Q2 2022 Owens & Minor Inc Earnings Call
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Good day and thank you for standing by welcome to the Owens <unk> minor second quarter 2022 financial results Conference call.
At this time all participants are in a listen only mode. After the speaker presentation there'll be a question and answer session.
To ask a question during the session you will need to press star one one on your telephone.
Please be advised that today's conference is being recorded I would now like to hand, the conference over to your first speaker today, Alex Joe <unk> Director of Investor Relations. Please go ahead.
Thank you.
Hello, everyone and welcome to the Owens <unk> minor second quarter 2022 earnings call.
Comments on the call will be focused on the financial results for the second quarter of 2022 as well as our outlook for 2022 both.
Which are included in today's press release the.
The press release, along with supplemental slides are posted on the Investor Relations section of our website.
Please note that during this call we will make forward looking statements.
Matters addressed in these statements are subject to risks and uncertainties, which could cause actual results to differ materially from those projected or implied here today.
Please refer to our SEC filings for a full description of these risks and uncertainties, including the risk factors section of our annual report on Form 10-K, and quarterly reports on Form 10-Q.
In our discussion today, we will reference certain non-GAAP financial measures and information about these measures and reconciliations to the most comparable GAAP financial measures are included in our press release.
I'm joined by our President and CEO and Andy long, our executive Vice President and CFO I will now turn the call over to Ed.
Thank you Alex good morning, everyone and thank you for joining us on the call today.
Today in my prepared remarks, I will cover our second quarter performance.
Current market landscape and why I remain bullish on the long term prospects for the company.
First I'm extremely pleased with our second quarter results.
Our strong performance and our ability to manage through the macroeconomic headwinds in this quarter as a result of the following one or Owens <unk> minor business system of continuous improvement.
Driven by our dedicated teammates continue to deliver operating efficiency eliminate waste and provide productivity improvements.
Our unique and differentiated business model with vertical integration that limits, our exposure to certain macroeconomic conditions impacting others.
And three our increased presence in the patient direct space supporting patients with chronic lifelong conditions.
While the external conditions have become even more challenging over the second quarter.
It is clearly visible that once again, our team performed very well.
We were able to report strong results with both of our businesses continuing to operate at a high level.
We remain focused on providing value for our customers and service at the highest possible levels.
Both of which are central to our mission and our demonstrated every day as we as woven Owens <unk> minor business system into the fabric of the company.
Over the second quarter, our approach to providing value and service continued to pay off.
Our customers value the consistency with which we provide industry leading service.
Especially given the degree of unpredictability that healthcare space over the past two years.
This was proven once again in the second quarter as our products and health care services segment continued to take share by adding high quality wins as we work to optimize our customer base.
This means we are not interested in growth for growth's sake, but are intently focused on profitable growth with reasonable returns.
This will be a key benefit from putting it together and medical distribution and our products businesses.
We continue to get smarter about how we go to market our product portfolio and what makes the most sense for our customers and the company.
When combined with our embedded business system, we can begin to drive towards much more efficient and more profitable business segments.
Now turning towards the higher margin higher recurring revenue patient direct segments.
Our byrom business continued to outpace the market with 17% organic revenue growth year over year.
On a pro forma basis, our patient direct segment grew 10%.
With after your revenue growth in the mid single digits, which.
Which is particularly impressive in consideration of the supply constraints related to sleep apnea products.
We are also pleased to be off to a successful start of the <unk> integration and synergy achievement.
As we look to the remainder of the year, we expect Q4 to benefit from the acceleration of integration and synergies.
As well as increased patient growth from the receipt and deployment of incremental sleep products from our suppliers that will fill existing orders and reduce our backlog.
Now looking at Q2 from a high level.
Many things played out as planned and discussed in previous quarters, such as our ability to navigate the expected environment.
Reduction of PPE demand and the absence of the glass cost benefits.
However, as the quarter progressed, we also experienced acceleration of macroeconomic issues and new industry specific headwinds.
The macroeconomic headwind acceleration included increased inflation.
Higher interest rates and a stronger U S dollar.
The new and accelerated industry specific issues, including staffing constraints and product shortages, such as critical diagnostic products through the global supply chain issues.
These constraints have resulted in lower procedure volume and we expect these constraints to continue through the year.
Procedure volume is down sequentially from Q1, and our customers experience the downward trend that progressed throughout the quarter.
Resulting in volume that is meaningfully lower than pre pandemic levels.
In my conversations with current and prospective customer. The main reason for this is due to the factors I mentioned a moment ago.
These are driving the low procedure volume and overall reduced hospital demand.
And as a result, our financial outlook for the year has been adjusted.
Before turning it over to Andy to take you through the specifics of the quarter and our new outlook I would like to emphasize the following points.
One we continue to deploy the Owens <unk> minor business system to drive productivity and reduce costs as we work to minimize the impact of the accelerating macroeconomic headwinds.
In our view these macroeconomic headwinds will eventually ease however, the improvements that we make with our Owens <unk> minor business system will remain and provide value long into the future.
Next overall health care is resilience and hospital procedure volumes will normalize as industry specific headwinds ease.
And the existing Unserved demand flows through the system.
We are excited about the opportunity as we will be ready to capture this volume with our existing customers and new customer wins.
And finally, our patient direct business is consistent and strong driving recurring revenue as it focuses on serving patients with chronic lifelong conditions, who need their products, regardless of the macroeconomic conditions.
As I reflect on the past three years, we have repositioned the company for success and long term profitable growth. We have done this by deploying the Owens <unk> minor business system to help drive continuous improvement productivity and improved service.
Strengthening our organization with leadership and strategy focused on our unique value chain.
Consistently executing during the challenging and unpredictable time.
Regaining share and delivering meaningful high quality customer wins in our product and health care services segment, and finally, diversifying our revenue and EBITDA base through above market growth and byrom and the acquisition of <unk>, while strategically positioning our patient direct segment to <unk>.
<unk> on the shifting preference towards home care.
Simply put we continued to demonstrate the effectiveness of our long term strategy operational excellence and business blueprint.
I am confident in our ability to assess successfully manage through these challenges over time.
With that I will turn the call over to Andy for a discussion of our financial results.
Andy.
Thank you Ed and good morning, everyone. Today, I'll review, our financial results and key drivers for our performance in the second quarter, and then discuss our revised expectations and assumptions related to our full year outlook.
First let me start with our second quarter results.
Our reported revenue in the quarter was $2 5 billion up slightly from the prior year.
Gross margin of $533 million or 21, 3% of revenue was up 520 basis points from prior year.
The growth reflected the first full quarter contribution from <unk> sales, which have a higher margin profile.
Foreign currency translation had an unfavorable impact on gross margin of $6 9 million.
Or 28 basis points for the quarter.
Distribution, selling and administrative expense was $453 million.
Driven higher primarily from the addition of <unk> expenses and ongoing inflationary pressures, partially offset by stringent cost control and operating efficiencies.
Interest expense was $36 million in the quarter, which was $24 million higher than the prior year given that this was the first full quarter of higher debt related to the financing of the <unk> acquisition.
Given the rising rate environment, we took action in early April by entering into an interest rate swap. This increased our proportion of fixed rate debt to approximately two thirds of our overall borrowings.
The effective tax rate this quarter was 25, 6% compared to 21, 8% in last year's second quarter.
The change in rates resulted primarily from the non deductibility of certain acquisition related expenses.
Our GAAP net income for the quarter was $29 million or <unk> 37, a share.
Adjusted net income in the second quarter was $58 million.
<unk> to $80 million last year.
Current quarter adjusted EPS was <unk> 76 cents compared to $1 six and Q2 of last year.
Whatever you need to consider the impact that foreign currency had on our second quarter results.
Strengthening of the U S dollar in the quarter had an unfavorable impact on foreign currency translation, reducing adjusted EPS in the second quarter by five cents.
And an 8% reduction on a year to date basis.
Second quarter, adjusted EBITDA was $156 million with a margin of six 2% up 110 basis points versus the prior year.
FX had an unfavorable impact of $5 million.
On a segment basis products and health care services reported second quarter revenue of $1 93 billion.
Versus 226 billion year over year.
This was a result of lower cost pass through of approximately $100 million.
And lower PPD volume both as expected.
Long with lower procedure demand as a result of supply chain and labor shortages constraining capacity in our hospitals.
Alex and health care services operating income for the quarter was $61 2 million.
Compared to a $101 $2 million last year.
The decline versus prior year was the result of lower volumes as I just discussed.
Along with accelerating inflationary pressures in the absence of glove cost benefit partially offset by operating efficiencies generated by our continuous improvement business system.
Finally, the year over year foreign currency impact on revenue was unfavorable by $13 million and the FX impact on operating income was unfavorable $5 million versus Q2 of last year.
Turning to the patient direct segment, our net revenue in the second quarter was $573 million, an increase of 145% year over year.
<unk> revenue grew organically by 17% with strong double digit growth across all major product categories.
On a pro forma basis.
<unk> grew four 4% despite the delayed customer starts from the Philips respironics recall and other supply chain constraints.
Adjusted operating income for the quarter was $52 million compared to last year's second quarter $14 million.
Acquisition related synergies from the Onboarding of Africa continue to track to our expectations.
Moving now to cash flow the balance sheet and capital structure.
This quarter, we generated $90 million of cash from operations, bringing our year to date total to $170 million.
Free cash flow defined as adjusted EBITDA less net capital expenditures was $107 million in the quarter and $214 million year to date.
We're able to reduce debt by $67 million in Q2. In addition to completing the final planned acquisition consideration payments of $108 million in the quarter.
We're on track to reduce our net leverage ratio back to our target range of two to three times in the next 18 to 24 months.
As I've mentioned in his remarks, we've updated our guidance for the year. We now expect net revenue to be in a range of nine 8% to $10 1 billion.
Adjusted EBITDA to be in the range of $570 to $610 million.
And adjusted EPS in a range of $2 85 to $3 15.
The key drivers of this revised outlook reflect the accelerating industry specific and macroeconomic headwinds that we experienced in Q2, which has negatively impacted our view for the second half of the year.
Higher interest rates and the stronger U S. Dollar alone are contributing approximately 10, so the reduction in the midpoint of our guidance.
Both the short and long term expectations for Africa remains right on track and we continue to expect accurate at over $900 million of revenue and approximately $180 million of adjusted EBITDA for the partial year impact in 2022.
We remain confident in our synergy expectations related to Africa, and believe incremental annual revenue will be in the range of $80 million to $100 million.
An incremental annual adjusted EBITDA in the range of $40 million to $50 million within the next few years.
Additional assumptions for 2022 guidance include our gross margin rate of approximately 20% unchanged from prior quarters guidance.
<unk> expense in the range of $130 million to $135 million, reflecting the most recent assumptions related to rising interest rates.
Capital expenditures of $185 million to $195 million up from our previous guidance due to improvements in <unk> ability to acquire growth related patient equipment in the second half of the year.
An effective tax rate of 24% to 26%.
FX rates as of June 32022, and.
And fully diluted share count of $77 million unchanged from Q1's guidance.
And finally it is important to note our projected earnings cadence in the second half of the year sequentially. We expect the third quarter earnings to be by far the lowest quarter of the year with a significant rebound in Q4.
In Q3 macroeconomic pressures and industry specific headwinds are assumed to continue accelerating. Additionally.
Additionally, in Q3, we expect products in health care services, new customer win implementation costs with the corresponding onboarding benefits beginning in Q4.
Also in Q4, we expect meaningful benefit from seasonality accentuated by a larger percentage of profits coming from our patient direct segment.
Proved access to equipment, and our <unk> business, reducing our overall backlog of orders and our sleep product line and.
And greater realization of acquisition related synergies.
Please be aware that these key modeling assumptions have been summarized on supplemental slides filed with the SEC on form 8-K earlier today and are posted to the Investor Relations section of our website.
In summary, the underlying business continues to execute well despite the overarching macroeconomic headwinds and industry specific challenges that we're facing.
Implementation of our Owens <unk> minor business system continues to gain momentum as more and more teammates become trained in our structured approach to problem solving and continuous improvement methodologies.
Our disciplined capital deployment has enabled us to remain focused on reducing debt, while reinvesting in the business for long term profitable growth.
At this point I will turn the call back over to the operator to begin the Q&A session operator.
Thank you Sir.
As a reminder to ask a question you will need to press star one on your Touchtone telephone.
Please standby, while we compile the Q&A roster.
And I show our first question comes from the line of.
Ando from UBS Mr. <unk> Your line is open.
Hi, Thanks for taking my call guys I just wanted to I guess I wanted to explore a little bit the comments around the applegate business and see perhaps in the higher Capex and let's just talk through XP.
The expectations there for that business.
How they have changed a little bit.
Youre spending more now you have more access to see perhaps a when do you think the sort of bolus that might be out there patients do you see that coming through.
In your <unk> guidance.
Or is this just you have more access to pace to see perhaps now than you thought you were going to have.
Yes.
Starting to let Andy add some color. So we really think that's going to really impact significantly the fourth quarter. The way, we see it and we look at it is if you look at our back orders right now we roughly have about three to four months.
Normal month usage on back order right now and as as the suppliers. The manufacturers start to start to be able to produce more products and get it out to us and we're going to be able to fill those orders starting filling those orders at a higher rate for now probably later in the third quarter and then significantly in the fourth quarter. The other benefit of it as we have seen.
Some some additional product coming through right now and the beauty of that is once those products come in and you then start to get that recurring revenue of the consumables. So thats also going to help us.
Products that are placed in Q3 that will help drive that also in Q4, and then we really think about the brightness of it going into 2023 and as we get that several months back order filled the recurring revenue going forward.
Hey, Kevin It's Andrew just the only thing I would add to that is another piece of good news that we received in the quarter.
Is that the FDA did approve the Philips remediation plan on ventilators, and so that kind of gives us confidence that we will have the equipment needed for.
Ventilation throughout the end of the year and what we need to support the fourth quarter.
Also a cash flow issue too right. So now that we can start returning defend lasers that we have on hand to get those refurbished and put back into into the field thats going to reduce our cash flow, we're not going to be spending as much on ventilators because of what we have already getting refurbished we may not ask a patient related capex on ventilators.
Till early 2024, so it will be a cash flow benefit.
Got it can I, if I can ask a quick follow up I just wanted to make sure I understand the guidance change it looks if we're doing our math right that the vast majority of the changes.
FX and higher interest rates.
Is that a fair way to.
Characterized the <unk>.
Reduction in guidance, just looking at the math around.
The FX impact and backing that up and and the higher interest rates.
Yes, Kevin Andy Yes, absolutely so the way I think.
Of the 30 <unk> reduction in the midpoint of our EPS guidance, you're absolutely right as I said in my prepared remarks, the combination of FX and higher interest rates will combined to contribute about 10 of that 30.
But the single largest driver will relate to lower procedural volumes and you'll note that the midpoint of our revenue guidance came down about $150 million that $150 million to 100% attributable to our products and health care services segment and in terms of calendar <unk> at $150 million I'd say some of that we saw in Q.
Two.
Share of that reduction is going to happen in Q3, and the margin impact from that think of it because its in the proxy in health care services segment. This there'll be about a 10% pull through contributing $15 million of Bottomline profit or 15 cents of EPS impact in that 10% pull through or think of it as we're not going to get real.
Aggressive in taking variable cost out because we see this shortfall is being very temporary in nature, we're not going to be pulling out variable cost just only have to put them right back in in the fourth quarter. That's it's really not a smart move so we're not going to get aggressive on cost cutting and hence the pull through on that and that leaves about five per net inflation and I stress the net.
Because again, it's the impact of inflation.
You've seen the CPI continue to climb as we move throughout the year.
It's been inflationary pressures net of what we're going to be able to offset that so thats going to be hitting us in the third quarter pretty art and our remediation.
Steps that we take to mitigate that through our business system will take a little bit longer to gain traction and we will see the impact of that benefit in Q4.
Great. Thank you so much for all the color guys.
Thank you.
Hello and.
Sure.
Our next question comes from the line of Danielle <unk>.
From Citi. Mr. <unk> Your line is open.
Hi, Thanks for taking my question.
Excuse me all my questions.
I was wondering if you could put a finer point on.
Some of the product avail.
Availability challenges in the acute care setting they get the labor shortages that spin.
Widely reported on but on the.
A little more surprised on the product shortages Jayson I think in your prepared remarks, you mentioned it was really kind of the diagnostics side of things. So I was wondering if you can go into a little more detail about the shortages you are seeing there, what's causing those shortages and.
What's going to alleviate some of those pressures on the product side.
Yes.
The product side it really is.
The conference will begin shortly to raise your hand during Q&A you can dial one one.
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Pardon me Mr. <unk>, if youre on the line. Please hit Star one again to re queue for questions.
Hello, Hello, Mr. Hilton, Yes, yes, yes.
You are back in line.
Great So I.
I apologize about that we had a little technical difficulty here lots of the phone connection, but I'll just give you.
On the product side of it it's products that were procuring from external manufacturers. Another supplier that we then turnaround and distribute to the customer I'll. Just give you. One example, while there are several out there a simple example would be contrast di where there is a shortage of contrasts it's impacting the ability for our customers to be able to do the diagnostic.
Tests, they're prioritizing their diagnostic tests, but thats just one simple example.
Of a diagnostic product that's unavailable and look our manufacturing partners and those who make these products are working hard to take you to improve their productivity or improve their output and increased ixia as Keith mentioned as they increase their output.
And we're seeing that happen already but we expect that to remain in several of these examples to remain low in the third quarter, but start to recover in the fourth quarter.
Thank you. Thank you.
Okay.
And I show. Our next question comes from from alignment.
From Bank of America.
Yes.
This is Hannah Lee I'm on for Mike Cherny. Thanks for taking my question Justin light of ongoing cost pressures can you talk about some of the pricing power you have in both lines of businesses.
Some of the price, yes, so the way to really think about pricing power I mean, I think we think about it differently.
Really our different businesses so.
Paolo let me start with our patient direct business the reality on pricing power in our patient direct business is really limited to our ability to work with the private payers to adjust our reimbursement rates and we sit down with them and we have those conversations.
We explained through.
Times were successful and at times.
We hold off on some of those the other aspect evident our patient direct business is really CMS funding and thats relatively locked in.
So I think there is limited on that.
On the product side, we've been relatively successful I would say with having the open transparent conversations with our customers I would point to the glove cost pass through.
We're clear with our customers of what cost increases we had we laid those out to the customers directly explain what's the drivers work and based on that we were able to pass those costs through as they went up and then the same since we brought them down as product costs came down.
Think that transparency model has been clear and it shows that we've had the ability to both pass on cost increases and then quickly take the costs back down as our costs went down.
On the medical distribution side, there's really there's really not a lot of margin to play within that business because of the nature of the model at such a low margin business.
But in certain areas, we will work with our customers, we work with our customers not necessarily.
Product cost because that this decision is between the manufacturer and the end user.
So we will work with them on other things like optimizing freight and looking at different ways to take those costs out to offset it so.
So I think overall in the pricing power, it's different by each of the different aspects of our business I would say in our in our products business, our manufacturing business, we've done a very very good job.
<unk> on those costs, but its been because we've been open and transparent with our customers on.
Our on our patient direct business, we've done a very good job working with our external the external payers to make sure they understand the dynamics and where appropriately we have been able to get some adjustments and then on the distribution side again, it's really been focused on how do we optimize our operations and take waste out of it to offset that.
Okay.
Thank you.
And I show. Our next question comes from the line of Eric Coldwell from Robert W. Baird. Please go ahead.
Hey, Thanks, Good morning, I have a few questions here some of them are very technical.
I'll just start off with FX I, just want to make sure we're clear on the guidance impact across FX inflation and interest rates can you tell us what the original FX headwind expectation was where it was recently in the last update and then the incremental addition for FX and this update.
Yeah, Eric It's Andy Good morning, happy to take that question. So.
Maybe I'll just start by describing a little bit more than nature of FX and then we can give quantitative but again the strengthening dollar is primarily hit us in our selling currencies right. So the euro the pound the Japanese yen, so where we're converting local currency into U S. Dollars were taking the hit there we're not seeing the strengthening dollar help us much on the.
Cost side, because again most of our manufacturing footprint is in North America.
And quite frankly, where we have production outside the U S. Honduras and Mexico. The dollar has been relatively stable. So we're not seeing as much of a corresponding benefit on the cost side.
In the current forecast and what's changed from where we were last time, we talked at the Q1 earnings call.
With that dollar strengthening sharply during Q2, we expect that to be probably contributing about <unk> <unk> of FX headwind from where we were last time, we talked.
And again, we're using the June 30th FX rates.
As the basis of our guidance for this this time dismissed forecast I know that FX rates have eased a little bit here in July and as that continues that could provide us with a little bit of lift but at this point in time, we are using the June 30 rates the original guidance.
When we came out in the fourth quarter was based on December 31, FX rates.
Okay in that original guidance can you remind us what the original expectation was.
Eric I would actually have to get back to you on that I don't know how much.
No no problem and then.
Could we get.
The apria EBITDA into Q.
So what I'll say is.
We haven't given quarterly amounts, but when we have confirmed is our expectation for the year.
I've made earlier comments, but on a full year basis I expected when I say full year pro forma 12 month basis, we expect <unk> to contribute.
$240 million of EBITDA and for the period of ownership post March 29th of this year, we do expect to.
In excess of $180 million of EBITDA contribution.
Under our definition and that is.
Right on track I feel very good about that forecast.
Okay, Great and then on the glove pass throughs, the $100 million in the quarter can you remind us how that stacked up versus your expectation and then.
I don't think we saw a specific update on the $400 million to $450 million range for the year.
Yes, so I would say that the $100 million of headwind was probably a little bit slightly less than what we had expected.
In terms of the update on the full year, we haven't changed our guidance, but I would say we're at the lower end of that range.
Okay, and then final one from me and thank you for all of this.
With the revenue headwind in.
Distribution and products.
Here in the quarter, and then as well as the outlook.
It sounds like.
The vast majority is really related to distribution, but I want you to clarify that or quantify that if you can.
Making sure that we're not missing something on products, we've all expected and easing of demand through the year, but.
It feels like the majority of this guidance reduction is related to the volume situation as opposed to products being materially lower than you expected is that correct.
Yes, Eric It's Andy I think you hit the nail on the head I think the $150 million reduction in guidance as I mentioned earlier is all product in healthcare services.
And although it's hospital utilization, driven which is primarily medical distribution to I don't want our audience to forget that we do have a portion of our core product portfolio that is non PPE. So there is a portion of elective procedure related products in our proprietary portfolio, albeit smaller than that.
So there is a little bit of impact on the proprietary product side, but youre absolutely correct. The lion's share of that is going to be in medical distribution.
Okay.
Thank you very much.
Thank you.
Im showing no further questions in the queue at this time I would like to turn the call back over to <unk>, President and CEO for closing remarks.
Thank you everyone. Thanks for joining us on the call. This morning.
There's a couple of areas I wanted to cover is obviously I'm really pleased with how our second quarter turned out as I stated in my prepared remarks, we continue to gain share and win some meaningful high quality customers I think the other thing that's important to note is that the fact that within our patient direct business.
We're really continuing to diversify the total company revenue and EBITDA and we're doing that really in two ways. One is the strong growth from our Byron business again in the high teens of growth as well as the <unk> acquisition that we will continue to expand and help diversify the total company revenue and EBITDA and again, we saw great growth in <unk> for the quarter in the mid single.
Digits, so continuing to see the beginning of our synergies and the integration work very very well.
Ultimately I think historically the last three years, we've shown our ability to demonstrate as well as the effectiveness of our long term strategy, our operational excellence in our business challenge and we're really looking forward to the back half of this year and really continuing our strength going forward. So thank you everyone and look forward to talking again next quarter.
Thank you for attending today's conference. This concludes the program you may all disconnect.
The conference will begin shortly to raise your hand during Q&A you can dial star one one.
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