Accendra Health, Inc. (ACH) Earnings Call Transcript & Summary

Good afternoon, everybody, and thank you very much for joining us here for the Owens & Minor presentation at the Citi Healthcare Conference. My name is Jon Beake. I'm the global health care spec sales based in London. I'm very pleased to welcome CEO, Ed Pesicka; and CFO, Andy Long. So welcome, guys. Thanks for joining us today.

Thank you, John.

We are going to jump straight into Q&A. So I'll kick it off with a question on Apria. You recently made a pretty big splash in the home health market when you announced your $1.5 billion acquisition of home health distributor Apria. If the deal closes, it will be the biggest acquisition OMI have ever made. For those not familiar with Apria or your home health business Byram, can you lay out the strategic rationale for such a large transaction? And why you decided to make the acquisition now?

Sure. Yes. So Jon, first of all, thanks for the invite to be here today. We're excited to be here. And to the specific question, back in May of 2021 or less than a year ago at Investor Day, we talked about how much we like the home healthcare space. And when I talk about the home healthcare space, it's really around that patient direct model where products are being provided to the patient and then being reimbursed by the payer. So we really like that. We really like that space. We like it because it's about a $50 billion market that's grown about 6% per year on average. And when we looked at the space to grow in it, you had kind of the make-or-buy analysis of can you do it organically or inorganically. And when you think about the categories that our Byram business is in, and that business has been run extremely well. We acquired the business probably about 5 years ago. And at the time, it was $300 million to $400 million in revenue. And I think we disclosed -- I know we disclosed on January 10 that now it's approximately $1 billion in revenue. So that business has seen tremendous growth. The categories that, that business really participates in is diabetes, ostomy, wound care, traditional wound care, incontinence, urology and several other categories. So we're very strong in that. And primarily, our relationship of what we're doing, it is calling on the provider. But you think about those categories that we're in, and then we looked at categories we wanted to get in, which was home respiratory, start to sleep apnea, traditional DME and advanced or negative pressure wound therapy. And those are the categories that Apria was in. So it's rare in time to find an acquisition that has very little overlap. This one, it actually fits together perfectly with very little product overlap at all. So we really liked that aspect of it. So that's the first thing we liked about it is, one, it's in the fast-growing home healthcare space. It's $50 billion market size. It's highly fragmented and 4,000-plus players in it and has ability for us to put something together that actually creates value. And let me talk about what I mean by the value, Jon, is really in that space, we have 3 constituents. You have the payer, which -- it's important. You have the provider and you have the patient. And first and foremost, with the payer, now it gives them the opportunity to provide service to multiple -- to a single person from one supplier that can provide multiple products. And let me give you a specific example around that. So you take diabetics. So type 2 diabetics in the U.S., roughly 50% of them also have obstructive sleep apnea. A type 2 diabetic that is obese is close to 80% also have sleep apnea. So that's an example where a payer is having -- you could have multiple companies sending product to a customer. Now they have to deal with one. You go to the patient. Here's the patient who could have multiple issues, again, it's obstructive sleep apnea or respiratory at home as well as diabetes and maybe wound therapy, they could be getting deliveries from multiple people. And if there's a problem, they then have to deal with multiple distributors and multiple home health patient direct companies to fix those issues. Well, now they can get it all from one. And then the third leg of that stool really is the provider. And it was the different call points that we had. So Byram's call point is primarily the provider itself or the clinician in the office, whereas Apria's call point would be in the hospital in the sleep apnea clinic, the discharge nurse in the hospital. So now you have the ability with different call points to talk about that breadth of that product portfolio that comes together that can make it better for the clinician or better for the provider, now they have one point of contact, better for the patient, that single point of contact and also better for the payer. So I know it's a long-winded answer, but there's a lot of reasons why we liked it. And it really stems from -- it's a highly fragmented market. It's growing really quickly. It has the ability for us to take that strong growth we had in Byram and layer that in and then you take the product portfolio, it's something that we can get to much faster inorganically than if we would have invested organically over the next several years on that.

Great makes sense. I -- you mentioned at the end, that growth, which is what I'd like to sort of come on to next. If we look at these, the recent disclosures from Apria, you basically got sort of growth expectations in the region of about 5% on the top line over the next 3 years -- CAGR, sorry, and with a 20% margin. And if you compare that to Byram, which is expected to grow at sort of 12%, 13% CAGR and with a low sort of 8%, 9% margin. Can we -- can you just discuss why you've got those differentials in growth and the margin profiles of the 2 business and how we might see that change in the combination and sort of any sort of revenue and cost synergies that you can speak to as well?

Yes. So a lot in that question. Let me talk first on the first part of that, which is really around the growth in the 2 businesses. So a very different growth profile. But that also comes from and being a critical part of the portfolio. So diabetes is one of the fastest-growing categories in the U.S. healthcare, specifically from the home or patient direct model, that is growing extremely fast. I think -- I believe and I know our team did a really good job talking about the features and the benefits of what Byram brings. We've been able to grow very quickly in that category as well as in the other categories. Frankly, outpaced the market growth. The margins in those categories because that's more of a consumable type item or -- so that's something that has a different real margin profile than on the Apria side. Apria growth rate, really in the lower single digits, but margin profile very different. But that's also a nature of that business, too. In the Apria business, if you think about it, it's a capital business for a razor-razor blade type business. And the fact that the sleep apnea device is the -- a razor, and that's the capital investment and then the razor blade is the repeat order that comes in, the various components that connect to the person. Same thing with resp home, respiratory oxygen tank is the capital and then the tubing and the mask and everything else is more of a consumable. So that's a different business, different profile. And then the delivery mechanism is a little bit different, too, on that, which adjusts for those types of margin differences. On revenue growth, really, we talked about this as a revenue opportunity. The opportunity now to have the commercial teams, our local sites or I should say, the Apria local sites, I guess it's not ours until pending the close. But the Apria local sites where they have that high-touch delivery model, which then can broaden the commercial view with that broader portfolio. Products are carrying, it's a connection to the doctor that can provide the choice to give the customer multiple things from one source. And then as I said, the patient and the other leg of the stool that being the payers. On synergies, look, there's a normal corporate overhead synergies. Take 2 public companies, you bring them together, there's normal synergies associated with that. We're still -- the acquisition is still pending. We're working on integration right now. We're identifying what we can, but we're still operating the 2 companies independent until the deal is closed, pending the final close, that's when we'll be able to get in and really look more closely at some of the other synergies that potentially are there broadly where we can have an open conversation around some of the commercial potential synergies that we believe are there.

Great. Very clear. And just thinking about the home health space and competition, there's [indiscernible] headline and share -- XYZ company share prices move around a lot on whether it's an Amazon headline or whatever it might be. How do you intend to fend off these competitive threats? And where do you see them coming?

Yes. So here's what's different about, I think, what we do in this space. And it's home health, but it's really a patient-direct model. And it's not a retail model. It's a patient-direct model and the fact that virtually, there's a lot of companies in the world that can ship a $600 box to a home. However, it's the connectivity with the payer that makes the difference and makes it significant. Shipping the product is the easiest part of that component. The most difficult thing is actually the reimbursement. And it's the disciplined process we go through at Byram, and it's the disciplined process that goes it through at Apria to make sure a high percentage, very, very, very high percentage of everything that is shipped is billed and collected. So an example, what we do is we'll work with the payers that when a patient calls, a new patient calls we're going to the payer to make sure they're covered by that insurance provider and that we have the ability to bill. We'll work with the provider to make sure that the doctors' notes support that. And then we have that ability then to make sure we do the collection. Versus others -- the retail model doesn't have to worry about that because the credit card is paying for it instantly when the product is delivered versus ours, it's that after work we do, we do that. That's really critical and really important. So that's why it's a little bit different than, let's say, in Amazon, who's great at shipping and collecting on credit cards, but really has a different mix when you start to look at being -- having to go to the payer to collect that money and all the work that has to be done and all the internal protocols that have to be there. In addition to that, John, I'll tell you one other thing is, when you look at our client base, our client base can be anywhere from 18 to 100 years old. So -- and we also have the ability today to not just take an online order we can take an order via an e-mail. We can take an order via a telephone call. We can take an order via a fax. We can take an order even by the old fashion, put it in the U.S. postal box and drop it off and send it in. So that's the other thing is we're not nearly defined to one. We give that broad selection because the base of our customer -- or our customer base is broad, and we have to make it easy for them to order which is the best solution for them. So there's a lot of different factors there.

Very clear. And I'm intrigued to know how many of your orders come in by fax, but I don't know whether you disclose that.

That's less and less every day.

We've still got one in our trading floor, a machine. I haven't seen it used for a long time anyway. I digress. So we move to product section now. And -- obviously, the topic that you've probably spoken about as much as anything else in recent conference calls and like, which is PPE demand. And obviously, you continue to benefit from variants like Omicron. Can you comment on how the variant impacted recent demand for PPE stockpiling at both healthcare and non-healthcare clients. And then what percentage of your hospital clients are still using non-medical-grade PPE. And if I could sort of tack on to that, you spoke yesterday on your call about the sort of -- some sort of permanent changes, whether you can sort of just describe what you see as the future sort of run rate of PPE use, what does your hospital look like in terms of users or whatever it might be.

Yes. So let's just -- again, a lot of that -- that's okay. So first and foremost, one of the things that where we are and we're different is we make medical-grade PPE across the spectrum of PPE on large scale. Meaning we don't just make N95s, we make N95s, we make surgical masks. We make fluid-resistant surgical masks level 1, 2 and 3. We make isolation gowns bearing levels. We make surgical gowns. We make drapes. We make we make surgical wrap. We make all of that. We make gloves. So it's really a broad-based self-manufactured PPE on scale. And that's important because that as a backdrop makes us different as our manufacturing of it. Not only we manufacture it, we're manufacturing that -- we're going from raw material to the nonwoven fabric that's used in all of that fabric-based PPE. We actually can control that and make that. So that has made a difference over time. And then you go to the next phase of how did Omicron impact us. Look, most hospitals now have their stockpile set as they want. Some still growing it, some still adjusting it. But so when Omicron happened, we had a couple of things that happened in the market. We had electric procedures towards the end of December shutdown in some places or slow down. We have hospitals that then would have the ability to go and grab a product out of their stockpile and then now need that replenished, kind of that's their safety stock as needed. I think the other thing is medical-grade PPE is critical. And when emergency use authorizations came up. Some of that product we help customers dispose of and then we can help them replace it with our own product. So we think about it right now is there's other things that we've done because we knew that pre-pandemic, you were here in PPE, height of pandemic you're here. It's never going to go our mind back to that. It's going to slow down from the height of the pandemic because of stockpiling and stuff like that. But the protocols are in place. The protocols are still in place. And after 2 years of honoring those protocols, we believe they're going to continue. So while people may not be wearing masks on the street or in the local grocery store, the hospital protocols are ingrained now. One of our colleagues just had their first grandchild this week. And he was telling the story that he walked into the hospital. And it was -- he saw all of our Halyard masks everywhere. He saw our duckbill N95s. When he went in to see his daughter. He was handed a Halyard mask to wear for the 10-minute visit he was allowed, then he went out and the next person. So the protocols are there. We believe they're going to continue to stay because they work. So that's why we think you're going to see more of that higher elevated steady state. If you think about a great example of that is sequentially from Q3 to Q4, we actually saw growth in PPE. And we saw that for a lot of reasons. One is the protocols that are in place. Two, and the second aspect is we have longer-term agreements with customers, multiyear agreements with customers on PPE. Three, we were able to expand our customer base, whether it was through our channel or through different channels, expand the customer base that wanted our PPE. In addition to that, we talked a lot about taking that PPE and continuing to leverage our capacity with portfolio expansion beyond the traditional hospital. So some great examples of that are our gloves. We're making gloves that can go into the retail market with patented packaging that can then be used in the retail market. It's addition of chemo gloves, surgical gloves, industrial, clean room type gloves, that enable us to broaden that and take the same products that we can make, adjust them and then broaden it to a different market. International market is a great example. During the bulk of the pandemic, we were constricted from exporting product out of the U.S. because we were here supporting our customer base. Now we have the ability to start to export that again as we get to probably the equilibrium we're at now in supply/demand we're in and those restrictions, where we can actually move some of that product to international markets. So there's a lot of factors that tell you here's where it was, here's where it went to. Those protocols are still in place, and that's going to continue to move and then there's opportunities as that moves up and down to expand that portfolio, expand the markets we serve with that. I think that's the -- I think I answered most of those questions. But I will close out on this is again, one of the things that has made us different is our manufacturing. I talked about our Americas-based manufacturing. We have the ability to manufacture in the U.S., Mexico, Honduras. It's all close proximity. In addition to that, a significant portion of our gloves, we talk about 40% to 50% of our gloves we're making today in our own factories. And then we're adding capacity to bring another 1 billion to 1.5 billion incremental gloves through our factory, which is an opportunity for us to add new lines to leverage the existing building and fixed cost structure, the existing boilers and nitrile processing to be able to make more gloves in our own factory. And that just creates more opportunity for us to serve the market.

Okay. Yes. I think we did cover the various components of the question. Just sticking on products and to an extent the PPE sort of tailwinds. Just on margins, they obviously significantly expanded during the pandemic going from 4.5% EBIT margin in '19 to slightly above 14% in 2020. As PPE demand wanes, what gives you confidence that margins won't revert back to those pre-pandemic levels?

Yes. I think first, Jon, it's this PPE wins. I think, again, it goes back to the comment I made, but sure it was pre-pandemic. Here, it was in the pandemic. It's slightly below that, but with all those new protocols and the opportunities and the expansion, that continues. So that's one, as setting that as the base. I think the other aspect you've got to recognize is the fact that we focus tremendously on continuous improvement over the last 3 years. We continue to find ways to get more throughput out of our existing lines. All the different things we did now enables us to get tremendous amount more throughput out of our lines than we're able to get before. So it takes our cost per unit down. And then we drove down -- we drove down our variable cost, as you get more units through. It's the basic fixed cost leverage is another reason why we're able to continue to do that. And that's primarily in our factories of manufacturing. In addition to that, from where we were in 2019 to 2020. 2020 -- when we joined in 2019, we added capacity to bring -- to make more of the nonwoven fabric. Well, that wasn't online in 2019. That is now, because that came online in Q1 of 2020. So now our cost structure is also different in being able to produce our own nonwoven fabric to make a good portion of our PPE. So that's a change, that's different from before. And that's -- all those reasons are why we believe we can continue to manage the way we've managed over the last several years and continue to grow the business.

All right, clear. And -- so moving on a bit, just thinking about sort of -- you touched a bit on private products earlier. Just thinking about private product portfolio expansion and -- bit of a tongue twister. So basically, clearly, an important growth driver for the business or lever of growth for the Global Products segment. And especially in light of this wane, although I fully hear your point that it's to a higher level than it was before. But as this wane in PPE demand comes through, you've talked about plans to expand OMIs incontinence portfolio and recently doubled your wound care product line. Can you provide any additional color on proprietary product expansion initiatives on the horizon for 2022?

Sure. Yes, we look at really in twofold. It's proprietary product expansion, you're right, like incontinence and wound care continuing to expand that. That has -- those have a nice -- a gradual runway, I would say, on those. But it's also the other aspect I talked about by taking products that we already make today and identifying additional markets for those to go into. It's taking products we make today and then demanding them, whether that's a chemo rated glove, whether that's a surgical glove, whether that's a glove that can be used in the industrial markets. So it's not necessarily always going to be going to a brand-new category like incontinence or expanding an existing category like wound care. It's also taking products we have today into different marketplaces where they're needed and wanted. I would say, besides portfolio expansion, we really have some great supplier partners that we also partner with in our distribution business that are critical to our customers, and we support them extremely well, I think, from our business model. But so the heart of the question is, we have the momentum beginning on some of those new products. But in addition to that, we're also looking at how do we take existing products either in the categories and expand that category or taking those into unique markets with unique packaging like our POP-N-GO retail glove packaging.

Cool. Right. And now moving on to Global Solutions. And just talk a little bit about sort of recent wins, the sort of $300 million, $400 million of incremental business in your core distribution segment recently. Where are you seeing the most strength? And also, can you point us in the direction of any important RFPs coming up in the next year or so?

Yes. So from an RFP standpoint, generally, you have -- contracts are 3 to 5 years on average. So generally, you can have between 1/3 and 20% of your business go up a bit. I'd tell you what we've tried to do is, during the last several years, everything we've done to help our customers, and at times, there are still products that they needed that just so much demand, it was tough to get and we tried to make sure we were taking care of all of our existing customers the best we possibly could. We've done a nice job of working with customers to renew those agreements and extend those agreements and our team has gotten much better at that. But in the same sense, we're also looking -- we also have a strong pipeline that continues the potential new wins. I think a great example that I used on the call yesterday was West Virginia University Health along with the state of West Virginia. It's a new win. It's a new win where we're partnered with the university. We're partnered with the state, not to help West Virginia University Health as well as all other health systems in the state of West Virginia. Partnered with them, we're going to add a new service, a distribution service center in West Virginia. And again, it's a long, long-term deal, a long-term transaction that enables us to better serve because they like the ability of our manufacturing footprint. They like the ability of one of -- some of the acquisitions we've done, that can put kitting locally there, that can continue to generate jobs. So there's a lot of things that we can do that continues to strengthen that. And lastly, we've also continued to proactively look at deals that I would say, in 2021, we had no regrettable losses. At times you're going to have losses because you're going to look at the contract, you look at the agreement, you're going to look at the relationship and can it provide the right level of returns based on what the customer needs. And at times, you're going to take a different path on those. But I would say, overall, we've done a -- we did a really good job in '21. The expectation is that continues in '22. Identifying our contracts that we have today, proactively working with our customers to renew those, proactively having those difficult conversations at time. If the economics aren't exactly right, so work with them to find ways. And that doesn't always mean raising a price. That also means that how do you look at the operations. If you have a customer ordering a single item, just take a simple example, 1 swab. That may not be efficient to pick, pack and ship a single swab. Work with the customer and say, well, it comes in a pack of 10, that may be more efficient and working with them on that as well as delivery times to drive operating efficiencies. And we've been more open talking with our customers and listening to them at the same time on how to drive efficiency. So that's why we feel like we have a strong path going forward. And then most recently, we combined the leadership in the businesses, our manufacturing and our distribution business. because the reality is that's the way the customers view us as one company, and it makes it easier now to have conversations and work through all the different circumstances that the customers want to address.

Very clear. And just sticking on these wins. We've recently had Premier Health Vizient, which you renewed your contract successfully with and that's what sort of 50% or so of business. Can you comment on how the process is going with HPG?

We have our contract extended through the end of April. We're actively working with them. Going through the different -- some of the different data points and different conversation points but that's progressing in the way we expect it to progress.

Okay. Very clear. And then moving on to elective procedures. Just -- obviously, we had disruption you mentioned, how there was sort of shut down in parts in December. Can you comment on what you're seeing sort of post Omicron, post this surge and how your outlook sort of -- what your outlook is for sort of elective procedure recovery over the next few months and the rest of the year?

Sure. So coming on Omicron. We saw in December, as Omicron increased, we had some hospitals that shut down completely elective procedures. Others that shrunk them down to what was -- just nonelective procedures. So we saw that slowdown in December. So you think about a normal cycle that December is usually one of the bigger months, November, December are the bigger months, primarily because people have had their co-pays filled up and now they have the opportunity to utilize -- frankly, utilize their insurance to their advantage a little bit more. Some of those got postponed. So now they've moved into Q1. And so you've got that additional pent-up demand that people want the surgery, want to get it done, and we're seeing that -- we're here 2 months into the year already. So we are seeing that influx and that increase, and that pressure on elective procedures. You've certain hospitals where some of the doctors' surgical blocks are completely filled already. So that's why we believe we'll see tremendous strength of that in the first half of the year because of the stuff from the end of last year that we thought would have been processed but it actually got pushed forward. And then we're planning it to be more normal, I would say, in the back half of the year.

Okay. Very clear. And another sort of common incoming from investors is, along with the sort of debate around the elective recovery is -- and something that's top of everybody's mind is inflationary pressures. I realize that you may be less impacted than some of your competitors who sort of rely more on imports. But how is it impacting your supply chain? How are you thinking about it throughout 2022? And where are you seeing the most pressure?

Sure. So I think one of the things we've seen is as product costs have gone up, we try to be open and transparent with our customers. The glove cost pass through, I'd say, is the great -- the best example of that. Andy, our CFO, talked yesterday about it, that in 2021, we had about $660 million of glove costs we passed through. That did generate a very slight benefit. But we also know that that's going to come out in the first half of 2022. And over the entire cycle of those glove cost pass-throughs, it should virtually be neutralized. So -- and I think that's just been -- we've been open with our customers saying, here's the issue. Here's the cost, here's what we have. We're just going to pass that through. That's a great example of some of the things we did. And on the other side of inflation, really, it's the different levers we have to pull. We talk about the Owens & Minor business system, and that's really around continuous improvement. It's eliminating waste. So in our distribution center, we made some investments this year around technology, and we like to balance technology and touch. We don't want to put so much technology in our DCs that they're fully automated, and you can't be flexible and scalable to service your customer and give them the touch that they need. So we've added technology that has driven operating efficiencies through our facilities. The same thing within our manufacturing footprint, the same thing through even back office, in our patient direct business. So those are things we've done to try to offset some of that inflation, whether it be wage, fuel, transportation or just general inflation for that matter. And I think your point is right, Jon, is the fact that the bulk of our products, our private label products or our branded products, that -- specifically that Halyard brand, we're making in our factories. And a significant portion of those are made domestically or near shore. That gives us a different transportation cost than what others might have. But in the same sense, we still have the flexibility to move the manufacturing as needed and then to balance that manufacturing out between our different facilities really in North America.

Great. And then also sort of, I suppose, another sort of inflationary element, but just labor pressures. If we could -- if you could just touch on what you're seeing there and hiring expectations for 2022.

Sure. Yes. So labor pressures, I think everyone is feeling that. But one of the things we try to do is focus on our teammates and really focus on reduction of turnover. And we did that by a lot of things we did for our teammates in 2021. We didn't have similar turnovers others may have had. Look, in 2021, we quadrupled our company's 401(k) contribution match. And that's for all of our teammates. In 2021, we also provided additional bonuses incentive for our workers that continue to work hard through all the waves of pandemic. In 2021, we absorbed the healthcare premium increases for our teammates. So we did a lot of things throughout the year to help mitigate that. In addition to that, we've adjusted our wages over time based on local dynamics and local requirements. So we've seen -- while we've seen churn and we've seen turnover. It's been more -- we've seen it less, I think, than what the market would describe employee turnover at. So that's a critical factor because I think what people focus on is just the wage inflation. But turnover is the other thing that's critical, and that goes back to this whole concept of continuous improvement in operating efficiency. If your cost is slightly higher, but you have lower turnover, now you have full functioning, full productivity, high-skill teammates being able to pick pack and ship your products in the warehouse, being able to set up a machine and drive productivity off of your line. So I think you can't just look at it in wage rates, which is important because wage rates are a big portion of it. But do you have tenured teammates that are well trained, that are highly productive that can help offset some of that wage increase. And that's the reasons why we did a lot of those things we did in 2021 throughout the year to continue to retain our teammates that are already fully trained, already at full productivity. And then as necessary, we've tweaked also wages on top of that where needed. And I think you can see even as the year progressed, we were still able to do that and drive enough efficiencies to mitigate as much of that as we possibly could.

Very clear. And then we're sort of coming up on time. Just a question -- a final question for me on capital deployment -- sorry, capital deployment priorities. You mentioned in the past that sort of debt repayment will continue to be your top priority going forward, followed by organic investment. Pro forma for the Apria acquisition, you'll be just shy of 4x levered. Do you still anticipate being able to reduce leverage to 2x to 3x within 2 years?

Yes, we do. I mean our long-term goal, as we clearly stated back in May, is to be a 2x to 3x leverage ratio. We're going to be close to 4x, call it, I think when you look at the EBITDA and the free cash flow we can generate from our business plus with the acquisition of Apria, that combination, it's not one or the other, it's both. It's going to enable us, over the next, we believe, 18 to 20 per months, post closing, to get our debt back into that 2x to 3x range, which is our targeted range. I think the other thing that's important is it's not just going to be focused on debt pay down, we're still going to have the ability with our EBITDA or free cash flow to reinvest back in the business. So it's not one of the scenarios where we're highly leveraged where you can only do debt paydown. We're still going to have the capability to invest in all of our -- in our organic investments that are in our 2022 plan as well as pay down that debt over this year and into next year.

Okay. Very clear. Right. I think that pretty much brings us up to full time. So with that, I'd like to say thank you very much, Ed and Andy for joining us today, and thank you all for your interest in Owens & Minor. And I hope you have a good rest of the conference. Thank you.

That's great. Jon, thank you, and everybody, thank you for joining us.