麥卡遜 (MCK) 2010 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the PSS World Medical Q2 2010 earnings conference call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question and answer session. (OPERATOR INSTRUCTIONS)

As a reminder, this conference is being recorded today, Thursday, October 29, 2009. It is now my pleasure to introduce Rob Weiner, Vice President, Investor Relations. You may go ahead, sir.

Thank you, Fran. Good morning everyone. Thank you for joining our fiscal year 2010 second quarter call. Today on the call, our speakers are David Smith, Chairman and CEO, Gary Corless, Chief Operating Officer, and David Bronson, CFO.

We issued our press release last night for the second quarter and if you need a copy of that or a copy of the workbook, you can find both on the Internet site as well as call us here at Investor Relations. The workbook contains GAAP and non-GAAP financial measures that provide greater detail into our business so I encourage you to take a look.

Now I'll point out that the Securities and Exchange Commission and state laws allow for the use of forward-looking statements, which we will make during this call to provide listeners and investors with greater insight into our businesses and our future goals and expectations.

The forward-looking statements involve a number of risks and uncertainties that could cause actual results of the Company to differ materially from what is expressed or forecast. For a list and descriptions of certain of these risks and uncertainties, we refer you to the forward-looking statement disclosures in yesterday's press release and to the other information provided in our most recent Form 10-K and other SEC filings, copies of which are available from the SEC, as well as on our website and from our Investor Relations department.

We may reference certain non-GAAP financial measures in an effort to provide additional information to investors. All non-GAAP measures have been reconciled to the related GAAP measures in accordance with SEC rules. You will find those reconciliation charts at the end of our Financial Workbook and in our Form 8-K submitted to the SEC.

For those listening to the call or webcast who may be interested in meeting with management, our upcoming investor relations activities include a day of investor meetings in Denver, Colorado on November 10 and a presentation and investors meeting at the Credit Suisse Healthcare Conference on November 11 in Phoenix. We are also planning an investor trip to the Northeast in early December. Please contact us if you would like to schedule a meeting with our team.

For our call today, we will follow our formal remarks by a Q&A session, as prompted by the operator. We will limit this call to one hour in duration.

I'm now pleased to turn the call over to David Smith, PSS World Medical's Chairman of the Board and CEO.

Good morning and thank you for being here this morning. We started this year reconfirming our 20% EPS goal. We had visibility into the troubled economy and our strategies remain relevant but required a tactical reset. We relied and built those programs and strategies on our people, culture and core strengths, including our past ability to turn on a dime. We are very proud of our teams and their performance.

We've added $0.09 to our fiscal goal at the six month point. Our strategies and tactics are proving to be a solid match with the economy and our customer market conditions. This success and progress is not the result of the economy improving. I have heard rumors of a recovery but all we've seen is a potential bounce off the bottom.

There are powerful and opposing market forces and strategies at work in our markets and Company. I'm going to talk to about some of the negative forces, positive forces and our strategies.

First, negative. The asset and wealth losses of 85% of Americans who have jobs plus the 15% without continue to impact healthcare spending. The customers' health and financials in general from regulatory burdens, tort, administrative costs, reimbursement cuts and uncertainty continues to impact the market. Extremely tight credit conditions are impacting small and medium businesses including customers and distributors.

And our assumptions are that the market conditions and forces do not change in the short term and medium term.

It reminds me of a quote from Winston Churchill. "When you're going through hell, just keep going."

Now, the positive forces. First, our customer is more willing to listen and in greater need of solutions than ever. Second, our people are open to change and inspired by the mission. Third, our competitors initially went in the wrong direction and now they only have price in their quiver and that arrow falls flat against our solutions. Fourth, previous investments are delivering good results, and fifth, we moved quickly to adapt new investments to extend our runway on our strategies.

Now to some of our strategies. Our Lean initiative has ignited a passion and innovation of our entire organization. We have tens of millions of projects underway in addition to what we've already accomplished. David Bronson will provide some examples.

Our Reach strategy has already produced more than our original annual goal of 7,000 new customers. Our customer Strengthen strategy is producing big results, creating healthier customer, leveraging our menu of business and clinical solutions. Gary Corless will give you stats and examples of both reach and strength.

So all three, Lean, Reach and Strength and strategies have significant runways to drive results over what our markets and our pre-crisis business model could produce. So our markets are stable but pressured by economic and environmental forces. Our strategies are timed and matched with a solid runway for the future. We see continued opportunity to execute and produce above-market growth and returns.

Now there's a whole bunch of topics I could talk to you about in this quarter but it feels to me like flu is the most relevant, so I'll start with H1N1.

We estimate about $23 million of incremental product sales in the quarter are from H1N1. A majority of those sales were low margin flu test kits. Last quarter we explained we had no reliable way to estimate H1N1 timing or impact but we decided to stockpile two the three times the product by category of the normal flu season based on reports out of the southern hemisphere including data from the William Blair Flu Monitor and the Euro Surveillance Reports.

This strategy proved to be a great investment as manufacturers struggle to meet demand with back orders while we fulfilled all of our customer needs. Our original data indicated H1N1 would peak and decline as vaccinations started. As you know vaccines are delayed and while we have seen a peak in demand, it has flatlined rather than declined at this point. That could begin to change tomorrow, we just don't know.

This week more vaccines are available but not until December will they reach originally expected late October and November levels.

So now to regular flu season. We sold and distributed 100% of 2.3 million Novartis doses of regular influenza vaccine. There have been widespread shortages nationally felt by other distributors related to the manufacturing focus on H1N1 vaccine production.

We have watched the southern hemisphere again and anticipated normal to medium regular influenza season. It is unclear to us and will be impossible to determine how much H1N1 will be dispensed in the regular flu season. In the southern hemisphere and in Europe there have been multiple secondary outbreaks in geographies that were hit lighter originally by H1N1. Again, hard to predict but we are stockpiled for whatever our customers need.

Now, I'll turn the call over to Gary and then to David Bronson, and then I'll finish up with the closing remarks.

Thanks Dave. I guess the best way to describe what's happening on the street right now, I would characterize it as a tug of war - our offering and our team up against old and some new environmentally driven challenges. Our measure of success continues to be the customer acceptance of our solutions and our results not the street, both continue to reinforce our belief that we have the right strategies at the right time.

We believe that more than ever it is important for us to continually test our beliefs and we accomplish that by being extremely close to our customers and all those who serve them. This is more than lip service. This is a disciplined process and just the past quarter included designated officer/customer (inaudible), open forums with our top vendors, quarterly what's working and not working session with our top PSS sales reps and a round table meeting with both sales top reps and leaders.

The feedback from vendors and customers has been consistent. We need you to do what you're doing. Continue to reach new customers and strengthen all of them.

The feedback from our reps is, "I get it. I know what I need to do and here's what I need to get it done."

Now let's look specifically at PSS and the execution of our Strengthen strategy. As we have shared, Strengthen is focused on improving the customer's clinical and business health resulting in a growing and profitable relationship for us both. This includes helping it control costs, improve efficiencies and improve care as well as improving their service to their patients.

One way we do that is by helping them in-source services they used to outsource when appropriate. An example of this opportunity is in the area of point-of-care diagnostics. Although this can require a capital investment on the part of the physician, at a time when longer term investments get more scrutiny, the Strengthen logic is often winning out and we are making strides.

Our equipment grew sequentially from $26.8 million in Q1 to $32.1 million in Q2. Our lab diagnostics sales are up double digit. Excluding flu, lab diagnostics grew 11.5%. When including flu tests we were up a full 39%.

A good example of one of our reps leveraging the strength of our offering to help a customer also speaks to the importance of our Reach strategy, and I'll explain. PSS rep [Brian Irish] from Orlando, Florida found this opportunity on one of our designated Reach days. It turns out that West Orange Nephrology was working with a local competitor that had been struggling to help them meet their goals of a full service laboratory. As we often find, the rep was well intentioned but untrained and lacking a compelling offering. The process had stretched out for four months.

Brian's cold call turned into a several hour conversation reviewing their current plans and the holes Brian could help them identify. Within two short weeks, we were able to get them on the way to a healthier and growing practice and were not only rewarded with the sale, but with their supply business and a setup of a new location as well.

More often than not, we're finding that the best way to accomplish our strategy of reaching new customers is by strengthening them, helping them identify the larger problems they are facing and then using our experience and offering to help them. The overlap of these important strategies is a multiplier for us.

So that leads us to Reach and our results. Again, Reach was designed to address both the need and opportunity that the current environment has created. The need to offset lower physician office utilization and some customer consolidation, and the opportunity to take advantage of consumer's willingness to try new alternatives.

In Q2 we reached out to many potential new customers and opened over 5,000 more new accounts. In addition, almost 60% of the customers who gave us a try in Q1 continue to order in Q2. A full half of these customers are now ordering more than their initial order, showing encouraging sign of our reps' abilities to leverage their foot in the door.

Lastly for PSS let's talk about the importance of addressing the most recent MGMA survey identified as one of the customer's top three concerns - controlling escalating costs.

As part of our Strengthen strategy, we are directing our reps to not wait for the subject to come up, but to provoke the conversation leading from a position of strength. We have a full offering of tools to help customers control their costs and increase their efficiencies.

Generic RX and a growing stable of our own quality brands has again proven to be the right strategy at the right time. We can offer attractive pricing and improve our gross margin, satisfying both the customer and our shareholders. Proof of our customers' acceptance is PSS's 20% growth of our brand and 18% growth in generic RX.

Now let's take a look at Gulf South. Although different in many ways, Elder Care and Physician offices are facing new challenges and therefore share the need for more than the traditional distributor offering. We believe this opens up the opportunity to change the nature of our relationship while differentiating Gulf South from some pure box moving competition. We'll do this by strengthening Elder Care customers in real and different ways.

In addition, we're adding a Reach focus similar to PSS due to the unprecedented opportunity to share our offering with newly open minded customers. We will update you on our progress on future calls.

Evidence that the customer is open to Gulf South as more than a traditional distributor is Gulf South rep Thomas Matthews' recent strengthening a customer in Stanwood, Washington. When first introduced to our new solutions, they did not see the value of our expanded offering of caregiver education and consulting services. Not because they didn't believe in them, but because they didn't believe they needed it.

A couple of weeks later the director of nursing called Thomas in a panic and said, "Tell me more."

The facility had suffered 13 deficiencies in a recent audit. With the help of our partner, Pathway Health Services and the implementation of our five-star rating recovery program, Thomas helped our customer, grew her business and changed the nature of our relationship.

In addition to these new offerings, we're continuing to help skilled nursing facilities and home care customers control their costs through programs that improve outcomes like CORE, the formulary products backed by evidence-based studies as well as our brands that help them meet their need for quality and cost control.

This is evidenced by the continued success we're having leveraging our brands like Select, Nightingale incontinence and REPARA wound care, resulting in double digit growth at 13% at Gulf South.

At both PSS and Gulf South we are committed to being very close to the customer and all who serve them, giving us the opportunity to adapt quickly, find the opportunities and the difficulties and continue to come out on top in this game of tug of war.

Thank you and I will now turn the call over to our CFO, Mr. David Bronson.

Thank you Gary. Good morning everyone. We had excellent financial results this quarter, driven by focused execution from the team, some of the examples which Gary has shared with you.

Record profitability, meaningful progress on operational and financial strategies a new high water mark for return on committed capital at 42.5% for the quarter and for the second straight quarter, the highest operating margin we have posted so far this decade.

Consolidated revenue grew 143% in the quarter with same-day sales growth of 5.9%. In the Physician business, sales growth was 16.6%, 8% same-day sales growth and excluding approximately $23 million to $24 million of sales of H1N1 flu related products, it was about 1.8% same-day sales growth.

Growth in our Select brands or our brands was 20%. Equipment sales, as Gary mentioned were $32 million, up about $5 million from Q1 but still below prior levels -- prior year levels. The financing environment for equipment continues to be challenging, although leasing application denials were slightly lower this quarter.

Lab diagnostics growth was 39% driven by sales of flu test kits and total pharmaceutical product sales grew by 14.8%.

In the Elder Care business, same-day sales growth was 1% with total net sales growth of 9% for the quarter.

Select brand growth was 13%. Scaled nursing facilities growth per billing day was flat and home care growth was 8.2% per billing day.

While the overall sales growth rates continue to be challenged by the market conditions Gary described, we're especially proud of our ability to leverage growth while increasing operating efficiencies and lowering operating costs through focus and strong execution.

Consolidated income from operations was $38.6 million, an increase of 191 basis points to a 6.9% operating margin for the quarter.

The Physician business operating margin was 10.7%, an increase of 300 basis points and Elder Care business grew 150 basis points to 7.1% operating margin.

Net earnings per share of $0.37 as we reported, grew this quarter by 76%.

On the balance sheet, consolidated DSOs improved on a year-over-year basis by more than a day in Elder Care to 49 days and by almost two days in the Physician business to 39 days.

Inventory turns improved in Elder Care by about one a half days. Days on hand increased slightly in the Physician business as we invested in flu related products to make sure we can continue to provide for our customers' needs.

Now we continue to make investment decision based on the 30% hurdle rate for return on committed capital. This is how we establish the return benchmark for any of our initiatives, whether it's new product technology and acquisition or a new service. Our return on committed capital for the first six months of this year was 34%.

Operating cash flow in Q2 is $8.7 million, bringing our year-to-date total to $53.6 million. We've raised our goal for the full year operating cash flow to $96 million to $102 million, about $4 million higher than our original goal.

As I mentioned earlier, one of the most encouraging results for this quarter was the improvement in our cost to deliver. Now we certainly did get some leverage from the extra billing days and from the flu volume, but I would also tell you that a large part of momentum here is coming from the success of our lead programs, especially in our field operations.

The additional volume flowing through the system this quarter also highlighted some areas where there are some significant opportunities for future improvements and we really feel like we're just beginning to scratch the surface in terms of the total opportunity.

The pace of these programs, the generation of ideas and suggestions as well as successful implementation is accelerating. Our leaders and associates are fully engaged in this initiative and are starting to make it part of our Company DNA.

The biggest gains this quarter were seen at the end of our process where we take -- fulfill orders, pack the orders, stage them and deliver them. Our distribution centers are finding innovative ways to streamline these processes while at the same time improve order accuracy.

But for us, lean is much, much more than taking unnecessary steps out of repetitive processes. It's also acknowledging and responding to new realities and here's one good example from our Orlando Physician distribution center.

The branch leadership team down there noticed that as we get more and more of our orders coming through online through SmartScan and MyPSS, a larger percentage of those orders are coming in earlier in the day. They responded by adjusting the working hours of the section shift, better matching the workload with the labor pool.

The result, the branch increased -- the branch saw an increase in -- of 7% in lines shipped but a 15% decrease in labor hours. This is just one of dozens of examples we could share which cumulatively contribute to the operating margin improvement of almost two full basis percentage points this quarter.

To wrap up, we've increased our full year EPS goal by about $0.09 a share to $1.15 to $1.17. $0.05 to $0.06 of this increase is related to sales of H1N1 flu products. $0.03 to $0.04 is the traction and success we're seeing in our business strategies Reach, Strengthen and Lean.

We've also increased our goal for operating cash flow to $96 million to $102 million for the year.

Now I would just remind you that this quarter, our Q3, we have 61 billing days. That's seven less sequentially and five less than prior year.

I'll turn the time back over to Dave for some closing comments.

Okay, before we take questions, let me just say a few things. These are unique and complex times. My belief is that this is not a cycle but a reset of economic realities. We are very proud of our team's attitude, approach and performance. We believe our strategies are timed and matched to the economy and our customers' needs. I'm very confident in the future yet uncomfortable.

We must continue to navigate the powerful forces at work, dedicated to each other, our customers' biggest needs and shareholder value. Our objective is simple - outperform our markets by at least two times while strengthening our principles and culture.

With that, Rob, we'll take questions.

Operator, if you could open it up to Q&A please.

Thank you. (OPERATOR INSTRUCTIONS) Our first question from the line of Glen Santangelo from Credit Suisse. Please proceed.

Hey guys, thanks. I just had a couple of quick margin questions for you. Dave, you talked a little bit about the Lean programs and the impact it's having on your margins but the margins in your Elder Care business if not mistaken were the highest I think I've seen in years if not ever. Is that really a function of the Lean program and are those margins kind of more sustainable at this level?

In our Elder Care business we have been focused on improving our selling margin as well and so we've really been working with our sales team to make sure that our customers are recognizing the value that we add with our product offering. We have seen a higher mix of Select products in Elder Care and we did see a fairly significant decrease in blood costs that hit this quarter so gross margin, Glen, was higher in the Elder Care business.

As far as cost to deliver in Elder Care, they are making improvements with the Lean and reducing and streamlining their operations, but also the shift to more home care, which is growing faster than skilled nursing facilities, that has a higher inherent cost to deliver it. It also has a higher inherent gross margin.

So from a cost to deliver standpoint, those two things kind of balance each other out. Does that help?

Okay, is that maybe also what maybe impacted revenue growth a little bit, lower cost, (inaudible), and private label and a shift towards home care?

Glen, this is David. I actually expected that was going to be the question and what I would tell you is, and Gary's presentation mentioned he's going to update you on Reach. We are just about to rollout Reach at Gulf South. We've been really focused in a very methodical way with a lot of manual time of our sales force spent on our contracting, our costing, our pricing and the things that drive the margin line. And I think our results on really good on the margin line. They didn't show on the revenue line because that's not where the focus was.

So I thought the question was going to come on the revenue side. It came on the margin side. The answer's the same though.

The other thing I would tell you is the Lean strategy does have something to do with this. The crisis in the economy, the crisis in our markets and those things, our mission to save 300 employees and the Lean project all kind of brought every department, every person in this Company together in a way that is driving programs that we had on the margin side in a faster way than normally would have happened here.

So projects on the Select and branding and sourcing side are being driven faster because the operating folks are talking with them more on how to drive the process and how to drive our strategy to a quicker end. And the result is higher margins. The result is more profitability, less cost, more efficiency.

So it is not just one thing, it's several things, but it did, in my opinion, effect revenues in that division because of the selling time.

And then Dave, maybe if I just ask a quick followup on the Physician side. The $23 million that you specifically called out, you said that was a lot of low margin flu test kits, so is it fair to say the margin on that incremental revenue is much lower than your corporate average?

It's not real low margin. We're certainly not giving it away but it is lower margin than the average.

And then when I just look at this quarter kind of given what we're seeing presented by the CDC and what we're seeing on TV, you would think you're going to see some additional flu sales as well continuing to come through this quarter. So we should think about that when we model, is that a fair statement?

I will tell you right now, we are at the peak levels of our flu test kit sales and it's been flatlined now for about two weeks or so. It's choppy. It goes up one day, it goes down the next, but it's pretty flatlined for last couple of weeks maybe, since the September 27 week.

I don't know when that changes. It's hard for me to talk about this upcoming quarter and next. I couldn't predict the first peak so I can't predict the first drop. I want to tell you, it's flatlined but it's at a very high level and we really don't know what's going to happen in the market.

Every day when I pick up the paper I know as much as you do and then I read the stat report and I see the correlation.

Okay, perfect. Thanks for the comments.

Our next question from the line of Richard Close from Jefferies & Company. You may proceed.

Yes, thank you. With respect to the flu, just staying on that, where -- as we look at the quarter, obviously a big number, how did that progress through the quarter if you could give a sense of timing?

The revenue, I mean.

It started pretty aggressively in August, was it August? About August, the second week in August, the first week in August, and it went up like a roller coaster ride. And it stopped kind of at the 80%, 90% peak and it hasn't stopped.

So what I would say is it was a quick hit. We fortunately had two to three times of inventory built up in resourcing group. We made a good investment there so we did not really have any shortages of any products.

We had -- there's one 1500 mask that is a trouble spot and that's basically the only products difficulty we have.

So it was from the second week, it went straight up of August and it's been flatlined pretty much ever since.

And then when we think about you guys stockpiling, you guys mentioned that a couple of times, let's say the flu drops off a cliff here and doesn't get worse, what -- are you negatively impacted at all?

You know what I'll tell you is all these products are products that we sell in the normal course of our business and our customers are going to use masks for the next 50 years. Our customers are going to use gloves every day and hand sanitizer and lotions and those kinds of things, so there's not any products really that we have difficulty with.

The flu test kits are the hardest to stock. They're the dated items but we also have flu season coming up in January, February and March, so it's the same product that we use for our normal flu season.

So our strategy was, take the normal basket of about 200 products that we use for flu season, double-triple the inventory and maintain that pool as we go through all these events because we just can't predict them.

If you look at that southern hemisphere reports, they're all over the map but it's a two to three times' event. So that's what our strategy was. It's worked very well for us. We don't see inventory risk on the backside. It was just a capital risk. It was an interest risk or a return on committed capital risk. It wasn't a product risk.

Okay, and then with respect to the earnings guidance and talking about $0.05 to $0.06 of the raise being H1N1, just to be perfectly clear, that $0.05 to $0.06 is and on a go-forward basis in the second half of the year? It doesn't necessarily include year-to-date, right?

In the first quarter, Richard, we shared that the impact was about $1.6 million pre-tax. This quarter's about $2.9 million pre-tax so you can kind of do the math and see what we expect for the back half versus the first half.

Okay, so the $0.05 to $0.06 is for the entire year.

Yes, sir.

Okay, and then just a final question. Not a huge number, but I saw on Elder Care the allowance for doubtful accounts. I guess showed an increase year-over-year. I know it's down, I believe for the six months but was there anything special to note on that?

No. We had a fairly significant recovery last year that hit -- lowered the reserve and our bad debt was actually favorable this quarter and our DSOs are great.

Okay, great. Thank you very much.

Our next question from the line of Larry Marsh from Barclays Capital. You may proceed.

Thanks, good morning. I'm going to be creative and talk about flu. I know nobody wants to do that these days. But let me just sort of then think ahead, Dave and get you to elaborate a little bit about next year.

So it seems to me if you're saying $0.05 to $0.06 for the full year, obviously as Dave Bronson mentioned, $0.04 already, it feels like the volumes are certainly a bit ahead of what I would have thought, so maybe you get $0.06 plus for this year.

But if I think about your franchise, 11 and 12, you've been good at sort of identifying what could happen, where not to be in flu. Why shouldn't we think of that sort of $0.06 as non-recurring or is some of that, as you talked about, going to continue to be with for the next couple of years as you build your flu franchise?

Larry, that's a great question because I really H1N1 as non-recurring. Now, at the same time we're negotiating -- having great discussions with Novartis on what we do next year, as far as what we do together to market more through our channel versus other channels and how we go after more of this market in the same way we're doing it now, which is the no-risk, go use your relationship, market the heck out of the product and charge to the hilt.

So I would say, yes, I don't think H1N1 is a recurring theme. I think it'll be incorporated into the vaccination process, etcetera.

Now at the same time I sure as heck wouldn't want H1N1 to mix with bird and have all kinds of problems so I would just say that I would take it out. I would tell you that we are going to continue to drive the Novartis relationship and expand our offering in a way that doesn't incorporate risk to the balance sheet and to the shareholders but leverages our relationship and leverages Novartis' product.

And we're going to be a larger player. We've got 10,000 new accounts and we'll be driving more product into those. But as far as H1N1 continuing, I just don't see it.

It does sound like incrementally you feel like some of the dysfunction of the flu market that you've addressed in the past, which is tails you lose-heads they win, is changing from the manufacturing standpoint?

I think so, Larry. And actually, man there's a lot of disruption in the flu vaccination market. I don't know, Gary, if you wanted to mention that but just how many customers or distributors didn't get product this time and --

We're definitely seeing that the Reach campaign is well timed with some disappointed customers that may have pre-booked with a competitor that didn't get their full allotment, so we have some competitor customers that got zero percent, some that got 30%. So there's a lot of fluctuation in that -- in the satisfaction of the customer base depending on which distributor they booked with.

(Inaudible).

Kevin, I think you've got a thought also. That's a seasonal yes, Larry.

Yes, Larry, also we are seeing a number of customers adopt a testing philosophy with the flu rest kit so I would say that's going to provide a little uplift against prior year run rates for that product category.

So I guess to try to put that in a final answer, we're seeing that continued dysfunctional relationship with other distributors and manufacturers. We're seeing continued disappointment with the customers. We're seeing our model work completely differently where we're marketing together with them and we fulfill 100% of what we say we're going to.

We're seeing testers test more because this is an area where there is patient value and cash flow and we think we're going to continue to grow our relationship now that we're comfortable that we're not taking on risk and we're leveraging our relationship and leveraging the product.

So to me it's an area of growth but the H1N1 is an event versus a business model.

Okay. Great, thank you for that. Second question from me is on the doc business. You're up in this quarter now close to 2%, same story even without flu and so that's kind of back to where you were before at least in the fall before the world changed a good bit. Is it fair to say that you're thinking, David, that you think 2% is kind of the new normal? Or in your mind do you think over say the next two years there will be opportunity to get back to that sort of 5% - 6% that you've been seeing in the past?

Well that's the million dollar question.

(Multiple speakers)

Yes, it's really a good one. We're right in the middle of the throes of it. I will tell you, when I saw the McKesson numbers at 5% with 3% acquisitions and they said that flu didn't affect their numbers, which I know can't be possible, so they probably declined in the business.

So I haven't -- I've been looking for other competitors' numbers so I can kind of get a feel for what everyone else is doing because we haven't seen Hyde reports yet. But my tummy tells me the market's flat to down because if we held onto the exact same customers, we would be down in revenues today. If we wouldn't have strengthened existing customers with new programs and reached new customers, I know for certain, for certain, revenues would have been down.

So the market is still not rising. It's still declining in my opinion. It's still -- we're rising. We have the right strategies and tactics for the market but I haven't seen anything tell me that the market has started to grow yet.

So when does that really happen? It's already happened for us but when does it happen in general and then where is my two times number off of that? That's -- I'll be honest with you. We started strategic planning last week and these are the conversations we're having.

Where is that turn? What are the events that caused that turn? What are the fundamentals that caused it? How do our programs grow past it? How much do we get growth over the expected norm?

Right now, it's 2%. What will it be next year? I've got to be honest with you, talk to me in March or April, I'll tell you. That's when I'll announce the plan. Right now I'm still trying to figure it out but I do think that the market's still shrinking based on what I'm seeing from our existing customers and competitors.

Okay, thanks. Now I follow the guidance. Just simplistically, I'm thinking you guys beat really by $0.08+ at least versus general view this quarter. You're guiding up at the midpoint by $0.08. Dave Bronson talked about a penny or two more from flue, which may have already been sort of in your thinking.

Is that the way we should be thinking of it, which is your view of the second half of the year is the exact same as what you had been suggesting above and beyond this quarter? Or are you saying you're more bullish for the second half and you're just trying to be conservative in your guidance?

Our view --

I see the fingers pointing.

Our view is that our guidance went up by $0.09, Larry, and $0.05 to $0.06 of that is flu and the rest of it is traction that we have seen and we expect to continue to see in the Reach and Strengthen and Lean programs. So it's more -- the bottom line is it's more than just what we've done so far.

But Larry, I'm very confident in our ability to execute. I'm just uncomfortable with the world I'm living in. So I don't think -- I think the numbers that we've put out indicate what we absolutely will accomplish and if we get outside we'll give it to you but the world's a very complex world. I'm very uncomfortable with it. We've got big forces out there that we're dealing with and I think we're doing very well with it and I'm very confident in our programs, but I prefer to just keep going and keep adjusting as we go.

Okay, very good. Thanks, good results.

Our next question from the line of Randall Stanicky from Goldman, Sachs. You may proceed.

Hi, it's Alex Beckler actually for Randall. Good morning.

Good morning.

Good morning, Alex.

I'm jumping a bit ahead but do you guys still have a guidance reading out there for fiscal 2011? It's in the context of your updated guidance for fiscal 2010, how soon do you think about 2011 guidance? Is this something you're still comfortable with or should we focus on 2010?

That's probably a quarter or two out for us as far as adjusting and reconfirming and reworking that. I just think we're just a smidge early there for us to go there.

Okay, and then second question, cash flow obviously very strong this year. Can you update us on the M&A environment and how close we are to (inaudible)?

I'm sorry. I missed the last part of that.

M&A guidance and when you're going to announce a deal.

Okay, so we've done four transactions, Alex, so far this year. There's a few more in the pipeline that we haven't announced yet. The four that we've done are relatively small, probably $10 million of annualized revenue but we continue to work the pipeline.

Okay, thanks.

Our next question from the line of John Kreger from William Blair. You may proceed.

Thanks very much. Question about the Reach strategy within the Physician business, David, I think you said you've already beat your 7,000 customer add goal. Do you have a new goal and do you think you can drive that momentum through the rest of the fiscal year?

In prep for the call, I knew, John, you'd be asking that question. And we haven't sat down and reset the number. To be honest with you, we wanted to see a little more data on what the first 5,000 - 5,500 or whatever the number was in the first quarter did. We've seen that. We wanted to see if the second quarter, 5,500 or 5,400 or whatever the number was does the same kind of behavior. And I kind of think we're on a pretty good trajectory here to continue that add but where do we see the fall off? Where do we see the repeat orders and what kind of numbers do we have?

We clearly already have beat the 7,000. That's a 'gimme.' Are we going to reset that? Yes. Have we done it yet? No. We're probably -- this month we'll be talking about that and reset it.

Okay, and in terms of where those accounts are coming from, are you seeing any one source in particular pop up consistently or is it across the board?

I would say -- this is Gary Corless. I would say that our reps target who they believe to be the slowest antelope, right? So sometimes that is a weak rep with a strong company. Sometimes that is a strong rep with a weak, local company. So really to be honest with you, there really isn't one particular competitor that we're taking share from nor targeting.

It's -- we are on a local basis going for the weakest antelope that's doing the least amount for their customers in this time when the customers a lot more. So no specific targeting, no specific competitor that we're taking share from, and to be honest with you, I like that overall. It works better for us.

Great, thanks Gary. Thinking back to your Analyst Day, I think you were pointing to the fall when you'd have more clarity on a couple of topics. One was the IT market and the other was some new Select product rollouts, a little bit higher end. Can you give us an update on both of those if possible?

Okay, first on the Select, I told you all January. It's probably going to be April when we roll that product out. The FDA has been -- has slowed down their approval process from 30 days to 90 to 120 days and so that product got stuck in that process and so we've got an April launch date for it instead of January.

It doesn't really impact our numbers, because to be honest with you, it was about a tie to the runner between the investments we were making and the returns we were getting on that product. So as far as economics for the fiscal year, it doesn't impact it but we did see a slow down in the FDA approval process.

As far as IT, I would tell you, the government has been moving slower than anyone anticipated so it's a pretty confused mass up there on K Street. We don't have the rules that we thought we'd have but we have great conversations going on with some really good companies.

So -- and there's some pretty big new entrants into this space where they're trying to develop a product and looking for channel partners. So I'd say we're still having those conversations. I'm not ready to disclose the menu. We did stop our relationship with the one software product we were selling because we just don't believe selling software to the customer is the right answer. So that's a negative. That hurt our economics for our numbers that we had to find somewhere else. But we're finding that in other places.

Athena, we had a very good quarter with. We beat our expectations. We were already ahead of next quarter's expectations with a couple transactions so that product's a good product. We won't completely make up for the software loss that we terminated the relationship with but we see some really good products that we're going to choose and pick a menu from.

We really were hoping that the government would put out their final rules and make it really easy for us, which they haven't done.

Great, thanks very much.

Our next question from the line of Eric Coldwell from Baird. You may proceed.

Thanks very much. Dave, you just mentioned Athena for the first time on the call and said you're ahead of plan. I'm curious if we could just get that number from you. You've been able to give that to us in the past.

Yes, hold on a second. Do you have another question, Eric, while we're looking for that?

I have a whole bunch.

Okay, fire away. We'll come back to you.

Okay. Just quickly, seasonal flu, you pushed through the entire Novartis relationship or the commitment there. Do you get more seasonal flu vaccine this year or is that a (inaudible) and we're going to be looking at next year to see the new number?

We did not participate in the after market or the spot market. We just don't have the confidence and don't have the trust in participating in that market mainly because it's a kind of off-brand market. It's a transactional market. We're more strategic in our relationships, so the $2.3 million we got, we put out and we presold and so everything worked perfectly.

We are in the middle of conversations with Novartis now I think -- is that correct? --on how many we're going to commit to for next year so we're probably a little early on giving you that number but we will give it as far as what next year's will be.

Okay. Next question and you did address this to some extent. Physician segment, hard to find holes in anything in the story here but 1.8% same-day with the -- sounds like new, 11,000 new accounts year-to-date. You did mention that that market would be down excluding the Reach and the new accounts. I'm just curious whether you think you could quantify how much it would have been down on a same-day basis x-swine flu and x-the new accounts.

We haven't done the math to be able to give you that number but my tummy tells me it's a point or two.

Okay.

Just looking at what traditional customers buy if we haven't been impacting them with other programs.

That's great. Okay.

And then we gave you the Athena. We were about 116% of plan. We had about 50+ deals in the quarter which is a little more than last quarter. It's about 110 providers and I would say we're going to be ahead of that next quarter.

Okay, and then last two quick ones, I think Glen brought this up on the call but the profitability on swine flu and there was some comments about the lower margin flu test kits, but if I look at this, it seems as though your operating profit was about 12.6%, $2.9 million on $23 million in sales so could you help me to understand the commentary about those being lower margin sales?

Well, they're all going to existing customers, Eric, so the cost to deliver is very low, incrementally, on that so we do get nice structure on that.

Okay, so when you say lower margin, you're talking about contribution margin, the gross margin.

Gross, yes.

Okay, got it. Finally, the strategic question, Physician reimbursement via Medicare, there's been some wrangling on Capitol Hill here about whether or not to change the reimbursement methodology and obviously that hasn't happened yet. I'm just curious what your thoughts are for Medicare payments to Physicians next year, which are scheduled to drop pretty dramatically.

I think no matter who we talk to they don't want to do that and they believe that we need more primary care physicians. We need more primary care assistant physicians. We need all kinds of primary care activity, wellness activity, etcetera.

So you're in the middle of watching sausage being made and I would tell you that I don't know of any group up there that's happy with the other group, so I think you've just got to watch and see what happens but I don't believe that they're going to cut the physician. I think everyone wants to give the physicians a raise. It's just in the middle of sausage being made and I think it's just as ugly as you can get up there right now.

I guess maybe, and I agree. I think we're going to get some temporary legislation here but what would be the Company response or outlook if the world comes to an end on that front and we do get the big drop off on Medicare reimbursement? How material do you think that would be in terms of the impact on your business and what would you do to respond?

It's hard to know what the impact would be because you don't know how long it would last before the outcry got the bill passed and whether they'd give the money back to the doctors and whether it would even mean anything when it was all done versus it being a problem.

A doctor makes about 15% of their revenue. If they cut 20% of the revenue, the math to me just doesn't work. I think you don't have any doctors. So it's just a bad scenario for anybody in the healthcare business, whether it's a manufacturer, a distributor, a doctor, a nurse, a patient. So I don't know how to model that one other than it would be really bad.

And pretty unlikely I think.

I would say anything's likely up there right now and unlikely. But I jus think that that one thing probably has everybody's attention. They're just trying to negotiate something else to resolve it. Everybody's going to do it but they're trying to figure out what they can get in order to get it done.

That's fair. Thanks very much.

Our next question from the line of Robert Willoughby from Banc of America/Merrill Lynch. You may proceed.

Hi Dave, from Churchill's perspective this may be your finest hour. But you mentioned on the IT side that big new entrance looking for channel partners. Obviously that would be you. Are these agreements that would be -- build out your current capabilities or is this something that supersedes all existing relationships? What exactly are you looking to add?

Well, there's different products. There's all kinds of products from connecting doctors to doctors, for benchmarking of disease state management. There's scheduling products. There's products that would tie into patient record information so there's going to be a big entrance that of course we'll try to capture the retail side, which is the patient side and they're going to be looking to connect to other products.

There's products like Athena on the revenue cycle side and the EMR side, so there are a whole multitude of things out there that are going to be -- have to be inter-operable and connectible.

And the last thing that you want is the doctor to be in the middle of the software game. What you want is products that are ASP in nature and that can be connected and work together.

And there's going to be some companies that just connect things. There's going to be some companies that do the patient side. There's going to be some that do the billing and the EMR and the scheduling and all kinds of things, so what you're trying to do is find the right companies and the right combination to put together.

And then what do you need to rebuild as a company like us? Do we need 12 specialists in the field to help our sales people? Do we need 20? Do we need 10? What are the resources that you need to help product management and product train and help with the sales cycle?

So depending on which one we do, depending on the menu that we combine first, will depend on the investment and how we have to change our sales process.

But what I will tell you is our people are in the conversation with the customer right now. And we're directing them to different products. It would be nice to direct them to a product that we also participate on the income side with.

So whether we want to be in that conversation or not, we're in it. Our customers are talking to our people about their problems and we're provoking our customer to talk to us about their problems, which is in our Strengthen and in our Reach strategy. So we need an answer there. We need the right menu and if we have to build out a few things with it, we'll do that based on the earnings from that product.

So there's no one size fits all vendor of sorts as yet from your perspective.

Oh man, we are so far from that. This is going to be Wild West and a food fight when it comes to all the products and all the combinations of crazy things that are going to be going on out there. I've never seen more money being thrown at anything in my life and nobody having any idea what they're doing.

And just, Dave Bronson, the AR billed in the quarter, is that just a product of a longer selling period?

The AR bill? Yes, it was -- a pretty good chunk of that, those flu related sales came through into September and they're just not due to collect, but from a DSO standpoint, it looks pretty good.

Okay, thank you.

Our next question is a followup question from the line of Richard Close from Jefferies & Company. You may proceed.

Yes, just really quick, you talked about bonus accruals in first quarter and second quarter. If you could just remind us what those amounts were and then what it was in the second quarter and then is anything baked in for the third and fourth?

Yes, our new goal envisions any incremental compensation that we have because you can't -- obviously we're halfway through the year, so you have to be halfway to your accrual at least for the ones that are for annual bonuses. So we're halfway there so our goals and our outlook for the rest of the year includes the rest of that amount.

In the first quarter, I think it was around $5 million, $4.9 million and in the second quarter it was about $3 million -- a little under $4 million and that's both annual programs for all of our employees and leaders as well as the long term programs.

Let me just say they're all self-paying or self-funding so you have to hit your numbers after the accruals are met. You can't book them ahead of time because you have to know that you can hit the numbers after the accruals or what the right accrual is.

And a lot of these are unpredictable from the standpoint I really didn't know that all the field people at PSS would earn a bonus this year, which is exciting for me because that means they're performing and they're doing very well, and we just have to book it as we go. But it self-funding. It is self-fulfilling.

All right, thank you.

Our next question from the line of Steve Valiquette from UBS. You may proceed.

Thanks for the French pronunciation there. I know that Athena is a small part of what's going on for you guys and your business. I apologize for bringing it up again but I just want to understand the goal there. I think you said 1,000 adds was your goal previously and you also had in the December quarter last year you had sort of a spiky looking quarter the way the trend (inaudible). So is there some seasonality in that space is what I was trying to get more color around that. Thanks.

I'd like to help you with that but there really isn't seasonality in my opinion. It's -- it really is just -- I expected to have a low result because of the delay of what is meaningful use, but just the opposite. We beat our expectation and we also had other activity that is telling me we're going to do even better next quarter but I wouldn't tell you it was seasonal. I would tell you it is more just the activity of our customer, the economy, the economics of the practice, the conversations we're having and whether there's other products out there that fit as well.

So I think we're pretty happy with exceeding the goal. We think we can do much better than we are doing if we had more resources combined between the two of us. I think there's better alignment that could happen to get even more productivity but no seasonality and the momentum is going forward.

Okay, all right. Thanks.

We have no further questions at this time. You may proceed with your presentation or closing remarks.

Okay, thanks everybody. It's a great quarter, look forward to talking to you next and congratulations to our teams. Thank you.

Ladies and gentlemen, this does conclude the conference call for today. We thank you all for your participation and ask that you please disconnect your lines. Have a great day, everyone.