Q3 2022 Owens & Minor Inc Earnings Call
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Good day, and thank you for standing by welcome.
Welcome to the Owens <unk> minor third quarter 2022 earnings conference call at.
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 this session you will need to press star one one on your telephone you wouldn't hear an automated message advising your hand is raised.
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 Investor Relations.
Thank you Hello, everyone and welcome to the Owens <unk> minor third quarter 2022 earnings call.
Our comments on the call will be focused on the financial results for the third quarter of 2022 as well as our outlook for 2022, both of which are included in today's press release.
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 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.
Today, I'm joined by <unk>, President and Chief Executive Officer, and Alex Bruni, Executive Vice President and Chief Financial Officer.
And Andy Long Executive Vice President and Chief Executive Officer of products in Health care services will be joining us for the Q&A section.
With that I will turn the call over to Ed Ed.
Thank you good morning, everyone and thank you for joining us on the call today.
I'd like to start this call by addressing the factors that were in line with our expectations as well as the unanticipated factors that drove the recent change in our outlook.
While there was some new challenges combined with the continuation and acceleration of existing challenges.
Many key aspects of the third quarter occurred as expected.
Starting with one we continued gaining momentum in our patient direct segments growing organically in the mid to high teens across all major categories.
We also continue to see improvement in our ability to access equipment, which allowed us to meaningfully reduce our overall backlog of orders in our sleep product line.
Two as planned we successfully onboard a new acute care customers and our product and health care services segment with the investments made in Q3 and Q4, providing benefits in the future.
Three as a result of our investments in predictive analytics.
AI and inventory optimization, we continue to improve our already market leading service levels.
And four as expected and discussed last quarter.
Future volumes in Q3 were soft and well below the 2019 pre pandemic levels.
Now let me discuss the unanticipated factors in Q3 that drove our recent change in our outlook.
One is the third quarter progressed, we saw more and more of our acute care customers delay reorders.
Choosing tippett fleet, there stockpiled items, including our higher margin, that's an IP products.
Simply put our previous guidance did not factor in.
Ladies and gentlemen, please standby your conference will resume momentarily.
Please continue to hold your conference call will resume momentarily.
Hello. This is at Sika apologize about the.
Connectivity issues, but let me continue back to where I left off at so now let me discuss the unanticipated factors.
In Q3 that drove the recent changes in our outlook first as the quarter progressed, we saw more and more of our acute care customers delay reorders choosing to deplete their stockpiled items, including our higher margin S and IP products.
Simply put our previous guidance not factor this in as an assumption.
Second from a macroeconomic standpoint, the federal reserve actions were more aggressive than expected the.
The U S dollar strengthened and fuel prices reversed course and began to increase towards the end of Q3.
Three as we ended the third quarter, we concluded that the execution and velocity of the actions we were taking in our product and health care services segment were insufficient to offset the future impact of macroeconomic headwinds as we successfully had done in the past.
And finally.
While we were beginning to see slight improvements in procedural volume, we did not see the extent of the ramp up of procedural volumes, we expected at the end of the third quarter and into Q4.
Accordingly, we have made changes to address these shortfalls and the good news here is that there are numerous short term and long term opportunities in this segment that will allow us to operate more efficiently and more cost effectively.
Just a few of them.
One we will continue to leverage our industry leading service levels.
This is help retain existing customers and win new business with attractive customers. This is an important distinction since as we have said in Q1 and Q2 not every customer is going to make financial and operational sense for us we remain focused on profitable growth. Two we are refocused on expanding our portfolio of products.
Which provide longer term benefits three we are implementing changes in the way, we incentivize our sales team to drive proprietary product penetration and conversion along with supporting our key supplier partners.
And finally going forward, we will more aggressively implement the Owens <unk> minor business system into this segment simply put we must execute better and faster.
Moving on to the patient direct segment the effectiveness of our business system is readily apparent in our patient direct segment.
We have experienced many of the same macroeconomic pressures in this side of the business as well, but have been able to offset some of the same challenges.
Difference is simply in the execution.
In the third quarter, our patient direct segment segment achieved organic revenue growth in the mid to high teens across sleep diabetes, urology, ostomy and continence and wound care.
On a pro forma basis. This segment grew at 11, 4% year over year.
Also our ability to procure sleep equipment was better than expected, which enabled us to grow our census asleep patients and meaningfully reduce our backlog of orders.
This highly recurring revenue base will compound nicely as we head into 2023.
With the backlog asleep patients clearing and the patient census, growing we will see more sleep supply sold in the future and this will benefit the bottom line.
Finally from an integration and synergy perspective, we are ahead of our internal targets.
Overall, the patient direct segment will continue to be a larger and larger portion of the total company earnings and cash flow.
We believe that the attractiveness of this faster growing higher margin segment is overlooked by the market and the near term and long term perspectives of this segment is very exciting.
Before I turn the call over to Alex to take you through the quarterly financials and our recently revised outlooks I want to emphasize a few points.
First our commitment to the hospital customer and our industry, leading service is paying off and new wins again, we will remain selective in pursuing the share gains that are most impactful to the bottom line.
Next the use of stockpiled items for current activities by our customers as temporary and as these stockpiles are depleted demand for our S and IP products should return to normal.
Three you will see a more rapid and full some deployment of the Owens <unk> minor business system in the product and health care services segment.
I believe there will be an even greater appreciation for the strength and steadiness of our patient direct business more and more of our earnings and EBITDA will be coming from a patient direct segment and I believe the recurring revenue nature and growth rates of this segment will become properly valued.
And finally, I am confident that our core business fundamentals remained strong and we have the correct strategy across both business segments.
With that I will turn the call over to Alex for discussion of our financial results Alex.
Thank you and good morning, everyone. It's my pleasure to be with you today and I look forward to meeting many of you in the weeks and months ahead.
Today, I'll review, our financial results and key drivers of our performance in the third quarter, and then discuss our revised expectations and assumptions related to the full year outlook.
First let me start with our third quarter results our revenue in the quarter was $2 5 billion virtually flat from the prior year driven by the contribution of Apria and strong organic growth within the patient direct segment offset by lower revenues within the products and healthcare services segments.
Gross margin of $513 million or 26% of revenue was up 740 basis points from prior year as well.
It was driven by patient direct and reflected the contribution of Apria sales and sales mix within that segment.
Year over year for Q3, foreign currency negatively impacted revenue by $12 million gross margin by $6 million and.
<unk> operating income by $5 million.
Distribution selling and administrative expense was $445 million driven higher primarily from the addition of Apria expenses and ongoing inflationary pressures, partially offset by operating efficiencies and productivity gains derived from the Owens <unk> minor business systems.
Interest expense was $40 million in the quarter, which was $28 million higher than prior year, driven by the debt financing of the <unk> acquisition in late March.
As a reminder, floating rate debt represents approximately one third of our overall borrowings inclusive of our interest rate swaps.
The GAAP effective tax rate this quarter was 36, 2% compared to 12, 6% in last year's third quarter. The change in rates resulted primarily from the mixture of income and losses in jurisdictions in which we operate as well as the prior year's utilization of foreign tax benefits.
Our GAAP net income for the quarter was $12 million or 16 cents a share.
Adjusted net income for the quarter was $31 million or <unk> 41 cents a share.
Third quarter, adjusted EBITDA was $127 million with a margin of five 1% up 140 basis points versus the prior year.
On a segment basis products and healthcare services third quarter revenue was $1 $9 billion versus approximately $2 $3 billion last year. This change was driven by approximately $110 million of lowered well cost pass through as well as reduced hospital demand a customer's reliance on existing stock.
Myles.
Products and health care services, adjusted operating income for the quarter was $24 million compared to $64 million last year.
And this change was attributable to the factors just discussed along with accelerating inflationary pressures.
Turning to patient direct this segment had an excellent quarter.
Net revenue in the quarter was $594 million, an increase of 142% year over year growing 11, 4% on a pro forma basis with strong double digit growth across key product categories, and aided by our better than expected ability to procure sleep equipment.
Adjusted operating income for the quarter was $60 million compared to last year's third quarter, a $15 million.
The synergies we are generating within our patient direct business are tracking ahead of expectations and we continue to expect <unk> to add over $900 million of revenue and over $180 million of adjusted EBITDA for nine months of contribution in 2022.
And the next few years, we continue to expect deal synergies to add incremental annual revenue of $80 million to $100 million and.
A mental annual adjusted EBITDA in the range of $40 million to $50 million.
Moving now to cash flow the balance sheet and capital structure.
This quarter, we generated $69 million of cash from operations and on a year to date basis, we have generated $238 million free cash flow defined as adjusted EBITDA less net capital expenditures was $84 million in the quarter at just under $300 million through the first nine months of 2022.
During the quarter, we further reduced net debt by $35 million and we were comfortably within <unk>.
Comfortably within all debt covenant requirements.
Leverage reduction remains a top priority and there is no change in our target net leverage net leverage ratio of two to three times.
Now, let's look at our current guidance for the full year 2000, 22022, we expect net revenue to be in a range of $9.8 billion to $10 billion adjusted EBITDA in a range of 527% to $537 million and adjusted EPS in a range of $2 50 to $2 60.
As we look at the key drivers of this revised outlook versus the previous guidance. There are few items to note first we have reduced our revenue assumption by $50 million at the midpoint. This decrease reflects our new assumptions on softer Q4 procedural volumes and factors in the recent trends in customer reordering.
As we mentioned over the quarter, we saw more of our acute care customers delay reorders choosing instead to deplete their product stockpiles.
Given this we are expecting a much different sales mix in Q4 than we had previously projected.
This is driving the majority of the 45% reduction in the midpoint of the adjusted EPS guidance for the year.
As expected interest expense for the year as slightly reduced to a range of $128 million to $130 million due to ongoing.
Debt management, and continuing to lower average daily debt levels, partially offset by higher interest rate assumptions.
For a complete summarized wisdom modeling assumptions, please refer to the supplemental slides filed with the SEC on form.
<unk> 8-K earlier today, which we have also posted to the Investor Relations section of our website.
Looking farther ahead, we are in the midst of our normal budgeting cycle, which would put us in a position to discuss our outlook for 2023 in the first quarter.
As we've discussed the changes to our outlook for this year came as a result of some unanticipated challenges and without question. We are very focused and have a renewed urgency to address these issues.
There were also many positive takeaways from the quarter, we are very proud of our service quality and new wins and successful onboarding within the products and health care services segment.
And we remain very excited about the performance and outlook for the patient direct segment.
<unk>.
At this point I'll turn the call back over to the operator to begin Q&A operator.
You Sir as a reminder to ask a question you will need to press star one on your telephone.
Please standby, while we compile the Q&A roster.
Okay.
Right.
And I show. Our first question comes from the line of Kevin Caliendo from UBS. Please go ahead.
Hi, Good morning, everybody, it's essentially Andre alfonzo in for Kevin.
I guess, if we could just get a little bit more granularity around your expectations for the run rate of margin in products in 2023.
And if I could just slip one in.
I appreciate it a little bit more color on your thoughts around sort of the sleep apnea.
Backlog and how we should think about that manifesting in the numbers through to next year. Thanks. So much sure I'll start this is Ed I'll start with the second part of the question of Alex Dino talk a little bit about the projection going forward.
I think the way to still think about the sleep product as you know we had a very strong quarter in sleep, we were able to you know bay.
Basically get access to additional product the team executed extremely well on it and frankly, we took our backlog down to back to almost close to where were sitting now today closer to normal levels of what we would anticipate.
So while we had anticipated the depletion of that backlog to lead us into Q1 of next year and early part of 2023, we actually were able to capture most of that business now because of the additional capacity that we received additional volume are received and frankly incredible execution on the team's part to get those products out so how does that manifest into the future.
Yes, the obviously, placing the equipment is one thing it's now that that recurring revenue will start to occur in Q4 or late in Q4 is generally to get a 90 day supply with the initial <unk>.
Deployment of the product and then that recurring revenue will start to continue to to flow throughout all of 2023 versus where we originally thought we would fill those those the vet equipment orders into 'twenty three and then start to gain that so it's really been strong execution on the patient direct team focus on partnering.
With the sleep manufacturers getting the product out to get US ahead of the curve.
And really get our back orders and backlog on that back down to what we would see as a normal rate where we sit today.
And then I'll, let Alex cover a little bit on the first part of the question on kind of standard run rates and where we are in the process. Thanks, Ed Good morning, Andrea So within Phs the trends that we've seen here in Q3, we do expect to continue at least in the short term through Q4, and I think that's reflected in our guidance.
And as I mentioned, we are in the middle of our budget process and do expect to have greater visibility in the first quarter.
The markets continue to be very dynamic and guide we'll work through that over the next month or so.
Right.
Thanks very much.
Thank you.
One moment for our next question.
And I show. Our next question comes from the line of Daniel gross Slide from Citi. Please go ahead.
Hi, guys. Thanks for taking the question.
It seems like most of the pressures you're facing our macro.
In nature, but you mentioned that there are specific actions you didn't take quickly enough and you're going to begin implementing I'm wondering if you can put just a bit of a finer point on what specifically you can do in the near term given these macro pressures don't seem to be abating anytime soon.
How quickly that will manifest and at more normalized margins for the products and solutions business.
Sure.
So really it is both a mix of macro as well as some of the industry specific that we're seeing so I talked a little bit about the destocking, that's having a material impact on us here and in Q3, and then extending into Q4.
It's really the fact that hospitals are under financial constraints. They have a tremendous amount of stock on hand of PPE, which historically they haven't had.
We're electing to utilize that versus restocking. So they are using their quote safety stock to bleed down inventory, which is having a material impact on us.
I think on the macroeconomic side you know there's several different things that were in the process of doing.
Some of those things to offset the macro impact one is route optimization as fuel prices continue to go up there is still tremendous opportunities for us to maximize and optimize our route optimization optimization within the customers.
That's going to take a period of time to work with our customers from a delivery standpoint.
There is additional.
Really embedding the Owens <unk> minor business system within our product and health care services segment.
The ability for us to continue to take cost out of that business aggressively by driving continuous improvement and I think the way to really look at it as compare and contrast, the two segments. Many of the same macroeconomic pressures impact patient direct that impact of product and health care services segment, our patient direct through the embedding of the Orange.
A minor business system have been able to quickly take cost out of that system to be more effective that same implementation has to happen on the other side of our business and on the product and health care services segment.
The other thing I would talk about it to really continue to look at it at offsetting some of the macroeconomic is looking at the Labor Force you know one of the things we had anticipated coming into Q3 and going into Q4 was a stabilization of the labor we didn't see that in Q3 and Q4, However, we actually believe.
As the economy continues to tighten the labor force.
Create opportunities for us to have a better labor force and then keep our employees and teammates for a longer period of time and reduce that turnover. So that's another aspect of it continuing to look at ways, where we've identified of how do we reduce the turnover of our teammates in our distribution centers. So that way, we can have well trained teammates that are much more effective than new.
Hires so that's another aspect of how we're thinking about it.
Thanks, I appreciate the color and if I could slip one more in here.
You mentioned a lot of the margin pressure within products and.
And solutions is due to product mix as well that the higher margin products just haven't come back as much as you expected.
Given you had generally seen higher margins within your products proprietary products business does this mean, you're you're really seeing most of the pressure within proprietary products rather than the core distribution segment.
Yes, I think that's the right way to think about it.
And in really it comes down to this is while we're winning customers we're continuing to grow.
Our general distribution business. The one area, we're seeing today, primarily our proprietary S and IP products, we're seeing less and less demand, we're not seeing utilization go down in the hospital or the product, we're actually seeing hospitals reduce their purchasing of those products because they have a stockpile at.
And that's one of the things Thats fundamentally changed as you know during COVID-19 over the last two years.
Many of our customers went out and bought products from us from other manufacturers and indirectly anywhere they can find the product they built those products up and stockpile and now theyre electing to actually utilize those products that are in their stockpile complete those down to a lower level and then we that's when the recurring revenue will start to happen an increase again.
Our products business, specifically the P P based products.
Thanks, I appreciate the color.
Okay.
Thank you.
And I show. Our next question comes from the line of John Stansell from J P. Morgan. Please go ahead.
Hi, This is John on for Lisa Thanks for taking my question.
Just wanted to dig in a little bit on the.
The synergies that Youre seeing I think you called out kind of head of schedule, but about hearing the commentary correct about the same amount that $40 million to $50 million of EBITDA contribution. So I guess my question is are you seeing a more than expected.
Synergies from Premier Rural integration.
How should we think about that going forward yes.
The answer that question is absolutely we are again.
I've watched the patient direct business come together App Ram Byrom I've watched them, both collectively embrace and embed the Owens <unk> minor business system.
We've watched them continue to grow do you think about the growth rate I think Q2 pro forma growth rate was approximately 10% in Q3 pro forma growth rate growth rate is 11, 4%. So just think about that the ability to cross sell the ability to identify opportunities.
I would say there synergies on both sides and the fact that we've embraced the fact that.
Byrom has learned from aspirin Deprey has learned from byrom.
<unk> has effectively done some of the things that have made apria successful in Africa has done many of the things that has made Byron successful again youre seeing that in growth that again pro forma last quarter. This quarter was 10% up to 11, 4% Youre seeing that in operating income overall and I believe it went from 9.1 to 10.
10%.
Adjusted operating income as a percentage are you seeing margin expansion and again that is driven by cost elimination that has been driven by better operational effectiveness that is driven by top line growth and I think it's also important that the same with the synergies we're seeing growth not just in one category two categories, but virtually all major categories grew at double.
<unk>. So those are the quantitative examples that are validating the synergies and continuing to drive the adjusted operating income margin expansion as well as the accelerated topline growth.
Great. Thank you.
Thank you.
And I show next question comes from the line of.
Charlotte Kolb from Bank of America. Please go ahead.
Hi, This is Charlotte on for Mike. Thanks for taking my question.
Can you talk a little bit about the competitive environment and any impacts that you're seeing from a share perspective versus peers.
Yes.
Yeah from a competitive environment I mean, all the businesses are different obviously, we've got our manufacturing business. We've got a distribution business, we got a patient direct business.
I would like to but I believe that you know if I, if I take those and the other order our product that our patient direct business continues to grow and again again I said at 11, 4% pro forma and in really in the high teens or double digits across the board I should say with in all major categories I'd like to believe that in those markets. We're playing.
We are continuing to grow at or above market.
I would say also within our within our medical distribution, we continue to see new meaningful wins come into the into our business, but I'll also qualify that is and the fact that we're continuing to look at the right wins and retaining the right business.
We look at it is is there meaningful losses in Kansas gained meaningful wins in across the board I would say, we're gaining some very meaningful wins with the opportunities for those to continue to grow.
We're also doing putting together programs with our medical distribution business that when we win customers. A great example that is the market is one of the recent announcements we had an WVU.
That's not just an opportunity to win there its to grow in the entire state with the footprint, we're adding and then the geographic states around that so that's why I say this great success on that.
I would say in the P P space or in our in our proprietary products.
Think the Destocking isn't just affecting us it's affecting many others in the market too that are in this space.
And as we look at our contracts across our customer base. We continue to maintain those we continue to have expansions of new customers coming onto our P. P are coming onto our contracts are P. P. So I think across the board we're doing extremely well.
Great. Thank you.
Okay.
Thank you.
I'm showing no further questions in the queue at this time I would like to turn the call back over to Mr. Ed <unk> for closing remarks.
Well, firstly I just want to thank everyone for joining us on the call today, but before I hand, the call I want to reiterate a few key points I want to make sure we all take away from <unk>.
Today's conversation.
First at Owens <unk> minor, we are completely committed to our <unk> customers and continuing to provide.
Leading in our leading industry our industry leading services.
That service level, where providing continues to deliver on new wins for us and we're going to continue to focus and as I. Just stated in the previous question the rate growth going forward second really the stockpile issue. We've got customers that have a tremendous amount of product stockpiled.
Seeing customers utilize that stockpile I met with a customer most recently that had been burning through their stockpiling hours completely through it met with other customers that validated yes, we're utilizing some of our stockpile to offset.
Some of the financial woes.
Those things are is that stockpiles depleted and it's not going to last forever that demand for our product exists it still exists and they're using those products today next youre going to see really an increased intensity around the Owens <unk> minor business system, and our product and health care services segment.
Finally, we've talked about this back in Q1 Q2 and in various open communications Youre going to continue to see a mix shift at Owens, <unk> minor, where more and more of our earnings and EBITDA are going to come from the patient direct segments and I really believe as people understand that segment. It has tremendous recurring revenue nature as well as it has high.
Your growth and it's a more profitable segment that then our patient their product in health care services segment, and Youre going to continue to see that mix shift as we go forward.
And finally.
Over the long term I am completely confident that our core business fundamentals remained strong and we have the correct strategies across both segments. So I want to thank everyone and I look forward to sharing our progress when we report on our fourth quarter results in early 2023. Thank you.
Thank you. This concludes today's conference call. Thank you for participating you may now disconnect.
The conference will begin shortly to raise your hand during Q&A you can dial star one one.
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