Owens & Minor Inc (OMI) 2006 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Owens & Minor's third quarter 2006 earnings conference call. My name is Sharon and I will be your coordinator for today. [OPERATOR INSTRUCTIONS] I would like to turn the presentation over to your host for today's call, Mr. Craig Smith, President and Chief Executive Officer of Owens & Minor. Please proceed, Mr. Smith.

Good morning, everyone. And thank you for joining us today for our discussion of the third quarter 2006 financial results. With me today is Jeff Kaczka, our Senior Vice President and Chief Financial Officer. Charlie Colpo, our Senior Vice President of Operations. Beth Moore, our Associate General Counsel. Olwen Cape, our VP and Controller and Dick Bozard, our VP and Treasurer. Before we review results from our second quarter, Trudi Allcott will read a brief Safe Harbor Statement. Trudi?

Thank you, Craig.

Except for any historical information 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 pressures such as pricing within the Health Care 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 health care 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 we will archive our call on our website for the next three weeks.

Thank you, Craig.

Thank you, Trudi. Let me call on Jeff Kaczka to review our financial results. Jeff?

Thank you, Craig. Good morning, everyone. We had a very busy quarter and except for a charge related to our direct to consumer receivables we are very happy with our results. There are, however, several things that complicate our results, but I will try to give you a clear picture of what's happening. With a we are most pleased with is the revenue growth for the quarter and the fact that we closed on the acquisition of the McKesson Acute Care business which is a significant milestone for our company.

On to our results. We're very pleased to report that revenue for the quarter was $1.3 billion, up 9.8% from last year and that's our largest quarterly growth rate in five years. On top of that, we had one less sales day in the quarter so on a per day basis we grew 11.5%. Because we closed the acquisition on the final day of the quarter, we had absolutely no McKesson revenue included in these results. The revenue growth was organic and came from a combination of new accounts and penetration in existing accounts including the Department of Defense. Our year to date revenue is now $3.9 billion, up 7.6% from last year. Congratulations to the sales team for creating a lot of momentum.

Our earnings results are a little complicated. We reported diluted earnings per share of $0.36 versus $0.42 last year, and net income of $14.5 million versus 16.8 million last year. These results were affected by three items. A pre-tax charge of $4.5 million or $0.07 per share to increase our reserve for doubtful accounts in our direct to consumer effort. Approximately $1.3 million or $0.02 per share for expenses incurred to prepare for the transition of the McKesson business. And a pre-tax impact of about $500 thousand or $0.01 for the expensing of equity based compensation.

As we previously reported, we had to increase the reserve for doubtful accounts at access by $4.5 million which was recorded in SG&A. We are disappointed by this, but the issue was related to the very rapid growth we've experienced over the last year or so, and we have moved quickly to ensure the problems are resolved and that systems and processes are adequate to support continued growth. For example, we're implementing recommendations from an industry consulting firm, and we also hired an industry veteran skilled in managing similar portfolios of receivables and in implementing process changes. The $1.3 million of expense is related to the McKesson acquisition included hiring and training new teammates to ensure that customer conversions are handled efficiently. Making system improvements to accommodate the new business and travel to the new facilities by the transition team.

Year to date, earnings per share was $1.03 compared to $1.22 last year and net income was 41.4 million versus $48.7 million in the previous year. These results were impacted by the third quarter items, as well as a few more items. The second quarter $11.4 million refinancing charge. $2.2million for year to date expensing of equity based compensation. And about $900,000 for our first quarter move to the new home office.

Turning to other results, our gross margin for the quarter was 11.0% improved from 10.9% in the third quarter last year, and year to date gross margin was 10.9% compared to gross margin of 10.7% last year. SG&A for the quarter came in at 8.5% of revenue compared to 7.9% last year. We have seen very nice improvements in the underlying core business, but total company SG&A, of course, was impacted by the items we just discussed, the access charge, the transition expense, equity based compensation expensing and the home office move.

I should mention that our September 30th balance sheet includes an estimated $122 million of net inventory and $49.8 million of other assets, as well as $6.3 million in liabilities, all recorded in connection with the acquisition which occurred on the last day of the quarter.

DSO was up one day to 27 days and our inventory turns for the quarter was 9.7 excluding the $122 million from the acquisition. This was down from 10.3 last year primarily as a result of building inventory for new accounts. Consequently, we had negative operating cash flow of 10.8 million for the quarter, while year to date operating cash flow is now positive $31.3 million. Historically, we have used cash in the fourth quarter. This year we anticipate additional use of cash in the fourth quarter associated with the transition of the McKesson business, including some increases in inventory to support the acquired customers, higher receivables, increased capital expenditures, and expected pre-tax earnings dilutions. This should be offset, partially, by higher payables. We do, however, expect the transaction to produce positive operating cash flow after the transition.

Before we turn to our guidance for 2006, I want to let you know how we intend to report our financial results going forward. For the fourth quarter and the full year 2006, we will let you know the impact of the McKesson acquisition on revenue and earnings, so that you can clearly see the impact of the transaction and how the rest of the business is performing. When we issue guidance for 2007 with our year end results, we expect to include the impact of the McKesson acquisition in our outlook including what remains of the 10 to 15 million in expected dilutions.

Okay, our 2006 guidance. We expect to see revenue growth at or above the 6 to 8% range. And as a result of the $4.5 million charge, which had a $0.07 impact, we anticipate diluted earnings per share in the range of [$1.68] to $1.73 excluding the one-time charge of $11.4 million for the early retirement of debt. This guidance also excludes the expected increase in revenues, as well as the dilutive earnings impact from the acquisition of the McKesson Acute Care business.

As we said before, we anticipate that the pre-tax dilutive impact will be in the range of 10 to 15 million over the course of the transition period with greater dilution at the beginning of the period and I would really like to emphasize this. And this is because of the transition service fees paid to McKesson and because the efficiencies of the transaction are obviously realized after the conversions take place. I would like to stress that what we spend on the transition may well be some of the smartest money we've ever spent. We are committed to successful transition of new customers, teammates and facilities to Owens & Minor. Once we can complete the transition, we expect meaningful accretion to earnings from the acquisition.

So in summary, it's been an exciting quarter on top of a very busy year, and with the exception of the AR charge it's been an incredible quarter. Our strongest revenue growth in five years. The successful sign-up with our Novation customers. The renewal of our agreement with Broadlane. Completion of a very significant acquisition, and our transition process is well underway.

Thank you. Now I will turn it over to Craig.

Thank you, Jeff. And as you've just heard, this was a very busy quarter for us at Owens & Minor. I have been here a long time and I have to say, if this isn't the top quarter with the most activity that we've had since I have been here, it ranks very high up there. And as Jeff said, one of the things that I'm very proud of this quarter is that our revenues grew at the strongest pace that we have had in five years. We successfully resigned over half of our business with the new Novation of and Broadlane agreement. We moved our second largest facility and opened a new small facility in the third quarter. We closed the acquisition of the McKesson business.

And throughout the quarter I'm probably even more proud of this than the sales growth is that we leveraged our core expenses against just great top line growth. We are very pleased that even with all of this activity going on we still met our internal targets. I'm proud of our teams in the field and at the home office for managing this growth really very effectively.

Before I turn to the McKesson acquisition, let me just touch on a few of the big items from the quarter. With the Novation sign-up, this effort involved really a significant commitment in time and travel for our core sales teams. We were fortunate to have most of the larger accounts precommitted before we went into the sign-up period. And of the smaller and medium sized accounts, we won the majority of those accounts. And even though we were competing against 16 distributors on this agreement, we finished the sign-up with no material change in our revenue base.

Also during the quarter, we renewed our long-term relationship with Broadlane by signing a new five year agreement. And we are pleased to renew this relationship which dates back to 1999. With the new agreement, we will offer our superior mix of supply chain management service. And for the first time, it's also formally, this agreement also formally offers our wisdom suite of products to Broadlane members.

Now let's turn to the acquisition of the McKesson Acute Care business which we completed on the last day of the quarter. Upon the closing we immediately launched a transition phase. And thanks to the preparation work of many, many people, the preparation work we did in the third quarter by many people, we are off to a very fast start with transition activities. We are already benefiting from the experience and knowledge of the McKesson sales teammates and others who have joined Owens & Minor.

We are very pleased, as we have been from the beginning of this, with the caliber of these new teammates, and I've got to tell you, they are just a very enthusiastic gang about being a part of the Owens & Minor family. By the end of this week, we will have trained three-quarters of the new sales team. As a matter of fact, as we end this conference call I'm going to go down and spend a day with these folks. There has been a lot of interactive -- interaction with the senior management team for Owens & Minor and they have been engaged in week-long sessions here at the home office to get an introduction to our culture. Our way of doing business and our programs and services, which they are very enthusiastic that they have an opportunity to sell these.

In the third quarter, we will also start training the new drivers and warehouse teammates. With the leadership of our transition team, we are off to a strong start on our aggressive conversion schedule. To date we have completed customer conversions for two McKesson facilities. These early conversions went according to plan and allowed us to successfully test our processes and procedures. To date, the customer acceptance of the change has been positive. We continue to believe that these customers will benefit from our sole focus on acute care distribution and our expertise in the marketplace.

I'd like to give you some idea of what's involved in the transition of this acute care business. First, as a reminder, of the 24 McKesson DCs serving the acute care markets, we took ownership of 12 facilities after the close. Now we are in the process of either closing or converting these facilities. We also are converting the customer base from the remaining 12 McKesson facilities. These transitions will resemble typical customer conversions at which we are very skilled. As a reminder, this is a carve out acquisition and we are doing what is necessary to ensure an orderly transition of customer accounts from McKesson to Owens & Minor.

Let me give some detail on what will happen during the transition. As stated earlier, during the transition, we are subcontracting with McKesson for day to day servicing at customer accounts until we move them to Owens & Minor. We will transport roughly an estimated 1,000 truck loads of inventory. We have cross-referenced our product data files in loading of local customer contracts. We will expand, and we are in the process of doing that, or reconfigure selected facilities around the Company -- country and the Company to accommodate the expanded business. We will convert systems on the acquired facilities, and our transition teams will be travelling to new and converted facilities throughout the transition phase as we convert customers to Owens & Minor. And we will continue to aggressively train our new sales teammates to introduce them to our value added products and services and our way of serving the acute care marketplace.

We have said before, and we will say it again, this was a great deal for Owens & Minor and we will do what is necessary to ensure that the transition is a smooth one for customers. We are very excited about the acquisition as it is a unique opportunity and a great strategic fit for Owens & Minor. With our core business on very solid ground, this was a perfect time for us to grow our business with this acquisition.

All in all, again, I will just say this was just a really very busy quarter for us. Our organic revenue growth was strongest it's been in five years. We signed new agreements with Novation and Broadlane. We moved our second largest operating unit into a better facility, and opened a new small one in a rapidly growing market. We acquired the McKesson Acute Care business, and I am still -- I just can't tell you, I'm just really pleased with all of this activity we achieved, strong productivity in our core business.

And I want to thank our teams in the field and at the home office who have done a great job this year in managing our business. And behalf of everyone at Owens & Minor, I want to welcome our new teammates and customers onboard and thank our transition team and those who are supporting them as we enter this important transition phase. Thank you, and we'd will be glad to take your questions.

Thank you, Mr. Smith. [OPERATOR INSTRUCTIONS] Our first question will come from the line of Larry Marsh of Lehman Brothers.

Thanks and good morning. This is actually Steven Postal for Larry.

Good morning.

First a quick clarification. I know you said the '06 guidance excludes the McKesson related cost, but does that guidance exclude the $0.02 in McKesson related cost that you already saw in the third quarter?

Yes, Steven. That would be part of that 10 to 15 million dilution that we had previously communicated. It's just a question of the timing, the transaction actually closed on the last day of the quarter. We always anticipated having preparation costs associated with that. We just happen to have no revenue or margin associated with the transaction in this particular quarter. But we had the expenses. It's part of the 10 to 15.

Okay. And on the DOD business that you mentioned, you mentioned increased penetration with that account. What is driving that increased penetration? And has the penetration in that account peaked, or can we see that moving higher?

That's a good question. Part of the penetration, as you know, historically, any time that we have taken on business or we have existing business, the strength of our top line really comes from sales penetration. So we continue to sell programs and services with the DOD. We continue to expand or product portfolio, and we had a very strong quarter in the third quarter, but we feel that we can maintain a pretty strong growth in the DOD, the rest of this year and going into next year.

And, Craig, has the negative impact from the changes in the grey market have those changes ebbed?

We have been out of the grey market -- I mean, we were probably one of the advocates of getting out of that market a long time ago. We really work on our efficiency and productivity programs with our larger manufacturers. And primarily got out of that market a long time ago, really working on a better supply chain for our end users, which are our customers. So we have, what I would call logistics and operating programs with most of our larger manufacturers that really works on driving costs down for everybody in the system. So we started getting out of that probably three years ago. And it was a very small piece of our business three years ago. So it's something that we really wanted to be out of and really to work with our manufacturers. So that really does not have an impact on us.

Okay. And then on the depreciation and amortization, it was up year on year and also sequentially. What is driving that? Is it some of the increase in D&A related to the McKesson acquisition?

No, no, Steven. That really is driven on the direct to consumer, which includes the amortization of the intangible assets from the acquisitions we had done there. And it also includes the amortization of the capitalized advertising. That's what's really driving the growth.

Jeff, can you talk about maybe what run rate D&A would be on a quarterly basis?

It will vary some, Steven, depending on the amount of capitalized advertising that we will do. But I would just look at the historical patterns. You will see over the course of the last 20 months since we've owned the acquisition that that has picked up and that has, in fact, been the driver. So I think your best way of estimating that is, in fact, to look at the patterns.

Are you asking specifically, Steven, for the direct to consumer business?

I was just wondering how we should think about-- whether it's 3Q D&A will be the number to think about on a recurring basis-- or normalized basis?

I think what you will see is, you will see us d,o at least on the acquisition side, which we have been pretty active on the direct to consumer business, you will see that slow down over the next year as we really focus on the direct to consumer business. We're going to really be focusing on expenses and really leveraging the customer base that we have down there, so the focus, at least from an expense standpoint, will be to really be to focus on the direct to consumer to drive our overall cost down there.

And then just a final question for me. Can you just elaborate on the write-off in the direct to consumer business? Should we think about -- when we think about bad debt expense for that business, is it going to be greater going forward as opposed to what we have seen over the past year and a half?

Let me say a few comments and then I will hand it over to Jeff. If you look at the business, our goal when we first bought that business was to really ramp up the customer base, which I feel we have done a good job on, and was to really be a number one, two or three in that marketplace, and to do that primarily through acquisitions, which we did very successfully. Sometimes when you are focused on that top line and the acquisition piece, some of the things from an operational standpoint, you're not at the top of your game. And so again what I will say is, we're going to slow down the acquisitions. We are going to focus on operations. And we are going to focus on the collection piece of this business, and I think Jeff will give you more information. We have got a great AR person down there that has a long-term history of collections in this business. And we feel he is going to do a good job for us. and I will give Jeff some time to give you a couple of comments on that, too.

Steven, we really view this as more or less a one-time issue that was very much symptomatic of the rapid growth we experienced down there. We did triple the customer base. We have become the number three player in the market. But a few things stressed and slipped through the cracks. The way we had been reserving in the previous months was very much reflective of the history in that business and in that industry and that certainly is where we would ultimately expect to return to.

Okay, thanks a lot.

And our next question will come from the line of Lisa Gill from J.P. Morgan. Please proceed.

Good morning, it's Atif Rahim for Lisa.

Good morning.

I had a follow up on the McKesson acquisition. Could you remind us of what the transition period was over which you intend to incur this 10 to 15 million in cost? And, secondly, will the whole transaction be accretive in fiscal '07? Or would there still be dilution in that period?

Our transition period is, as we mentioned, last quarter, is six months. That's a very aggressive transition schedule, which we feel confident in achieving and that's the period of time for which we will experience the dilution. We also mentioned that post that transaction-- or transition we do expect it to be accretive. Yes, we would expect it to be accretive for next year. We will provide that in the guidance when we issue the total year 2007 guidance with the year end results.

Okay. And the 12 additional facilities you've taken on, are those all going to be closed or just a few of them?

We really haven't commented on that, as I did say in my remarks, we will convert some of those and close some of those. I'm very sensitive about the teammates in those operating units. Clearly, our goal is not to keep all 12 of those open. And I think what we will do, Atif, is in February we will probably come back with an exact count on how many distribution centers we will have. It is clearly, our goal is not to leave all 12 open. And we are going to move through this thing very rapidly and try to give you guys as much information as we possibly can through this transition period.

Thanks. And then a follow-up on the DTC business, could you comment on the number of lives you have at this time? And then on the capitalized advertising costs, where do they come in on your balance sheet?

Sure. Atif, as you remember at the end of last quarter we said we had 136,000 customers. At the end of this quarter it was up to 155,000.

Okay.

Now that does not include the last three acquisitions. But we do make sure that we have a period of reorders before those actually go into the count, so we aren't counting the last three acquisitions. So you will see a bigger base number in the fourth quarter.

And then on the advertising costs?

It is a -- it appears in noncurrent other assets.

And what period are these amortize?

They are amortized over four years on an accelerated basis.

Thank you.

And our next question will come from the line of Terri Powers, Robert Baird. Please proceed.

Yes, good morning, everybody. This is Terri in for Eric Coldwell. First, on the direct to consumer basis thanks for providing the patients. Can you provide the sales and profit contribution in the third quarter?

Yes, Terri. Of course, we have the $4.5 million AR charge, which was booked to SG&A. And therefore, our operating earnings for the quarter was actually a loss of $4.7 million. So excluding the charge, a slight operating earnings loss, the revenues were $25.7 million. So we are now running at about $100 million pace. That was up 50% over the prior year.

Great. Thank you, very much. And then, I wanted to ask on the core acute distribution business, are you seeing any benefit from raised manufacture prices that could be stemming from increased raw materials cost, latex, what have you?

No. It's very little, Terri. This is all, really, true sales growth that is coming through. We did a lot of validation on numbers on that and inflation is minimal on what we are selling.

That's great. Question for Jeff, understand the commentary regarding the cash flow. I was hoping you might be able to give just a little bit more color. Do you still expect full year cash flow from operations in 2006 to be positive, but just less than the $31 million year to date due to use of cash? Or could we see for the full year a use of cash?

Terri, we haven't really provided the cash flow guidance in that regard. But I just wanted to remind everybody that, generally in the fourth quarter we do use cash. You can see that historically. This fourth quarter will be unusual and that is really related to the McKesson Acute Care acquisition. And remember, we do have inventory that had come associated with that acquisition, but for a period of time during the customer conversions we tend to carry safety stocks, so that inventory, I would expect to build associated with those accounts, as well as our -- the rapid growth in the remaining piece of core business. We will add receivables there, but of course we will have payables that will offset that to some extent.

So that will have some relatively significant impact on us in that third quarter. As we get through the transition, though, we expect this transaction to be cash accretive. The closest we come to the end of that transition the more positive, in fact, that will be. And I want to stress again, all these -- the effects to the balance sheet, to the cash flow, to the dilution, are much greater at the beginning of the period of this transition and for a lot of good reasons. That's when we are paying the transition service fees. That's before we realized the efficiencies. And the further we go out, the more this business takes on, more of the earnings and cash flow characteristics of the traditional ones in minor business.

Okay, great. I had just two housekeeping questions. Jeff, where will be the transition fees that you're paying to McKesson show up in the P&L?

SG&A.

Great. And then can you give us a little bit of color on your future plans for debt pay down following the acquisition? You took out about $121 million on your credit facility. How long do you see before paying debt down, what's the plan there?

We haven't shared a timetable on that, Terri. But, clearly we felt very confident in using our existing facility, which is a $250 million revolving credit facility, along with the available cash that we had at the time to fund the transaction. We expect it to be somewhat, the transaction itself, to be somewhat cash dilutive but it becomes accretive after the end of the first quarter. It is our intent to pay down debt once it's accretive.

Thanks. I will step out.

And we, of course, share this with the credit rating agencies. And as you know, we have maintained our credit ratings.

Yes, thank you very much.

Our next question will come from the line of Robert Willoughby from Banc of America.

Hello. Unfortunately, John Wood. Just a one quick one. Is it possible to estimate the number of patients represented by your last three DTC acquisitions?

I think that would be, John, something we wouldn't do because we have not done it in the past. We've always, again, I think, as you know we are fairly conservative on reporting numbers, and we really feel we have a pretty good formula that we follow before we add them on. But I would say that there is an opportunity to see a pretty good increase in the fourth quarter from those three acquisitions.

Were all those done in the third quarter? Or were some also in the second?

All were done in the third quarter. One was small and two were fairly good sized.

Thank you.

[OPERATOR INSTRUCTIONS] And our next question will come from the line of Glen Santangelo from Credit Suisse. Pleads proceed.

Yes, thanks, Craig, just a couple of questions here. I'm curious to get a little bit more information about the DTC business. Can you give a sense for maybe how big it is on a revenue run rate now?

It's over 25 million for the quarter, Glen, and I would say that that's a pretty good run rate at this point. Again, without the three new acquisitions that we have in place on that. So it has ramped up fairly significantly over the last several quarters. And we did break the $100 million mark run rate.

And you said that's without the last three acquisitions?

That's correct.

Okay. So when I think about that, the better than expected revenue growth you reported this quarter, how much of that would you say is organic? Is it mostly all organic?

Oh, yes.

Yes.

All right. The other thing I wanted to talk about, Jeff, I'm just a little bit confused on the guidance. You are suggesting $1.68 to $1.73 for the full year. What are you using for earnings for the first nine months in that calculation?

What we would use there basically is our reported earnings excluding the bond refinancing charge of $11.4 million and excluding the McKesson $1.3 million dilution. It does include the AR charge from access.

I'm sorry, you said it excludes the --

No, it does include the 1.3, yes.

Includes the 1.3. Do you know what that number is or no? What you reported for the first nine months?

Well, we reported the, we've reported the $1--

I will ask it an easier way. What's the range you are expecting for the fourth quarter?

Well, let me do that calculation.

You got us on that one, Glen. [LAUGHTER] I got 14 people with calculators in here.

We are up all night with our calculators. Jeff, while you guys are trying to figure that out, I just wanted to also ask about the tax rate in this quarter, kind of dipped down couple hundred basis points. I was wondering what that was a function of?

Olwen will take that.

It's really one of the adjustments that we do periodically as we adjust for the open tax years that are subject to audit. We true up our exposures. I think we had something like that maybe a year ago. It's not kind of an ongoing thing. It's just more of a one time item there.

I'm sorry, what? You true up what? I didn't understand that.

We true up our tax liabilities as we look at the years subject to audit and we had a year fall off this year because of the statute.

Okay, thanks. So, when I'm modeling the fourth quarter should I ratchet that tax rate back up to 39.5 and use that for 2007?

We don't usually give guidance on our tax rate. So use your judgment there.

Okay. That's fine. Jeff we can follow-up offline, and I just wanted to make sure I'm accounting everything correct-- correctly.

Okay.

[OPERATOR INSTRUCTIONS] And our next question will come from the line of Mike Hughes from Delaware Investments. Please proceed.

Yes, couple of questions on the Diabetes business. What is the overall revenue mix there by payor?

Well, we usually don't break that out, Mike, and it does as we do these acquisitions it has changed over a period of time. What I would say today is,the focus really has been around Medicare, which usually allows you to collect your money quicker, and it's probably -- I don't want to use the word "cleaner" but you get reimbursed faster. The goal really has been to increase our mix on the Medicare payor mix, which I think we have done a pretty good job over there, and I will be fairly comfortable to say that a large percentage of our business today is Medicare.

Okay. And remind me how reimbursement works for Medicare? Is there is a co-pay? What's the bad debt? Is that related to private pay and managed care?

It would take us probably an hour to sit down and explain it. It is out -- comes out of several buckets that there is a little bit in each one of these buckets. Again, think to get back to what I said earlier, it's really not that we are not getting reimbursed. It's that we really, were moving so fast that we got a little bit ahead of our policies and procedures. So there is a difference. We do have a mix of private pay. We have got HMO. We have got Medicare. Each one of them are a little different. There is -- do you want to give a little flavor on that?

Yes, Mike. What's happened historically is that the preponderance of the growth in the direct to consumer area has been involved with the Medicare reimbursement as an industry. Likewise, the reimbursements from the government do require a lot of administration. Once the papers are filed correctly, then the reimbursement is very quick to Craig's point, and we see that is a benefit as the systems are tightened up which we have been doing recently. And our recent experience has been an improvement in the DSO there.

So we see the processes being longer than what we have normally in our core business. As opposed to having credit risks with a hospital system, now it's more managing your administrative processes properly. The collection rate on what the industry has seen over the years has been in the 90% rate. So the reimbursements, you could get it from the Medicare then, there may be a co-pay, so then the next step is to get it to co-pay, or they may have had a gap insurance, which you would file with that second party and then the third party. So you can see, the entire cycle is longer by the fact that you have to go through these multitude of steps.

Okay. And then just think being that business, you've got $100 million business essentially break even. What are the long-term margin goals there? It seems like there is a lot of upside just in that business. It could be a big swing factor. Could you speak to that?

You are right, Mike. I think, what our opportunity is, is if you look at the margins that we have in the business, one of the, obviously, one of the goals that we wanted to do was to get a big enough critical mass that we could improve our product costs, which we have done a phenomenal job over the last 18 months doing that since we've had the business. The opportunity really is on the SG&A and the improvement and the efficiency of using technology and the internet to really drive our cost down. I mean, we had the sales, they are growing. We had the margins. Our opportunity really is to take this business and focus on it.

The other thing that we have not talked about, we have been really focused on the expense side or the charge, strategically this is still a very good business for us, three to five years, as we follow the consumer out of the hospital. So we are looking at this as a long term business. It's a small part of our business. And we are going to continue to invest in it. We are going to grow it out. And we feel that, as from our follow the patient strategy, that this is a key part of our strategy in the future years to come. But right now we have got some work to do. We have to get it operationally right. We have to slow the growth down a little bit and get the overall business back on track. But I would agree with you, long-term this could have some strong benefits for the Company.

So at the current level of sales can you get it to maybe a more respectable operating margin, maybe around a 10% number?

Our goal, my goal is to get this back on track as quickly as we possibly can. So it's going to take us some time, I think we did a pretty good job in the third quarter. We reduced our head count down there pretty dramatically. We have some things logically that we have to do, and we are getting some better policies and procedures in there. Our goal is, in the end, it was very profitable last year. Part of this is that we just grew so fast through acquisition we got ahead of ourself, and we really need to focus, as you know, Owens & Minor is really very strong at just core competency and moving the box. And we have to put some Owens & Minor core competency down there to get it where it needs to be.

One last unrelated question, Jeff, did you say there was a one time moving charge in this quarter? Did I hear that right? Or was it last quarter?

No, what I had mentioned was the back in the first quarter.

Okay. I thought so. Thank you very much. Appreciate it.

And just to clarification on Glen's question. Year to date our reported earnings per share is $1.03, adding back the bond refinancing of $0.17 and the $0.02 for the McKesson dilution thus far, that will put us at $1.22 year to date with our guidance being $1.68 to $1.73, excluding the dilution and the bond charge that would imply $0.46 to $0.51 for the fourth quarter, again, excluding the McKesson dilution.

Sharon, let's take one last call if there is one out there.

Thank you, sir. Our final question will be coming from the line of DeForest Hinman from Paradigm Capital Management, please, proceed.

Hi, guys. I just had a couple questions on the Diabetes business. Looking at our calculations that we have, your accruing the advertising, in an [amortizing] [inaudible], looks like the business doesn't generate any positive cash flow. We have done a good job of growing the top line of the business. It sounds like we are in it for the long-term. Can you talk about our expectations for the cash in all that business, when is it going to start generating positive cash flow for us?

That's, that's something that we certainly haven't forecasted for the public. Although, internally it would be something to look at. It's something that we've wanted to grow. We needed to get into a position where we have a strong position within the market. And as I mentioned before, we are number three right now, and in order to do that it did require some investments and advertising some investments in some of the tucked in acquisitions, as Craig mentioned. We're going to slow down the tucked in acquisitions for a period of time. But we will still continue to invest in the capitalized advertising. Generally, other than those investments in the advertising and some investments in receivables, this is a very low asset intensive business. So we would expect this to be a generator to the overall results and overall cash flow in the long term for Owens & Minor.

Do we have any kind of like ballpark ideas? Is it a year? Is it two years? I mean, can you give us a little--

Less than two years, I can definitely tell you that. And our goal is to get this thing back on track. We had a good year last year. We kind of hit the wall last quarter from a head count standpoint. And just really a catch-up on these acquisitions. I think we did a very good job in the third quarter on the head count piece. We have got some more work to do on the expenses. Clearly, it's pretty high on my radar screen, and we're going to do everything we can to get this back on track.

Again, what I would say is, that this is a three to five year strategy that long-term we are going to grow this business out. We're going to build disease states, we're going to connect with the hospital. So, what I would like to say is that 99% of our business, which is our core business, is healthy. It's strong. It's viable. We're going to continue to invest in this direct to consumer. We're going to grow it. But we're going to run it more efficiently and more productivity-wise than we have in the past nine months. And, that's my goal, is to work with the guys down in Florida to get this thing back where it needs to be.

And how much advertising was accrued in the quarter, and how much did we amortize in the quarter related to that business?

Mike, the amortization of the capitalized advertising was 900,000. The D&A was 3.8 million for the quarter. Year to date D&A was 9.1 million. And the amount actually capitalized in the quarter was $2.4 million.

Thanks a lot, guy.

Okay, thank you.

We will now have closing remarks from the President and CEO, Mr. Craig Smith. Please, proceed.

Thank you, Sharon. Again, I just want to thank all of our people involved in the transition. All of our folks, the new McKesson teammates, I want to welcome aboard. For us, we feel this was a very good quarter. We hit our targets. We had great sales growth. We leveraged our core where we are off on a great road with our new customers and our new teammates. And we look forward to sharing our numbers with you after the fourth quarter. Thank you and have a great day.

Thank you for everyone who participated in today's conference. You may now disconnect.