Q3 2023 Owens & Minor Inc Earnings Call
Participants
Alexander J. Bruni; Executive VP & CFO; Owens & Minor, Inc.
Edward A. Pesicka; President, CEO & Director; Owens & Minor, Inc.
Daniel R. Grosslight; Senior Research Analyst of Healthcare Technology; Citigroup Inc., Research Division
Eric White Coldwell; Senior Research Analyst; Robert W. Baird & Co. Incorporated, Research Division
John Paul Stansel; Analyst; JPMorgan Chase & Co, Research Division
Kevin Caliendo; Equity Research Analyst of Healthcare IT and Distribution; UBS Investment Bank, Research Division
Jacqueline Marcus; MD; Alpha IR Group LLC
Presentation
Operator
Good day, and thank you for standing by. Welcome to the Owens & Minor Third Quarter 2023 Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Jackie Marcus, Investor Relations.
Jacqueline Marcus
Thank you, operator. Hello, everyone, and welcome to the Owens & Minor Third Quarter 2023 Earnings Call. Our comments on the call will be focused on the financial results for the third quarter of 2023 as well as our outlook for 2023, 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 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, which 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.
Edward A. Pesicka
Thank you, Jackie. Good morning, everyone, and thank you for joining us today. Our third quarter represented another strong indication that we are executing at a high level. We generated high single-digit top line growth in our Patient Direct segment and low single-digit improvement in our Products and Healthcare Services segment. Our operational performance in the quarter was complemented by a significant reduction in our overall debt position combined with robust cash flow generation. I'm incredibly proud of what the team has done thus far with our operating model realignment program, and I am excited about what the future holds for our organization.
Let's now look at the business in a little more detail, starting with our Patient Direct segment. The performance of our Patient Direct segment in the third quarter continued to outperform the market, demonstrating the enduring strength of our go-to-market strategies and our service offerings.
This is evidenced in the strength of our new patient starts across most categories. The Patient Direct segment continues to identify opportunities for growth, including investments in technology, expanding our commercial capabilities and footprints and identifying adjacent conditions and associated products. There is significant opportunity in this space as we see more patients and providers preferring at-home treatment options for chronic conditions, and we are well positioned to capture this opportunity.
Now let's turn to our Products & Healthcare Services segment. For the second consecutive quarter, our Medical Distribution division saw year-over-year revenue growth of more than 5%, driven by same-store sales combined with net new wins, and when excluding the impact of PPE, sales grew at 8%. We continue to face the saturation of PPE in various markets, including, but not limited to, health care, government, industrial and national markets, which led to a 14% top line decline in our Global Products division when compared to prior year.
Finally, much of our operating model realignment program is focused on improving this segment through operational excellence and driving efficiencies in our manufacturing footprint and supply chain network. In the 9 months since we launched our operating model realignment program, our team has done a tremendous job of positioning us to achieve or even exceed our target of $30 million of benefit in 2023. We are doing exactly what we said we would do when we launched this program. Improve our operations, generate savings, reduce working capital and allow for future investments. It should also be noted that the operating model realignment program not only continued to deliver economic benefits, but it has enabled us to reassess how we do business every day.
As a result, we are well on our way to achieving the objectives established when we launched this program in the first quarter of 2023. We have also made great progress with respect to our balance sheet. We paid down $188 million in total debt during the quarter with $0.5 billion in net debt reduction in the first 9 months of this year. With our healthy operating cash flow of $157 million in the quarter and over $600 million of operating cash flow in the first 9 months of this year. We remain focused on paying down debt we took on to acquire Apria as well as making further investments in our people, products and processes.
These efforts are part and parcel with making Owens & Minor stronger. Before I turn the call over to Alex, I'd like to take a moment to address a recent update from the FDA regarding its April 2023 communication about certain O&M Halyard facial protection products. We worked diligently over the last 7 months with the FDA to provide extensive testing and performance data demonstrating that our products provide the level of filtration and fluid resistance for which they are rated.
I am pleased to report that on September 29, the FDA updated its recommendation to confirm that the Halyard Facial Protection products may be used in accordance with the product labeling for both particle filtration and fluid resistance. We are glad to bring this review to conclusion, which reaffirms the safety and effectiveness of our Halyard facial protection products. In conclusion, we continue to deliver on our 2023 commitments, including the strengthening of our balance sheet, the paying down of debts, the market-leading performance of our Patient Direct segment and the improvement of our medical distribution division. With that, let me turn it over to Alex. Alex?
Alexander J. Bruni
Thank you, Ed. Good morning, everyone. Let's dive into our third quarter performance. On the top line, we posted total revenue of $2.6 billion, up nearly 4% from the prior year. This uptick in revenue was driven by a 9% year-over-year improvement from our Patient Direct segment with strong revenue growth across many of our product categories, led by sleep and diabetes, our two largest categories. We also saw a 2% growth in our Products and Healthcare Services segment compared to the prior year due primarily to revenue growth in non-PPE product categories.
We continue to see positive momentum in our Medical Distribution division, which helped to offset the decline in our Products division. Our third quarter gross margin was $538 million or 20.8% of revenue compared to $513 million or 20.6% of revenue in the third quarter of 2022. The changes in our gross margin can also be attributed to the strength of our Patient Direct segment and strong performance across most product categories.
Turning to expenses. Distribution, selling and administrative expenses for the quarter were $453 million, making up 17.5% of revenue. The rise in DS&A expenses was mainly due to the added cost of supporting $94.3 million or 3.8% growth in net revenue when compared to the prior year. This included a $15.4 million increase in teammate benefit costs. However, these increased expenses were partially offset by productivity gains from the operating model realignment program and overall continuous improvement efforts. GAAP operating income for the quarter was $24 million, and adjusted operating income was $84 million. PHS experienced a decrease in operating income from shifts in product sales mix and reduced demand for PPE. Interest expense for the quarter was $38 million, which is a $2 million decrease from a year ago, driven by reduced debt, but partially offset by higher interest rates.
GAAP net loss for the quarter was $6 million or a loss of $0.08 per common share. Adjusted net income for the quarter amounted to $34 million or $0.44 per share. Adjusted EPS benefited by $0.06 due to a LIFO credit as a result of a $101 million reduction in our PHS segment inventory in the third quarter. We have anticipated this benefit in Q4, but we were able to realize it a quarter early due to exceptional inventory management while maintaining market-leading service levels. Adjusted EBITDA in the third quarter was $135 million, with a margin of 5.2%. We continue to be well positioned to achieve $30 million of adjusted operating income benefit in 2023 from our operating model realignment program as well as exiting the year with a $100 million run rate.
Moving to cash flow, balance sheet and capital structure. We continue to generate significant operating cash flow with $157 million this quarter, beginning year-to-date total to $629 million, driven by strong working capital management and profitability. Our strong cash flow allowed us to reduce total debt by $188 million and net debt by $117 million during the third quarter. This brings our year-to-date net debt reduction to $0.5 billion. These actions brought our total debt to $2.1 billion and net debt to $1.9 billion and brought net book leverage to below 4x at the end of the quarter.
Having delivered a solid quarter in Q3 in line with expectations and as we head into the fourth quarter, we narrowed our guidance for 2023 to reflect our confidence in patient Direct and the operating model realignment program. Balanced against the lack of visibility and caution we have around PPE product sales for the remainder of the year. We are narrowing our full year guidance for revenue to be between $10.3 billion and $10.4 billion adjusted EBITDA to be between $535 million and $555 million and adjusted EPS to be between $1.30 and $1.40.
As we begin to look ahead to 2024, we're excited about the prospects for our Patient Direct segment, where we plan to invest to ensure its future growth and market leadership. We expect our PHS segment to continue on its path building on the benefits of our operating model realignment program to becoming a low-cost provider with a broader proprietary product portfolio while retaining our focus on the customer. With the combination of our growth outlook and planned investments, we expect 2024 adjusted EBITDA and adjusted EPS to grow in the low double digits. We will elaborate more on this at our upcoming Investor Day. With that, I'll now turn the call over to the operator for questions.
Question and Answer Session
Operator
(Operator Instructions)
Your first question today comes from the line of Kevin Caliendo from UBS.
Kevin Caliendo
Thanks for taking my question, I appreciate it and congrats on the solid quarter. How much visibility do we have in the business right now when we talk about on Patient Direct when it comes to impact from GLP-1s, which is certainly a topic and on the PPE demand. But just thinking about going forward, do you feel that it's getting better, you have better visibility, the same, worsening? Just love to hear, as you think about -- we're coming up to Analyst Day in a month and everybody is going to be focused on your long-range plan and your guidance there. And I'm just wondering how you feel about your own visibility into the business.
Edward A. Pesicka
Thanks for the question. Thanks for the comment upfront. Here's why we think about the GLP-1s, for us, it's really business as usual. And if you look at what we've seen even again in this quarter, is we saw again double-digit growth in both sleep and diabetes, and those categories continue to be extremely strong for us. And you think about it, we've got nearly over about 1 million new patients diagnosed with diabetes in America every single year. In addition to that, we still believe there's about 20 million Americans who haven't even been diagnosed yet with OSA that have it. So you just think about the opportunity size out there.
I think the second aspect of it, really, as we continue to manage and drive this business, we recognize that you've got GLP that will help people, but it's not going to be a cure for everything. We really think also that the market is somewhat overreacted to the GLP-1s. So if you look at where we see it going, we continue to see tremendous opportunity in two of our major categories, diabetes and sleep. Due to the amount of people that haven't been diagnosed and is still out, and the amount of people that are being diagnosed with those issues every year, and we continue to see growth in that segment. So I guess we see it a little bit different than maybe others do.
Kevin Caliendo
Okay. That's helpful. And if I can ask a quick follow-up. We had some news this week that CMS, I guess, is going to reinstitute a plan, which would cut DME reimbursement. I don't know if you guys have looked at that, it starts [11 '24] and could impact the Patient Direct business. Have you analyzed that? Is it meaningful for you? Any comments there would be helpful.
Alexander J. Bruni
Yes. This is Alex Bruni. So we obviously we follow this closely. And I think what we're seeing is consistent with our assumptions and what we've factored in for next year broadly. Ed, I don't know if there's something you want to add?
Edward A. Pesicka
Yes, that's really it. I mean, obviously, it's already been factored in. And I think there's still -- again, we also look at it as still a tremendous opportunity for growth. And I think you also have to look at our payer mix, which is much heavily weighted to the private side payer than it is from the public side payer. So that also mitigates some of that risk for us. But again, we think there's tremendous opportunity in that segment. We're working with our external suppliers too at the same time as well as expanding our portfolio. So we baked it in already into assumptions for 2024.
Operator
Your next question comes from the line of John Stansel from JPMorgan.
John Paul Stansel
This is John on for Lisa. Just want to walk through the Global Products business. Maybe a little bit of color, I think you said down about of 14% in the quarter. I guess, are there pockets of relative strength or weakness that you could speak to?
Edward A. Pesicka
Yes, if you think about the pockets of strength within the global products, it's really all of the non-PPE items. So if you think about some of the products you make, whether it's surgical infection prevention products, excluding PPE, we continue to see strength there. In our MediChoice brand products, we continue to see strength there. So it's really isolated to the traditional or classic PPE. And then even within that, there's a mix between that, whether it be face protection, gloves, gowns and other aspects. But I think the way to look at it is it's more narrowly isolated in PPE within all of our products. The rest of our S&IP products are doing well, our MediChoice and our broader product population is doing well. Frankly, getting through this FDA notice, it's really helped us tremendously too because now obviously, working with direct FDA closely on this one. It's now reopened up the opportunity for us to start to grow and sell that portion of our facial protection, too. So I guess the short answer is, it's really isolated and narrowed to PPE within our Global Products division.
John Paul Stansel
Great. And then just a quick one on gross margins. It looks like you'll see another step up sequentially into the fourth quarter, which I imagine lines up with seasonality. But is there anything to call out as we start to think about how gross margins will play out in '24?
Alexander J. Bruni
Yes. Thanks, John. Yes, so the update to the guidance to 20.5% is consistent with where we thought things would be at the beginning of the year and in Q1, we did take it down a bit in Q2. But, obviously, the gross margin is driven primarily by mix, and it is factored into where we think we're going for next year. Obviously, we'll have more to say on that as we get into December at Investor Day.
Operator
Your next question comes from the line of Daniel Grosslight from Citi.
Daniel R. Grosslight
You had a nice improvement in product in terms of the EBIT margin sequentially, I think it was around 90 basis points, which was ahead of our expectations. I'm curious if that was in line with your expectations or was it ahead? And maybe if you can kind of dig into what drove that improvement. And then looking forward, obviously, 4Q implies a pretty big increase in sequential margins, largely due to seasonality. I'm curious if you can break out that margin improvement for 4Q between products and services and Patient Direct?
Edward A. Pesicka
Sure. So absolutely, what we assumed would be if you think about how we talked about the phasing of the year early on with profits continuing to rise during the year, having those, what I'll call, larger step changes from Q1 to Q2, Q2 to Q3 and Q3 to Q4. That's exactly how we planned it out. And what's really driving that? There's a couple of factors that are driving that product and Healthcare Services segment. And it's one, it's the growth we're seeing in our medical distribution business, so that mid-single-digit growth that we've seen in the medical distribution business, with share gains as well as new wins.
That combined with the next aspect of it, which is the operating model realignment, which wasn't just a tweaking. It's more of a transformational change in how we do business. That's helped us take cost out of the business and help us add more productivity to the business. It wasn't just the operating model realignment. It was our normal continuous improvement team that continue to drive implementation on that. That's also helped in what was expected. We knew as the year progressed as we put those programs in place, that would take some time. And now we're starting to see the benefits of those where -- on the time we had anticipated and to the value we had anticipated. So those are some of the key drivers of what's helped us drive that profit improvement.
Daniel R. Grosslight
Got it. And you mentioned share gains as a driver of your core distribution growth more recently. I'm curious where are those wins coming from? Are they from other large national distributors or kind of smaller more fragmented distributors. Are they in specific products? Maybe just double click into where the share gains specifically are coming from this year?
Edward A. Pesicka
Yes, it's primarily from a mix of some smaller, but really more of the larger competitors. And it's a mixed two ways. It's a mix of pure new wins that are -- that we won business from some of our competitors but it's also expansion at current customers where they may have been doing self-distribution, along with us as their distributor partner and they've gotten out of self-distribution for us to implement a model that can drive efficiency for them and really cost savings.
The other thing I want to touch on that I didn't on the first question you asked, I think, is important is really the other thing we've done and while this doesn't necessarily impact the segment profit is what we've done by utilizing both continuous improvement in the operating model -- the operating model program is the reduction in inventory and working capital that has driven a significant amount of operating cash flow and frankly, has enabled us to pay down a significant amount of debt. We're talking close to $0.5 billion of debt pay down year-to-date. So those are some things we've done that are also part of the operation model real alignment and really strengthening of our [PNHS] segment business. that translates into other parts of the P&L.
Operator
And your next question comes from the line of Eric Coldwell from Baird.
Eric White Coldwell
Thank you for the comments, especially the preliminary outlook on calendar '24. Quickly trying to do some math on what low double digits means it looks like, if I think of that as being somewhere in the, call it, 10% to 12%, a little over 12%, maybe. It looks like earnings per share comes in well below the Street, but EBITDA comes in line or maybe even above. And I'm just curious, is there something going on below the line here to pull the EPS down more while the EBITDA is actually looking okay?
Alexander J. Bruni
Yes, thanks Eric. No, I think there's nothing extraordinary happening this is consistent with how we see the business evolving. So there's nothing surprising there.
Eric White Coldwell
Okay? And then with Global Products, the minus 14% due to PPE, but you say everything else is strong. I really think we could use some additional help on mix within the segment, i.e., how much is PPE, where was that? And then how much is the weighting of everything else. If you're down 14% and PPE is only a part of the segment, that means PPE has to be down pretty substantially at this point, which to me is a bit surprising given some of the commentary we're seeing from other distributors and some manufacturers, say, the glove companies in Asia, et cetera. So I'm hoping for a little more help with the mix within that segment.
Edward A. Pesicka
Yes. So if we think about the mix incentive last year in Q1, Q2 and Q3 were really record -- really the first 2 quarters, even in the third quarter of this was really strong. I recall in Q3 of last year, a lot of our customers are ramping up for the triple demic at the time and taking on a significant amount of products, and PPE during the peaks of COVID was a material portion of that segment. What I can say, Eric, is we have seen -- if you think about the drop that we've seen in demand for PPE, we've seen that to curve flatten out, I would say. And now as we start to move forward, as we're starting to overlap some of this -- next year as we start to overlap the -- what I'll call the decrease of stability in it. We would expect it to somewhat flatten out as we go forward.
Eric White Coldwell
And then on Patient Direct, you highlighted some areas of strength. You also said a couple of times, strong new starts in most categories. What were the categories where you did not see strong starts or where perhaps there was some pressure?
Edward A. Pesicka
Yes. Probably the one that continues is really in the home respiratory. Home oxygen, NIV. You got some recall issues. But also in addition to that, during COVID, that was a significantly strong business, both NIV as well as home oxygen. That's the one area where you're seeing it. And that's relatively consistent with what we've seen throughout the year. But other than that, the bulk of the categories are doing really well. And we decided just to call out two of them, which are our two largest categories, that being sleep and diabetes, which again, both grew at double digits.
Eric White Coldwell
Perfect. And then last one for me. I know it's a lot, but the commentary, maybe some foreshadowing here on heavier investments. When you say investments, are you talking about CapEx? Are you talking about M&A? Are you talking about operating expenses, building teams, adding sales? I'm just give us a sense on what you're talking about with the investments looking into '24 plus.
Edward A. Pesicka
Yes. We'll go into this in a lot more detail at Investor Day, but it's really more around the operating side of the business. It's commercial, it's category management, it's sourcing, it's those types of investments that are more operating related that will have payback as you go forward.
Operator
There are no further questions at this time. Mr. Ed Pesicka, I turn the call back over to you for final closing remarks.
Edward A. Pesicka
So thank you, operator. First of all, I'd like to thank everyone for joining us this morning. as an organization and personally, we are extremely excited about the work that we've done so far in 2023. And I also want to remind you about our upcoming Investor Day, we hope you'll either join us in person because it will be in Boston or virtually on Wednesday, December 6, at 8:30 a.m. Eastern Standard Time. We'll be taking a deep dive in the areas and focus on our recent performance, our strategy, our opportunities and our vision for the future of Owens & Minor. So with that, hopefully, we'll see you December 6, and thank you.
Operator
This concludes today's conference call. Thank you for your participation. You may now disconnect.
