Owens & Minor Inc (OMI) 2005 Q2 法說會逐字稿

[BEGINNING OF AUDIO CUT OFF]. On the call with me today are Jeff Kaczka, Senior Vice President and Chief Financial Officer, Dick Bozard, Vice President and Treasurer, Olwen Cape, Vice President and Controller, and Grace den Hartog, our Senior Vice President and General Counsel.

Before we begin, Trudi Allcott, our Communications Director, will read a Safe Harbor Statement. Trudi?

Thank you, Craig. Except for any historical information, the material discussed today may constitute forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those projected.

These include the ability to assimilate the operations of an acquired business, the potential loss of key personnel, intense competitive pressure such as pricing within the healthcare industry. They also include the success of direct marketing programs in attracting new customers, the ability to retain existing customers, changes in customer order patterns, changes in healthcare laws and regulations, changes in government including Medicare reimbursement guidelines and private insurer reimbursement amounts, the ability to maintain product suppliers, product price increases by suppliers, and other factors discussed from time to time in reports filed by the Company with the SEC.

The Company assumes no obligation to update information contained in this call today. And, finally, we will archive this conference call on our website for the next three weeks. Thank you. Craig?

Thank you, Trudi. And now, let me call on Jeff for a review of the numbers.

Thank you, Craig. Good morning everyone. We are pleased to report that revenue for the quarter was a record $1.21 billion, up 8.2% over last year, and that brings our year-to-date revenue to $2.4 billion, up 8% compared to the same period last year.

The growth is coming from a combination of new business, penetration of existing customers, and some contribution from Access Diabetic Supply. This healthy growth rate is an indication of the success of our strategy and our strong relationships with our customers.

For the quarter diluted earnings per share was $0.40, up 2.6 % over last year, while net income was $16 million, up 4.2%. Year-to-date diluted earnings per share was $0.80, up 5.3% compared to last year, and net income was $31.9 million, up 6.5%. These earnings results were a little less than expected as a result of a couple factors related to core distribution gross margin.

Our gross margin for the quarter was 10.6% of revenues, and that has improved from last year’s second quarter gross margin of 10.3%. This gross margin improvement was driven by contributions from Access Diabetic Supply, which has significantly higher margins than our core business. However, these gains were partially offset by declines in supplier incentives and lower contributions from alternate source purchasing related to our core business.

Year-to-date gross margin was also 10.6% compared with 10.3% from last year, again, driven by the contribution from our new acquisition.

We are pleased with the SG&A results so far this year. SG&A for the quarter came in at 7.9% of sales, and that’s up from 7.6% in the prior year, but the increase is attributable to the consolidation of Access, which has a higher expense ratio to go along with its higher margins. Likewise, SG&A year-to-date was 7.9% compared to 7.6% last year.

I should also mention that depreciation and amortization was up $1.3 million for the quarter, and this, of course, was attributable to the amortization of the estimated customer and other intangibles related to our recent acquisition.

The tax rate for the quarter was 37.6% thanks to reductions in the Company’s estimate of its tax liability for year it’s subject to audit. We do, however, expect a full year tax rate similar to that reported in the first quarter, which was 39.3%.

Asset management was also quite strong during the quarter, with inventory turns at 10.7, well up from last year’s turns of 10.0. DSO also improved to a very low 24.8 days compared with DSO of 25.5 days last year. This strong asset management is a major reason for the success in generating cash flow. Year-to-date our operating cash flow is $121 million.

Turning to our outlook, our guidance for the year remains unchanged. We anticipate revenue growth in the 5 to 7% range. Although the revenue comps are a bit more challenging in the second half, we’re clearly aiming at the high end of this range. And we’re also anticipating that our earnings per share will be in the range of $1.71 to $1.73 for the year. Reaching our goals for earnings per share will require a lot of work and a strong second half, but we do have a comprehensive plan underway that will help us reach our goals by the end of the year, and Craig will give some more insight into these plans.

So, in summary, very strong sales growth of 8.2%, some core gross margin pressures affecting our EPS growth, excellent asset management, a positive $121 million in cash flow year-to-date, and very nice progress with our exciting acquisition, Access Diabetic Supply.

Thank you. Now, I’ll turn it back to Craig.

Thank you, Jeff. Before we move on to questions, let me share some thoughts about our second quarter performance and about our long-term prospects.

First of all, we are pleased with our revenue growth this year, which demonstrates we’re meeting the needs of our healthcare customers, we are trusted in the marketplace, and we are effectively cross-selling our services.

On a bright note, we signed agreements with Premier and Catholic Health Initiatives, where we already had existing customers in each, but we are excited about the potential for new business in both of those organizations. The CHI agreement named us as one of two authorized national distributors.

We also saw quarterly improvement in gross margin compared to last year due in large part to the contributions from Access, our recent acquisition. However, overall margin is not where we want it to be. Consequently, we are working on leveraging our long-term strategy to bring about margin improvements.

For example, even though MediChoice sales were up over last year, we are a bit behind on our plan for this year, and we have gotten some pushback from manufacturers and some GPO’s, and we are to some degree facing some stiffer competition in the marketplace. However, we have refocused our sales team on their MediChoice goals, and two buying groups, MedAssets and CHI, have recently approved MediChoice for their membership to buy.

We just finished a product launch in May which will carry us through this year and into next year, and we have one more product launch in September, for a total of three, and we intend to revisit lost opportunities and sales leads generated from earlier launches.

Other margin initiatives in the works include a refocus on PANDAC, our wound suture closure asset management program. Let me take a couple moments on that. That program is well over 35 years old today. We have an OM medical specialties group that is responsible for selling PANDAC to our hospitals. We have refocused that group. They had several programs and services they were selling, and they now have two programs that they’re going to be selling for the remainder of the year into next year which are really focused around high margin programs and services.

We are also in the process of taking marginally profitable accounts up to acceptable levels, and we are working with some [profitable] suppliers.

And, of course, OMSolutions is a big margin initiative for us. We are turning this team’s focus to larger, more comprehensive engagements which have a greater impact for customers and are more profitable for Owens & Minor. We are also going to make sure that OMSolutions more closely reflects the core, which is efficient, cost effective, and highly productive. On a positive note, OMSolutions will cross-sell an estimated annualized $125 million to the core this year.

And, let me congratulate our team at Access. They have outperformed our expectations this quarter. We are very pleased with the progress this team is making to serve healthcare consumers at home. They have grown their customer base from approximately 60,000 at the time of the acquisition to more than 90,000 today. As expected, Access also made a strong contribution to margin.

Operationally, we did a great job this quarter. If you remember, we said we’d work on inventory turns in the first quarter and our team responded. In fact, we had noticeable improvement this quarter with inventory turns.

While we had some disappointments this quarter, we also had positives. But even with the margin improvement, we are not satisfied. The Company is completely focused on meeting our goals for the year. Access is contributing, OMSolutions is engaged, we are pushing to meet our MediChoice goals, and we are working to reduce our overall expenses. The whole management team is committed and they have a strong sense of urgency, and we have a point-by-point plan to reach our goals for the year.

And, finally, this quarter I’ve met with over a dozen customers, mostly hospital CEO’s but I’ve also been very active meeting with materials managers. And what they tell me is they want better and improved quality, lower costs, and tools to make the supply chain more efficient, and we are in the best position to help them do that. We are in good shape operationally, financially, and strategically, and we are excited about the future.

Thank you and we’d be glad to take your questions.

Thank you, Sir. [CALLER INSTRUCTIONS]. Our first question is from the line of Christopher McFadden with Goldman Sachs.

Thank you. Good morning everybody. A few questions-- first, relative to the revenue growth, could you just clarify what would be considered the organic revenue growth in the core business versus the contribution from the diabetes business?

Well, I think the internal growth would be probably roughly between 3 and 4%. The Access really, Chris, contributed more in terms of margin than overall sales. I would say it was probably somewhere around 1%.

Got you. Secondarily, I know you’re queuing up here for obviously some Premier activity. Are there costs in the quarter that were realized as you are anticipating that relationship?

Chris, we really are just now-- we won that award July 1st, so we’re just starting up. We have targeted, of course, several accounts that are non-Owens & Minor accounts. And, as you know, we have enjoyed a great relationship with Premier without a formalized agreement.

We’ve had several customers over the years say, “We’d love to do business with you, but you’re not an authorized distributor,” and we have that opportunity today to really expand our penetration. But we have done very well with Premier. I think we’ve got a good opportunity with CHI where we probably have a smaller percentage of the business, and now we have a formalized relationship with just two distributors competing for the business.

I understand. And then, additionally, you talked about in your prepared comments, Craig, you felt like there might have been some slightly stiffer competitive dynamics in the marketplace. Can I get you to expand on that in as much detail as you feel comfortable?

Sure. And I do have to recognize you. You have been asking me about that for probably the last three or four quarters. And I think we’ve been, Chris, a little bit under the radar screen as we build up, and I think we’ve shown that in the last year, maybe the last 18 months, we do have the ability to move market share on these commodity items, low-end commodity items, and we’re getting some pushback from some manufacturers on price points on individual pieces of the business.

But how we approach MediChoice is as a market basket of products. So we take a pretty strong line that it’s really a program, it’s not an individual product, but we are getting some pushback on some individual items and some individual manufacturers.

Good. Let me stop there. Thank you very much for the detail.

And, Sir, our next question is from the line of Lisa Gill with J.P. Morgan.

Good morning, Lisa.

Hi. It’s actually [Arthur Freeman] for Lisa Gill. Thanks guys. Just going back to one of your comments you made regarding declines in supply incentives, are you seeing that on more of the commoditized products or is it largely around the branded side from the manufacturers?

Well, actually, as you know, as you’ve followed us, we’ve done very well on the Focus program, which was really the strength of our vendor incentive program over many, many years. So we have been very active in that. Really, the MediChoice piece was a filler for opportunities to grow the overall portfolio on vendor incentives. We still see some opportunity as we move out of this alternate source purchasing program, which we have aggressively been doing over the last 18 months, to work on supplier programs that work on operational efficiency and help overall drive the costs down with the manufacturers.

The other thing we’re looking at is we do have some suppliers where we have minimums or they’re non-stock or non-contract, where we have stocking products that we already have in our facilities. So we’re really looking at profitability by stock-keeping unit by stock-keeping unit, and that’s probably where the next opportunity is for us.

Okay. And in terms of MediChoice going on, what are the new products you’re planning to launch in that area? Any ideas you can give us around that?

Our launch in May was respiratory. Kind of in my new role, I’m getting a little bit away from all the operational particulars that I had, but I believe it’s a mixed bag of products in September not a specific product category launch.

Okay. That’s great. Thanks a lot.

And, Sir, our next question is from the line of Larry Marsh with Lehman Brothers.

Craig and Jeff, good morning. Let’s see. Craig maybe or Jeff, to the extent that you can elaborate, you talked about some of the specific steps you’re going to take to accelerate gross margin improvement and reduce costs. I know you elaborated a little bit on MediChoice introductions. Could you talk a bit about specific plans you have to help drive those margins in the second half of the year?

Well, I did talk about about four of them. Actually, we’re going to see a fairly significant contribution from Access over the next five months. As you can see, that’s growing dramatically from 60,000 to 90,000 in one quarter. That’s, obviously, at a much higher margin and they’ve had a lot of internal growth.

As we also, Larry, go after these bigger engagements through OMSolutions, we see that we’re getting a higher margin on that versus the [onesy-twosy] engagements that we did a year ago or 18 months ago. We’re also on the PANDAC program, which we talked about, for years. We do have this medical specialties group, which it specifically works in the operating room. We have taken a lot off their plate to particularly focus on PANDAC and SugiTrack, two of our higher margin programs.

And then, we also have just a total refocus on MediChoice. There’s a very high sense of urgency. We have all the sales directors in this week and next week, and they’re individually reviewing their margin plans with Jeff or [Charley] Colpo or myself as they’re back here in meetings.

So, we’ve got a very heightened sense of urgency. It’s actually about 11 different initiatives that we have. The 5 or 6 I just talked about are the key components of it. But we meet every Friday, we’re tracking this, and we are on top of it.

Okay. Thank you for going through that again for me. Could you talk a little bit about Solutions specifically? I know last year you had highlighted it wasn’t quite at the profit level that you had hoped for. Is your message today that it is at the profit level you would like it to be and you think there is good visibility for it to really expand its profitability in the second half of this year?

Well, I think you know me pretty well. I’m never usually very happy with the profitability, period. We can always be more profitable. We are improving. I think last quarter I had told you that-- shared with everybody that Scott Watkins, who is an old veteran, consulting veteran on the West coast, is now Mark van Sumeren’s number 2, and he is refocusing that whole organization on larger engagements and more profitable engagements and he’s taking a look at the whole structure of Solutions and making sure we have the right people, that we’re spending money appropriately. And, as you know, in distribution when you’re making a penny on every dollar, you manage your expenses very frugally, and Scott will be taking that approach going forward with Solutions.

So, we have made good progress, Larry. I still believe it is very much a key strategic component for us for hospital penetration. You can see through the annualized sales where we’re either taking an account that’s five, six, seven years with us and taking them to the next level where we are getting competitive business through OMSolutions engagement.

So, we’re really-- we’re looking at it as a standalone, but we’re also looking at it and how it pulls new sales and potential sales growth through the core, and the number, the top line shows that.

Okay.

And if I may clarify something in regard to the top line, if organic growth is defined as that growth excluding acquisitions, that organic growth is closer to the 7% range. When Craig had mentioned the 3 to 4% range, he was talking about the penetration in our existing [hub] and there is, of course, the winning new business on top of that as well.

Okay. And just two other quick things-- just confirm, Craig, in your role in the channel, higher raw material costs really have no impact on your margins? Is that fair to say?

Well, actually, to some degree it does. On the price increase, roughly 40% of our business today is activity-based costing through CostTrack. So that’s really fee driven, but there still is a cost component on that with the manufacturer, and if the manufacturer takes a 5 to 7% increase, that does have some impact on our business.

Also, in the cost-plus environment when the manufacturer takes a price increase-- and, as you know Larry, we’ve been fairly flat the last two or three years-- but that would also have an impact on our margin also.

So those would have slightly negative impacts?

Positive impacts.

I’m sorry. These are all positive impacts with higher raw materials costs. I see. So that’s helping to offset some of the lost profits from the alternate source business?

Well, today we still are pretty well flat from an inflation standpoint, so we really have not seen inflation this year or in the last two years. Now, there is some pressure on latex and plastics and other prices, and the manufacturers are really feeling it. And we really haven’t been notified yet that anybody is going up, but there are a lot of suppliers very concerned about their raw materials costs going up significantly here in the last six months.

Okay. Then, finally, just a reminder, Jeff-- with the addition of Access, you have this deferred direct response advertising cost in your cash flow statement now gets the function of that business. Over what period of time are you amortizing those costs?

Generally, about four years.

Okay. And we should just take that figure that you show in your cash flow statement and assume that’s a good quarterly run rate to use?

Well, let me have Olwen--

Larry, it’s the accountant here. What will happen is we’ve started capitalizing that with the acquisition of Access, so that asset will continue to build and the amortization will continue to build over a period of approximately four years, the amortization period.

So that could continue to creep up as Access continues to grow. Okay.

Also, we are amortizing it on an accelerated basis.

Right, over that four-year period?

Yes. There will be more disclosure in our 10-Q, so that’s probably the easiest way to get it clear.

Primarily though, Larry, those 30,000 new customers, about 4,000 of those came from an acquisition, [DDS], and the other 26,000 was just from growth. So we are seeing every month add-ons without acquisitions to the customer base.

Okay. Very good. Thanks.

And, Sir, our next question is from the line of Glen Santangelo with Credit Suisse First Boston.

Thanks guys. I just have two quick questions. Earlier in the call you sort of talked about the revenue contribution from the recent acquisitions. Would you say it is fair, Jeff, at this point to say that the acquisitions are maybe accretive or are they diluted at this point?

No. The acquisitions are accretive.

They’re still accretive.

For the quarter and year-to-date. Modestly accretive.

Modestly. Okay. So as you look at the back half of the year, I mean you obviously have some work to do to make your EPS numbers. Are you banking on or assuming better profitability on the base business or a greater contribution from some of these recent acquisitions?

Well, certainly, with the growth of the customer base, we would expect contributions in the second half.

So greater contributions from the acquisitions?

Well, Glen, yes, and the fact that we’re growing the customer base every month through direct mail. So it isn’t going to be flat-lined at 90,000. We’re still going to see continued growth for the next five months at Access.

I will also say, though, that we are expecting margin improvement in the core and in OMSolutions. So it’s not just Access. This is going to be overall managed margin management for the Company and we’re not going to bank on Access to carry us through the year. This is a Company initiative and a Company plan and we’re going to deliver the plan.

Okay. Thanks for those comments. The last question I had was as you look at acquisition opportunities going forward, I mean, what are you seeing? I mean are you excited about anything you see out there? Should we expect more acquisitions from the Company over the near and immediate term?

Boy, that’s-- we’re always looking at acquisitions. We now have really a team that’s dedicated to that. They’re looking at-- our strategy is to follow the patient, and so we’re really investigating all avenues of potential acquisitions that would support the strategy. I know that’s a very vague answer, but clearly the [Cyrus] Medicals and the QSights have had a tremendous impact on our portfolio for Solutions in consulting. So if we could see some small technology companies that might have some benefit to the overall profitability of a customer, we would continue to look at that.

We’ll continue to look at acquisitions in Access. Now that we have this amortization pretty well lined up and factored in, we’ll continue to look at that. But, again, we’re getting some great growth from the Access folks in Florida just on a day-to-day basis. So we’ll continue to look at that. Every day we’re looking at opportunities. We want to make sure they’re accretive. We have committed to the Board that the acquisitions will be accretive. For every ten you look at, one kind of bubbles up and you get a good opportunity.

Thanks for the comments. Appreciate it.

Sir, your next question is from the line of Terri Powers with Baird.

Hi Terri.

Good morning everyone. Thank you very much. I had a few housekeeping questions and a couple of other things. The first thing I wanted to ask about was just a little bit more color on MediChoice. You mentioned that it has been growing nicely year-over-year but still a little bit below plan internally. I was wondering if you could just give a little bit of color? I don’t know if you can give growth, maybe a number of [skews]. And can you give us some sort of color on contribution to the firm’s results? I assume it is positively impacting gross margin, etcetera.

It is positively impacting gross margin. It is growing nicely. We were very aggressive with our plan this year. We have well over 1,000 stock-keeping units. That will go up with the next launch. And we continue to see that grow. Here we are in the third year and it’s continuing to grow very strong.

Again, we have had a little bit of pushback, but Owens & Minor has always enjoyed competition and we always rise to the occasion, and we’re going to sell the value of MediChoice and not drop our price. So, we feel that there’s a lot of opportunity with MediChoice going forward. The color piece, though, would be is that we’re up now over 1,000 stock-keeping units.

Okay. Great. I wanted to move to working capital. Inventory turns were very nice this quarter at 10.7 I believe and, clearly, that’s the area that you guys really have been targeting recently is the opportunities given how low DSO’s have been. 10.7 is pretty good. How much further can we go here?

Well, actually, it’s an amazing number with the sales growth that we’ve had. It’s a very good number. I just met with [Charley] Colpo, who has inventory, and he thinks we’re doing very well. He’s going to try and tweak it a little bit. But if we can hold 10.7 with the high end of our range on sales, we’re going to be doing pretty good for the year.

Excellent. And then this is a little bit of a clarification maybe for Jeff. Looking at the D&A this quarter was clearly above what we were expecting. You mentioned the color on amortization of intangibles related to acquisitions. I was just wondering if you could provide a little more color. Is that related to customer relationships, and maybe you can give an idea of burn on that? And what I’m really trying to get at here is you had a little over $5 million in D&A this quarter, and I was just wondering if that’s probably going to be the expected level on a go-forward basis, at least in the near term, and where that’s likely to go.

Terri, let me let Olwen address that.

Hi Terri. I’ll answer your last question first. The level that we’re at right now should be fairly steady. We still are working off an estimate on the intangibles. The bulk, as you said, is customer relationship intangibles. We expect to get the valuation work finalized in the third quarter, but we believe that where we are now is materially correct. So, we may have a few small adjustments. We are expecting to amortize those relationships over about four years and on an accelerated basis.

Okay. Great. That’s excellent color. Thank you very much. And then just had a housekeeping question on WISDOM3-- can you guys talk about the rollout, the status of how that’s going?

It’s going well. We’re still in beta test. We are out talking with customers about it. The Company is very excited about it, and we are getting a lot of good response on the potential of taking a lot of our WISDOM2 customers to WISDOM3. This will have, Terri, a very significant impact on these larger engagements as we move forward. It’s a key point that we need to have. As I said, I’ve been out talking with a lot of CEO’s in the last quarter and there is a high interest with WISDOM3.

Excellent. And last question and I’ll jump out-- can you guys give us an update on the integrated service center deals, [Cheyenne], Utah, etcetera?

They’re going very well. We are full-blown. With Iowa, we are talking about additional services. I do believe that we are now delivering stationery for them. We do have desktop delivery at Iowa. [Cheyenne’s] is still ramping up and Utah is still ramping up, and we are looking for other potential customers to come into that.

There is an interest among several of our customers-- I wouldn’t say it’s a huge number, but these are large systems, that are looking to have perhaps a distribution center dedicated to them and run by us, and so we are having some discussions with some other customers.

This is a long-term sell and program though. You just don’t flip the switch on these overnight. I mean Iowa we’ve been in it almost a year and I would say we’re maybe headed towards Phase 3 and there are 5 phases. So it really is built around open-book and trust and integrity and really having shared objectives. So there is a lot of discussions, there is a lot of prep work, there is building of business plans, but we do feel we’re on the right track with that.

Thank you very much for the color guys.

And, Sir, our next question is from the line of Robert Willoughby with Banc of America Securities.

Morning guys. It’s [John Worthing] for Bob. Craig, if I’m not mistaken, I think you moved Access’ location in the quarter, and I’m just trying to get a sense of maybe there were some one-time costs in the quarter that won’t recur there. Can you give me a sense of that?

Well, actually, we’re in the process of doing that. We are moving to a new facility in the third quarter. You know what? Let me give that to Dick, because Dick is really the executive sponsor and he can probably give you the color on that.

Sure. We are in the process of moving currently. It will be completed in the third week of August. So, it is a crossover between the two quarters as it relates to the expense. The expense was rather small in the first period-- I mean in the prior period. So, it will be a reasonable move. The costs are not unusually egregious. The team is well-positioned. It’s a really solid plan that we have to make the relocation.

I would want to say just to reemphasize that we are clearly very excited about what we’ve done with Access, what they’ve done. It was the right choice for Owens & Minor at the right time. They validated our strategy to enter this high-growth market. It’s accretive year-to-date and it’s exceeding our expectations.

We talked earlier on the management team. They know this business. They know how to market their products. They know how to attract good customers. The culture is an excellent fit with Owens & Minor. And they’re running a shop that is very tight financially, and they have excellent customer service. Clearly, the team has proven that they can grow this business.

Since the acquisition, we’ve seen solid gains. As Craig mentioned earlier, to grow from 60,000 customers to 90,000 customers in this short period of time is just outstanding, and the majority of that being organic growth. We did add one small acquisition, as Craig mentioned, of approximately 4,000. And one of the reasons we wanted to do a small acquisition initially was to in essence prove to ourselves that we could do it effectively, and that acquisition was very successful. The conversion went beyond our expectations, and we know now that we have a team in place that’s ready to take on additional acquisitions going forward with a lot of expertise.

So the strategy ahead for us continues to be to manage the risk in the acquisitions and to choose them wisely, which the team is doing. And, as Craig mentioned, we are evaluating a number of prospects in the market currently.

So when you look at the company, Access, you’re going to see that there’s an exciting opportunity for many years to come. They’re solidly positioned in a very high-growth market. The management team is very talented, and this has clearly been demonstrated, and we have a plan to grow the business. So we’re very pleased with what we’ve done and we are looking forward to strong progress as we go forward and this becomes a bigger part of our strategy.

Thanks for the comments, Dick.

Certainly.

[CALLER INSTRUCTIONS]. Sir, our next question is from the line of [David Boeff] with Paragon Capital Management.

Hi. Congratulations, Craig.

Thank you.

Access has generated incredible growth, and so I just wanted to sort of understand that business a little better. That’s all direct marketing? That’s how you’re--?

Correct. That is primarily around [Trent] in magazines and some telemarketing, but primarily, yes, direct to consumers from that standpoint.

And what’s the value to a diabetes customer? Is it lower cost versus where they get it now or is it convenience?

I think it’s both. The first is that primarily if a customer goes to a retail pharmacy, they’re going to pay a higher price for the products. Plus, there is some paperwork that the pharmacist has to fill out and appropriately file for that. But it really is around convenience and privacy. A lot of diabetes patients are elderly. It’s tough for them to get to the pharmacy.

I’ve been down there. Dick has been down there, Jeff-- we’ve all been down there. The people on the phones do a great job with these folks. There is a very high comfort level, but there is also a very high privacy around the patient really being able to do that out of the home.

So there is some price, there is some convenience, but also from the privacy standpoint of having to be able to do that at their home.

And how large is the diabetes market?

Currently, it’s a $4 billion market. That is expected to grow to $6 billion by 2009. So approximately 17 million people will be diagnosed between now and 2009.

Wow. Okay. And the last question was you made a comment about the respiratory. I didn’t understand that.

Well, we do have respiratory patients out of Access. It’s a very small percentage of our business. It’s probably insignificant really. It’s really around diabetes, but there are some patients or customers that do call for respiratory products, but it’s a very small percentage of that business.

Is that a different distribution model?

No, not really. It’s a very small number of stock-keeping units. It can be done over the phone, and it’s basically the same model, different products.

Okay. Great. Thanks a lot.

[CALLER INSTRUCTIONS]. Sir, our next question is from the line of [Stallion Mitchu] with Stone Financial.

Good morning everybody. I have two questions. First, the higher margin diabetic supply business you mentioned, how much higher are the margins?

Well, we never break that out separately, but it’s significantly higher than the other businesses that we’re in.

Just an idea. I mean instead of let’s say--

No. We really-- that, really, we don’t break that out. It is fairly higher as a percentage versus the other businesses. Now, it’s a smaller piece of our business today, but it is fairly significantly higher.

Other question-- in your guidance-- from your guidance I understand that the sales will remain virtually flat the next two quarters. Is this correct, Jeff?

This is Jeff. Our guidance remained the same as of the beginning of the year, which was a 5 to 7% growth. Both Craig and I had clearly indicated that we’re aiming at the top end of this range. The comps are a bit more challenging in the second half as there was $74 million more revenue last year in the second half than the first year, but, again, we’re clearly aiming at the top end of the range.

And by that [I find] your EPS guidance indicated that you have about [$0.54] more EPS than the first two quarters. What--? This appears that you have to do some-- to cut some expenses. Could you detail what expenses you intend to cut or you expect to cut?

We clearly have our work cut out for the second half, but as Craig outlined, we’ve got tremendous opportunities on the gross margin side of the equation, and we always look for cost improvements, and we’ve got the team behind the comprehensive plan to make our goals for the year.

Just an idea, could you give where your cost improvements will be, whether in general and administrative expenses or in gross margin?

Well, the gross margin really is a little bit different than the expenses. It would be an overall-- we’re looking at our overall cost structure. We’re looking at overtime and temporary help. We’re looking at travel. We’re looking at everything. Primarily, though, we’re focused on one piece of the business. On the margin piece, we pretty well detailed out that we’ve got 11 initiatives. So it’s really a combination of taking the margin up and looking at our overall cost structure, which we do day in and day out a very good job on.

Okay. And the last question is you mentioned that a few months earlier that you will use a fee-- you’ll start to use a fee-for-service approach. Could you tell us how--? What is the percentage of total revenues of this fee-for-service business?

Yes. It’s CostTrack, which is our activity-based costing model. We have been in that for several years now and we’re at about a run rate of 39, 39.5%, which is a pretty big percentage of our business, mostly around our larger hospital systems that are working on process costs versus price costs.

Okay, thank you very much.

[Carlo], how about we take one more question?

Actually, Sir, this does conclude our question-and-answer portion of the call, and I will turn the presentation over back to Mr. Craig Smith for any closing remarks.

I want to thank you all for your questions and your interest this morning, and we look forward to seeing you again next quarter and answering any questions that you have. Thank you and good day.

Ladies and gentlemen, we thank you for your participation in today’s conference. This concludes your presentation and you may now disconnect. Good day.