Omnicell, Inc. (OMCL) Earnings Call Transcript & Summary

All right. We can go ahead and get started. Hello, everyone. I'm Adam Heussner, part of the technology -- part of the health care technology and distribution team here at Credit Suisse. Thanks, everyone, for joining us. Next up, we have Peter Kuipers, Executive VP and CFO; and Kathleen Nemeth, VP of IR from Omnicell. A way of background, Omnicell is a leading provider of solutions targeting patient safety and operational efficiency in health care facilities. Peter joined Omnicell in 2015 as Executive VP and CFO. Peter is going to begin with a quick presentation, and then we can open the line for Q&A. But with that, Peter, over to you.

Yes. Thank you, Adam. I thought what we would do is we'll give an overview of the company's strategy, our platform offering and our go-to-market approach and momentum that we have. This is a presentation that's available publicly on our website as well. We'll probably spend 15, 20 minutes on the presentation and leave the rest of the time for the Q&A. So why don't we go ahead, Kathleen? A disclaimer. So the way to think about pharmacy, we focus on health systems at pharmacy and then our retail pharmacy as well. We are, we believe, a category creator, really transforming the care delivery model in pharmacy, and we'll talk about that a little bit more after this page. Here are the financials. So why don't we skip those for now. We can come back to those. Let's go to the problems in pharmacy. So for the ones new to the story, the pharmacy in health systems is actually a very complex area. It's a very difficult function to execute. Think about health systems not as 1 hospital building, but think about large health systems that we focus on that have dozens of hospital buildings, dozens of patients, surgery centers, et cetera, where you do need medication. Medication is a very integral and critical part of Western medicine care delivery. Looking at the page here on the left, core or the complexity of the issues around the number of meds or drugs that you need to really have available at any given time to be delivered to the right patient at the right time via a medical professional and with the right dose as well. So you need to have about 3,000 to 4,500 different SKUs, different meds available in your large health system, where you might have 20 hospitals, buildings and 40 outpatient surgery centers. So that's where the complexity starts. The outcomes today are mediocre, I would say, at best. You can see the outcomes on the left side, 1 out of every 200 drugs dispensed to a patient has an error in many other areas you can see there, it is drug diversion where drugs are used by a medical professional or by a family member. The financial aspects of rising drug prices, I think, are pretty well-known. From an efficiency perspective, we had the american association of hospital pharmacists does an annual survey of work time [ goals ] for pharmacy teams. Think about pharmacy teams as being 600, 700, 800 to 1,000 people in the team between pharmacists and pharmacy techs. The study finds that about 75% of all time is administrative or logistic and does not include any interaction with patients or its focus on clinical care. So there are, of course, active drug shortages, a lot of prescriptions never filled. Compliance is a difficult arena as well. And then more and more really important is the people aspect where all these manual efforts lead to dissatisfaction for employees, 50% or more experienced burn out, turnover rates to attrition in health system, pharmacy teams. In our population, we've got a large part of the market is running anywhere between 20% and 40% annually. So you have a pharmacy team of 1,000 people and your attrition rate is 400, you need to -- 40%, you need to replace a higher train and replace 400 people, so 100 per quarter, which is difficult. On the right side, you see what we can deliver. So what we do is medication management automation. We automate the delivery of drug dispensing throughout a health system and also retail pharmacies. So we have some good solid outlooks we can deliver today. We are on a path. We go to the next page. Okay, can we go to our next page. There's an independent autonomous pharmacy advisory board, who came out with a wide favor framework last year, I believe, on what are the issues in pharmacy and how can automation deliver better outcomes in different areas. You see at the bottom, I think, this is a summary page on efficiency, on safety, on compliance, et cetera. We believe in our customer group and we have a large part of the market that generally our customers are Level 2. We can deliver today with our platform Level 3, but we Level 3 in a quarter. And we are executing our road maps for Levels 4 and 5. We now have 151 out of the top 300 U.S. health systems who are long-term sole source partners of us who have signed 7, 10 or in times 15-year exclusive agreement to really go on this journey. And the vast majority of these have long-term co-developed plans for this together that we develop with them to really move the needle and get to the next levels of automation. Let's go next page here, Kathleen? So how do we do this? So we have the largest, we believe, largest installed base of connected devices. You see at the bottom of the page. In the middle of the bottom bar, you see central pharmacy connect devices. So the XR2 robot and IV robots and workflow for IV. Typically, medication is prepared and stored and dispensed in the central pharmacy location and then brought to the floor either in an ER, OR, or a patient area via dispensing systems that you see on the left. We are connecting it all via the cloud, and then we have value-add software like Omnicell One and the robotic services and life & health and 340B that really bring to life and add the value on the connected devices and drive the outcomes. Let's go next page. So we operate in large TAMs. We believe that the top 200 U.S. health systems represent around 70% of the TAM for the first 3-year rows here. Retail, we took kind of [ 2 ] separately here with EnlivenHealth. Let's go next. So we believe an important point here is that our business model really drives resilient and high feasibility revenue. We have a very healthy backlog that we have reported by the end of last year. We have updated our guidance in the last earnings call. We've increased our bookings guidance, revenue guidance and profitability guidance metrics as well. You can calculate using those numbers what our expected ending backlog would be this year. So that gives high visibility into forward revenue, again, 151 out of the top 300 U.S. health systems have signed a long-term sole source agreement with us. And the vast majority of those have -- actually, we have developed a multiyear co-developed investment plan that we have, as a result, also higher visibility from a very high customer retention. Then on the right side, the dark green, those are -- that's the connected device revenue, again, because of the backlog, because of the 151 long-term sole source agreements, because of the high customer retention and the long-term [indiscernible] plans, investor plans, we have very high visibility in that forward revenue as well. And in the lighter sheets of green, we have a pure recurring revenue between technical services and then the lighter screen is the -- what we call fan services, which is SaaS and subscription software and tech-enabled services that latter part that 6% we expect to be able to grow quite aggressively. Let's go next page. So as this is measured as a percentage of revenue, so those Advanced Services were about 6% of total revenue in 2020. This year, we expect that to be around 10%. We increased that point or guidance point from 9% to 10% earlier. Now we think it's a stall at 10% of total revenue. while we're also growing revenue aggressively, right? And then we expect to grow that to 20% or 30% by 2025 based on reasonable assumptions, mostly on our current customer base. Let's go next. So here is our total growth trajectory that we've laid out earlier this year. So we expect organic revenue growth to be between 11% and 12%. Again, it's expansion of automation, current customers, market share gains, upgrade cycles and it will drive innovation to the next level of Autonomous Pharmacy. Then on top of that, we believe we're a very logical acquirer in medication management automation. So we expect to get another 300 basis points or 3% of additional revenue growth for total revenue growth goal CAGR of 14% to 15%. Let's go next page. Also from a profitability perspective, we're executing on margin expansion of about 400 basis points, both from the OM line and on the non-GAAP EBITDA line, really driven by improved business mix from these expanded services that have higher gross margins. The long-term sole source partnership agreements have pricing momentum. We, of course, have volumes and skill benefits. Then we also have specific manufacturing saving programs and internal process efficiencies. Let's go next. Here's our shareholder return are pretty evident. Stock has been doing well and is being appreciated. Let's go next. So then in summary, we believe we are a category creator solving real issues in pharmacy in the large market. We are a partner -- a strategic partner to health systems. We have high visibility revenue, [indiscernible] factors I just discussed. And we have a strong track record of profitable growth. So why don't we open it up for questions?

Yes. No, that would be great. Thanks for the presentation, Peter. So I have some prepared questions, but if anyone from the audience wants to ask a question, feel free to e-mail me at adam.heussner@credit_suisse.com, and I can ask on your behalf. So, Peter, yes, thanks again for the presentation and for participating this year at our conference. Maybe just going back to just the Continuum of Care that you have as part of the Omnicell platform, can you just give us a sense about how you're able to drive your customers to focus more on the clinical aspects of what they need to do in their day-to-day opposed to just the administrative tax that come along with pharmacy inside of a health system?

Yes. I think there's 2 parts to your question there, so the team of care really goes from acute to kind of non-acute to retail. I would say we have a very strong platform, probably a market-leading platform on the acute and kind of outpatient care side, if you will. And then also on the retail side, we're building this platform in life and health with leading communication tools, med synchronization tools, also with the acquisition of FDS. It includes also our financial tools to improve profitability for retail pharmacies. And then it also now includes with FDS Amplicare medical plan comparison tools also. So that platform is also growing. So that's kind of the Continuum of Care, right? We then maybe look on the kind of the health system side. Again, we have meaningful partnerships with these 151 health systems where we're really looking at what are the issues in pharmacy that, that team experiences. They do get a partner on-site actually, it's called a Customer Success Executive. Normally, that's a pharmacist or a nursing consultant that really helps them develop the strategy and also the investment strategy to resolve some of these issues and fee automation, get to better outcomes. And that includes also better experience of life and work, feel less manual touches.

That's makes a lot of sense. When we think about just the whole platform in general, I know you gave a slide that talked about the -- or showed an image of the revenue breakout in terms of where it's coming from. But when we think about just the software and the technology behind the whole form, how would you kind of rank the level of importance, whether it be just through the underlying software versus these devices that you have as part of the platform as well?

Yes. So the choice of specifically having 151 large health systems, they focus really on the platform, right? So they want the outcomes and to some extent, how it's delivered is less important. From an R&D perspective, we said publicly before that the 70% plus of our R&D spend is software related, right? Now that is both, maybe go to the cloud page again, Kathleen, that is both control software for these connected devices, right? It is, of course, cloud software and then it's also, of course, the software that you see as part of the dark green here of these Advanced Services. So that's kind of the relative investment level, if you will. However, I think we're at a competitive advantage because we have these connected devices in the field, right? Medication has a physical appearance, we need to safeguard that, track it, have high visibility to really operate a pharmacy to good levels of outcome.

And these future devices that you kind of alluded to in the slide deck, is there anything that we should be taking into account here of what type of devices these would be projected out to be? Or any high-level thoughts about what these future device aspect might be?

Yes, what you've got to think about in building the framework of the 5 levels of automation that we just looked at, right? So there's more automation going from Level 3 to 4 and 4 to 5 and take out manual steps. That's kind of the way to think about it. The critical -- where errors occur or less visibility occurs, where losses occur is always where there's a human involved really, right? So it could be more robotics. It could be more software, et cetera, right? So we haven't -- we traditionally don't disclose what we're working on from a product road map perspective you would understand.

Fully understand. And you called out the 151 of the top 300 health systems in the U.S. you're working with, just give us a sense like who else is operating in this market? And maybe even more so, do you see health systems doing some of these capabilities themselves instead of partnering with a vendor such as Omnicell?

The answer to the latter is no. We could talk about competition. Maybe go to the cloud base again, Kathleen. So we believe we have the most complete platform today, right, servicing, really enabling at Level 3 in a quarter. There are point solution competitors, right? So back to decades in place in the kind of point-of-care systems on the bottom left, but they don't have robotics or 340B software or as a service software, if you will. Swisslog has robots or the pharmacy robots, but they don't have an IV robot. They don't have the point-of-care units at the bottom left. Of course, they got nothing on the top layer as well, right? So that's the way to kind of think about it. So the choice is core health system, most of them are recognizing the problems in pharmacy to kind of the first page where we started on. And you want to improve, there's really 2 choices, right? One is you choose Omnicell as a strategic partner, we have the most complete platform, not fully complete because we need to go Level 4 and 5; or you work with 10 or 15 point solution vendors and you have your IT team try and stitch it together with APIs and [ hosting, ] which is likely more difficult, probably less efficient and probably more error prone.

Let's talk about some of the cross-sell opportunities that you see across the platform. Obviously, you have a very robust solution set right now, but maybe just talk about some of the cross opportunities you see as part of the acquisitions you've done? And maybe just how accretive you're thinking about these deals that you've done recently?

Yes. Maybe specifically to point out 340B is a very important program for health systems. The vast, vast majority of these 151 health systems that we have long-term partnership agreements with, are licensed or have content entities where they can have a 340B program. So there's a great opportunity there. I think we've disclosed 1 or 2 cross-sell wins already since the acquisition. So that's a great part of the platform to have. There could be future integration actually between 340B and central pharmacy robotics, you see in the middle there because of the flow of the [indiscernible] and where you actually get the discount. So I think that's fantastic. We expect good cross-sell opportunities from FDS to EnlivenHealth and the life and health customers, right, the services that way. And also the other way, a life and health software modules we expect to also be able to cross-sell to FDS customers. So those [indiscernible].

Very interesting. What's been the overall, I guess, impact of COVID on your business? Obviously, the health systems have been under pressure a little bit here because of the focus on COVID specifically, but maybe just talk about how -- maybe just the focus from the health systems perspective has shifted for solutions like yours throughout COVID and maybe where we are now?

Yes. I mean what we saw doing kind of the first wave of COVID was that the health systems realized that their visibility to where they have these 3,000 to 4,500 meds of SKUs was very limited. So to treat a COVID patient, you need 75 different meds. So that wasn't acceptable. We believe that raised really medication management automation to an even more strategic level, and we think it's staying there, if you will. So very strategic. I think from -- there's an operational perspective and health systems being able to implement medication management automation systems. I mean, that ability really came back late last year, and that hasn't changed and health systems really know well now how to treat COVID patients and have implemented all safety processes as well. So that's not a hindrance for us to engage and implement systems.

And maybe just -- if we think about maybe the spectrum of health systems, you have the very large ones on one side and kind of the more regional ones on the other. Would you say you get -- Omnicell is pretty penetrated across all of those different types of, at the large ones and your smaller ones? Or are you more focused on the smaller health systems? Or maybe just give us some thoughts there?

So maybe first, maybe a question we sometimes get that we've talked probably about it kind of within the 151 health systems that have a long-term sole source partnership agreements, how are they spread out over the top 300? The answer there is it's a pretty equal spread between the super large, medium large and then the large, if you will. So maybe that's one part of the answer. And the other data point that we've given is that we believe that the top 300 U.S. health systems make up about 70% to 80% of the TAMs that are relevant for our solutions, right? So we do have smaller health system or hospital customers as well, but they make up a smaller part of revenue.

Got it. Makes sense. Maybe just give us some sense about how Omnicell manages more like the -- some of the controlled substances, maybe some like the opioids. How does that impact your business? And what kind of protocols or initiatives are in place to help manage that side of pharmacy, I guess?

Yes. Well, really, I would say, first of all, if you automate as a health system, you get to the next level of automation. You get more visibility, including also more visibility and tracking of narcotics. We do offer a diversion software tool that's part of Omnicell One. That really looks at behavior of medical personnel, looks at make sure people are actually on shifts, make sure that they don't sign in, where they're not supposed to work. They look at algorithms around wasting of narcotics or morphine to see if there's patterns there or not. So you can kind of triangulate in and correlate. I believe it also has algorithms around kind of the speed of actually entering numbers on the keyboards. People that use narcotics have sometimes [ X ], I guess, a faster way of typing some words. So we've got some good knowledge there and algorithms that we can actually with confidence detect -- those tools can help detect potential medical professionals that commit that version, right? So that's an important tool. And then, of course, then the HR team of the health system will need to work on that, if you will. That's the [indiscernible] that we do. We provide the software tool. From a fiscal perspective, we have a specific controlled substance dispensing tool, if you will, that's part of the point-of-care units on the bottom left. So that's a premium upgrade. We're essentially -- it's automated dispensing, but only 1 unit can be dispensed at the time. And it can only be the dispensed that if it is prescribed to a certain pace and a certain time that's on that location before that specific math, and it's architected that way that we cannot get to the other doses. And we see some good uptake in that solution. We announced actually, I think, it was this week, the partnership with Fresenius Kabi, right? So those specific formats of Fresenius Kabi, we ensure that those can go through the controlled social dispensing system as well.

Got it. Very interesting. What about just the regulatory landscape and how you think about that, I guess, more so impacting your customers? 340B is always in the news in terms of developments there. But maybe 340B and anything else you're willing to share in terms of the regulatory landscape that you've been maybe watching more closely as of late?

Yes. So 340B, what we have said publicly is if you kind of look at the history every couple of years, there is pushback from pharmaceutical companies that operate at a 90% gross margin level on participating in a program with their meds, if you will. And then you also see then the government support or the legal system support, federal support, court support for the 340B -- in favor of the 340B program. And I think if you look at [indiscernible] research it, we see that trend again in the last couple of months where there are a number of manufacturers that had excluded certain meds from the -- to partake in 340B program. And if you look, I think, over the last couple of months, what we've seen is that there are court rulings that are in favor of the 340B program and then the manufacturers are obliged again to put those medications back into the program.

Got it. And on Slide 13, I believe you had -- you laid out kind of the long-term margin expansion opportunities. Can you just elaborate on some of those specific components that you think about as you bridge to that long-term margin opportunity? And what types of investments you're making now to kind of bridge to those levels in the future?

Yes, I think that's a good question. Yes, I talked about what the profitability drivers are. But they, of course, they do come with investments. So improving the business mix to more Advanced Services, that is driven by essentially software engineering, right? So that's where we make investments. On the long-term customer, long-term partnerships, that investment there is mostly on go-to market, mostly in the form of Customer Success Executives, right, that are embedded in the health system that help map out what are the current problems, what are the KPIs, what do you want to drive about the strategy and investment. So that's a commercial investment. The economies of scale and then, of course, in manufacturing savings, we have certain programs in automation, tender saving programs that we have put in place and then price efficiencies, and that's more on the IT side and then price improvement side. Yes. But it does -- that's an excellent point, Adam. It does require investments. And I think in our prepared remarks every quarter, we do comment on that as well that we keep reinvesting of course, part of the growth or the additional profitability into further scaling out of business. We think there's a -- we're in it for the long term, our 151 and other health care customers. So these are really multiyear -- multi, multiyear horizons and improvement programs.

Got it. Let's talk about some of the more, I guess, timing dynamics in the market that probably no company is immune to is just the labor markets. And obviously, with your business, a lot of it is technology-based and innovation-based. So I mean, have you seen any difficulty in recruiting or retaining those maybe high-value employees who are driving a lot of the innovation and thought processes that drive some of those future technologies and innovations for the business? Is that anything that you've seen recently?

Yes, absolutely. We -- in our prepared remarks last week in the earnings call, we pointed out that we had hired over 100 new employees net hires, if you exclude the acquisition, right, of FDS. And the majority of those were actually software engineering -- and what we call customer experience, which is really implementation services, right, and consultants. So that -- those are highly talented, sought-after employees and team members. We think we're a very attractive employer. We are making a difference in health care. We do believe we're a category creator. Any of the current size and the future size of the company, I think, as you compare it to the really, really large health care technology companies, you can have an impact here, a real impact and then work with customers as well. So -- and we're on the mission, right? So we had 2 weeks ago with a leadership meeting with the top 120 people in the company, and then I have to say it's probably the -- by far the strongest leadership team I have been part of. So I'm very proud of what we've done, and there's much more to come.

That's great to hear. Maybe just the other question I'll ask about just the supply chain disruptions we've seen globally with the device aspect of your portfolio, has that been much of an impact? Or has that been fairly offset by some of the efficiencies that you've been able to put in place?

Yes, to be clear, if we kind of -- let me kind of summarize what we said publicly, right. So we've always put customers first and then employees a close second. So we want to support our health system customers back in the May, June time frame, specifically for semiconductors. We saw that demand that supplier was diverging, right? So we had a choice to make. So we analyze what we could do. Option 1 is kind of continuing what you were doing, or option 2 is look forward and really because we have a healthy backlog, right? So we know many, many months ahead, what implementations will occur, right? I already contracted. We know the configurations of those systems. And then we also know, of course, what we need from a semiconductor perspective. So we decided to do a prebuy for the calendar year '21 and a prebuy for calendar year of '22, which comes, of course, with inflationary costs, but the trade-off is that we have a high level of confidence and surety of supply. Again, it's not 100% sure. There's still risk management, but at very high level of confidence, and we have no shortages so far. We've said in public comments as well, which is fairly exemplary. What we've also done is we have qualified alternative CPU parts that we can also use with at least the same performance or a better performance. And then we've also done direct buys from semiconductor manufacturers, right, that we didn't buy directly. And then lastly, we have taken inventory of semiconductors early. You saw that in the prepared remarks, I think it was $3 million or $4 million of additional inventory in the third quarter of semiconductors, right? So that's from a supply chain perspective. I'm sure that we have a high confidence surety of supply, but it comes at inflationary cost. And we said, I think for the fourth quarter that we had around $3 million -- $2 million to $3 million more inflationary costs in the fourth quarter compared to the third quarter. Now third quarter, of course, also had already a fair amount of inflationary costs. What we've said going forward is that we also have, of course, freight and steel inflation. Now those 2 markets inherently are more spot markets, right? So for example, sea containers, shipping costs, for example, the rates for those, it's fivefold from what it used to be 12 months ago. So that definitely is higher from what it used to be that, that will continue, to some extent -- to a large extent, also probably into 2023. We do supplement or replace sea freight with airfreight when needed. We've done that, and we'll continue to do that because the priority is serving our customers. And then somewhat similar fashion steel as well, also a spot market, but we have teams both on the freight side and steel side to really look at and make sure we continue to operate the supply chain. So again, high confidence. But I think from a cost perspective, on steel and freight, there's more volatility, right, because you cannot do forward buys, right? So we have also, at the same time, initiated pricing actions. They are threefold: one, we increased pricing -- list prices; two, increase the minimum levels or expected levels on the margin levels of deals; and three, we've increased service pricing. Now that said, of course, the impact to the P&L of these pricing actions will follow later because, of course, the already contracted purchase orders and contracts in backlog, by and large, were not necessarily touching, right? So the inflation kind of comes first and is at a higher level and then pricing actions are more and more offsetting, we believe, the inflation as we go into this quarter and next year.

Got it. No, makes a lot of sense. And maybe just last question as we wrap up here, but you've got a strong presence here in the U.S. with 151 health systems, does -- maybe just give us some sense about the international business and whether you see that as more of a -- or maybe a larger growth opportunity longer term? Or maybe just some high-level thoughts on U.S., domestically versus international?

Yes. Our international business is growing at a very strong clip. I think the difference between domestic practice of pharmacy and international is that the level of automation or need for automation, the workflows is higher in the U.S. and Canada than it is by and large in Europe. So in our customer base, and we look at -- this is more on a simplified level, but, let's say, a hospital building has 100 theoretical or potential locations for connected device or including a robot by it. We see in the U.S. that around 60 of those 100 locations are -- do have a piece of automation, a connected device. And that used to be 55, 5 years ago or maybe 50, 5 years before that. That same metric is probably 20 in the U.K., 20 in the Middle East, maybe around 10 in France and probably lower in Germany. So the adoption is starting as well in international. There's a little more complexity that the workflows are different in every country. So we really have to watch scalability and the level of investment we put in, but definitely a growth market. So we definitely believe in the long term, that's a very strong double-digit growth.

That's great. Anything else that you wanted to highlight before you wrap up for today in terms of Omnicell to market and maybe just some high-level thoughts as we wrap up for today?

Yes. So I mean you've seen the financials in the [indiscernible] we had a really good quarter. We increased bookings guidance. We increased revenue guidance. We increased EBITDA guidance. We increased non-GAAP EPS guidance. We had a strong free cash flow performance. We signed 3 new long-term sole source agreements, 2 of which were competitive takeaways. We announced that what's called CPDS, which is a full robotic service for one of the VAs in the U.S. And then -- so we're pleased with the momentum, and we think we're well managing inflation and surety of supply, partially offset with pricing actions. So very, very pleased with the momentum. It's not unexpected because we are managing the business kind of on a layer basis, on a go-forward basis and drive that recurring part and visibility. So really pleased with the execution of the strategy by the teams.

That's great. And with that, I think we can wrap it up. But Peter, thanks a lot for participating at the conference. And thank you for everyone who joined in today, and that's Peter Kuipers, CFO of Omnicell.

Great.

Thanks, Peter.

Thanks, everyone.