Accendra Health Inc/Va/ Q2 FY2022 Earnings Call

Good day, and thank you for standing by. Welcome to Owens & Minor’s Second Quarter 2022 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. I would now like to hand the conference over to your first speaker today, Alex Jost, Director of Investor Relations. Please go ahead.

Thank you. Hello, everyone, and welcome to Owens & Minor’s 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 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 may 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 Pesicka, our President and Chief Executive Officer, and Andy Long, our Executive Vice President and Chief Financial Officer. I’ll 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 in our ability to manage through the macroeconomic headwinds in this quarter is a result of the following. One, our Owens & Minor 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 & Minor 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 continues 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 segment. Our Byram business continues 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 Apria 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 environments, the reduction of PPE demand and the absence of the glove cost benefits. However, as the core to our progress, 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 include 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 experienced 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 customers, the main reasons for this are the factors I mentioned a moment ago; these are driving the low procedure volume and overall reduced hospital demand. 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 & Minor 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 Owens & 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 & Minor 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 in delivering meaningful high-quality customer wins in our Products 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, operational excellence, and business blueprint. 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 will 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 the prior year. The growth reflected the first full quarter contribution from Apria 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 Apria 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 Apria 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 $0.37 per share. Adjusted net income in the second quarter was $58 million compared to $80 million last year. Current quarter adjusted EPS was $0.76 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 $0.05, and an $0.08 reduction on a year-to-date basis. 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 in 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 Philips Respironics recall and other supply chain constraints. Adjusted operating income for the quarter was $52 million compared to last year’s second quarter $14 million. Acquisition-related synergies from the onboarding of Apria continued 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 times to three times in the next 18 to 24 months. As Ed 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 billion to $10.1 billion. Adjusted EBITDA to be in the range of $570 million 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 $0.10 of the reduction in the midpoint of our guidance. Both the short- and long-term expectations for Apria remain right on track, and we continue to expect Apria 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 Apria and believe incremental annual revenue will be in the range of $80 million to $100 million and incremental annual adjusted EBITDA in the range of $40 million to $50 million within the next few years. Additional assumptions for 2022 guidance include a gross margin rate of approximately 20% unchanged from prior quarters' guidance, interest expense in the range of $130 million to $135 million reflecting the most recent assumptions related to rising interest rates, capital expenditures of $185 million to $195 million up from our previous guidance due to improvements in Apria’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 8-K 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 & Minor 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.

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

Hi, thanks for taking my call, guys. I want to explore a little bit the comments around the Apria business and CPAPs and the higher CapEx, and 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 CPAP. When do you think the bolus of patients might come through in your Q4 guidance? Or is this just that you have more access to CPAPs now than you thought you were going to have?

Yes, I’ll start and let Andy add some color. We really think that’s going to significantly impact the fourth quarter. The way we see it and the way we look at it is, we look at our back orders right now. We have roughly three to four months of normal usage on back order. As the suppliers and the manufacturers start to be able to produce more products and get them out to us, we’re going to be able to fill those orders, starting to fill those orders at higher rates 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 the recurring revenue from the consumables. That will help drive results in Q4 for products placed in Q3. And then we really think about the brightness of it going into 2023 as we get that several-month backlog filled and the recurring revenue going forward increases.

And Kevin, it’s Andy. The only thing I would add to that is another piece of good news that we received in the quarter: the FDA did approve the Philips remediation plan on ventilators. That gives us confidence that we will have the equipment needed for ventilation throughout the end of the year and what we need to support the fourth quarter. It’s also a cash flow issue. Now that we can start returning the ventilators that we have on hand to get those refurbished and put back into the field, that reduces our cash outflows. We will not be spending as much on ventilators because some are already being refurbished. We may not have patient-related CapEx on ventilators until early 2024, so there will be a cash flow benefit.

Got it. If I can ask a quick follow-up: I 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 due to 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 higher interest rates?

Yes, Kevin. Absolutely. So the way I think of the $0.30 reduction in the midpoint of our EPS guidance, the combination of FX and higher interest rates contributes about $0.10 of that $0.30. But the single largest driver relates to lower procedural volumes. You’ll note that the midpoint of our revenue guidance came down about $150 million; that $150 million is 100% attributable to our Products and Healthcare Services segment. In terms of calendarization of that $150 million, some of that we saw in Q2, but the lion’s share of that reduction is going to happen in Q3. In terms of margin impact from that, think of it as about a 10% pull-through contributing $15 million of bottom-line profit impact, or $0.15 of EPS. That 10% pull-through reflects our view that we’re not going to get really aggressive in taking variable costs out because we see this shortfall as very temporary in nature. We’re not going to pull out variable costs only to have to put them right back in the fourth quarter; that’s not a smart move. That’s why we won’t be highly aggressive on cost cutting, which limits the pull-through. That leaves about $0.05 for net inflation, and I stress 'net' because we will offset some inflation through our actions. Inflationary pressures have continued to rise during the year, and our remediation steps to mitigate that through our business system take a little longer to gain traction; we expect to see the benefit of those actions in Q4.

Great. Thank you so much for all the color, guys.

Thank you. Our next question comes from the line of Daniel Grosslight from Citi. Mr. Grosslight, your line is open.

Hi, thanks for taking 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 have been widely reported on, but I’m a little more surprised on the product shortages. I think in your prepared remarks you mentioned it was really kind of the diagnostics side of things. Could you 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?

Yes. So, Dan, the product side—

Technical Difficulty

Hello?

You’re back in line. Yes, you’re back in line, sir.

Great. Dan, apologies about that. We had a little technical difficulty and lost the phone connection, but I’ll give you more detail. On the product side, these are products that we procure from external manufacturers and other suppliers that we then turn around and distribute to the customer. I’ll give you one example—there are several—contrast dye, where there has been a shortage of contrast dye. It’s impacting the ability for our customers to do certain diagnostic tests; they are prioritizing procedures. That’s one clear example of a diagnostic product that’s been unavailable. Our manufacturing partners and those who make these products are working hard to improve productivity and increase their output, and we are already seeing some improvement. We expect that several of these examples will remain constrained in the third quarter but start to recover in the fourth quarter.

Thank you.

And I show our next question comes from the line of Hannah Lee from Bank of America.

Hi, this is Hannah Lee, I’m on for Mike Cherny. Thanks for taking my question. Just in light of ongoing cost pressures, can you talk about some of the pricing power you have in both lines of business?

Sure. We think about pricing power differently across our businesses. In our Patient Direct business, pricing power is largely tied to our ability to work with private payers to adjust reimbursement rates. We engage in those conversations regularly—sometimes we’re successful and sometimes we hold off. On the Patient Direct side, CMS funding is relatively locked in, so there is limited pricing flexibility there. In our products business, we’ve been relatively successful engaging in open, transparent conversations with customers. For example, with the glove cost pass-through, we were clear with our customers about the cost increases, explained the drivers, and we were able to pass those costs through as they rose and then bring them down as costs declined. That transparency model has allowed us to both pass on cost increases and roll them back in line with market changes. On the medical distribution side, there’s not a lot of margin to play with because of the low-margin nature of that business. In certain areas we work with customers on other levers—optimizing freight or looking at different ways to reduce costs. So overall, pricing power varies by business: limited on Patient Direct except for payer negotiations, effective in certain product categories through transparent communication, and constrained in medical distribution where operational optimization is the primary lever.

Thank you. And I show our next question comes from the line of Eric Coldwell from Robert W. Baird. Please go ahead.

Hey, thanks. Good morning. I have a few questions, some are technical. I’ll start with FX. I want to make sure I’m clear on the guidance impact across FX, inflation and interest rates. Can you tell us what the original FX headwind expectation was, where it was recently in the last update and then the incremental addition for FX in this update?

Good morning, Eric. I’ll start by describing the nature of FX and then be a bit quantitative. The strengthening dollar has primarily hit us in our selling currencies—the euro, the pound, the Japanese yen—where we convert local currency into U.S. dollars. We’re not seeing much corresponding benefit on the cost side because most of our manufacturing footprint is in North America, and where we have production outside the U.S. in Honduras and Mexico, the dollar has been relatively stable. In the current forecast, and what’s changed from the last update, the dollar strengthened sharply during Q2 and we expect that to contribute about $0.05 of FX headwind from where we were last time we spoke. We’re using June 30th FX rates as the basis of our guidance. I know FX rates have eased a bit in July; if that continues, it could provide a little lift. But at this point, we are using the June 30th rates. The original guidance when we came out in the fourth quarter was based on December 31st FX rates.

Okay. And that original guidance, can you tell us what the original expectation was?

Eric, I would have to get back to you on the exact amount for that original expectation; I don’t recall the precise figure right now.

No problem. Could we get Apria’s EBITDA in Q2?

We haven’t provided a specific quarterly EBITDA amount for Apria. What I will say is that on a pro forma 12-month basis, we expect Apria to contribute $240 million of EBITDA. For the period of ownership post-March 29th of this year, we expect to have in excess of $180 million of EBITDA contribution under our definition, and that expectation is right on track.

Okay, great. And on the glove pass-throughs—you noted $100 million in the quarter—can you remind us how that stacked up versus your expectation? And I don’t think we saw a specific update on the $400 million to $450 million range for the year.

The $100 million impact in the quarter was slightly less than what we had expected. In terms of the full year, we haven’t changed our guidance, but I would say we are at the lower end of that previously mentioned $400 million to $450 million range.

And final one from me: with the revenue headwind in distribution and products here in the quarter and the outlook, it sounds like the vast majority is really related to distribution. I want to make sure we’re not missing something on products; is the majority of this guidance reduction related to the volume situation as opposed to products being materially lower than you expected?

Yes, Eric, you’re correct. The $150 million reduction in guidance is entirely in Products and Healthcare Services. While it’s hospital-utilization driven—primarily medical distribution—there is a portion of our proprietary product portfolio tied to elective procedures, so there is a smaller impact on proprietary products as well. But the lion’s share is indeed in medical distribution.

Okay. Thank you very much.

Thank you. I’m showing no further questions in the queue at this time. I’d like to turn the call back to Ed Pesicka, President and CEO, for closing remarks.

Thank you everyone. Thanks for joining the call this morning. A couple of final points: I’m really pleased with how our second quarter turned out. As I stated in my prepared remarks, we continue to gain share and win some meaningful high-quality customers. It’s important to note that within our Patient Direct business, we are diversifying total company revenue and EBITDA in two ways. One is the strong growth from our Byram business, again in the high teens of growth, and the other is the Apria acquisition, which will continue to expand and help diversify total company revenue and EBITDA. We saw solid growth in Apria for the quarter in the mid-single-digits, and we continue to see the beginning of our synergies with the integration work going very well. Ultimately, over the last three years we’ve shown our ability and the effectiveness of our long-term strategy, our operational excellence, and our business model. We’re looking forward to the back half of this year and continuing our strength going forward. Thank you everyone, and we look forward to talking again next quarter.

Thank you for attending today’s conference. This concludes the program. You may all disconnect.