Owens & Minor, Inc. (NYSE:OMI) Q4 2022 Earnings Call Transcript February 28, 2023
Operator: Good morning. My name is Chris, and I’ll be your conference operator today. At this time, I’d like to welcome everyone to the Owens & Minor Fourth Quarter 2022 Financial Results 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. I will hand it over to Alex Jost, Director of Investor Relations. You may begin.
Alex Jost: Thank you. Hello and welcome to the Owens & Minor fourth quarter and full-year 2022 earnings call. Our comments on the call will be focused on the financial results for the fourth quarter and full-year of 2022, as well as our outlook for 2023, all included in today’s press release. The press release along with the 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.
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 Pesicka, President and Chief Executive Officer; and Alex Bruni, Executive Vice President and Chief Financial Officer. I will now turn the call over to Ed.
Ed Pesicka: Thank you. Good morning, everyone and thank you for joining us on the call this morning. I would like to begin the call with a quick recap of 2022. Our company celebrated its 140th anniversary of service to the healthcare community, while achieving our highest annual revenue in the company’s history at nearly $10 billion. In addition, we completed the largest acquisition in the company’s history acquiring Apria on March 29. This further strengthened our position as a leader in the fast-growing, higher margin home health care industry; enhancing our ability to support healthcare beyond the hospital and into the home. As a result of this acquisition, we have materially changed the profile of our overall business with the majority of our profit and EBITDA now coming from our Patient Direct segment even though this segment currently makes up less than 25% of total company revenue.
In addition, this segment provides recurring revenue with higher growth rates and margin profiles in our Products and Healthcare Services segment. We are excited as the current and future trajectory of the Patient Direct segment. Turning now to the fourth quarter. Our results were mixed between our two segments and they were even mixed within our Product and Healthcare Services segment. Starting with our Patient Direct segment, which continued to deliver outstanding revenue and profit growth, while closing out a record year. When adjusted for the Apria acquisition, the segment delivered revenue growth of more than 10% in the fourth quarter with double-digit growth in most key product categories. In addition Patient Direct delivered nearly 11% profit margin, growing 280 basis points year-over-year on an adjusted basis, aided by above market growth, synergy realization and strong execution.
In addition to the strong performance in our Patient Direct segment, our medical distribution division part of our products and healthcare services segment performed well. Our medical distribution division retained key accounts, recorded new wins and continued to deliver leading service levels. Overall, the segment revenue increased nearly 2% on a sequential basis, driven by solid performance in the medical distribution business. However, our Global Products Division’s surgical and infection prevention products continue to be impacted by significant excess stock in all channels and at our customers. The fourth quarter showed that we need to move quickly to offset reductions in demand, increases in cost and pricing headwinds, particularly in our Global Products division.
The market dynamics that continue to negatively impact our higher margin S&IP products and it has become clear that our company’s cost structure needs to better align with the evolving market. In order to address the current and prospective market realities, we have initiated a company-wide operating model realignment program. This program will have a dedicated team to accelerate profit improvement and reduce costs. The team will be led by Dan Starck, who will utilize his experience driving successful large-scale transformations at Apria, as well as the successful integration of Apria Environment. Building upon his successful leadership of the Byram division, Perry Bernocchi will be promoted to CEO of the Patient Direct segment. He will also further the integration of Byram and Apria to better serve our customers and drive efficiencies.
With these proven leaders in place, we are confident in the continued success in our Patient Direct segment and success in the operating model realignment, which we have already built out the teams and we’ve started to work on the program. The Owens & Minor leadership team has resolved that the business model realignment program will quickly and sustainably drive an expected $30 million of adjusted operating income in 2023. In addition, the program is expected to deliver approximately $100 million of adjusted operating income run rate by the end of 2023, and approximately $200 million of adjusted operating income run rate by 2025. In addition, the program is expected to provide between $250 million and $400 million of working capital benefits by 2025.
We further believe that this program will enhance our overall quality of service to our customers, increase our margins and allow us to continue to focus on debt reduction and reinvest in higher growth, more profitable opportunities. Coming out of this program, we believe that products and healthcare services segment will deliver between 2% and 3% sustained operating margin and Patient Direct segment will continue to deliver margin expansion and strong top line growth. Now let’s look at the detail of how the operating model realignment program will drive cost reductions and profit improvements. It will focus on the following four work streams: One, sourcing and demand management, which includes direct and indirect material cost reduction and utilization efficiencies.
Two, organizational structure redesign, which includes savings related to reduced overhead and structural changes resulting in headcount reduction along with elimination of non-value-added work. Three, network rationalization and operational excellence, which includes the optimization of manufacturing footprint and the supply chain network. And four, commercial excellence and product profitability enhancement, which includes price for the value we provide, growth from accelerated proprietary portfolio expansion, SKU rationalization and strategic supplier management. Look, we’re not waiting. The program has already started and we are in process of evaluating and implementing cost reductions and profit improvements to support the four work streams.
We will aggressively look across the entire company for efficiencies and savings with a heavy focus on the areas where the greatest opportunities exist. And here are just a few of those areas including a much more aggressive procurement approach. Quickly evaluating and rationalizing the entire manufacturing and sourcing process to eliminate waste and drive value; optimization of our factories and DC network; aligning capacity to existing and sales opportunities; reduction of SG&A headcount and overhead costs; streamlining back office functions; and enhancement of our sales effectiveness for profitable growth through aligned compensation structures, and enhanced tools, which will allow us to grow our proprietary product portfolio. We will operate with urgency and focus to right size the business in these new market conditions just as we did to address the pandemic and the other improvements achieved over the past four years.
We expect that these work streams will provide benefit that they take hold and will position us as a stronger more profitable company going forward. As I look back over the past four years, we have accomplished a lot and have a lot more to do. During the past four years, we have drastically improved the service levels and productivity of our medical distribution division and stop the trend of significant business loss. We have deployed a business development team that has leveraged the strength of Owens & Minor to deliver new wins in our medical distribution division. We have substantially increased full-year operating cash flow from $116 million in 2018 to $325 million in 2022. The cash flow improvement over the past four years has allowed us to pay down debt, invest in the business and acquire Apria, materially changing the profile of the company.
And finally, we rapidly expanded our manufacturing output of our S&IP products to unprecedented levels to protect caregivers in the fight against the COVID-19 pandemic and to maintain continuity of supply for our customers. However, to do this, we also significantly increased our cost structure, which we now must address in this post-pandemic market realities that adjusted rapidly during the second-half of 2022 in both product pricing and demand. This will be addressed by the operating model realignment program. As we look ahead, we remain focused on executing our strategy to leverage, invest and grow our Patient Direct segment, further diversifying our total company revenue, adjusted EBITDA and the creation of margin expansion. We will utilize our products and healthcare services segment to develop deeper customer relationships and expand our proprietary product sales both in and out of our channels.
And finally, continue to strengthen free cash flow to reduce debt and reinvest into profit expansion opportunities in higher growth areas. It is important to keep in mind that our acute care customers are increasingly looking for our Patient Direct segment to help service their patients in the home and we are uniquely positioned to support this rapid evolution of care moving to the home. I will now turn the call over to our CFO, Alex Bruni for a more detailed discussion of our fourth quarter operating and financial performance, our new cost savings plan and our 2023 financial guidance. Alex?
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Alex Bruni: Thank you, Ed. Good morning, everyone. Today, I’ll review our financial results and key drivers for our performance in the fourth quarter and full-year. Then provide commentary on segment level performance and finally discuss our expectations and assumptions related to the full-year 2023 outlook. First, let me start with our fourth quarter and full-year results. Our revenue in the quarter was nearly $2.6 billion, up 3.4% from the prior year and up 2.2% sequentially from Q3. For the full-year revenue was $10 billion, up 1.7%. Fourth quarter gross margin was $407 million or 16% of revenue, up 210 basis points from last year’s fourth quarter. Full-year gross margin was $1.8 billion or 18.3% of revenue, up 290 basis points from the prior year.
The increase in gross margin in the quarter and for the full-year was driven by the inclusion of Apria and sales mix partially offset by inflationary pressures and reduced demand for S&IP products, which included customer reliance on stockpiles. In addition, gross margin reflects a $92 million inventory valuation adjustment recorded to cost of goods sold in our Products and Healthcare Services segment during the fourth quarter. This reserve was recorded as a result of excess PPE inventory at year-end relative to the current demand outlook. The demand for these products began to decline in the back half of 2022 and fell sharply through year-end. The decrease in demand is due to customers utilizing the stockpiles created during the once in the century pandemic.
This inventory valuation adjustment, which was about 5% of our gross inventory, was classified as a non-GAAP item, due to the highly unusual circumstances associated with this extraordinary charge. Distribution, selling and administrative expense was $456 million in the fourth quarter and $1.6 billion for the full-year. The increased expense in the fourth quarter and for the full-year was driven by the addition of Apria. Along with ongoing inflationary pressures, partially offset by operating efficiencies and reduced incentive compensation. Adjusted operating income was $67 million in the quarter and $369 million for the full-year 2022. Year-over-year, foreign currency negatively impacted fourth quarter revenue by $10 million and adjusted operating income by $3 million.
For the full-year, foreign currency negatively impacted revenue by $43 million and adjusted operating income by $16 million. Interest expense was $41 million in the fourth quarter, which was $30 million higher than the prior year. Interest expense for the full-year was $129 million, which was $81 million higher than the prior year. Both the quarterly and full-year increases were driven by the associated debt financing for the acquisition of Apria and rising interest rates. Adjusted net income for the fourth quarter was $22 million or $0.28 a share. For the full-year 2022, adjusted net income was $184 million or $2.42 a share. Fourth quarter 2022 adjusted EBITDA was $117 million with a margin of 4.6%, up 60 basis points versus last year’s fourth quarter.
Full-year 2022 adjusted EBITDA was $518 million with a margin of 5.2%, up 20 basis points versus the prior year. Moving now to cash flow, the balance sheet and capital structure. This quarter, we generated $87 million of cash from operations, up 73% year-over-year. For the full-year, we generated a very strong $325 million, up 162% year-over-year. We ended the year with a net leverage ratio of 4.7 times. Total debt was $61 million lower than at the end of the third quarter and we’ve reduced debt by approximately $143 million, since we funded the Apria acquisition in April 2022. It’s important to note that our debt compliance leverage ratio at the end of the year was almost a turn lower than the book leverage I just stated. Leverage reduction continues to be a top priority and we expect the continuation of our ongoing actions along with our operating model realignment program will accelerate leverage reduction to our target of 2 times to 3 times.
Turning now to our segment results beginning with our Patient Direct segment. This segment continued to excel in the fourth quarter. Net revenue in the fourth quarter was $617 million, an increase of 135% year-over-year. Full-year net revenue was $2.1 billion, an increase of 114% year-over-year. In the fourth quarter, on an adjusted basis for the Apria acquisition, Patient Direct grew revenue by 10.3% year-over-year with double-digit growth in most key product categories. Segment income for the quarter was $66 million, compared to last year’s fourth quarter of $17 million. For the full-year, segment income was $194 million, compared to $58 million last year. More impressively, in the fourth quarter, on an adjusted basis for the Apria acquisition, Patient Direct grew adjusted segment income by 50% year-over-year with a margin increase of 280 basis points to 10.7%.
This improvement was driven by synergies and fixed cost leverage aided by continued above market growth and operational discipline. Looking ahead, we believe Patient Direct will maintain its strong organic growth and outperform the market in 2023. Moving on to products and healthcare services. Net revenue in the fourth quarter was $1.9 billion, down 12% year-over-year. So as Ed noted earlier, up almost 2% sequentially versus Q3, driven by retention and implementation of new wins, and seasonality in our medical distribution divisions. Net revenue for the full-year was $7.9 billion, a decrease of 11% year-over-year. The decrease in net revenue in the quarter and for the full-year was driven primarily by reduced S&IP demand and customer destocking.
Segment income for the quarter was $1 million, compared to $68 million last year. For the full-year, segment income was $175 million, down 54%, compared to last year. The decline in the quarter and for the full-year was driven by post-pandemic reductions and pricing and demand for S&IP products, including destocking along with inflationary pressures and foreign currency translation. Before discussing our full-year 2023 guidance, I want to take a moment to expand on the operating model realignment program as discussed. We are focused and committed to addressing our challenges in a thoughtful, but urgent manner to improve profit and cash flow. The targets we set out today will improve many key fundamental metrics of the business. Once again, we expect to deliver approximately $30 million of adjusted operating income to the P&L in 2023, ending the year with a run rate benefit of approximately $100 million and approximately $200 million annualized by the end of 2025.
Furthermore, we expect $250 million to $400 million of working capital benefit over the course of the program. We’ve recognize this operating model realignment in the four work streams Ed laid out are necessary to put the company in the best position to win in the current and expected future environment. Our leadership team hit successfully executed large scale change initiatives in the past and are committed to successfully doing so here. Now let’s look at our full-year 2023 guidance. We expect net revenue to be in a range of $10.1 billion to $10.5 billion. Adjusted EBITDA to be in a range of $490 million to $550 million and adjusted EPS to be in a range of $1.15 to $1.65. Given the backdrop of what Ed and I have discussed this morning and the operating model realignment program that is now underway, I would like to provide some commentary related to our 2023 guidance and some added color around our expectations for the cadence of earnings throughout the year.
With the continued volume and price pressure we are seeing on our S&IP products, along with the normal seasonality in our Patient Direct segment, we expect consolidated revenue in Q1 to be down sequentially from Q4 by approximately 5%. We expect that adjusted EPS in the first quarter could be as low as negative $0.10. We believe the vast majority of our earnings will occur in the back half of the year as our operating model realignment program benefits take hold our S&IP product volumes begin to recover and normal seasonality ramps up across our business. Our key assumptions for 2023 include expected realization of approximately $30 million of adjusted operating income benefit from the operating model realignment program. Destocking begins to subside in the back half of 2023.
A gross margin rate of approximately 20.5%, interest expense in the range of $175 million to $180 million and adjusted effective tax rate of 26% to 27%, diluted weighted average shares of 77.5 million, capital expenditures of $190 million to $210 million, stable to improving commodity prices, and FX rates as of 12/31/2022. Please refer to the supplemental slides filed with the SEC on Form 8-K earlier today, which we’ve also posted to the Investor Relations section of our website. In addition, I’d like to point out a few administrative matters. To be more aligned with peer companies and to provide investors with a cleaner view of the company’s cash earnings beginning in the first quarter of 2023, we will be modifying our non-GAAP reporting to include stock compensation and the inventory LIFO provision, both of which are non-cash items as reconciling items to arrive at adjusted EBITDA.
Additionally, we will change the line-item presentation in our statement of operations to break out intangible amortization from our distribution, selling and administrative expense, which will be combined in a separate line item with acquisition-related charges. Ahead of reporting the first quarter results, we will file an 8-K to recast 2022 quarterly results to reflect these changes. Finally, in the coming weeks, we will be filing a Universal self-registration statement. Our current self-registration is approaching this three-year life and solely as a matter of good governance we will file a new registration statement. At this time, we do not have plans to issue any securities. At this point, I’ll turn the call back over to the operator to begin the Q&A session.
Operator?
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