Omnicell, Inc. (OMCL) Q3 2018 Earnings Report, Transcript and Summary

Good afternoon. My name is Jason, and I will be your conference operator today. At this time, I would like to welcome everyone to the Omnicell Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the call over to our host, Mr. Peter Kuipers, Chief Financial Officer. Sir, you may begin your conference.

Thank you. Good afternoon, and welcome to the Omnicell third quarter 2018 results conference call. Joining me today is Randall Lipps, Omnicell Founder, Chairman, President, and CEO. This call will include forward-looking statements subject to risks, uncertainties, and other factors that could cause actual results to differ materially from those expressed or implied. For a more detailed description of the risks that impact these forward-looking statements, please refer to the information in our press release today, in the Omnicell annual report on Form 10-K filed with the SEC on February 27, 2018, and in other more recent reports filed with the SEC. Please be aware that you should not place undue reliance on any forward-looking statements made today. The date of this conference call is October 25, 2018, and all forward-looking statements made on this call are made based on the beliefs of Omnicell as of this date only. Future events or simply the passage of time may cause these beliefs to change. Finally, this conference call is the property of Omnicell, Inc. and any taping, audio duplication or rebroadcast without the expressed written consent of Omnicell is prohibited. Randall will first provide an update on our business, then I will cover our results for the third quarter of 2018, and our guidance for the year. Our third quarter financial results are included in our earnings announcement which was released earlier today, and is posted in the Investor Relations section of our Web site at omnicell.com. Our prepared remarks will also be posted in the same section. Let me now turn over the call to Randall.

Good afternoon, everyone. Our third quarter results reaffirm Omnicell's vision and position as the number one medication management platform that is enabling our customers to stay ahead in a dynamic healthcare environment. The business continued to scale and again further momentum in several areas. First, I'd like to give a brief update on our financial results, followed by an update on our three strategic growth strategies. The third quarter represents a record for Omnicell and strong momentum in many areas. The third quarter of 2018 is our first quarter to exceed $200 million in revenue. The third quarter non-GAAP EPS of $0.63 per share represents a company record, and gross margins are again in the 50% plus range, demonstrating the strength and scalability of our business model. The third quarter had a record number of multimillion dollar commercial agreements, with 90% plus of these deals being platform deals. And third quarter had very good momentum in bookings, and a healthy increase in product backlog, including a strong increase in the product bookings gross margin. Now, we believe that the following trends increase the strategic importance of medication management automation. First, healthcare systems continue to consolidate both horizontally and vertically, thereby driving the need for medication management automation solutions to be on one platform to improve patient and financial outcomes for both inpatient and outpatient. Secondly, spending is the fastest-growing expense category in healthcare. Pharmacy spend is the fastest-growing expense category in healthcare, and as healthcare organizations increasingly manage total cost of care, medication management across the care continuum elevates its strategic importance. Lastly, the formation of nontraditional healthcare entrants will drive the need for increased integrated medication management automation. We believe that our industry-leading medication management platform across the continuum of care very strongly aligns with these healthcare trends. Now, in the last number of years we have successfully grown the business by executing three scalable growth strategies. Under our first strategic growth pillar of the differentiated platform, we're excited about our advancements in innovation as we continue to build and expand our industry-leading medication management platform with the goal of achieving the fully digitized and automated pharmacy. In December, last year, we announced the XR2 Automated Central Pharmacy System, and the IVX Workflow. During the third quarter of 2018, we signed several new commercial agreements for both the XR2 and the IVX Workflow products, and we continue to see a healthy build in the commercial pipeline. As we communicated before, the revenue contribution in 2018 from the XR2 and the IVX Workflow products is modest given the timing of the flow, from bookings to backlog, and eventually the revenue. The Omnicell XT Series also continues to be well received and accepted by customers. Throughout 2018 and future years we expect to see continued growth in the pipeline, bookings, and live XT frames. The differentiated platform has also demonstrated to be a driver of momentum in customer acquisitions and success in the market. It is clear we are winning in the marketplace. Increasingly we are seeing the market power of the Omnicell platform providing strategic value to our customers. We believe that there are no comparable competitive medication management platform offerings. The third quarter has a record number of multimillion dollar commercial agreements, over 90% of which multimillion dollar bookings are with customers adopting multiple products on the Omnicell platform. This is up from over 80% in the prior quarter. In the third quarter of 2018, our new and competitive conversions were 22% of total company bookings, over 80% with competitive conversions, and the remainder were from greenfield customers who had never automated before. For the 12 months ending September 30th, 2018, our new and competitive conversion rate was 27%. In the third quarter of 2018 we continued to experience considerable wins, and we had added notable accounts to our customer base with a number of large competitive conversions during the quarter, we believe that we gained further market share, continuing the trend of market share gains that we have experienced for many years. We also signed long-term partnership deals with existing customers. Couple of the strategic wins this quarter, Augusta University Health, in Georgia has selected Omnicell's comprehensive industry-leading medication management platform to help enhance provider and patient outcomes. This renewed and expanded long-term partnership includes the XR2 Central Pharmacy robot, IV robotics in Central Pharmacy, and the XT Series Automated Dispensing Systems, as well as the performance in our cloud-based predictive intelligence platform and optimization services to improve business and patient outcomes. Dignity Health Bakersfield Memorial Hospital, in California, will be the first Dignity site to use our IV robotic technology for in-house sterile compounding, supporting enhanced patient safety and better financial and operational outcomes. Our second strategic pillar of expanding into new markets also was a significant growth driver in the last several years, which we believe sets us up for the future. Internationally, we are pleased to announce our first IV robotics deal and entrance into the South Korea market with multiple hospital locations. Our third strategic pillar of expanding our presence and relevance through acquisitions has also continued to deliver strategic results. We're seeing notable cross-selling momentum within in the total product platform and combined customer base, specifically for our Central Pharmacy Robotic solutions, including XR2 and IV and Performance Center solutions. In the third quarter, we strengthened the development of our cloud based solutions that we have in our portfolio with expansions of the Omnicell patient engagement platform. And initial commercial engagements with pairs and large retail pharmacies. The Omnicell patient engagement platform now consists of medication therapy management with pharmacist workflows for comprehensive medication reviews, targeted patient interventions, medication synchronization, and interactive voice response messaging on one single platform. Meanwhile, we are building the infrastructure base with now over 40,000 pharmacies worldwide in our customer base. We believe that our three strategic tillers created the foundation for our success, and continue to drive future growth and scaling of the business. Now, let me turn it back over to Peter for some more detail on the third quarter financial results. Peter?

Thank you, Randall. Our third quarter 2018 GAAP revenue of $204.3 million was up over 9% year-over-year. Our year-to-date 2018 GAAP revenue of $576 million was up 11.5% year-over-year. The third quarter earnings per share in accordance with GAAP is $0.33 per share up from $0.20 per share in the third quarter of 2017. Our year-to-date 2018 earnings per share in accordance with GAAP was $0.57 up from a loss of $0.02 per share in the first five months of 2017. .: We use non-GAAP financial statements in addition to GAAP financial statements, because we believe it is useful for investors to understand the amortization of acquisition related costs and non-cash stock compensation expense that are a component of our reported results as well as onetime events and onetime acquisition and restructuring related expenses. The full reconciliation of our GAAP to non-GAAP results is included in our third quarter earnings release and is posted on our website. The third quarter financial results were strong and demonstrate the strength and scalability of our business model. .: The non-GAAP EPS favorability was mostly driven by platform pricing strength and product mix and to a lesser extent a strong cost management and favorable tax expense. Year-to-date 2018 non-GAAP EPS was $1.38 per share and is up 60% compared to the first nine months of 2017. In addition to strong revenue and profitability growth, there are more indicators showing the momentum the business has. First, gross margins are again in the 50 plus range demonstrating leverage. Secondly, the third quarter had a record number of multimillion dollar commercial agreements, 90% plus of these deals being platform deals. Lastly, the third quarter had very good momentum in bookings, a healthy increase in the product backlog and a strong sequential increase in the product bookings gross margin. Our business is also reported in segments consisting of automation analytics and medication adherence. Automation analytics consist of our XT and OmniRx automated dispensing cabinets, anesthesia workstations, central pharmacy, Omnicell supply, Omnicell analytics performance center and MACH4 robotic dispensing systems. Our acquisitions of Avantech, MACH4, Aesynt and InPharmics are also included in this segment. The medication adherence segment consists of a broad platform of subscription software, medication packaging and equipment used by pharmacists to create adherence packages that assist retail pharmacies in helping patients stay adherent through their medication regimens. Our acquisitions of MTS Medication Technologies, SurgiChem and Ateb are included in the medication adherence segment. We report certain corporate expenses that cannot be easily applied to either segment separately. On a segment basis, our automation and analytics segment contributed $168 million in GAAP revenue in the third quarter of 2018, up from $155 million in the that quarter of 2017. GAAP operating income of $45 million in the third quarter of 2018 compared to $31 million of GAAP operating income in the same quarter last year. Non-GAAP operating income of $52 million for the third quarter of 2018 compared to $37 million of non-GAAP operating income in the same quarter last year. On a year-to-date basis, GAAP revenue for 2018 was $478 million, up from $425 million year-to-date in the prior year. GAAP operating income for 2018 year-to-date was $101 million compared to $56 million in the prior year. The medication adherence segment contributed $36 million in GAAP revenue in the second quarter of 2018, up from $32 million dollars in the third quarter of 2017. The GAAP operating loss of $3 million in the third quarter of 2018 compares to breakeven GAAP operating profit in the same quarter last year. Non-GAAP operating loss of $0.7 million for third quarter of 2018 compares to $2.5 million of non-GAAP operating income in the same quarter last year. The year-over-year variance of both GAAP and non-GAAP operating income was mostly driven by a onetime excess and obsolete reserve or slower moving inventory. On a year-to-date basis, GAAP revenue for 2018 was $97 million, up from $91 million in the prior year. And operating loss for the first nine months of 2018 was $5 million compared to $2 million in the prior year. Non-GAAP common expenses were $21 million in the third quarter of 2018, up from $19 million in the prior quarter. This increase is primarily driven by accruals for bookings incentives. Non-GAAP other income and expense for the third quarter was a net loss of approximately $2.3 million, primarily consisting of interest expense on the outstanding loan balance and the impact of foreign currency re-measurement. Let's now move to the balance sheet and cash flow. Third quarter 2018 cash flow from operations was $16 million, mostly driven by net income. Inventories at September 30, 2018 were $99 million, down $5 million from the prior quarter due to improvements in strategic stock levels for the XT series, the XR2 simple pharmacy robot and the IVX workflow products and then an increase in our excess and obsolete reserves. We now have three concurrent product introductions that we see ramping over the years. Bookings, then backlog and then conferred into revenue. Because of seasonable based sales outstanding for the third quarter with 93 days up seven days from the second quarter in 2018, the increase is mostly driven by timing of billing during the quarter. Based on our customer agreements we largely invoice upon shipments. Generally, shipments and related billings are in the last month of the quarter become revenue, in the following quarter after installation is completed. The month of September 2018 was a record billing month. At September 30, 2018, our cash balance was $44 million compared to $46 million at the end of June this year as of September 30, 2018 we had a $190 million of outstanding funded debt and our loan leverage measured is outstanding total funded loan balance over the last 12 months of bank EBITDA was approximately 1.6 down from 1.8 as of June this year. During the quarter we paid down $14.5 million on our loan and revolver facility. During the quarter we did not sell shares of common stock and they are at the market offering. Our headcount is 2,426 at September 30, 2018, up 79 from the beginning of the year. Let's now move to guidance. The guidance for the fourth quarter 2018 is as follows. We expect fourth quarter non-GAAP revenue to be between $211 million and $217 million. We expect the fourth quarter 2018 non-GAAP EPS to be between $0.64 and $0.69 per share. Our full-year 2018 guidance is now as follows. We are increasing the product bookings guidance range. We now expect 2018 product bookings to be between $645 million and $670 million. This is up from our previous guidance of $630 million to $665 million. This represents a 16% organic growth rate when taking the midpoint of the new guidance range. We're narrowing the 2018 non-GAAP revenue guidance. Our previous guidance range was $780 million to $800 million. We now expect 2018 non-GAAP revenue to be between $787 million and $793 million. This represents a greater than 10% organic growth rate when taking the midpoint of the new guidance range. As of January 1, 2018, we adopted ASC 606 revenue from contracts with customers. The largest impact of this adoption was the reclassification of GPO fees from operating expenses to reduction of net revenue of around $8 million annually. The net impact of the ASC 606 adoption on the timing of recognition of revenue is minimal in any given quarter in 2017. The net impact of the retroactive adoption was an increase of $0.04 in non-GAAP EPS in the third quarter of 2017. As discussed previously, our 2018 guidance includes the impact of adoption of ASC 606. We are raising the non-GAAP EPS guidance by increasing the bottom end of the previously provided guidance range of $1.90 to $2.05 per share and we now expect the total year 2018 non-GAAP EPS to be between $2 and $2.05 per share. This represents a 43% year-over-year organic growth rate when taken at mid point of the guidance range. When reviewing 2018 guidance, it's important to note a couple of items that are included. First, for 2018, our non-GAAP results include approximately $2 million of integration expenses for Aesynt and Ateb that we do not adjust for, based on our non-GAAP policy. These integration costs directly impacting non-GAAP operating margins and non-GAAP EPS, mostly consist of IT expenses for CRM, ERP and HR systems consolidations. Lastly, for 2018, we expect interest expense related to the senior secured credit facility to be around $7 million or equivalent to a non-GAAP EPS headwind of around $0.14 per share. Finally, for 2018, we are assuming an annual average tax rate, 21% to adjust GAAP tax expenses to non-GAAP tax expenses. This concludes our prepared remarks. And now, we would like to open the call to take your questions.

[Operator Instructions] And your first question comes from Mohan Naidu from Oppenheimer.

Thanks for taking my questions. Randy, on these platform deals, is this a trend you're seeing more from existing customers or new customers and I guess, what is jumpstarting this trend now?

Well, I think it definitely is from both sets of customers. I think what we see as these provider networks morph into investing as much money and time and energy into the outpatient, they need a comprehensive platform. And so, it becomes more of a strategic decision than just workflow solution set for one area of the hospital, or one area of the outpatient clinic. So, you want to really take a total solution set towards the customers to gather all the data, so that you -- because you're responsible for the patient no matter what environment they are in. So that's pretty good trend, and we think that will continue.

And I guess I'm presuming as part of this platform, XT is core part of it?

Yes, it's part of it, but it's really multiple products on the platform that are integrated.

Okay. All right. On XR2, have you guys implemented XR2 on any new customers already beyond the beta testing customers, and do you have any scheduled for Q4?

Yes, we have more implemented, we have more scheduled for every quarter going forward, and ramping up through 2019.

Okay, got it. Bookings so far appear -- with the new bookings guidance, which implies like 14% to 18% growth for the year, should we see an acceleration going into '19 on the revenue side, I mean, I guess beyond the 8% to 12% growth rate you talked about before?

Yes. Thanks for the question. We think the 8% to 12% longer term financial framework, organic growth in the top line still holds. We would say though although we don't disclose the number, we do see a healthy increase in the backlog, in the quarter that we actually exceeded, consensus in the midpoint of guidance. You should also take into account that of course with such product revenue, we have service revenue as well. So, while bookings growth year-over-year is an indication for a big chunk of products revenue. Our service revenue tends to grow at a lower growth rate, right. So, 8% to 12% holds for now, but it's definitely very positive momentum we see in the business, there are many aspects.

Got it, and one last question on the margin side, 15% operating margin target, I guess you are hitting that in this quarter. Should we think about a new updated target on the operating margin side?

Yes. So we think from a longer term perspective, the 15% target holds. You do see of course improvements in the profitability measure on non-GAAP operating margin basis every quarter this year, and that is true. Definitely leverage is up nicely. So we would expect -- we are not going to give specific guidance for 2019, of course we do that in the January call, but it's probably fair to say that you can expect modest improvements through the year, if you will, trend lines, right, through each year, bearing in mind that generally the first quarter of any given year seasonally, a lower revenue quarter for us than the prior quarter. So we will definitely see a trend line going up over time. But on the fourth quarter or the first quarter, that's probably going to be a step-down if you will, and then increase again through the year in 2019, but it should quarter performance, if you model it out, it could potentially be higher than this year.

Got it. Awesome. Thank you very much for taking my questions. Congratulations on a great quarter, again.

Yes, thank you.

[Operator Instructions] And your next question comes from the line Matt Hewitt from Craig-Hallum Capital.

Good afternoon, gentlemen. Congratulations on the improvements here in Q3. I just wanted to dig into the margins a little bit better or little bit more, specifically you saw product gross margin, you've had a nice step-up here in the last two quarters. Are you on track you think to get back to a similar level as you saw maybe a few years ago, or are you in the mid 50s, maybe even upper 50s, I'm not saying '19, but over the next three to five years, is that kind of the trajectory you are on?

Yes, I would say over time we definitely see again modest improvement almost similar to like the operating program levels, modest improvements over the quarters to come. We see an uptake over the next couple of years. We would point out that with the acquisition of Aesynt, three years ago we definitely had a mixed down on the gross margin level. It's always good to bear in mind that we have a different mix in the total base, but yes, we see modest improvements going forward.

Okay. And then shifting to the service gross margin, that's been a little bit more lumpy. Where does that stabilize or where does that kind of shake out over that same kind of three to five-year time period? Do you see that improving a little bit or is that purely a function of mix and implementation timelines and stuff like that?

Well, definitely mix, but there's probably also modestly improve as well over time here. Remember that we have a number of new product lines that are probably a little bit more service-intensive in the beginning, so we probably scale better over time there as well, but we will provide more guidance as we go along with it next year.

Okay. I think, Randy, you had mentioned that you're up to 40,000 pharmacies now on the platform. Where was that in Q2 or Q4 a year ago, I'm just trying to get a frame of reference?

Yes, so we had 32,000 retail pharmacy locations going into the quarter.

Okay, so a nice set up. Do you anticipate a similar type jump here in Q4, or was there some one-time items or one-time customer acquisitions here in the third quarter that allowed you to have that big step up?

We don't necessarily want to get into habit of forecasting, giving guidance on the number of customers. So, we track, of course, our customer base, and it's also in our company description, with our filings, so that has increased over the last months, over 40. But we're building infrastructure there, so think about it as a growing technology platform. Or as you noted maybe in the script as well, that we now also have initial commercial engagement with payers in the U.S., right, so that is a new customer base for us, and we definitely see growth going forward, so.

Okay, great. And maybe one last one from me, I think you mentioned that you're going to get back to the -- or you're implying 21% non-GAAP tax rate for the year. That implies a pretty substantial step up here in the fourth quarter. What impact could the timing of the tax payments here in the third quarter that would lead to that big jump in Q4? That's it for me. Thanks.

Yes. No, so just to clarify, the 21% effective tax rate is for the adjustments from GAAP results to non-GAAP results in the bridge. So the GAAP is actually different, and that fluctuates by quarter, if you will, based on permanent and discreet items.

Okay. All right, got it. Thank you.

Yes, okay.

Thanks, Matt.

And your next question comes from Gene Mannheimer of Dougherty & Company.

Hi, Gene.

Thanks. Hey, good afternoon. Congrats on the quarter. Let's see, I want to ask you with the rollout of Performance Center couple of years ago, and acquisitions like Ateb and some of the others, what percent of your business today would you say is software-centric versus five years ago. And similarly, how has your base of recurring revenue as a percent of total trended over the last few years?

Well, we're not necessarily going to break that out at this point. We can talk about the directions, if you will. So if you look at our products, of course, and we've talked about this before publicly as well. Most of our R&D investments actually are software-related investment. A lot of value prop from the platform actually comes from that software integration and the features and performance it delivers. So just from the nature and the reasons why the customers are investing in our products is software related. Now, we do have a pure software stream that we're considering potentially breaking out in the financial statements going forward, so we might do that starting next year. That definitely has a nice growth rate. But I would say the majority is software-based, albeit not pure software, right.

Okay, all right. No, very helpful. Thanks, Peter. And were there any notable M5000 sales or other med adherence packaging sales notable during the quarter?

None to specifically call out, I mean maybe it's good to remind -- a good reminder of the customer names that we actually mentioned in the earnings scrip is only a subsection. We do have many wins in the quarter, also with existing customers. So we don't disclose, of course, all our customer wins. But every quarter we have med adherence automation wins in bookings and also installations in revenue.

Right. So the Cleveland Clinic announcement from Q2, was that something that would've installed in Q3 or what can you share about that?

Yes, so that's a longer-term agreement. That one is running live. I think it actually was live at the end of the second quarter, yes.

Okay, all right. Great, thank you.

And your next question comes from the line of Mitra Ramgopal of Sidoti.

Yes, hi, good afternoon. Randy, I know you talked about the IV Robotics market in South Korea. And I was just wondering with robots settling down in March, if you can give us a sense for the strategy as you look to grow the business overseas, if there's going to be any changes or pretty much just to continue as is?

Yes, so if I understand you right, we've mentioned the IV initial sales in South Korea on the IV platform, and just kind of what our strategy is on IV as we go forward, particularly overseas. And I think that compounding is an issue worldwide. It's a pharmacy fraught with safety issues and dosing issues that require a lot of attention, and as well as exposure to toxic pharmacy drugs. So having a robotic solution set makes a lot of sense for a lot of reasons, and so each of these countries, outside of the U.S., have a little bit different viewpoint of it. But I think that we've been mainly focused on the U.S. and I think as we continue to develop products we will look at the solution set for pan Europe a little more intently and some of the other smaller markets, so great solution set to take to almost any first-world healthcare system.

Okay, thanks. And again, I know it's probably coming up to almost two years since the Ateb acquisition, I was just wondering your appetite on that front, and are there any areas in particular you might be interested in? And I know there's only so much you can say on that.

Well, I think the most important part is we made a big investment over the last two years to consolidated the platform to a single platform that allows all of the pharmacies in the network to access different solution sets that are medication therapy management, MTM it's sometimes called. So while you can get med synchronization you can also get comprehensive medication reviews, you can get access to IVR, some other pieces of the solution set that you need to run through an outpatient pharmacy directly. And so this simplifies the proposition to the pharmacy who doesn't want to have several systems to go to. To get these solution sets they can go to a single cloud vendor that's got very advanced, very interactive, easy-use systems, engage with patients that really allow them to be engaged over time, and make them very sticky and engage in the whole process, just not the dispensing of medications. So, we think it adds tremendous value to improving patient healthcare for everyone, and it particularly adds a lot of -- makes a lot of sense for retail pharmacies, but also outpatient pharmacies that are located in these large providers another natural win for them.

Okay, thanks. And then finally as you look at investments in terms -- clearly, you're brining on a lot of new products and a much bigger platform for your customers. As it relates to the sales force and in any investments there, et cetera, are you pretty much in good shape as it relates to not necessarily needing to hire or expand?

Yes, I think the sales force has evolved as our company has evolved. And so if you look at our go-to-market strategy, they're really around more the platform positioning and selling and sort of an ongoing relationship day-to-day with the customers, opposed to event-driven. And so that also means we have to change and retool our sales force with different types of either people or a retraining of them to get really connected to these really important large customers that we have in order to work with them over the next five to 10 years. To get the fully digital pharmacy it really takes a lot of work and influence to get there. So our whole mindset toward this has changed. And really I think that as consolidation has happened, it's allowed us to move our cost of sale around a little bit to match where customers are today, which is very large entities.

Okay. Thanks again for taking the questions.

Yes.

And there are no further questions in queue. I would now like to turn the call back over to Randall Lipps for closing remarks.

Well, I'm really proud of the first nine months of the year, and really represents a validation of both our strategy and the hard work that Omnicell team has been working on for several years to, not only create this platform, but to begin to deliver it in earnest. And as we see healthcare evolving and really providers really bearing more of the payer look, if you will, we know that medication management is strategic and to being able to win and improving healthcare for everybody. So I think that this evolution of both our customer and our platform is now meeting the market and resonating with them in a really positive manner. And I just see it over and over again as I touch these customers. And it's really a great shout-out to the Omnicell team who has spent really countless days and weekends and hours putting this platform together so that we can really solve the industry issues at large scale, with significant savings and significant improvements in patient safety around the medication use area, so thanks to all of them. And we'll see you next time. Thank you.

Ladies and gentlemen, this does conclude today's conference call. You may now disconnect. Thank you for your participation.