Owens & Minor, Inc.

Good day, and thank you for standing by. Welcome to the Owens & Miner Second Quarter 2022 Financial Results Conference Call. At this time, all participants are on the listen-only mode. After the speaker presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star 1-1 on your telephone. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, to Alex Jost, Director, Investor Relations.

Please go ahead. Thank you.

Hello, everyone, and welcome to the Owens & Miners second quarter 2022 earnings call. Our comments on the call will be focused on the financial results for the second quarter of 2022, as well as our outlook for 2022, both 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. The matters addressed in these statements are subject to risks and uncertainties, which could cause actual results to differ materially from those projected or implied here today. Please refer to our SEC filings for a full description of these risks and uncertainties, including the risk factors section of our annual report on Form 10-K and quarterly reports on Form 10-Q. In our discussion today, we will reference certain non-GAAP financial measures and information about these measures. and reconciliations to the most comparable GAAP financial measures are included in our press release. Today, I'm joined by Ed Visica, our President and CEO, and Andy Long, our Executive Vice President and CFO. I will now turn the call over to Ed.

Thank you, Alex. Good morning, everyone, and thank you for joining us on the call today. Today in my prepared remarks, I will cover our second quarter performance, the current market landscape, and why I remain bullish on the long-term prospects for the company. First, I am extremely pleased with our second quarter results. Our strong performance and our ability to manage through the macroeconomic headwinds in this quarter is a result of the following. One, our Owens & Miner business system of continuous improvement, driven by our dedicated teammates that continue to deliver operating efficiencies, eliminate waste, and provide productivity improvements. Two, our unique and differentiated business model with vertical integration that limits our exposure to certain macroeconomic conditions impacting others. And three, our increased presence in the patient direct space, supporting patients with chronic lifelong conditions. While the external conditions have become even more challenging over the second quarter, it is clearly visible that once again, our team performed very well. We were able to report strong results with both of our businesses continuing to operate at a high level. We remain focused on providing value for our customers and service at the highest possible levels, both of which are central to our mission and are demonstrated every day as we have woven the Owens & Miner business system into the fabric of the company. Over the second quarter, our approach to provide value and service continued to pay off. Our customers value the consistency with which we provide industry-leading service, especially given the degree of unpredictability that healthcare has faced over the past two years. This was proven once again in the second quarter, as our products and healthcare services segment continue to take share by adding high-quality wins as we work to optimize our customer base. This means we are not interested in growth for growth's sake, but are intently focused on profitable growth with reasonable returns. This will be a key benefit from putting together the medical distribution and our products businesses. We continue to get smarter about how we go to markets, our product portfolio, and what makes the most sense for our customers and the company. When combined with our embedded business system, we can begin to drive towards much more efficient and more profitable business segments. Now turning towards the higher margin, higher recurring revenue patient direct segments. Our Byram business continued to outpace the market with 17% organic revenue growth year over year. On a pro forma basis, our patient direct segment grew 10%. With Apria revenue growth in the mid single digits, which is particularly impressive in consideration of the supply constraints related to sleep apnea products. We are also pleased to be off to a successful start of the accurate integration and synergy achievement. As we look to the remainder of the year, we expect Q4 to benefit from the acceleration of integration and synergies, as well as increased patient growth from the receipt and deployment of incremental sleep products from our suppliers. that will fill existing orders and reduce our backlog. Now, looking at Q2 from a high level, many things played out as planned and discussed in previous quarters, such as our ability to navigate the expected environment, the reduction of PPE demand, and the absence of the glove cost benefits. However, as the quarter progressed, we also experienced acceleration of macroeconomic issues and new industry-specific headwinds. The macroeconomic headwind acceleration included increased inflation, higher interest rates, and a stronger U.S. dollar. The new and accelerated industry-specific issues including staffing constraints and product shortages, such as critical diagnostic products due to global supply chain issues. These constraints have resulted in lower procedure volume, and we expect these constraints to continue through the year. Procedure volume is down sequentially from Q1, and our customers experience the downward trend that progressed throughout the quarter, resulting in volume that is meaningfully lower than pre-pandemic levels. In my conversations with current and prospective customer, the main reason for this is due to the factors I mentioned a moment ago. These are driving the low procedure volume and overall reduced hospital demand. And as a result, our financial outlook for the year has been adjusted. Before turning it over to Andy to take you through the specifics of the quarter and our new outlook, I would like to emphasize the following points. One, we continue to deploy the Owens & Miner business system to drive productivity and reduce costs as we work to minimize the impact of the accelerating macroeconomic headwinds. In our view, these macroeconomic headwinds will eventually ease. However, the improvements that we make with our own minor business system will remain and provide value long into the future. Next, overall, healthcare is resilient, and hospital procedure volumes will normalize as industry-specific headwinds ease, and the existing unserved demand flows through the system. We are excited about the opportunity as we will be ready to capture this volume with our existing customers and new customer wins. And finally, our patient direct business is consistent and strong, driving recurring revenue as it focuses on serving patients with chronic lifelong conditions who need their products regardless of the macroeconomic conditions. As I reflect on the past three years, We have repositioned the company for success and long-term profitable growth. We have done this by deploying the Owens & Miner business system to help drive continuous improvement, productivity, and improved service. Strengthening our organization with leadership and strategy focused on our unique value chain. Consistently executing during a challenging and unpredictable time. Regaining share and delivering meaningful, high-quality customer wins in our product and healthcare services segment. And finally, diversifying our revenue and EBITDA base through above-market growth in Byram and the acquisition of Apria, while strategically positioning our patient direct segment to capitalize on the shifting preference towards home care. Simply put, we continue to demonstrate the effectiveness of our long-term strategy and operational excellence, and business blueprints. I am confident in our ability to successfully manage through these challenges over time. With that, I will turn the call over to Andy for a discussion of our financial results. Andy? Thank you, Ed, and good morning, everyone. Today I'll review our financial results and key drivers for our performance in the second quarter and then discuss our revised expectations and assumptions related to our full-year outlook. First, let me start with our second quarter results. Our reported revenue in the quarter was $2.5 billion, up slightly from the prior year. Gross margin of $533 million, or 21.3% of revenue, was up 520 basis points from prior year. The growth reflected the first full quarter contribution from AFRIA sales, which have a higher margin profile. Foreign currency translation had an unfavorable impact on gross margin of $6.9 million, or 28 basis points for the quarter. Distribution, selling, and administrative expense was $453 million, driven higher primarily from the addition of AFRI expenses and ongoing inflationary pressures, partially offset by stringent cost control and operating efficiencies. Interest expense was $36 million in the quarter, which was $24 million higher than the prior year, given that this was the first full quarter of higher debt related to the financing of the AFRI acquisition. Given the rising rate environment, we took action in early April by entering into an interest rate swap. This increased our proportion of fixed rate debt to approximately two-thirds of our overall borrowings. The effective tax rate this quarter was 25.6%, compared to 21.8% in last year's second quarter. The change in rates resulted primarily from the non-deductibility of certain acquisition-related expenses. Our GAAP net income for the quarter was $29 million, or 37 cents a share. Adjusted net income in the second quarter was $58 million, compared to 80 million last year. Current quarter adjusted EPS was 76 cents, compared to $1.06 in Q2 of last year. However, you need to consider the impact that foreign currency had on our second quarter results. The strengthening of the U.S. dollar in the quarter had an unfavorable impact on foreign currency translation, reducing adjusted EPS in the second quarter by 5 cents and an 8-cent reduction on a year-to-date basis. The second quarter adjusted EBITDA was $156 million with a margin of 6.2%, up 110 basis points versus the prior year. FX had an unfavorable impact of $5 million. On a segment basis, products and healthcare services reported second quarter revenue of $1.93 billion versus $2.26 billion year-over-year. This was a result of lower glove cost pass-through of approximately $100 million and lower PPE volume, both as expected, along with lower procedure demand as a result of supply chain and labor shortages constraining capacity in the hospitals. Products and healthcare services operating income for the quarter was $61.2 million compared to $101.2 million last year. The decline versus prior year was the result of lower volumes, as I just discussed, along with accelerating inflationary pressures and the absence of glove cost benefit, partially offset by operating efficiencies generated by our continuous improvement business system. Finally, the year-over-year foreign currency impact on revenue was unfavorable by $13 million, and the FX impact on operating income was unfavorable $5 million versus Q2 of last year. Turning to the patient direct segment, our net revenue in the second quarter was $573 million, an increase of 145% year-over-year. Byram revenue grew organically by 17%, with strong double-digit growth across all major product categories. On a pro forma basis, Apria grew 4.4% despite the delayed customer starts from the Phillips Respironics recall and other supply chain constraints. Adjusted operating income for the quarter was $52 million compared to last year's second quarter of $14 million. Acquisition-related synergies from the onboarding of Apria continue to track to our expectations. Moving now to cash flow, the balance sheet, and capital structure. This quarter, we generated $90 million of cash from operations, bringing our year-to-date total to $170 million. Free cash flow, defined as adjusted EBITDA, less net capital expenditures, was $107 million in the quarter and $214 million year-to-date. We were able to reduce debt by $67 million in Q2 in addition to completing the final planned acquisition consideration payments of $108 million in the quarter. We're on track to reduce our net leverage ratio back to our target range of two to three times in the next 18 to 24 months. As I've mentioned in his remarks, we've updated our guidance for the year. We now expect net revenue to be in a range of $9.8 to $10.1 billion, adjusted EBITDA to be in the range of $570 to $610 million, and adjusted EPS in a range of $2.85 to $3.15. The key drivers of this revised outlook reflect the accelerating industry-specific and macroeconomic headwinds that we experienced in Q2, which have negatively impacted our view for the second half of the year. Higher interest rates and the stronger U.S. dollar alone are contributing approximately 10 cents of the reduction in the midpoint of our guidance. Both the short- and long-term expectations for AFRIA remain right on track, and we continue to expect AFRIA to add over $900 million of revenue and approximately $180 million of adjusted EBITDA for the partial year impact in 2022. We remain confident in our synergy expectations related to AFRIA and believe incremental annual revenue will be in the range of $80 to $100 million and incremental annual adjusted EBITDA in the range of $40 to $50 million within the next few years. Additional assumptions for 2022 guidance include a gross margin rate of approximately 20%, unchanged from prior quarter's guidance. Interest expense in the range of $130 to $135 million, reflecting the most recent assumptions related to rising interest rates. Capital expenditures of $185 to $195 million, up from our previous guidance due to improvements in APRI's ability to acquire growth-related patient equipment in the second half of the year. An effective tax rate of 24 to 26%, FX rates as of June 30, 2022, and fully diluted share count of $77 million, unchanged from Q1's guidance. And finally, it's important to note our projected earnings cadence in the second half of the year. Sequentially, we expect the third quarter earnings to be by far the lowest quarter of the year, with a significant rebound in Q4. In Q3, macroeconomic pressures and industry-specific headwinds are assumed to continue accelerating. Additionally, in Q3, we expect products and healthcare services new customer win implementation costs with the corresponding onboarding benefits beginning in Q4. Also, in Q4, we expect meaningful benefit from seasonality accentuated by the larger percentage of profits coming from our patient direct segment, improved access to equipment in our APRIA business, reducing our overall backlog of orders in our sleep product line, and greater realization of acquisition-related synergies. Please be aware that these key modeling assumptions have been summarized on supplemental slides filed with the SEC on Form 8K earlier today and are posted to the Investor Relations section of our website. In summary, the underlying business continues to execute well despite the overarching macroeconomic headwinds and industry-specific challenges that we're facing. Implementation of our Owens & Miner business system continues to gain momentum. as more and more teammates become trained in our structured approach to problem solving and continuous improvement methodologies. Our disciplined capital deployment has enabled us to remain focused on reducing debt while reinvesting in the business for long-term profitable growth. At this point, I'll turn the call back over to the operator to begin the Q&A session. Operator?

Thank you, sir. As a reminder, to ask a question, you will need to press star one one on your touchtone telephone.

Please stand by while we compile the Q&A roster.

And I show our first question comes from the line of Caliendo from UBS. Mr. Caliendo, your line is open.

Hi, thanks for taking my call, guys. I just want to, I guess I want to explore a little bit the comments around the APRIA business and CPAPs and the higher capex, and let's just talk through expectations there for that business and how they've changed a little bit. You're spending more now. You have more access to CPAPs. So when do you think the sort of bolus that might be out there of patients, do you see that coming through in your 4Q guidance, or is this just you have more access to CPAPs now than you thought you were going to have?

Yeah, I'll start and let Andy add some colors. So we really think that's going to really impact significantly the fourth quarter. The way we see it and we look at it is if you look at our back orders right now, we roughly have about three to four months of normal month's usage on back order right now. And as the suppliers and the manufacturers start to be able to produce more products and get it out to us, And we're going to be able to fill those orders, starting filling those orders at a higher rate probably later in the third quarter and then significantly in the fourth quarter. The other benefit of it is we have seen some additional product coming through right now. And the beauty of that is once those products come in, you then start to get that recurring revenue of the consumables. So that's also going to help us. You know, the products that are placed in Q3, that'll help drive that also in Q4. And then really think about the brightness of it going into 2023. And as we get that several-month back order filled, the recurring revenue going forward. And Kevin, if Andy, just the only thing I would add to that is another piece of good news that we received in the quarter is that the FDA did approve the Phillips remediation plan on ventilators. And so, you know, that kind of gives us confidence that, you know, we will have the equipment needed for ventilators. ventilation throughout the end of the year and what we need to support the fourth quarter. But it's also a cash flow issue too, right? So now that we can start returning the ventilators that we have on hand to get those refurbished and put back into the field, that's going to reduce our cash flow. We're not going to be spending as much on ventilators because of what we have already getting refurbished. We may not have patient-related capex on ventilators until early 2024. So it'll be a cash flow benefit.

Got it. If I can ask a quick follow-up, I just want to make sure I understand the guidance change. It looks, if we're doing our math right, that the vast majority of the change is both FX and higher interest rates. Is that a fair way to characterize the reduction in guidance, just looking at the math around the FX impact and backing that up and the higher interest rates?

Yeah, Kevin and Andy, absolutely. So the way I think of the 30-cent reduction in the midpoint of our EPS guidance, you're absolutely right. You know, as I said in my prepared remarks, the combination of FX and higher interest rates will combine to contribute about 10 cents of that 30 cents. But the single largest driver will relate to lower procedural volumes. And you'll note that the midpoint of our revenue guidance came down about $150 million last that $150 million is 100% attributable to our products and healthcare services segment. And in terms of calendarization of that $150 million, I'd say some of that we saw in Q2, but the lion's share of that reduction is going to happen in Q3. And the margin impact from that, think of it, you know, because it's in the products and healthcare services segment, that there'll be about a 10% pull through contributing, you know, $15 million of bottom line profit or 15 cents of EPS, And that 10% pull-through, think of it as we're not going to get really aggressive in taking variable costs out because we see this shortfall as being very temporary in nature. We're not going to be pulling out variable costs just to only have to put them right back in in the fourth quarter. That's really not a smart move. So we're not going to get aggressive on cost-cutting and hence the pull-through on that. And that leaves about $0.05 for net inflation. And I stress the net because, again, it's the impact of inflation. You know, you've seen the CPI continue to climb as we've moved throughout the year. So it's that inflationary pressures net of what we're going to be able to do to offset that. So that's going to be hitting us in the third quarter pretty hard. And our remediation, you know, steps that we take to mitigate that through our business system will take a little bit longer to gain traction, and we'll see the impact of that benefit in Q4. Great.

Thank you so much for all the color, guys.

Thank you.

And I show a next question comes from the line of Daniel Grosslight from Citi. Mr. Grosslight, your line is open.

Hi, thanks for taking my question. Excuse me, my questions. I was wondering if you could put a finer point on some of the product availability challenges in the acute care setting. I get the labor shortages that's been widely reported on, but I'm a little concerned more surprised on the product shortages. And I think in your prepared remarks, you mentioned it was really kind of the diagnostics side of things. So I was wondering if you can go into a little more detail about the shortages you're seeing there, what's causing those shortages, and what's going to alleviate some of those pressures on the product side. Yeah, so, Dan, yeah, the product side, it really...

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