Accendra Health, Inc. (ACH) Q2 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Owens & Minor Second Quarter 2016 Financial Results Conference Call. My name is LaToya, and I will be the operator for today. [Operator Instructions] As a reminder this conference call is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Truitt Allcott. You may begin.

Thank you, LaToya. Good morning, everyone, and welcome to the Owens & Minor second quarter 2016 earnings call. I'm Truitt Allcott, and on behalf of the team I would love to read a safe harbor statement before we begin. Comments today will be focused on financial results for the second quarter 2016, which are included in our press release. In our discussion today we will reference certain non-GAAP financial measures. Information about these measures and reconciliations to GAAP financial measures are included in our press release and in the supplemental information posted on our website. In the course of our discussion today 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 the our press release and our SEC filings for a full discussion of these risk factors. Participating on our call this morning are Cody Phipps, our President and CEO, who will provide an overview of the business and the progress we're making on our transformation initiatives; Randy Meier, EVP and Chief Financial Officer and President of International, who will give an update on our results in more insight into the performance of our three segments; and Nick Pace our General Counsel is also on the call today. Now I'd like to turn the call over to Cody Phipps, our President and CEO, who will start things off this morning. Cody?

Thank you, Trudi, and good morning, everyone. Thank you for joining us on the call today. For the quarter our teams performed well across our global enterprise enabling us to exceed expectations and achieve revenue growth of 2.5% and adjusted diluted EPS of $0.52. These results reflect the strong execution of our global teams throughout the first half of this year. I am encouraged that our message of attacking complexity across the healthcare value chain is resonating in the marketplace. In recent weeks we have resigned significant existing business and signed several new customer agreements which all will speak to our ability to create significant and sustained value working with our customers. Our ability to provide this kind of value is also growing in new and meaningful ways. In particular, we are becoming increasingly more attractive to clinically relevant manufacturers. In fact, we have recently signed an agreement with a leading manufacturer to provide a unique global solution. As part of this agreement we will handle all of the business for their domestic healthcare subsidiary, and we will be shipping to 45 countries around the world. Our facility in the Netherlands will serve as the central European hub for this client. What I find encouraging is why manufacturers are choosing Owens & Minor. We are healthcare and healthcare only. We are global and are investing in new global capabilities including comprehensive quality and regulatory systems. We occupy a unique position in the middle of the flow of goods, funds and information between manufacturers and the point of care, and we are dedicated to attacking system wide complexity and creating value for manufacturers all the way to the point of care. Now for an update on the four elements of our transformation agenda. Regarding the first initiative, strength in the Senior Leadership Team, we welcome Jay Glasscock as our new Senior Vice President of our Global Clinical and Procedural solutions business. Jay, who joined us during the quarter, has a great deal of operating experience in the life science and medical device industries. He is a strong leader with a proven ability to develop high performing teams. We will continue to add leadership and talent to accelerate our strategies. With the second initiative, strengthening our domestic services business, progress on both the commercial and operational fronts drove strong second quarter results. On the commercial front we continue to see overall growth trends among our existing customers. As I mentioned, we have also worked hard to retain existing customers and win new business. That said, the environment remains highly competitive as all stakeholders are reacting to the pressures of declining reimbursements. However, our customers realize that we are a transparent and collaborative partner in helping them attach complexity and realize their goals. We will continue to innovate and develop new capabilities and services to further enhance the value we bring to our customers. On the operations front, we continue to streamline our operations and infrastructure. While the journey to standardize and drive waste from our processes will take time, the good news is that we are already making steady progress as you can see in our results. Rony Kordahi, our new EVP of Supply Chain and Operations, will lead this agenda, and as I have said in the past we will drive new levels of efficiency with every move we make. As for the third element, enhancing the execution of our current growth strategies, our international and CPS segments continue to make progress. Our CPS team has signed a significant new customer that is scheduled for on boarding this summer. Under this five year agreement the CPS team will provide custom procedure trays to 45 hospitals across 20 states in the U.S. We look forward to serving this new customer and of this exciting opportunity. As for the international segment, we continue to build on our trend of profitability and strengthen our commercial pipeline, and we are in strategic discussions with a number of important new customers. Randy will brief you on the international segment in a few minutes. As for the final element, developing future strategies for long term success, throughout the first half of this year we have invested meaningful time and energy into our strategic planning process. At this point our Management Team and Board are aligned and enthusiastic about our new strategy for sustained profitable growth. We are now moving into the execution planning phase, and we intend to share more detail about our new strategy at Investor Day later this year. In summary, we have made meaningful progress on our transformation agenda. We met or exceeded our expectations in the first half of this year. We have aligned with our Board on a strategy that positions Owens & Minor for the future, and, while we operate in a competitive market, our unique position in the industry allows us to offer a compelling value proposition for both manufacturers and providers. We remain committed to accomplishing the goals we set for 2016. And looking ahead, we see substantial ways to expand and grow our service offerings. In short, we like where we are, and we like what we are, a global healthcare services company. Thank you. Now Randy will review our financial results. Randy?

Thank you, Cody, and good morning, everyone. I will begin today with an update on our consolidated results for the second quarter and the year-to-date. And then I will conclude with additional insight into the three segments. Adjustments made to our reported results and reconciliations to GAAP are outlined in our press release. As Cody said, we are pleased that we achieved adjusted diluted EPS of $0.52 for the second quarter, a reflection of our progress in becoming a leaner more efficient organization. For the year to date period we achieved adjusted EPS of $1.02, placing us in solid footing as we head into the second half of the year. Across our global enterprise our teams are performing well. Consolidated revenues for the second quarter increased 2.5% to $2.48 billion when compared to last year. On a year to date basis consolidated revenues improved 2.6% to 4.94 billion. Revenue improvement in both periods resulted from strong domestic performance and from one extra selling day in the first quarter when compared to last year. On a same day basis revenues improved 1.8% for the year to date period. Adjusted consolidated operating earnings for the quarter improved 5.2 million to 58.8 million resulting from solid performance across all three segments. On a year to date basis adjusted consolidated operating earnings increased 9.8 million to 114.3 million. For the year to date period the adjusted effective tax rate was 37% compared to 37.7% for the same period last year. Asset management metrics continue to be solid including DSO of 21.5 days and inventory turns of 9.3 times. Operating cash flow for the first six months was 42.6 million compared to 247 million last year. This difference was primarily driven by changes in working capital including the timing of accounts payable which we have previously mentioned. Turning to a discussion of the three segments. Domestic segment revenues for the quarter increased 2.9% to 2.35 billion. For the year to date period revenues improved 3% to 4.67 billion. In both periods revenue growth came primarily from our large provider customers as well as from one additional selling day in the first quarter. For the quarter domestic segment operating earnings were 43.5 million, improved 13% over last year. For the first six months of the year domestic segment operating earnings improved 11% to 85.2 million. The improvement in both periods resulted primarily from revenue growth and expense control initiatives partially offset by a lower level of income from manufacturer product price changes. As for the international segment quarterly international segment revenues decreased 4.6% to 88.6 million. For the year to date period international segment revenues declined 8.6% to 172 million. Excluding the previously discussed exit of a UK customer last year and the negative impact of foreign currency, quarterly revenues improved 1.5% while year to date revenues declined 1.5%. Due to improved performance in the UK and profitable results across the network, the international segment had operating earnings of nearly 900,000 for the second quarter, down slightly in comparison to 2015. As for the year to date period operating earnings improved 1.2 million to 2 million. The international team continues to deliver positive results, and they are to be commended for their performance so far this year. As Cody indicated, we signed an agreement with a global manufacturer where we will provide services in the U.S. and Europe, and we have several new manufacturers on boarding in the coming months. In addition, we have signed an agreement that expands our vaccine delivery services to include every region of the UK. Finally, we have opened a new state of the art facility in Belgium to accommodate growing opportunities in this region. As for the CPS segment, revenues for the second quarter were 135 million, a decline of less than 1% when compared to last year. For the year to date period, revenues were 276 million, an improvement of 4.1% reflecting improved alignment with the domestic segment sales efforts. Operating earnings for the CPS were 14.3 million for the quarter and 27.5 million year to date, reflecting improvement in each period when compared to the prior year. As Cody indicated, during the quarter the CPS signed a government customer where we will service 45 hospitals across 20 states. We are excited about this opportunity and the traction we are seeing throughout our cave business. Moving on I did want to take a moment to update you on a large domestic customer that is transitioning out of our network. Since our last call we have had numerous discussions with the customer regarding their transition. More recently they have notified us that they intend to exit our service a couple of months earlier than initially estimated and that, that transition has already begun. Despite this early exit, we believe our strong first half performance and the growth initiatives that we have underway will offset the impact of this accelerated transition. We are confident that we can manage through this change in our customer base and remain focused on delivering our 2016 goals. While this will represent a headwind in 2017, we are taking the necessary steps to adjust our team resources and facilities to efficiently serve our valued customers. At this point, we are hitting our goals and executing at a high level. Accordingly, we are affirming our 2016 financial outlook of adjusted earnings per share in the range of $2 to $2.05. Moving forward, we remain focused on growing our business and positioning our Company for sustained profitable growth. We will align ourselves with partners who understand our value proposition, and even with ongoing pricing and margin pressures, we are well positioned to provide real value to the market. Our strategy is to provide innovative services that remove complexity, waste and expense from the supply chain for both providers and manufacturers. Thank you, and with that we will turn it over to the operator for questions.

Thank you. [Operator Instructions] The first question will come from Robert Willoughby of Credit Suisse. Your line is open.

Randy can you reiterate what the cash flow targets for the year would be, and is there any impact whatsoever of some of new business that you had mentioned here that you have signed? Is there any type of associated working capital built you would expect to see as those deals ramp up?

Hey, Bob. Thanks for the question. From the latter part of that question I would not expect any of the on boarding to give us any working capital increases or anything like that. Certainly with the transition out of some of our larger customers we can manage that pretty handily with our existing levels of working capital. Would you restate your first question again?

What is a cash flow target for the year?

We haven't really provided any targets for cash flow or EBITDA, but I'm sure you remember as you look back on average over the last three or four years we end up generally in that $150 million to $200 million range. So, I think that continues to be a reasonable target for us.

What is the driver in the second half then? You're kind of off that target.

Again, if you look back over the last three or four years we have had some fluctuation in the timing of our cash flow. As we indicated this quarter, we had a pretty significant swing as a result of working capital issues at the end of 2014 that had a pretty significant impact in the first quarter of 2015. We can see ourselves all three of our businesses continuing to perform. Some of our inventory levels coming down as we move throughout the year. I expect we will continue to be in that range as we move forward.

If I could to a quick follow up there I see the CapEx is lower particularly overseas. I am curious to know what you have done over there anecdotally that drops that cash flow number or CapEx number meaningfully. And then maybe Cody more broadly for you with share repurchases with some of the deals you have seen, is there any change in philosophy whatsoever in terms of that dividend here and boosting that as you have done over the last few years?

I will handle the international. I think we have made significant transition in the international business over the last two or three years. So, we are really focused on growing the business now, so we like the platform that we have. We have indicated there is going to be some incremental investment moving forward to accommodate growth and continue to tie the network together in a [indiscernible] European fashion. But again I think a lot of the heavy lifting over there has been done. And as we look ahead, I think there will be certainly any capital expense will be more tied to growth initiative than just a repositioning of the business itself. I think there's more comparison in the transition.

Bob, I will just answer on the second part of that question. We're going to continue to have a balanced approach to returning capital for shareholders. Obviously the dividend is important to us and to our shareholders and we've got a 10d51 plan on share repurchase. So I don't see any significant changes in that.

Thank you. The next question comes from Sean Dodge of Jefferies. Your line is open.

Good morning. Cody, you mentioned continued progress on your initiatives to streamline the domestic business. If we look at the realignments you have made it seems like the conclusion the voluntary separation plan, can you put some book ends around the run rate cost you have taken out of the domestic business so far?

Let me speak to the long term, Sean. First I see a lot of opportunity to improve our operation. That is a feature of our strategy and leaning out our operations, and you see in my remarks I commented everything we are going to look for greater and greater efficiency. So we're putting those bookends on our strategy right now but we are looking at three to five years on where should our operations be. I don't want to put a number on that yet, but we will be detailing that after you in the near term here. It will be significant.

Okay. And then you also mentioned the signing of a 3PL client. It sounds like it's got a big international component, certainly encouraging to hear. Can you speak a little bit more to your Outlook internationally maybe some thought on the sales pipeline going forward or prospects?

Let me comment and then I will let Randy jump in on that. Yes we did sign a major new customer, and we don't really like to use the use the word 3PL, because we think we are different than a 3PL. We are healthcare only and were scaling up healthcare services. And what I see us doing over time is bringing our domestic operations and our international operations together into a very compelling value proposition for clinically relevant manufacturers and Biopharma companies. I will let Randy, specifically.

Again, we are excited about the opportunity to work with this global customer and on boarding both in the U.S. and our international franchise. And as Cody indicated over the last three years we have really moved away from the traditional 3PL activity much more Healthcare Services oriented designed predominantly to help more clinically relevant products as we go and help our customers go to market. And we have seen a tremendous amount of activity over the first six months of this year from large pharmaceutical and biopharmaceutical medical device and diagnostics companies. As we indicated, we have added the rest of the UK in terms of our vaccine business, in terms of aligning and leveraging some of our specialty services and cold chain so we see a return to growth is we're coming back into the second half of the year. When you exclude as we indicated the impact of a significant transition of a customer from UK last year and some of the FX, we did see growth in order and I think this is the beginning and next quarter you will see a comparisons that we have been talking about, so you will have a little bit more straightforward visibility. We do expect a return to growth in the second half of the year.

Just as a quick reminder, is it July that the UK client exited, so we will begin lapping that?

Yes.

Okay. Great. Thanks again and congratulation on the new win.

Thank you. The next question comes from Robert Jones of Goldman Sachs. Your line is open.

Thanks for the questions. I guess a follow up on the recent win the global manufacturer that you mentioned. It sounds like your position is something a little bit different unique a new solution relative to what you might have done in the past with global manufacturers. Could you maybe just get a little bit more on how this is actually different from a traditional agreement maybe from a service perspective but also from a financial perspective?

Let me comment first on what's driving this a why we're excited about the opportunity. As I mentioned in my comments, the declining reimbursements are putting pressure on the healthcare system in general. We see that pressure working its way up through the manufacturers, and what that's causing for us is a lot more strategic discussions with clinically relevant manufacturers about how to streamline our costs and go to market a different ways. Everybody is challenging traditional paradigms as to how to take cost out but also reached the point of care in the most efficient streamlined way. So that is what is creating the opportunity for us. The difference and reason we don't want to be like every other 3PL company we want to focus on what we bring to the table. We occupy a unique position smack dab in the middle of clinically relevant manufacturers all the way to the point of care. When you think about 3PL there's traditional developing and pick, pack and ship operations. We think we can create more service and solutions to take those products all the way to the point of care and connect the manufacturer with meaningful data and information. So we're just at the beginning stages of that, but that's what I'm referencing when I say it's different than 3PL.

Okay, got it. And then one follow up. If I look at the guidance it does obviously suggest that EBITDA margins will be down fairly significantly in the back. Could you maybe help us quantify some of the headwinds you outlined. I know one was around manufacturer pricing looks like it slipped from a tailwind to a headwind, and I know you guys highlighted the large domestic client that will be transitioning a little bit earlier the next year. Could you maybe just help us think about some quantification around those or other headwinds?

Sure. The vast majority is really focused on our large customer that is transitioning out. We highlighted this in the first quarter as we talked about it at that point we were not quite sure of the specific timing. As we indicated that transition has started a few months prior to what we anticipated. But we have initiated a variety of strategies to begin to mitigate a lot of that. Any loss of a large customer I think it's going to have direct impact on your gross margins and some of your operating margins in the meantime. I think that is the vast majority of the impact. The other thing we have alluded to is there continues to be a fair amount of margin pressure in our domestic business, so I think that overall is where we're going to get too as we move ahead in 2016 and 2017. So, they competitive environment that we alluded to really is just that. But again for 2016 and the second half of the year, that majority is really related to the transition of that large customer.

Thank you. [Operator Instructions] The next question will come from David Larsen of Leerink Partners. Your line is open.

Hi. I think I heard a couple of new customer wins mentioned in the prepared remarks. Did you talk can you talk a bit more about the large hospital chain that you won? I think you said was a large hospital IDN with maybe 40 facilities across 20 states. Could you talk about what exactly you sold to them and the process that you went through to win that business?

I think that probably is a little bit of a misunderstanding. The large customer we were talking about was the global customer that was across 20 countries outside the United States and what we're doing. But we have went on and retained a couple of larger customers as well. As we don't comment on specific customers and whatnot that we have won. We just want to let everyone know that we remain very competitive in the marketplace. We continue to retain the vast majority of our customers and we are winning new business as well. The other customer we alluded to over is in our CPS business. We won a significant new contract with a governmental customer that will see us supporting about 20 states over here as well.

And David I think the second part of your question is to comment on why we're winning that. What I am seeing is I talked to customers with the pressure from the declining reimbursements. We our value proposition can be very transparent and attack system wide complexity for customers with these large systems. one what madeo is a minor grade, and that is what we are we committed to. So when we go when and value chain map their systems we're going after very significant and sustained improvement in their operations, and that's what's winning the day, and that is why we have won several new agreements with those.

Okay. For that government customer, it's across 25 states. Are there 45 hospitals? Did I hear that correctly?

Yes.

Yes.

Okay. Is that a clinical and procedural solutions win or is it the core distribution win?

It was a CPS win, CPT kits.

Okay. Kits and so forth. Okay. There is a large manufacturer where you sell products through Europe. There is also this government customer and then there were some other wins. Great. In terms of renewals for the rest of the year, are you largely through most of your larger client renewals, or are there more of those to occur?

There is still more occurring, but I would say we have gotten through most of the large one at this point. But there's that list is ever changing. It's a dynamic list. I would say at least for this year most of the big ones we have gotten through. We have held our own aside from the nature client on the West Coast that we have alluded to, we've held our own.

Thank you. The next question comes from Eric Coldwell of Robert W. Baird. Your line is open.

Thanks very much and good morning. On the new clients I know that you do not like to name clients but for rare circumstances, but could you possibly quantify the net new business and or the timing of when it would onboard?

Hi, Eric I appreciate the comment. As the retention rate goes excluding again our the big customer that we talked about, our net retention has been on a global basement global basis has been pretty much a push this year. When you look at when they are on boarding and off boarding that is typically as a forward looking six to nine months out as these things renew. So, we won a couple of new customers. We've retained a number of big customers. We have seen some turnover in some other customers. But on par again excluding that large customer out on the West Coast, we are doing pretty well.

I'm sure you've heard some of the intrigue that has been out there about some major accounts have been speculated as being at risk for departure. I would like to know how you respond. There has been some print articles out there naming specific accounts, and I think it's got everybody on pins and needles, so I would love to hear your general thoughts or observations about that.

We are well aware of those reports. Somebody has done quite a bit of investigation. Again, we just don't comment on specific customer names. I kind of wish they'd go out and find those names as well, but as Randy said, obviously any time you have a big loss and the one we've alluded to on the West Coast, that is significant for us. And we have said that will be a headwind for us in 2017. But net of that as Randy said, we are about at a push. And I am encouraged by that because we are strengthening our value proposition, and as I go out and talk to customers, they value this transparent approach and the way we're attacking system wide complexity for them. We are a little bit different and that because they are services company went on the product based companies, so that value proposition is starting to resonate. So, I know you want specific names and specific numbers but it is just too hard. A, we do not do the names and the numbers are too hard because the timing these are all dynamic situation so it is very hard to tag exact timing for those revenues.

I will say just to add some incremental color to that we have seen a little bit more turnover in the market and people more willing to change this year than in past years. But with that, we have had our fair share of wins, too. So, we have seen some turnover and also picked up a number of new customers and that is why we're comfortable from a net basis excluding our West Coast customer. We are kind of at a push right now. We see the opportunities and continue to be positioned pretty well.

That's fair. If I could be allowed a couple more quick ones. On the West Coast client, the earlier transition is that expected to be fully transitioned during the third quarter here? Does this kind of come and go pretty quickly, or does it spread out over a number of months?

I would say in that situation that was a 15 year relationship very complex interwoven processes so it's not they have started to transition. I doubt that it would be completed in the third quarter. It is going to take some time, and again it is a dynamic situation. So it is hard to put it as an exact timing on that.

Fair enough. And then quickly the CPS contract when given that to be fair this is the first time most of us if not all of us have had this kind of a business as a specific reporting segment, and you just broke out this segment more granularly a couple of quarters ago. Help us size what does it mean to win an account of the size that you are talking about? I guess it gets back to the old is it bigger than a breadbasket smaller than a Volkswagen kind of conversation, but maybe you can put some framework around this so we can have better cents on what this kind of account would mean in the scheme of all of your other CPS business?

First, it's a great question. The when you look at our year to date revolves on the consolidated numbers we do breakout this segment, and you can get a sense of the scale of the volume that we are doing. As you recall from back in the medical action date there three segments to the business this CPT side, there's the minor kits and trays which are again predominantly starter kits, and there's a small proprietary products area as you go forward. So, when we win a major contract, and this as we've been integrating this business over the last year I think this is what we have been targeting as we've fully aligned the domestic business and the CPT sales force towards winning some of these larger contracts. It is a challenge to ramp up and to do it, but I think both of the businesses that we have here in terms of the markets and trades and the CPC side are well prepared to handle the inflow of some of these orders, and we are going to manage through that towards the end of the year. As Cody alluded to in his remarks we see tremendous opportunity for growth in this area, and I think as we continue to put some good wins on the books it is just going to demonstrate our capability here to our customers.

And, Eric, I'd just comment in my remarks I mentioned Jay Glasscock joined our team so we formed a global business unit now. We have the global business leader is in place, and this win was just one proof point that it is starting to work. So, our expectations are this business is going to scale over time and this was a nice win for us in 2016 to start that process.

What kind of concentration do you have in that business? What would your biggest client be as a percent of that segment's annual revenue?

We'll have much concentration. It is a fairly diverse business. Most of the contracts are fairly modest when you look. This would clearly would be our largest contract out there. But again, it is relatively diversified given the number of locations we will be shipping too.

Thank you. [Operator Instructions] There are no further questions in the queue at this time. I would like to turn the call back over to Mr Phipps for closing remarks.

Thank you for joining us on the call today and for your questions. We remain committed to accomplishing the goals we have set for 2016, and we look forward to sharing our progress with you on our third quarter call. Thank you.

Thank you for your participation in today's conference. This concludes the call. You may now disconnect. Good day.