Ladies and gentlemen, thank you for standing by, and welcome to the Omnicell Third Quarter Earnings Conference Call. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Peter Kuipers, Chief Financial Officer. Thank you. Please go ahead, sir.

Thank you. Good afternoon, and welcome to the Omnicell Third Quarter 2019 Earnings Call. 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 27, 2019, 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 date of this conference call is October 24, 2019, and all forward-looking statements made on this call are 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 expressed written consent of Omnicell is prohibited. Randall will first provide an update on our business. After Randall's remarks, I will cover our results for the third quarter of 2019 and our guidance for the remainder of the year. Our third quarter financial results are included in our earnings announcement, which was released earlier today and is 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 now turn over the call to Randall.

Good afternoon. We are pleased to share the results of another record quarter. Key financial results for the quarter include: record revenue of $229 million, up 12% from third quarter of 2018; record non-GAAP EPS of $0.76 per share compared to $0.63 per share in the same period last year, representing a 21% increase; and non-GAAP operating margins of approximately 17%, up over 180 basis points from third quarter of 2018. The value we are creating through our Autonomous Pharmacy vision is being realized every day as more customers join us on our journey to revolutionize the pharmacy care delivery model. We're continuing to invest in technology to advance this vision. Our intention is for medications to be managed through a zero-error, fully automated and digitized infrastructure across the Continuum of Care. The Autonomous Pharmacy vision integrates a comprehensive set of solutions powered by the Omnicell cloud data platform across 3 key areas: automation solutions designed to digitize and streamline workflows; secondly, intelligence that provides actionable insights to better understand medication usage and improve pharmacy supply chain management; and third, automation of medication dispensing workflows, which includes expert services that serve as an extension of pharmacy operations. By connecting these solutions across the Continuum of Care, we have the opportunity to help solve for problems like prescription errors, medical wastes, medication adherence and opioid abuse: all significant industry-wide problems, driving medical costs up and reducing the opportunity for better health care outcomes. As we have previously discussed, our business has expanded over the years from a single-point solution to a platform of products and services that we are developing further in the vision of the Autonomous Pharmacy. This has resulted in large deal sizes across multiple products and we believe more comprehensive, valuable and enduring relationships with our customers. We're…

Thank you, Randall. Our third quarter 2019 revenue of $229 million was up 12% over the third quarter of 2018 and up 5% from the prior quarter. The increase in revenue was largely due to increase in XT Series implementations, growth in annual service and maintenance revenue from a larger installed base of equipment as well as increased population health solutions revenue. As discussed in the past, our population health solutions include medication synchronization, patient messaging and other adherence solutions. The third quarter earnings per share in accordance with GAAP was $0.46, up from $0.33 per share in the third quarter of 2018. The increase in earnings per share is largely due to higher revenue in the third quarter of 2019 and achieving economic -- economies of scale over our operating expenses. In addition to GAAP financial results, we report our results on a non-GAAP basis, which excludes stock compensation expense, amortization of intangible assets associated with acquisitions, acquisition and restructuring-related expenses, tax reform and restructuring income tax benefits and expenses, contingent gains in amortization of debt issuance cost. We use non-GAAP financial statements in addition to GAAP financial statements because we believe it is useful for investors to understand the effects of amortization of acquisition-related costs and noncash stock compensation expenses that are components of our reported results as well as onetime events and acquisition and restructuring-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. Third quarter 2019 non-GAAP EPS was $0.76 compared to $0.63 in the same period last year, representing a 21% increase. Similar to the increase in our GAAP EPS, the increase in earnings per share on a non-GAAP basis is again largely due to economies of scale achieved…

[Operator Instructions]. Your first question is from Matt Hewitt with Craig-Hallum.

First off, revenues, particularly product revenues came in a little bit light of my expectations, Street expectations. I'm just wondering if there was anything timing related, or maybe supply a little bit of color on how these orders are kind of flowing through given the strength in your bookings.

Yes. So bookings are strong. Backlog is quite healthy and strong. We're slightly below the midpoint of the provided guidance range. We had some headwinds from an FX perspective internationally, and then there's a little bit of timing delay in the U.K. from the Brexit influence as well and a tiny bit in the Middle East from the geopolitical developments there. So we wouldn't have those 3 factors, then we would have been at the higher end and exceeding the product -- the guidance range, if you will.

Okay, that's great. And then shifting gears to the gross margin. So product gross margin, a very strong quarter. I think it might be a record there on the gross margin. Meanwhile, service and other gross margin has kind have been ticking down a little bit. Where do you see those to kind of -- moving over the near to midterm? Can gross margins continue to expand as you add more and more software, or does that fall into the service? And if so, then why wouldn't that one be ticking up?

So for gross margin, we have a favorable product and customer mix in the third quarter. We do expect gross margins to continue to increase over time, with the caveat that typically the first quarter is a lower quarter in revenue, if you will, and then we build up during the year. So there's definitely a little bit of volume leverage as well in the third quarter and expected in the fourth quarter also. For service margins, we did mention the strength in population health solutions. That comes typically at a tiny bit lower margin compared to the more traditional service revenue that we have. And then we're also investing in professional services for implementations as we go forward. So those 2 factors, a little bit of what mix on service and they were investing also in professional services and they were ramping up but the installation implementations of the newer products and they are lower scale versus kind of the core products, if you will. That makes it the percentage a little bit down on the service gross margin line.

Your next question is from Mike Ott with Oppenheimer.

Peter, you mentioned I think, that some of the rev strength growth in the quarter was due to the population health solutions, just curious if you could call out strength in any particular health solutions.

Really across-the-board. I mean we went live at a larger program, if you will, that was nationwide, so that has some really good enrollments and that's the majority of it.

Okay. And then also, you said some nice government deal flow in the quarter. Is that fairly typical for the 3Q? I mean how does this compare to past years? I realized the government fiscal year end here at 9/30.

Yes. So third quarter, typically, is the higher quarter for government business. And so we would expect -- it's the highest quarter likely for government business in the year, so that's for bookings, right? We're very pleased to see that also the government is adopting components of the Autonomous Pharmacy, like the XR2, some pharmacy robot and IT automation. But you're right, third quarter is for most government organizations that we serve and partner with kind of a fiscal year end for them. But we do expect some more business also in the fourth quarter from government.

[Operator Instructions]. We have a question in queue from Matt Hewitt with Craig-Hallum.

A couple more here. Adjusted operating margin, obviously, a very strong quarter and above your typical 15%. I think you've kind of talked about that in the back half of the year, coming in north of that 15% historical target. I'm not trying to put you on the spot here, but you've got Q1, you just explained that typically you do see some deleveraging or some deleveraging there from a margin perspective. But how should we be thinking about this given the strength that you're seeing from a booking perspective, which should translate into revenues, you're seeing leverage in other areas of the business, is 15% still the appropriate number?

Yes. So we think for now it is. We do see strength year-over-year, that is absolutely correct. But we do have investments booking in the past with the Autonomous Pharmacy and some of the products that we already mentioned, and we are building out the new products as well. Plus we're investing in services, on a professional services perspective. So for now that is the kind of the total year, longer-term framework. We're looking at potentially updating it in the not-too-distant future. But for now it's 15%.

Okay. Another question regarding DSOs. You've shown steady improvement the last couple of quarters, bringing that number down. Do you have an internal range or target that you're shooting for? And maybe how close are we to getting there?

Yes. We're definitely reducing the accounts receivable balances, if you will, I think we went over the drivers compared to other MedTech companies on prior calls as well. We do not have a formal DSO target. The DSO is purely a mathematical calculation of the gross AR balance of a revenue in the quarter. The one part that's very difficult to estimate is really the shipments in the last couple of weeks of a quarter because they are mostly for installs and revenue in the following quarter as the debt fees makes it really difficult to estimate. But we do have the one piece -- we do have internal cash collection targets by the month, if you will, for the teams, and we're definitely driving those very hard, and we see some really good results.

One last one for me. Regarding Mercy. As you mentioned, top 5 health system, by my math, that's an extremely large contract, 10 years. The last sole-source agreement you signed with them, I believe, was back in 2003. So this is consistent with that kind of that longer-term partnership that you've previously had. But as we think about this, I would assume that they're upgrading the XT cabinets, they're adding XR2. How will those kind of layer into revenues? I would assume that -- or should think that they would be more front-end-loaded in this 10-year sole-source agreement. But maybe kind of walk us through how these longer-term agreements kind of layer on over their term.

Yes. I'll take that question, if you don't mind. These big customers who have been our customers for a long time really have to look at the redeployment of the newer technologies and really redesign it from the ground up, not just replace what they have, but how do you get much more out of the technologies and with coordinated connection between the pieces. And so as we build out the design of that over the next couple of years, then we really -- generally, you start with the oldest equipment. And so if they're an older customer, they have quite a bit of equipment that's aged. So and the newer equipment, of course, since they run the same initial software technology that we run today, they don't have to replace it quite as quickly. So the key is that we're able to deploy a total solution set that really gets to some of these pharmacy issues that have not been able to be addressed without sort of a total comprehensive view. But I, just from a rollout standpoint, I would think that Mercy has a lot of systems, which -- have been our customer for a long time, so they probably need to have some of those systems replaced sooner than later.

Your next question is from Mitra Ramgopal with Sidoti.

Just a couple of questions. I noticed SG&A coming in as a percentage of revenue the last couple of quarters. And I know early on, you're scaling up headcount a little. I'm just wondering where you are on that front.

Yes. So we'll drive a little bit of leverage here in the third quarter, fourth quarter. But we are growing, looking at backlog and bookings momentum and the pipeline momentum. We will continue to scale the SG&A as we're hiring. And like we said, we expect to do in the fourth quarter as well, we expect to go up in SG&A cost as well.

Okay. And again, I know you have a noticed...

And actually, in the fourth quarter, we do have a number of the bigger pharmacy and health conferences that also add cost to the fourth quarter as compared to other quarters.

Okay, okay. And I know you've obviously announced some nice wins recently, especially, obviously, in the U.S. So just wondering, outside the U.S. now if you're seeing any change in the business environment there.

Like we said in the earlier -- from an earlier question, we do see some headwinds from an FX perspective on the British pound and the euro. We do see some delays from the NHS. Capital spending, if you will, in the U.K., we think that's merely a delay that's mostly related, we believe, to Brexit. And then in the Middle East, you do have a little bit of a geopolitical impact on ordering patterns as well. We think that's most utilized as well. But we have a number of win as well internationally. We do see the ADC adoptions in part of Asia also picking up, specifically in Hong Kong and in Australia where we have some nice wins, if you will. So we've got some good momentum there, but probably a little bit lower in third quarter than we expected it to be as we into the quarter.

And finally, I know the tax rate obviously came in quite a bit in the third quarter. How should we be thinking about that going forward?

Yes. So we got it for the full year, right, for 9%] blended rate. And the fluctuations are really kind of depending on the benefit of the stock option exercises, so that's why it ticked up a tiny bit. But in that range, it's probably fair for you to assume in the future. In future years, however, got to make sure that you calculate the incremental profit at the federal U.S. rate of 21%, right, so that's going to stay at that lower rate to incremental dollars you need to really -- tax effect is about 21%.

Right, right. And then, finally, Randy, early on, you've mentioned a lot of things that you see you could be making a difference on, things like opioid crisis, et cetera. Just wondering if you're already having conversations regarding any specific things you could be doing in terms of working with your existing customer base.

Yes. I think that there's a whole new set of regulations and, I guess, scrutiny around opioid management and every health care institution. And we have solution sets now, and we are putting time and energy to advancing those to even more at the next level, because the scrutiny is this is one of the areas that pharmacies have struggled a little bit on and now are just behind the game because it's become such an important piece of executing a pharmacy, well, because people do need the opioids, but you got to make sure no one else is diverting them. So it's become mission-critical like it's never been before. So a big opportunity for us, and it's already a great product line that we have, but more to come.

Your next question comes from Bill Sutherland with Benchmark.

That Vizient deal, can you give us some color on that? Is that kind of like more of a partnering situation? Or how is that going to work?

Well, Vizient has always been a GPO that we've worked with over the years, for many, many years. Probably that new part of the Vizient deal is really -- they only had the core products and not a whole expansion line. And so we were able, in this round, to expand the product line to include IV workflow and robotics, the XR2 new product lines, and that's really important because you want those product lines to be presented as a package, not as -- well, Vizient is kind of supportive of this, but not of that. So that's important for us to have a good relationship with them, and because their members are really looking for their blessing on these things. They don't really buy the product directly of course, but it's important. And I think that was important -- important enough for us to mention it, and they've always been a great partner of ours.

Do you probably don't want to give a percentage, but are you in like the majority of their hospitals? Or is that a lot of...

Whatever our market share is, is probably the same market share that were in their hospitals. So -- or probably about half, somewhere around half of their members, maybe a little more if they represent the larger groups.

Okay. Curious, just in a general sense, on the operating margins. As you've talked about this before, but I just kind of want to see as you get more experienced with these larger multiyear platform sales. Net-net, should that be generally a lift for your operating margins?

Well, large-scale always gets economies of scale as well. However, what as we said on an earlier question, there's quite a bit investments to go to really bring the this vision of Autonomous Pharmacy to life. Randy talked about some of the areas that are cumbersome for pharmacies that are on big issues like opioids. If you step back and look at pharmacy, specifically hospital pharmacy, you are the leader of pharmacy in a hospital, you need to manage about 4,000 different SKUs, if you need to have full feasibility on. And that's not the case today, and there's a big gap there. Medication waste cost is between 5% and 7% of the annual medication cost for health systems. Feasibility is limited because a lot of the automation is only implemented at kind of points of care in the OR and in the ER. There is a lot of technology needs and growth to be had. So we do believe that there's quite a bit of investment for us to make to really help the industry to go to the next level.

And I'd just add to that. Our emerging products are growing really nicely. I mean, they're growing at a nice rate. But they're relatively still small, and so it's hard to get the scale on those until they get larger. So but the uptakes and the orders are nice, and I think it just confirms our story of a broader product line and platform that people really want to drive all the medications, not just some of those.

Your final question comes from Gene Mannheimer with Dougherty.

Good job on the record results. I had just 2 things. You talked about some major expansions in the quarter, certainly Mercy is a very good one. How about -- how should we be thinking about net new wins these days? Do you still view yourselves as net share gainers in the market? And my other question relates to the term, I heard, SEC inquiry. Just trying to understand if you could expound on maybe what areas they're looking into and where the concerns are.

So for the market share perspective, we've always mentioned this. And as you recall in a relative share of bed counts in the U.S. We do believe also this year that we have gained further market share, if you will, at a fairly consistent rate. We were clicking away and taking away about 100 basis points to 150 basis points of share. We believe that, that's continuing this year as well. And then on the voluntary informal SEC inquiry, we can't really comment on that kind of areas, but they're generally aligned, we would, say refer back to the self-proclaimed short-seller report. And there's nothing to report.

And there are no further questions at this time. Mr. Randall Lipps, your closing remarks, please.

Well, thanks for joining us today. And as we continue to see the Autonomous Pharmacy is something that the industry is really hoping for to help change the Continuum of Care in the way medication management is done. And it's very exciting. In our next midyear ASHP, the American Society of Hospital System Pharmacists in December, we'll be talking more about our road map and how the Autonomous Pharmacy is going to be rolled out to really address some of these big pain points to really change the way medication management is looked at and executed upon. So I hope you can join us there. And thanks again to the Omnicell team who have once again continued to perform well in the marketplace and really out to improve health care for everyone. Thank you very much. We'll see you guys next time.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.