Safe Harbor statement before we begin.
Our comments today will be focused on financial results for the first quarter of 2019, which are included in our press release. In our discussion, we will reference certain non-GAAP financial measures. Information about these measures and reconciliations to the most comparable GAAP financial measures are included in our press release.
In the course of our discussion, we may make forward-looking statements. These statements are subject to risk and uncertainty that could cause actual results to differ materially from those projected. Please see our press release and our SEC filings for a full discussion of these risk factors.
Participating on our call this morning are; Ed Pesicka, our President and CEO, who will provide an overview of the business and an update on the progress we're making; and Robert Snead, EVP and Chief Financial Officer, who will provide details on the first quarter results and more insight into our business performance.
Now, I would like to turn the call over to Ed, who will start things off this morning. Ed?
Thank you, Chuck, and good morning, everyone. I'd like to thank everyone for joining us on the call today. Robert will give an in-depth analysis of our quarterly results. But I am pleased that our earnings were in line with our internal operating plan for the first quarter of 2019.
Today, I want to spend most of the time talking to you about my observations from my first 60 days. Since I joined Owens & Minor in March, this is the first opportunity I've had to talk to you about the company. And I'd like to give you a sense of where we stand today based on what I've seen firsthand, as well as where we are going in the future. I will discuss our customers, our value proposition and changes we are focused on within our company.
From day one, I felt the most important thing I could do was to meet face-to-face with our customers, as well as our teammates, and that's exactly what I've done. These interactions have allowed me to have open and honest dialogue on a firsthand basis. In addition, the meetings and conversations have helped me to validate some of our strategies, as well as my initial perspectives.
Specifically, the meetings helped me to shape the initial adjustments and actions that needed to be made to the business. We have already made some changes and others will come as I continue to gain more information and insight around the needs of our customers, as well as how we can best service these customers and meet their needs.
The main takeaway from these interactions is that we have a great foundation that's based on our broad offering of products, our solutions and our services and I'm increasingly confident in our ability to drive profitable growth in the future. If you combine our offerings with our ability to adjust quickly to the unique demands of our customers in a rapidly changing healthcare environment, we have a recipe for success.
So let me first start with our customers. Over my first 60 days, I've made it a priority to meet with existing customers, as well as prospective customers. These conversations have been extremely valuable. I have gained an understanding of our customers' wants, as well as their needs. This has allowed me to focus on how we serve our current customers, as well as identify two things; one, opportunities for improvement at Owens & Minor; and two, ways we can expand our relationships with existing customers.
Relating to prospective customers, I've been able to learn why they are seeking change and how we at Owens & Minor can best meet their needs. To date, I have visited the facility, as well as talk to the leaders of our healthcare networks that represent approximately $2 billion in existing revenue. Next, I've met with significant number of prospective customers, these customers represent over $0.5 billion of potential annual revenue for Owens & Minor.
And then finally, I've met with our major GPOs, whose members represent approximately $6 billion of our revenue. While early in the process, I wanted to let you know that; one, we have already closed on incremental business that may bring us up to $100 million of revenue; and two, we have extended our Vivian contract through August 2020 with no significant changes in terms.
I have also learned that when properly articulated our customers value; one, our ability to be flexible, to adapt quickly and to customize their solutions to solve their challenges; two, our integrated solutions and services that help them mitigate risk, increase value and ultimately improve the clinicians experience; and three, our ability to move at a speed equal to the pace of the industry that's in change.
While our customers want their partners to be flexible and move quickly, they also expect a high level of service. If you think about it in a different way, this is just the basic price of admission to be able to compete. For many years, Owens & Minor had a well-deserved market leading reputation providing exceptional service.
However, during 2017 and 2018, our service levels lag, and at times led to customer dissatisfaction. However, we have made a number of changes and investments in our operations to improve services. These investments have resulted in significant improvement in service levels, compared to 2018.
We are now consistently meeting our overall service level targets and more aggressively addressing issues as they arise in the course of business. We are also beginning to drive productivity in our operations with improvements from 2018 levels. The service challenges in 2018 led the net customer losses, which has continued into the first quarter of 2019.
Let's be clear, we had our share of wins and losses with customers both large and small. Those that have moved away had done so largely in parts because of our previous service challenges. And this includes a large customer that will not renew its contract, because this contract ends in late 2019 and the customer is at the low end of our customer profitability, this transition will not have a meaningful impact on our 2019 results.
However, we have a multi-pronged approach to offset the impact in the future, which in one part includes a robust pipeline of customer pursuits, as I mentioned earlier. Going forward, we know, we must deliver service levels at or above our customers' expectations. And every day that we consistently demonstrate a high level of service, the opportunity for retention and that customer gains improves.
Also, I personally stress tested our solutions in service value proposition and at the appropriate customer contact point, it resonates. For example, I was recently at a customer meeting where we discuss QSight as a great example of one of our solutions.
Once we show the customer how QSight can mitigate risk, provide value, specifically with the return on investment greater than five times, and also improve the commission experience, we capture their attention.
Currently at this customer, we are in a pilot phase with the opportunity for a broader application into the future. Then, if you consider the role we play along the health care continuum, we can deliver even more value to providers.
We can serve patients in the home, with our Home Healthcare. We offer a portfolio of leading products from our Halyard and MediChoice brands. And provide patient care coordination with Fusion5.
Here again, we have not done a great job in messaging our ability to bring the value to the healthcare providers. This is going to change. As we continue to develop a higher level intensity, and make changes to better serve the customer, and drive profitable growth.
Now moving on to our teammates, over the last two months, I visited a number of our facilities and met with many of our teammates. As I travel around the country, I am learning more about the inner workings of our business, the current markets we serve and most importantly our culture.
Our teammate focus culture defines Owens & Minor and sustains us. However, we must understand that while we are teammates we must also be leaders, whether that is as a coach or captain. And as we always have, we will continue to operate with the highest, level of integrity.
As I've met with our teammates, I've been frank. I've been frank about what needs to change, so that we can further stabilize our business. First, we need to drastically increase our intensity. We must also maintain a firm focus on serving our customers, while running our business effectively and efficiently.
Second, we must continue to develop our teammates to ensure that we have the ability to serve a rapidly changing health care industry. Third, we will have a higher level of accountability and authority to honor our commitments to our customers, stakeholders and teammates.
Fourth, we will improve our ability to leverage the vast amount of data that we collect to serve our customers. Next, we are operating at a renewed sense of confidence, as a team that are -- we are one company, focused in one direction through the alignment of our goals and priorities.
Our sense of urgency is high. And lastly, we are laying the foundation for sustained growth and improved cash flow. We are working to deleverage the balance sheet as quickly as possible, while continuing to make smart investments in our business.
So, in closing, I am pleased that the overall results for the first quarter of 2019 are in line with our internal operating plan, allowing us to reconfirm our guidance range for the year.
I am also incredibly excited to have the opportunity to lead Owens & Minor. And build on its long and proud history of serving healthcare. As I mentioned, I spent significant time with customers, since joining the company in March.
I've heard firsthand, that our offering resonates with these healthcare providers. We provide efficient, customized solution with the ability to adjust on the fly, that allows our customers to mitigate risk, increase value and improve their experience.
I will continue to meet regularly with customers. These face-to-face meetings are extremely valuable, and there will be no letup. In fact, over the next few weeks, I will be meeting with customers, suppliers and teammates throughout the mid-Atlantic and Northeast regions. I look forward to these meetings.
Thank you. And now, I'll call-in Robert for his assessment of our first quarter results. Robert?
Thank you, Ed. Good morning everyone. Today, I will provide an update on our first quarter results, including a discussion of segment results and our outlook for the year. For the first quarter, consolidated revenues were $2.5 billion, an increase of 3.7%, compared to prior year. Quarterly revenue growth includes Halyard contributions of $189 million, net of intercompany sales and strong growth from Byram.
Revenue growth was partially offset by declining revenue from lost distribution business. The gap net loss for the first quarter was $14.1 million or $0.23 per share and adjusted net income for the quarter was $1 million or $0.02 per share.
You may recall that in February, we spoke of very minimal earnings for the first quarter and our results were in line with our expectations.
Now let's turn to our segment performance for the quarter. The Global Solutions segment revenues were $2.2 billion, representing a 4.6% decrease compared to the prior year. Results were positively affected by Byram revenue growth and growth in manufacturer solutions offset by decreases in our distribution business.
Operating income was $21 million compared to $37 million last year. The decline resulted from lower revenue, ongoing distribution margin pressure, increased warehouse and delivery expenses, and increased expenses to develop new customer solutions. These were partially offset by contributions from Byram.
As Ed discussed, we are seeing positive trends in our customer service metrics, which are now at or above targeted levels. While still a headwind year-over-year, we also saw sequential improvement in our distribution operations productivity and we expect that to continue through the year.
Turning to the Global Product segment. For the quarter, revenues were $347 million compared to $121 million last year. Revenues for the quarter included Halyard contributions of $240 million.
Operating income for the quarter was $7.7 million compared to $11.1 million last year. Results were impacted by commodity price increases, softness in sales, which were offset by expense control.
In addition, as shown in our summary segment information, our results also include inter-segment income of $1.7 million. This income is attributable to our product segment and occurs when end market product sales exceed product segment sales. Our segment earnings were in line with our expectations.
Turning to the balance sheet and cash flow. Consolidated long-term debt was $1.7 billion at March 31 and we use $61 million of operating cash flow during the quarter. Operating cash flow was affected by lower net income, plus the timing of working capital changes.
This timing was due to the normal holiday inventory build, combined with the impact of the flu season, resulting in a higher level of working capital. We have already seen much of this normalize in April and we expect working capital to be a positive contributor to cash flow for the year.
Now let me touch briefly on the new lease accounting standard we adopted this quarter. Our first quarter balance sheet includes approximately $200 million of assets and liabilities, representing the present value of our operating leases. The new standard has no impact on the cash flow.
Finally, I'd like to remind everyone of the expected cadence of -- last quarter, I mentioned several factors impacting our outlook including healthcare planned deductible, typical seasonality, Fusion5 investments, and the pace of customer on-boarding and our manufacturer and provider solutions businesses.
As a result of these factors, we believe that our adjusted earnings per share for the second quarter of 2019 will be in the mid to high single-digits. But we expect improvement over the course of the year with the bulk of the earnings late in the year.
In closing, I'd like to reiterate our commitments to driving cash flow and deleveraging the balance sheet.
Thanks. And with that, I will turn the call back over to the operator to begin the Q&A session.
Thank you. [Operator Instructions] Your first question comes from the line of Steven Valiquette of Barclays. Your line is open.
Great. Thanks. Good morning, guys and thanks for taking the question. So, I guess for us, maybe the results are pretty much in line as you guys described. So I'm just curious for an update on where you stand right now on the approximate percent of SKUs that you're distributing that are self manufactured. And also do you think that will continue to ramp up either throughout this year or over the next couple of years, as well just an update around that whole part of the strategy? Thanks.
Sure. Yeah, when you think about this year, we look at it two ways. We look at it both SKUs, as well as revenue as a percentage of our total revenue and let's talk specifically in the distribution business. There is a plan actively in place to continue to increase the SKUs and increase the portfolio both of our own self manufactured product that being the Halyard brand and the MediChoice brand, and are probably in the mid-teens right now with the expectation to be able to grow that revenue steadily over the next 18 months.
Okay. Great. That's helpful. Thanks.
Thank you. Our next question comes from the line of Robert Jones of Goldman Sachs. Your line is open.
This is Kevin on Bob today. Thank you for taking the questions. Just quickly I am – I know you guys had mentioned number of different factors that are contributing towards the ramp that's impart guidance like deductibles, seasonality et cetera. Which of these items would you say, you have significant line of sight into and which would you say could be more meaningful swing factors moving you between the $0.60 and $0.75 that you guys have outlined for guidance? Thanks.
Yeah. I'll let Robert start and then I'll add the color onto it.
Yeah. So as I mentioned in the prepared remarks healthcare plan deductibles is a big factor. Byram is a big contributor of that that was impacted by that. Their fourth quarter tends to be significantly higher than the first quarter, so that's a one and we have reasonable insight in that based on how revenues are developing through the first quarter.
The other one is the seasonality that exists in the business that's a pattern that we can look at historical data to see how that manifests itself. That is driven partly by the flu season, also its impacts our global business not just in the U.S. and Europe as well. The pace of customer on-boarding that I mentioned is another one that we have some visibility into as we've signed some contracts with both our provider solutions business, as well as our manufacturers business. And so as we're on-boarding those, we're expecting that business to be phased and how it's coming on later in the year.
And then the next one is our Fusion5 business that we've talked about, that's more in an investment phase and it's more of a fourth quarter event in terms of where that ends up. Little less clarity and where that ultimately shapes up to be, because it's a newer business and we're still, you know, working our way through that, but it's one that's more fourth quarter oriented.
And then the last thing, I didn't really talk about in the prepared remarks that is a factor is the commodity price headwinds that we had talked about last year, we saw that impact our results in the fourth quarter, we saw that in the first quarter of this year. There has been some abatement in that in terms of where recent -- more recent spot prices have gone, so we do expect to see improvement in the products business next quarter and in the later quarters in the year.
A – Ed Pesicka
And then let me just add a little bit color, the way I think about it is consistent. If you think about global products, our manufacturing businesses, the end of the year, we have year-end buys, which helps the seasonality of that business. From a Byram home health care, the deductible issue really drives significant improvements specifically in the fourth quarter related to that, where they'll do substantially more profit -- have generate substantially more profit in the fourth quarter than they do in the first quarter, as people hit their deductible maxes and then start to continue to increase their buys.
On the distribution, the core business, it's going to be continued operating efficiencies, we've started to see here in the beginning of the first quarter, as we've progressed through the year and we're continuing to see it here going into the second quarter. And then last as Robert stated is Fusion5, so Fusion5 has the investment into the beginning of the year and then based on the occurrences that occurred last year in October through March and the government reconciliation on that, we'll start to see that in the fourth quarter, the revenue which is a pull-through to profit. So that's the way you think about it in the four major portions of our business.
Great. That's really helpful. And then, just a quick one on free cash flow. I know you guys had mentioned a couple of the working capital items, which should hopefully benefit next quarter. Just at a high level, are you guys expecting to see growth in free cash flow this year? Or any sense of just trends would be helpful there? Thanks.
A – Robert Snead
Yes. We are. We focused on working capital management as we've talked about in past calls. This has been something last year that was probably domestic business that we've had. We've expanded our efforts for that globally. So part of the headwind we've had is just getting off the TSAs with the Halyard business. And so that's kind of a temporary issue, an issue that is really getting at driving some of that opportunity as we've gone through some of those transitions here in the first quarter that's given us more access and control over the business. And so we expect to drive working capital through the balance of the year and have that be a positive contributor to operating cash flow for the year.
Thank you. [Operator Instructions] Our next question is from the line of Kevin Caliendo of UBS. Your line is open. And your phone might be on mute.
Q – Kevin Caliendo
Sorry I apologize about that I was on mute. Thanks for taking my call. Can you talk a little bit about if you've contemplated doing any kind of asset securitization to help near-term on the balance sheet. Is that something that's necessary or something that is -- could be opportunistic for you?
A – Ed Pesicka
Yes. I'll start, and then Robert talk on the specifics. So from that, I think we've constantly, our goal begun to continue to look at different ways to deleverage the balance sheet. I mean additionally different ways to continue to provide more cash and let Robert talk specifically about this.
A – Robert Snead
Sure. We have within our credit agreement and ability to do a asset securitization, and we are -- we are certainly looking at that. I think from a -- the main focus of that would be geared towards driving interest savings those types of financings tend to generate lower interest expenses that would result in cash savings for us and then help improve deleveraging. So that's certainly top of mind and something that we're focused on.
And second question this was a little bit more broadly just about sort of the industry dynamics. And some of the checks we've done talking to some hospitals. We've heard that some hospitals are contemplating combining their wholesalers, meaning using their acute care providers to also or to RFP out both the acute care side and also their physician or alternate sites on-campus. Can we talk a little bit about if that's really a trend, and if you guys are positioned to be able to participate in that kind of RFP? I know in scripts you had the entire campus, I was just wondering sort of is that a dynamic that's happening and how you guys are positioned to take advantage of it?
Okay. So absolutely it is happening from spending time with customers. They are looking at their acute care, as well as their ambulatory service centers and the external part of their businesses. And scripts is a great example of how we with our ability to be flexible and provide unique solutions can -- I believe better serving those customers and others out there in that space. It's a different -- it's a similar call point, but it's a different service delivery model.
If you just think about it in a basic sense, some of those remote locations don't have loading docks, where the hospital does have a loading dock. And with our ability to deliver and customize a solution, and it enables us to, where I believe is better serve them as that continues to change within the healthcare field.
So we are seeing it. It's IDN by IDN specific based on the way they're structured, but we are positioned, I believe very well to be able to serve that as a -- as the industry continues to migrate in that direction.
What percentage of hospital systems do you think are actually moving in that direction?
It's still early on. So right now it's been low, but we're seeing the trend increase.
Great. Guys, thank you so much.
Thank you. [Operator Instructions] And there are no further questions at this time. I would like to turn the call back over to Mr. Pesicka for his closing remarks.
So I want to thank everyone for joining us on the call today. As I mentioned earlier, I'm extremely excited to lead Owens & Minor, as we continue to build upon our company's strong legacy in the healthcare field. Look forward to updating you on the progress in the future. So thank you everyone.
Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone have a great day.