Peter Kuipers - Chief Financial Officer Randall Lipps - Founder, Chairman, President, and Chief Executive Officer

Mohan Naidu - Oppenheimer Sean Wieland - Piper Jaffray Jamie Stockton - Wells Fargo Charlie Haff - Craig-Hallum Capital Mitra Ramgopal - Sidoti

Thank you. Good afternoon and welcome to the Omnicell third quarter results conference call.

At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time.

Joining me today is Randall Lipps, Omnicell Founder, Chairman, President, and CEO. This call will include forward-looking statements subject to risks, uncertainties, and other factors that could cause actual results to differ materially from those expressed or implied.

For a more detailed description of the risks that impact these forward-looking statements, please refer to the information in our press release today; in the Omnicell annual report on Form 10-K filed with the SEC on February 26, 2016; and in other more recent reports filed with the SEC. Please be aware that you should not place undue reliance on any forward-looking statements made today.

The day of this conference call is October 27, 2016, and all forward-looking statements made on this call are made based on the beliefs of Omnicell as of this date only. Future events or simply the passage of time may cause these beliefs to change.

Finally, this conference call is the property of Omnicell, Inc., and any taping, audio duplication, or rebroadcast without the express written consent of Omnicell, Inc., is prohibited. Randall will first cover an update on our business.

Then I will cover our results for the third quarter of 2016. Following our prepared remarks, we will take your questions.

Our third quarter financial results are, as usual, included in our earnings announcement, which was released earlier today and it's also posted in the investor relations section of our website at omnicell.com. Our prepared remarks will also be posted in the same section.

Let me turn the call over to Randall.

Thanks, Peter, and good afternoon, everyone. We are pleased to discuss our third quarter results.

I'm very proud of the performance, which continues on our consistent track record over the past several years. I am pleased to report record quarterly non-GAAP revenue of $179 million for the third quarter of 2016, representing a 2% sequential and a 43% year-over-year growth.

Our top-line results are in the middle of the revenue guidance that we provided for the quarter. Together with good gross margin, operating expense, and integration execution, this revenue strength resulted in non-GAAP EPS of $0.40 for the quarter.

Bookings momentum for new and competitive conversions continues to be strong, driven by our award-winning, differentiated products. As mentioned on our prior earnings call, with the acquisition of Aesynt, Omnicell has gained an additional 10% of the automation and analytics market.

On a combined basis, new and competitive conversions accounted for approximately 34% of year-to-date automation and analytics bookings. We believe that the year-to-date new account strength and our strong combined installed customer base gives us a robust platform for future growth, driven by expansion, replacement, and upgrade sales, as well as cross-selling opportunities across our product portfolio.

Our integration of Aesynt has been progressing very well. In the second quarter, we integrated the sales and field teams in North America to provide one face and contact to the customer.

And later in that quarter, we realigned other functions. As part of this integration, we had a modest reduction in headcount in early April.

We have now moved our integration efforts to focus on process integration as well as the development of a combined product roadmap. We are confident that the combined product development teams will continue to bring industrial leading and award-winning products to market to best serve our customers.

Now, in the last number of years, we have successfully grown the business by implementing three scalable growth strategies: growth through differentiated products, growth in new markets, and growth via acquisitions. In the third quarter, we continued to experience great wins and added notable customers to our Omnicell family under our first strategic pillar of differentiated products.

With several large competitive conversions, we estimate that we have gained further market share in the first nine months of 2016, a continuation of the market share gain trend and momentum as we have experienced for many years. This quarter, we had some great wins with prominent new customers as well as significant deals with existing customers, including Wellforce and University of Florida Health Shands Hospital.

Wellforce, a new health system in Massachusetts which was founded by Tufts Medical Center and includes Lowell General Hospital, has selected Omnicell's medication management and analytic solutions to ensure medication security and safety at its hospitals. Both facilities will be replacing and updating their medication distribution systems on the hospital floors.

Wellforce also purchased Omnicell analytics to help proactively to identify and prevent drug diversion. Wellforce continues our success with leading academic medical centers.

Earlier this year, as highlighted in yesterday's press release, we announced partnerships with both Dartmouth-Hitchcock and Stanford Healthcare to enhance clinical staff workflows and foster improved patient care. During Q3, longtime customer Shands Hospital substantially added to their portfolio of Omnicell products for both their main campus in Gainesville, Florida, and a new health heart and vascular hospital currently under construction.

With approximately 1,000 beds in their main campus and 260 rooms in the new facility, the University of Florida Shands Hospital chose Omnicell for a broad range of products that can best meet the needs of their growing health system. Our second strategic pillar of expanding into new markets also fueled growth in the last several years, and we believe sets us up well for the coming years.

Internationally, we had our first installation of a robotic dispensing system in Australia. Wattle Park, a community pharmacy near Melbourne, is automating their facility to allow pharmacists to spend more time with customers, provide better stock control, and improve efficiency.

The installation demonstrates our commitment to expansion into new geographies as well as expansion into the retail pharmacy marketplace. Our third strategic pillar of expanding our presence and relevance through acquisitions has also delivered great results with the acquisition of Aesynt business that was announced in 2015 and closed in the first week of January this year.

One of the areas where Aesynt allows us to expand our business is in the automation of fluid medication management. The IV solutions product line, which includes both automated and semi-automated solutions is the market-leading solution to automate both sterile IV and oncology medication preparations.

The solutions provide customers cost reduction, higher quality IV preparations, and improved safety for clinicians working with cytotoxic drugs. Also, over the next few weeks, we will be introducing our new corporate brand theme: Inspired by Care.

We view this as the foundation for our company and our vision to improve healthcare for everyone. It is what inspired me in the earliest days to create a better way to support nurses.

And today we now offer a wide range of solutions to ensure patients are safely and accurately receiving the medications and medical supplies needed for treatment across all care settings. At Omnicell, every employee is inspired by our customers and their commitment to care.

This inspiration flows through the solutions we developed, build, and support all in the name of keeping caregivers focused on what's most important: the best outcomes for patients. Every day we are focused on and dedicated to our mission to change the practice of healthcare with solutions that improve patient and provider outcomes.

We know that our health system partners are challenged by a dynamic and complex environment, impacted by consolidation, shifts towards value-based care, and escalating regulatory requirements. The data generated by our solutions often serve as key for customers pursuing transformative change.

To further unlock this potential, I am pleased to announce the launch of Omnicell's Performance Center. The Performance Center represents a paradigm shift in our approach to customer engagement.

This new real-time services offering will help our customers optimize their pharmacy operations, not only from using advanced technology but also from surrounding themselves with a team of Omnicell experts who will work with them to constantly monitor their operations and recommend improvements. We believe the Performance Center provides them a unique approach that will deliver tremendous value to our customers.

Our long-term vision for the Performance Center is to be continuously engaged in our customers' success by advancing more efficient operations, helping them meet regulatory compliance, and ultimately improving patient outcomes. Our newly launched Performance Center has already helped the few initial customers who have adopted the platform to save over $6 million just this year.

More Performance Center product launching details will be made available in the coming weeks. This new offering and our third quarter results again demonstrate the strength of the broad product portfolio that bolsters our role as a strategic partner to health systems all around the world.

Let me turn the call back over to Peter for some financial update.

Thank you, Randall. I will discuss a summary of our third quarter financial results and our guidance for the full year.

Our third quarter 2016 GAAP revenue of $177 million was up 41% from the same quarter last year and up 2% sequentially. The strength in revenue is driven by both expansion and upgrades at existing customers as well as by new and competitive conversion customers.

We continue to see particular strength of the combined product portfolio to enable strategic, tailored, and scalable solutions for customers. Earnings per share in accordance with GAAP were $0.05, which is down from $0.22 of earnings per share in the third quarter of 2015.

GAAP gross margin was at 46% for the quarter. In addition to GAAP financial results, we reported our results on a non-GAAP basis, which excludes stock compensation expense and amortization of intangible assets associated with acquisitions.

It also excludes one-time acquisition-related expenses and the acquisition accounting impacts related to deferred revenue and inventory fair value adjustments. We use non-GAAP financial statements in addition to GAAP financial statements because we believe it's useful for investors to understand acquisition amortization-related costs and non-cash stock compensation expenses that are components of our reported results, as well as one-time events, such as the gain on the Avantec investment in 2015 and the one-time acquisition related expenses.

A full reconciliation of our GAAP to non-GAAP results is included in our third quarter earnings press release and is posted on our website. Our third quarter 2016 non-GAAP revenues of $179 million were up 43% from the same quarter last year and up 2% sequentially.

On a non-GAAP basis, earnings per share were $0.40 in the third quarter 2016, up $0.04 or up 12% from the same quarter last year and up $0.02 sequentially. Non-GAAP gross margin was 50.7% in the third quarter, up 80 basis points from the second quarter this year.

Non-GAAP adjusted EBITDA was $27.5 million for the third quarter of 2016, up 15% from $23.8 million a year ago and up 5% sequentially. Our business is also reported in segments, consisting of automation analytics and medication adherence.

Automation analytics consists of our OmniRx automated dispensing cabinets, anesthesia workstations, central pharmacy, Omnicell supply, Omnicell analytics, and MACH4 robotic dispensing systems. Our acquisitions of Avantec, MACH4, and Aesynt are also included in this segment.

The medication adherence segment consists of all adherence packaged consumables, which are now branded SureMed and equipment used by pharmacists to create adherence packages. Our acquisitions of MTS Medication Technologies and SurgiChem Limited are included in the medication adherence segment.

As a reminder, we now report certain corporate expenses that cannot be easily applied to either segment separately. On a segment basis, our automation and analytics segments contributed $152 million in GAAP revenues in the third quarter of 2016, up from $103 million in the third quarter of 2015 or an increase of 48%, driven by the acquisition of Aesynt and by organic growth.

$25.5 million of GAAP operating income this quarter compares to $26.7 million for the same quarter last year. $38.8 million of non-GAAP operating income in the third quarter of 2016 compares to $29 million last year.

The medication adherence segment contributed $24.3 million of GAAP revenue to the quarter compared to $22.3 million in the third quarter of 2015. The weakening of the Great Britain pound resulted in a $400,000 foreign exchange headwind on revenue compared to the second quarter of this year.

Most of this impact fell through to margin, as cost of goods sold is mostly U.S. dollar based.

GAAP operating income for the med adherence segment was $0.8 million compares to $0.3 million a year ago. Non-GAAP operating income of $2.3 million in the third quarter of this year compares to $1.7 million in the third quarter a year ago.

Non-GAAP common expenses were $18.6 million compared to $11.1 million in the third quarter of 2015. The increase is mostly driven by the Aesynt acquisition.

Non-GAAP operating margin was 12.5% for the third quarter. And year-to-date non-GAAP operating margin is ahead of plan, driven by the strength in revenue and cost underruns.

In the third quarter of 2016, our cash balance increased from $41 million to $47 million, primarily driven by cash flow from operations. Year-to-date cash flow from operations is $24 million.

Our strong cash flow in the first quarter enabled us to repay $20 million of the outstanding balance of our credit revolver in March. In addition, we have repaid $5 million of principal on our term loan since the inception of the loan.

As of September 30, 2016, we had $230 million of outstanding debt. And our loan leverage, measured as outstanding total loan balance over the last 12 months of EBITDA was slightly below 2.0.

Accounts receivable days sales outstanding for the combined business were 91 days, up 6 days from the second quarter. The increase in DSO, however, was entirely billing timing driven as we exceeded cash collection goals.

Compared to the second quarter, we had an additional $20 million in invoicing related to shipments of equipment. Our customer agreements specify that for equipment sales, the company invoices 100% of the contract value at shipment date.

We review the collectability of our receivables regularly, and we do not believe that the fluctuation in DSO are indicative of a change in our rate of bad debt. Inventories at September 30 were $74 million and flat from last quarter.

Our headcount was 2,246 at the end of the quarter, also flat from last quarter. We are reconfirming our 2016 total year bookings guidance.

As discussed on our fourth quarter and full year 2015 earnings call, for 2016, we expect product bookings to be between $540 million and $560 million. As discussed in previous earnings calls, it's important to note that from time to time, installation completion timing on specifically bigger projects can impact revenue and earnings in a given quarter.

But we don't expect such quarterly fluctuations to impact the growth rate measured over multiple rolling quarters. We now expect 2016 non-GAAP revenue to be between $700 million and $710 million, depending mostly upon the timing of installation completion signoff.

We expect 2016 non-GAAP earnings per share to be in the middle of the range that we previously guided to of $1.50 to $1.60 per share. We are assuming an annual average tax rate of 38% on GAAP earnings on a combined basis.

This assumption includes the benefit of the R&D tax credit impact, as it has been permanently approved by the government. As discussed in prior earnings calls, we consider 2016 to be a transitional and transformative year as we integrate Aesynt and gain momentum from our expanded product portfolio and develop an integrated product roadmap.

As discussed on previous earnings calls, when comparing 2016 to 2015, it is important to note a couple of items that are new for 2016. First, for 2016, our non-GAAP expected results include approximately $10 million of integration expenses that we do not adjust for based on our non-GAAP policy.

These integration costs directly impacting non-GAAP operating margins and non-GAAP EPS mostly consist of retention costs, integration-related IT expenses, costs related to the implementation of Sarbanes-Oxley controls, costs related to tax restructuring, costs related to accelerated product development integration, and costs related to the integration team and project costs. The second bucket of items that we have in 2016 that we did not have in 2015 is that we do expect modest first year cost synergies in 2016 between $5 million and $10 million.

As we have demonstrated in the past, we have confidence in our ability to achieve our 15% non-GAAP operating margin target over time, and after integrating the acquired business and getting full benefit of the scale of the combined business. With the sales and field related reorg that we executed in early April as well as other actions, we are on track for the first year cost synergies between $5 million and $10 million, and are tracking more towards the upper end of this cost synergy range.

And then, lastly, for 2016, we expect interest expense related to the senior secured credit facility used to finance the Aesynt acquisition to be around $6 million. Compared to 2015, this is a headwind to non-GAAP EPS of around $0.10.

Operator, we are now ready to take questions.

Thanks for taking my questions. Randy, on the market share gains that you talked about, can you update us on where you are in terms of market share in the automation segment in the U.S.?

I believe in most recent survey that was done independently by the Association of Hospital Pharmacists, it showed us at right at 40%. Obviously, we have a lot of customers in backlog who have it installed who are not represented in that number.

So we think it's north of 40%.

Yes. Similar to what we have said previously and that still holds as we look at the data.

So we were 30% of the market before the Aesynt acquisition, then Aesynt was 10%, gets to 40%. And looking at our competitive conversions and competitive wins, we are on track this year to gain about 2% market share.

And we are tracking to that trend. So by the end of the year, we should be roughly around to 42% market share.

Got it, got it. And if you look at the U.S.

market right now, how do you see as the market that is prime for upgrading to G4 or the latest version, either from you guys or from your competitor? In other words, I'm looking at what kind of a mix of hospitals are going to look to replace their automated medication management solutions in the next 3 to 5 years?

I think every hospital system is on its own path of upgrade if you will. And obviously Omnicell has a great reputation of getting the best value of our products by allowing our customers to keep the majority of their systems in place in doing the G4 console upgrade.

But as we move forward, we think that when you combine that with the Aesynt base and our product roadmap into the future which frankly we're going to discuss more in detail at our December major tradeshow at ASHP, we are really going to be able to give customers a lot of choice on the avenues that they can take. And we've really been able to, in some ways, accelerate some of the choices that we can give customers beyond what we've originally thought.

So it really puts us in a great position with our entire customer base to move them along to more technologically advanced systems, with more technologically advanced backend systems that connect to the Performance Center. So we've got a lot of very exciting things going on, and we look forward to sharing it with everybody in December.

That sounds great. Thank you very much for taking my questions.

Thank you, Mohan.

So you ended the call talking about some 2016 items and one of them was $10 million of integration expense. So do I hear you correctly that that's $10 million of expenses that we can essentially take out of the model for 2017?

No. So we have talked in earlier earnings calls that we expect the integration to be two years.

And we expect to have a similar amount of integration cost that we do not adjust for in non-GAAP also next year. The composition or the nature of the components of that cost is a little bit different in the second year.

It will mostly focus on the IT systems implementations that I've talked about.

Okay. And then it goes away in 2018?

Yes, so we're trying to get to the run rate again of 15% in non-GAAP operating margin as we end 2017.

Okay. Thanks.

And so in the automation and analytics segment, I know you guys hate to do this, but we have to ask. Can you talk about what the organic growth is from both the core business as well as the organic growth within Aesynt?

And then maybe the third category is what's the – what kind of juice are you getting from the combination of the two? And what kind of organic growth could we expect going forward in that segment?

So a couple of questions there. So next week we will file our – or two weeks maybe file our 10-Q.

And one of the footnotes there in the quarterly report is the organic revenue calculation, if you will. And you can look at the 10-Q from last quarter and the quarter before that, the one that we will file in the coming weeks will show a 6% organic growth rate on an apples-to-apples basis when comparing 2016 to 2015.

So when you talk about organic growth rates, of course, G4, the console upgrade – we are roughly at an 85% upgrade percentage of the installed base. So that creates a little bit of headwind, if you will, as we are more to the tail end of kind of the natural cycle of that product, if you will.

From an organic growth rate perspective, one of the reasons for the acquisition besides getting to a combined product roadmap with the best products in the industry was really also the existing account base. At a sense, that has a fairly aged average installed equipment base.

So there is a lot of opportunity there. I would also say that, well, the organic growth rate is a little bit below what we like to run at.

The bookings rate in our guidance is double digits.

Strong, strong double digits.

Strong double digits. I'd say – well, we're double digits.

I don't know exactly if it's 12, 15. So we are feeling like we are getting great value out of having both companies together, having both product lines, having a broader product line to take a larger customer base.

And we are just getting into doing a lot better job at cross-selling as we've gotten in toward the end of the year here.

That's great. Thank you very much.

Thank you.

Thanks for taking my question. I guess, Randy, the Performance Center that you talked about launching recently, it sounds like that is a platform to try to drive deeper penetration of your analytical solutions with some of your customers.

I guess maybe, first, is that the right way to think about it? And then secondly, can you help us understand in a quantitative way how penetrated are your various analytical solutions?

Any feel for what the opportunity is with the average customer? Any metrics like that will be great.

This goes way beyond analytics. This goes to the point of not running the systems for customers, but standing behind them to make sure that we don't – nothing big gets missed.

And this has really come out of my personal frustration and going into the current customer account has been with us for five or 10 years and not having some of the best features turned on that provide the highest amount of safety, or highest cost return, or better regulatory compliance. And generally over time what happens in hospitals as these systems have gotten more complicated, they just got more difficult to run because of turnover of people, or the lack of training, or the difficulty of keeping the customer engaged.

So this is a whole new process. Only less than four or five customers in the country have actually had this system turned on.

Every single customer we have is available for this new service. And it's not – and I purposely did not use I don't really like the word analytics, because it doesn't really – everybody's got a lot of reports and a lot of data and so we want performance.

We want the systems running at top performance. We want operations at pharmacies running at top performance.

So we will have people backing up the systems, most likely in a remote location, monitoring systems to keeping everything running at the highest level and saving money every day in a real-time basis.

Is there any way to quantify how much you guys feel like you could do with a typical client facility-wise?

I think we'll talk about that in December a little bit more as we talk about kind of where we see the evolution of the product. But we think it's a powerful enough thing that it's not – it is not like a reporting package, where you're getting $50,000 to $100,000.

It's more significant than that. More on the SaaS model.

Multiyear, multimillion dollar contracts.

Yes.

Okay, that's great. Thank you.

Hey, this is Charlie on for Matt. I just wanted to ask a little bit about the health of hospital spending right now as you see it in the market place.

Yes, I think it changes pretty slowly. I think it's the smaller standalones are – I think probably smaller hospitals or standalone hospitals struggle a little more.

I think you see the power of the larger, integrated systems, their ability to funnel more patients and treat them across the continuum of care, which is very important with value-based pricing coming out. And they are positioned fairly well.

But I think they're all – everyone is still cautious. There's some changing – there's a lot of changes being proposed, and CMS and some of the Affordable Care Act pieces have still to come in place.

And so I would just say people are cautious about the go-forward. But interesting enough, one of the biggest topics in hospital discussions – in fact I'm at a conference as we speak, and the main topic is medication spend: how they manage it, how to get control, about what to do in Washington, outpatient versus inpatient.

This is just not a cost center anymore; this is the strategic area where hospitals need to manage in order to – or providers need to manage in order to be successful. And so it really helps us to bring solutions that can really drive real dollars to the bottom line for these groups.

Sure. And as you guys are providing value for your customers, is MACRA being finalized in the last couple of weeks here – is that something that your sales force is going to market with, and kind of presenting, like, hey, we can help you along those lines?

Or are we kind of waiting for it to develop?

I think we always have, Charlie.

Sure.

And our products really help with that, of course, and it helps also drive efficiency and controlling our drug spend.

Yes. Well, it's really interesting and I think a lot of people have derived value over it.

But with the Performance Center, we see people getting maybe 50%, 60% of the value of our systems in the data they have and we can double it with the Performance Center. And that's a real – we think it's a competitive differentiator and we just think it's the right thing to partner with hospitals.

It's really what resonates with the C-suite and it's the one thing that always works in healthware, which is how to lower the cost. We are not going to win unless we lower the cost.

And medication management is in some ways out of control. And bringing in the Performance Center will move mountains for these facilities.

So we are excited about it.

Okay, thank you.

Good afternoon. First, I was wondering if you are seeing customers sort of delaying getting onto G4, thinking they might as well wait for G5, since it's probably going to be coming out over the next year or two?

I'd say that we have started having the bigger long-term discussion about the long-term product roadmap with customers. And that definitely has given them broader choices to make.

And I would just say that they are excited about the roadmap. I think they are encouraged by the roadmap, that we are not going to suddenly stop supporting them or force them to do something without giving them a little time.

But we have started having those discussions, and we are already seeing an impact – a slight impact on the way purchasing habits and the way customers are going to do their strategic buys with us in the future. So a lot of this has to do with the fact that we have actually probably accelerated some of our development faster than we thought we could.

And it's really opened up a large opportunity for us to really go to some of the largest customers and give them great opportunities to step up.

Okay, thanks. And then quickly, I know you mentioned you expect to continue to take market share in the U.S.

I was wondering if you would give a sense in terms of what you're seeing on the international front. I know it's obviously a number of regions or different countries, but any overall thoughts in terms of your ability to win business there?

Yes, I think we are definitely continuing to win business, particularly in the UK. I think with Brexit there, that that's kind of frozen some of the decision-making.

I don't think we will lose the deals or we won't get them, but definitely we have seen a little weakness there. But we think that as things fill out that those choices, those orders will continue to come through.

I think in the Middle East, we still see strength there. France has never been fast, but it's been pretty steady and we continue to see orders from there.

But you know, on the med adherence side of the business, we've been working very hard on some new products there as well. We've already launched the software-only packaging product that allows pharmacists to use software to help them manage the packaging of our SureMed cards.

We are working on a series of products starting to small footprint, medium footprint and I can't believe anybody didn't ask me a question about the M5000, and the M5000 at the high end. And we will probably be showing but not launching an actual product in December on the small footprint side.

So a lot of activities there. And I think with – we just have a lot of product coming into the marketplace that just – it's going to give us a great opportunity as we move into 2017.

Okay, thanks again.

Well, I just want to thank everybody for joining us today. As you can tell, a lot of things are going on at Omnicell and we've got a lot of great things to talk about in the coming months.

I'm really extremely proud of the team on the Aesynt acquisition has just – it's gone really above our expectations, and it really is hats off to the folks who worked so hard to make it happen. And even our ability to invest and fund, and accelerate R&D is fun to watch because we are able to make a difference for our customers.

And as you can tell, I'm excited about the Performance Center. So I hope to see a lot of the investors or at least all the analysts at ASHP so that we can tell you more about it.

Thanks for joining with us today.

Thanks, everyone.