Owens & Minor Inc (OMI) 2007 Q2 法說會逐字稿

Good morning, ladies and gentleman, and welcome to the Owens and Minor second quarter conference call. My name is Teulesha, and I will be your coordinator for today. (OPERATOR INSTRUCTIONS). I would now like to turn the call over to your host today, Mr. Craig Smith, President and Chief Executive Officer of Owens and Minor. Please proceed, Sir.

Good morning, everyone. Welcome to the Owens & Minor second quarter 2007 conference call. We'll review our results and take your questions in a moment. But first, let me introduce my colleagues here today. We have Dick Bozard, Vice President and Treasurer; Olwen Cape, Vice President and Controller; Grace den Hartog, our Senior Vice President and General Counsel; and finally, the newest member of our team, Jim Bierman, our Chief Financial Officer.

Now Jim joined us just about six weeks ago, right before the quarter ended and he has definitely hit the ground running. He brings a broad business background to Owens & Minor with experience in several industries, including financial services and health care. And, he also has a very strong background in strategic planning and development. Most recently he was CFO of Quintiles, a North Carolina based CRO. Before that, Jim was a partner at Arthur Anderson where he served a variety of clients over two decades. He managed a diverse base of health care clients in Philadelphia and later led the financial services practice in the Carolina's and Southern Virginia for Anderson. Jim has the expertise, the experience and the skill set that will support Owens & Minor as our company evolves to meet the expanding needs of the health care market. Now, before we begin, Trudi Allcott, our Communications Director will read a safe-harbor statement.

Thank you, Craig. Our comments will be focused on the company's results for the 2007 second quarter and year-to-date, which are included in our press release. The press release, as well as a few supporting slides can be found on our website. In the course of our call today, we will be making forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Please see our press release and our SEC filings for a full discussion of these risk factors and finally, this conference call will be available on our website for the next three weeks. Thank you, Craig?

Thank you, Trudi. And now let me call on Jim to brief us on financial results. Jim?

Thank you, Craig for your kind welcome and good morning, everyone. Before I make a few remarks on our second quarter and year-to-date results, I'd like to comment on my first six weeks as a member of the Owens & Minor team. Owens & Minor has something special: an enduring culture; exceptional longevity; a strong position in a growing market; and the dedication of our team mates. These were the reasons I joined the team and I've been pleased that they have been confirmed through my experiences to date.

Now, turning to the second quarter financial results. Year-over-year performance was as we expected. But, this quarter the real story lies in the sequential improvement in gross margin and SG&A resulting in sequentially improved operating margin that when coupled with improvement in asset management led us to report cash flow from operations of nearly $90 million for the quarter. Improvement in these measures indicates that we have begun to realize the benefits we expected from the McKesson acquisition. As we turn to earnings, there are two factors to keep in mind. First, when comparing quarterly earnings to last year, 2006 results include a second quarter pre-tax charge of approximately $11.4 million related to the early retirement of debt. In 2007 year-to-date earnings include the pre-tax delusion of $8.1 million related to the transition of the McKesson business as the company previously reported in the first quarter. Consequently, for the second quarter 2007, deluded earnings per share were $0.45 compared to $0.26 last year and $0.27 for the first quarter of this year. Year-to-date deluded earnings-per-share was $0.71 compared $0.67 last year.

We're pleased to report that revenue for the quarter was $1.68 billion, an increase of 29% when compared to revenue of $1.3 billion last year. New business from the McKesson acquisition accounted for over two-thirds of the revenue improvement. In addition to the new McKesson customers, we have been very successful in penetrating existing accounts and bringing on new business this year. When compared to first quarter, revenue declined less than 1% representing the net affect of new business wins and the anticipated rationalization of the McKesson accounts. Year-to-date the McKesson business accounts for $544 million in new revenue. That brings our year-to-date revenue to $3.37 billion. An increase of 31.3% compared to the same period last year. Excluding McKesson, revenue growth year-to-date was approximately 10%.

Now gross margin for the quarter was 10.5%, a decrease when compared to gross margin of 10.9% in the second quarter last year, but improved sequentially from first quarter's 10.4% result. The decline from 2006 resulted largely from the impact of new GPO contracts as we reported last quarter. Sequential improvement in gross margin resulted from our efforts to fix the accuracy of the McKesson customer pricing files and convert McKesson's private-label to MediChoice, as well as pricing and reimbursement improvements at our DTC business. As for the year to date results, gross margin was 10.4% compared to gross margin of 10.8% last year. The year-over-year decline in gross margin is attributable to factors we discussed last quarter including lower gross margin on the McKesson business and newly signed contract renewals with our GPO partners.

For the quarter, SG&A was 7.9% of revenue comparing very favorably to first quarter SG&A of 8.5% and also to SG&A of 8.1% in the second quarter of last year. Sequential improvement resulted primarily from the winding down of the McKesson transition activities, the elimination of service fees paid to McKesson, and a lower provision for bad debt, as well as, operational improvements in our direct-to-consumer business. For the first half of the year, SG&A was 8.2% compared to 8.1% last year. For the second quarter depreciation and amortization expense increased $2.6 million year-over-year. Acquisition of intangible assets for both our direct-to-consumer business and McKesson, accounts for $1.4 million of this increase, along with greater depreciation expense resulting from capital additions to accommodate the McKesson business. Consequently, for the second quarter 2007, we reported operating margin of 2.2% of revenues, a decrease from the 2.4% operating margin in the same period last year, but a sequential increase from 1.5% in the first quarter of this year as we achieved improvement in the fundamentals of our business.

Now, briefly considering non-operating expenses. The tax rate declined from 40% to 39.3% year-over-year but sequentially was essentially unchanged. Net interest expense increased to $6.6 million this quarter compared to $2.3 million last year. This increase was due to funding the McKesson acquisition with cash and bank financing. We did see a sequential decline in interest expense compared to first quarter resulting from improvements in asset management. And in fact, asset management improvement was the big story for us this quarter with DSO improving to 28 days from 29.7 days at the end of the first quarter. DSO a year ago was a very low 24.9. Inventory turns were 9.4 for the quarter compared to 10.1 last year, but compared favorably to turns of 9.2 in the first quarter. We have been working on improving inventory management all year. And, although this trend is positive we believe we can achieve further improvements. As a result of strong asset management we generated nearly $90 million in operating cash flow in the second quarter, which we used to pay down our revolver to $169 million. For the first half of 2007, our operating cash flow was $86.4 million compared to $42.1 for the prior year. Our capital expenditures were $13 million in the first six months of 2007 compared with $11.2 in the first half of 2006. We believe operating cash flow will continue to trend positively in the second half of the year, however keep in mind that we have historically used cash from operations in the fourth quarter of the year.

Turning to our guidance for 2007. We believe that we will likely meet or slightly exceed the higher end of the previously stated revenue growth range of 15 to 20% for the year. And we also expect diluted earnings per share for the year to be in the lower end of the previously stated range of $1.85 to $1.95. In summary, this quarter we delivered on our promises. We are focused on operational excellence. And we see momentum taking hold. Thank you. Now I will turn it over to Craig for his remarks.

Thank you, Jim. And now I'd--I'd like to put the quarter into per-- perspective. Once again, we saw continued strong organic revenue growth which highlights our position as the leading supply chains solution's provider in our space. During the quarter, I felt we made some very good progress in integrating the McKesson business. Sequentially speaking, we saw operating margin improvement, thanks to the progress on expense management and slightly better than expected gross margin. Sequential improvement in asset management, which I think was a great story, drove operating cash flow into positive territory. And above all, the most important thing that I-- I-- I believe I saw and that we feel is that we've begun to see momentum during the quarter as we get back to business as usual. As we discussed on the last call, we recognize the urgency of bringing the new McKesson business into our systems and up to our operating standards as quickly as possible. And, although there is still room for improvement, you can see from our results we-- we did-- we did make some very good progress during the quarter. Now, for example, since we began the transition of the acquisition in the fourth quarter of '06, operating margin has climbed from below 1% or less than 1% of revenues in the fourth quarter to this quarter's 2.2% of revenues and-- and this to me is a significant turn around and our teams in the field and the home office are to be congratulated for this rapid improvement. Sequential asset management improvement was a very strong story for us this quarter. Two quarters ago, we-- we had negative $100 million in operating cash flow which we now have improved to nearly $90 million in operating cash flow this quarter. This turn around in cash flow came from a sequential improvement in DSO and a modest sequential improvement in inventory turns. We clearly still see opportunity to improve our inventory management and-- and right now our teams are already working on this. Going forward this will continue to be a very high focus for the company.

As for revenue, we have been on a strong growth track in recent quarters and of course this quarter was no exception. Penetration was strong and we have brought on some new business in recent months, offering further proof that we are providing the right service, operational excellence, and supply chain solutions that our customers are seeking. Another avenue of progress during this quarter was the year-over-year growth of our private-label. As promised, we converted essentially all of the McKesson private-label to MediChoice during the quarter and we see further opportunities to grow our private-label with new and existing customers. Turning to our direct-to-consumer business our remediation efforts with daily operations at Access continue. The business was profitable this quarter generating improvement in revenue and operating margin. The customer account which we give on a quarterly basis was 185,000 compared to 177,000 customers last quarter and of course, that's-- that's still good growth and as-- as you all remember, we had slowed the acquisitions down and-- and committed to working on the operations over the last several months, which we've done but we're-- we're still seeing growth in our customer base. As for competitive bidding launched by CMS(Centers for Medicare & Medicaid Services) our bid will be submitted this week in accordance with the deadline and as we said before, the competitive bidding process affects only a very small portion of our customer base.

Now, for the rest of the year, we see opportunity to gain further synergies from the acquisition. We continue to work with our new customers on improving the quality of their pricing files, accounts receivable and contract compliance. Our teams are working on improving inventory management. We are very focused on improving sales per FTE (full time equivalent employee) and sales per square foot, which are metrics we use to track efficiency and productivity. We remain focused on leveraging this acquisition to take advantage of the opportunities our new customers provide as well as the diverse talents of our new teammates. Now longer term, we are focused on achieving consistent financial growth, expanding our market share, continuing to seek growth opportunities in health care, one of the foremost that-- that I'm very focused on is continuing to educate and train our teammates so that we have the best team in the industry. And finally, deploying our technology solutions that differentiate Owens & Minor in the market place. Thank you, and we would be happy to take your questions.

(OPERATOR INSTRUCTIONS). And our first question will come from the line of Eric Coldwell with-- Eric Coldwell with Baird. Please proceed.

Thanks, good morning and good job. The-- the first question is-- Craig, you touched on this-- I was hoping we could get a little more color possibly from Jim on the direct-to-consumer business in terms of just sales and EBIT in the quarter?

Sure Eric. The di-- I'll give you both quarter and year-to-date, just so that it's--it's clear. The DTC revenue was $27.9 million for the second quarter of 2007 and $54.9 million for the first six months of 2007. And that's up from $21.2 million and $39 million in the comparable periods of 2006. Operating earnings for the DTC business was $2.3 million for this quarter, which gives us operating earnings of $1.3 million for the first six months and that compares to $0.3 million -- $300,000 for 2006 second quarter and it was ostensibly break even year-to-date in 2006.

Ji-- Jim, did I hear your correctly that EBIT was $2.3 million suggesting that north of 8% EBIT margin?

That operating earnings was $2.3 million.

Okay. Wow. Good job. Obviously, great work on DSO and inventory turns in the quarter. I-- I'm curious whether the company would care to give an outlook on cash flow for the year? I don't think you've commented directly on your expectations there and then, concurrent with that, what we might expect on the revolver and future debt-- debt plans as you generate the stronger cash flow?

Yes, the-- the cash flow for the remainder of the year as I said in my prepared remarks, we expect the third quarter to trend positive, the fourth quarter to-- to possibly be cash used from operations. Obviously, we were exceptionally pleased with the performance for the--for the second quarter. We remain optimistic that there are future opportunities to enhance cash during the course of the remainder of the year, particularly in the inventory area. And as we-- we do generate excess cash from operations, the current short term strategy is to de-lever the company by paying off the revolver or paying down the revolver. So, tha-- that's the current game plan on a-- on a-- for the remainder of this particular year.

Eric, let me just add a little bit on that from an inventory standpoint. We did pick up what I would consider a-- a fairly significant amount of new business in the second quarter that's ramping up and, so we're being a little cautious on the cash flow because we are ramping up this new business. Obviously, the opportunity for us is on the inventory side. It's-- It's not where I would like it to be or where the company would like it to be. So the-- the question is in the third quarter with this new business coming on and ramping up and how fast can we get -- we're kind of a little bit in a balancing act as how-- how fast can we get this inventory down? Which of course would have a direct impact on the cash. So, to Jim's point, we do feel we're going to have positive cash in the third quarter then usually in the fourth quarter if you look historically, they're-- they're just based on the-- based on the quarter and the truing up the cash usually isn't as significant as it is in the first three quarters of the year.

Yes, that's the historic expectation but still a good job in two Q. Final question that I have is on McKesson, just the progress in that business is starting to clearly show up and you benefited of course from the-- the-- the exit of the transition fees. I'm curious, Craig, if you could talk perhaps qualitatively if not quantitatively what-- where you feel you are in the ballgame here in terms of getting those customers on the right pricing files, getting the service levels to contract terms, going through the rationalization of those accounts which you will ultimately choose to exit? Where do you feel you are in the ball game? And then as-- as an add on to that you're currently at a run-rate of [$1 billion $50 million] in annual sales, would you care to give an update on where you expect that to fall out when all is said and done?

Yes, I-- I-- I think we've got a-- we've got some more to go, Eric, on your last question. I'm probably still comfortable at the $900 to $1 billion mark. We-- we-- we have jettisoned some business if you just look at the sequential run rate obviously we exited some McKesson business in the second quarter. We're-- we're still taking price up in accounts. The-- one of the positives for this quarter was that the McKesson business now is finally trending. The margin is trending up to where the Owens & Minor business is and [when--] I think that was the nice-- the nice surprise this quarter was we-- we've moved that along which would reflect in the strength of the pricing. I don't think we're completely finished there yet. We have a ways to go. I do know -- I mean, we-- we have monthly business reviews. We are getting people on contract compliance as quickly as possible. But I do think there's-- there's probably a little bit more that either the customer might find somebody else based on new terms that we're asking or that we would jettison. So I'm still probably fairly comfortable in the $900 million to a billion dollar range. Usually, when you're in these discussions there's either a period of time that they take the price up or there's a 90 day exit strategy and-- we don't want to leave anybody high and dry. So that's-- as you know, that's not our style. So I think we've got a ways to go. But I'm-- I'm still very comfortable in the $900 million to a billion dollar range.

Okay. Thanks again and good job in the-- in the results.

Thank you.

And now our next question comes from the line of Lawrence Marsh with Lehman Brothers, please proceed.

Thanks, good morning, everyone and Craig and-- morning, [everyone else?]

Hi Larry.

Dick. I wanted to follow up with Eric's question on the McKesson business. Craig, I know you've talked in the past about trying to keep the 100 sales reps and what they bring to the party [right] and the current existing customer relationships[right, right]. Can you give us an update of where that stands and reiterate in your mind the significance of trying to keep these-- these people and what they bring to the party.

Right. I-- and-- and one of the-- one of the things is we've-- we've-- we've done a re-- a little reclassification of the new sales force that came in. We actually ended up with about what I would consider 75 true full-line reps and about 25 support people that would be considered account reps. So about 100. But that number is down. We're probably down -- Charlie is on vacation so I don't have the exact number with me. But, we are down I would say probably 10 to 15 people in that group. The one thing Larry, that we -- we--that I-- I would like to see us speed up in the last six months of this year is that we of course have been very focused on the pricing, getting the service levels right, and I-- I'm-- I'm-- I believe that for the most part we have that pretty much behind us and we can start to focus on programs and services. The private-label was a huge -- we had everybody focused on moving this McKesson private-label over to MediChoice this quarter and we're 99.5% done. So, what-- what I think the expectations for me is in the second half of this year is to-- to see this group that we've invested a lot of training in really start to ramp up on the programs and services. So, we have trimmed that back a little bit. I think you'll probably see us trim back a little bit more in the sales force. We're now re-adjusting territories so that everybody is basically right-sized so that they can be more effective in all the territories going forward.

Okay. Just to confirm the 10 to 15 people are from the McKesson group?

That's correct. That's correct.

Have you seen any attrition in your own sales force that's unwanted?

No-- no, we have not. (inaudible - speaking in background)

Okay. So your message is that you would anticipate seeing that come down another 10 people or so?

Yes, I think-- I think-- I-- I'd hate to put a number cause I don't want 300 people out there scared to death that we're going to start hacking away at the sales force here. I think just through attrition-- I think there's probably another 10 or 15 and we're-- we're-- we're really looking at the whole sales force. We're looking at the territories -- getting the territories right. One of the things that-- if you remember, Larry, we talked about at the beginning of this year is that we were going to probably ramp up 50 new territories anyway. So we're in the process of-- of realigning everybody and getting that right. So there's-- there's probably another 10 or 15 people that might leave or based on performance or just the fact that now that the training's gone through, that some people may not be capable to handle the new duties.

Okay. So under the new classification you started with maybe 85 to 90? You're down to 75 true sales reps [right] and that could go down another 10 or 15?

Right. Right.

Secondly, maybe if I could get you to speak for Charlie since he's not there-- I know--.

He's on a well deserved vacation. Believe me. [laughing]

I know he set as a goal to convert all of the pricing files and transaction set data by the end of the third quarter-- excuse me by the end of the second quarter-- I just want to [right] confirm [right] that was all done?

We probably have-- just when Charlie and I think we have everything done, one pops up. So, I would say we're- we're well along to having that all wrapped up.

Okay. Great.

I think we had said-- I think we gave you a number last quarter of 80%. We're-- we're above that number and again-- I just-- with so many territories and so many new customers, if I told you we were completely done, something would pop up. But I-- we-- we clearly have our arms around it and you can-- you can see that, Larry, really in the McKesson core margin over the quarter improving. So, the trends are nice from the standpoint of we knew once we got this pricing fixed up [we--] we'd see the McKesson business from a margin stand point improving.

Great. Two other quick things then you mentioned that you have-- you signed and brought on a significant amount of new business in the second quarter. Is that associated -- could you elaborate on what that is?

Well again-- we don't usually comment on individual [ones--] wins or losses. We-- we had a lot of business that we were working on late in the first quarter. And then in the second quarter, we picked up some new business. And I think that has had some reflection on the inventory being higher than what I anticipated or Charlie anticipated we'd be at the end of the second quarter. So, what the nice story is that this will pick up. A lot of this will start to flow in. Probably mid- to late third quarter all the way into the fourth quarter. So, we-- we should see some nice organic growth through the rest of this year.

And so can you characterize that as being a-- a competitive win? A competitive bidding situation?

Yes. I-- what they're-- what they're looking at -- I really didn't-- and usually I'll comment on a little bit on-- that I travel a lot [I'm] out talking to a lot customers. I would say the new business that we are picking up for the most part are combined traditional Owens & Minor and OMSolutions business, where the customer is really looking more than just for a low price. And so what -- how you start that business out is of course you ramp up with the traditional business immediately and then Solutions (OMSolutions) starts to kick in once--once the business has moved over. So, we are seeing somewhat larger systems really taking a look at a-- look at a combined Owens & Minor offering of the traditional distribution and solutions. And, I think we've been really reporting that out over the last two or three quarters. A lot of the new business we're picking up is-- is not what I would just call your traditional core business. It's-- it's more of an advanced supply chain logistic solution.

Okay. And are you giving us any idea of the profitability of the McKesson business this quarter? I know your broke it out last quarter. But are you giving us (inaudible - next speaker talks over)?

I would say we're close-- I would say we're close to the Owens & Minor core business. And I would say that we made significant improvement in the second quarter reflected in the [10-5 ] and we probably have a little ways to go but we're a lot closer than what we were last quarter.

Okay. Because if I run the numbers, it-- if you're close to that-- if you're close to Owens on your core business, then it would say that you-- excuse me, then it would imply that your core business was down sequentially in EBITDA because you had a big increase in your EBIT from Access. So, wha-- wha-- what am I missing?

Well, you've got four people here flipping through a bunch of sheets of paper. So, I would say (inaudible talking in background) the core -- I would say though you'd probably have some progress still to do in the GPO sign-ups that we did. And we [au--] actually saw some progress also in that. But I would -- I-- we might have to do a little math on that. Because the numbers that we have would be is that the-- the core-- the core business is up sequentially [sequentially] second quarter over first quarter. I think part of the thing is, Larry, we were down pretty significantly in the first quarter so we had a bit of a dig out to do second quarter over first quarter. But, what we see is is that actually, the core margin is improving.

Okay.

So, I-- we-- we might have to get back to you with a little bit of math on that. But, our numbers show that basically the core margin is up sequentially, but again, it was down pretty low in the first quarter. So we-- we have some work to do still. I'm-- we're not-- we're not happy with where we are on the margin. We've-- we've got more work to do. So, clearly that still remains a top priority for the company.

Okay. Well I'll look to follow up with that. Thanks so much.

And our next question comes from the line of Glen Santangelo of Credit Suisse. Please proceed.

Yes. Hey Craig, just-- just a couple [good morning]-- just a couple of follow up questions here. [Yes]. It seems like SG&A showed a nice sequential decline. But could you give us a sense for maybe how much your SG&A might have been impacted in the second quarter by some of the transition kind of still spilling over into that second quarter to give us a sense for maybe how we should think about that trend in the second half?

Okay, I'm going to let Jim answer that.

Okay.

Yes. We've looked with-- with the transition being significant obviously in the-- in the fourth quarter of 2006 and-- and-- and the first quarter of 2007, we looked to the second quarter of 2007, the one we just finished as a-- as an approach to trying to see if-- if we've established a-- sort of a normalized run rate, if you will. And if you look at the $133 million of SG&A expense we had for the quarter, it fundamentally is without those transition related expenses. Now, that's not to say that the SG&A at $133 million can't be improved as we continue to fine tune the business. But it doesn't have unusual items related to the transition that we've been able to identify that are-- are of any significance to-- to-- to bring forth. The other thing we looked at in the $133 million is any aspect of seasonality or unusual items in it. And in the second quarter of any year, there's a bit of seasonality because of the awarding of stock options and restricted stock and some incentive pay-- bonus payments that may all be recorded in the second quarter. But that's a relatively small amount, and probably offsets normal variations that you would have. So, we're using that as pretty much a base going forward as we look to effect improvements to it [yes] as we go into the next couple of quarters.

Okay. That's great. Then-- then just my-- my follow-up question here is really on the McKesson business in terms of the pull-through of the private-label business into those McKesson customers. Could you give us a sense for how much you were able to accomplish in the second quarter versus maybe how much there still is to go?

Well, I would say, Glen, over the three months and I--I think in the first quarter I broke that out by month. So really we were actually for all intents and purposes done in June-- late June and so the pull through now for third quarter would be 99.9%. We still have a very small percentage of McKesson private label business and that's-- we're just selling the rest of that off. But clearly by late June, all of that now has been basically flushed out and they're on MediChoice, which as-- as we've talked about in the past has a-- has a much higher percentage profitability.

Just, really just trying to zero in on gross margins. (overlap on speakers) [Yes] Obviously, the gross margins were much higher than I think everyone [right-- right] was looking for and I'm trying to get a sense for maybe what drove that in the quarter. Maybe could you-- may-- maybe just give us a little bit of color on maybe why the gross margins were stronger than I think even you all had expected 90 days ago.

Again, as I said, that was a pleasant surprise. One we're taking price up and we're holding on to some of that business. The McKesson business has improved over the quarter just on the raw margin. It is the conversion of the MediChoice, all of the McKesson to MediChoice and we-- we have seen a slight improvement in the Novation business, which as you know we signed at a lower margin. So, it really is a combination of about four things and those are going to continue to be the four things that we work on in the third and fourth quarter is to-- to continue to work on [Ow-- now--] Owens & Minor profitability and accounts. We had two launches of private-label in June, so we added about [300 in SK-- 380SKU's-- new SKU's] on the private-label so we should [con--] continue to see that improve and we're going to continue to work on getting back the- the-- the initial loss that we had on the [GPO] signup. So we're-- we are still working on everything that we worked on in the second quarter. All of those started fairly-- fairly significantly. And, I clearly expect that to go into the third quarter and continue to work on margin improvement in the third quarter.

Okay. Thanks for the color and congratulations. [Uh huh]

And our next question comes from the line of Lisa Gill with JPMorgan. Please proceed.

Thank you and good morning. I [Good morning, Lisa] just had a few follow-up questions. On the gross margin, if we think about your sequential improvement and as we think about exiting the end of 2007, can you give us-- some indication -- maybe not an exact number -- but some indication [sure] as to-- if we'll get close to where you were historically and how we'll exit 2007? And then just-- secondly, with another follow-up-- when you talk about the new business that has come on, Craig-- as you're out there, can you maybe just talk about the competitive landscape? I mean-- are these competitive wins? Are these wins that are coming from smaller players? Larger players? Just taking more business from existing customers? If you could just give us a little color around that.

Well-- let me answer the-- the second question first. First, if you look at the organic growth, the major percentage of that still, Lisa, in the second quarter is primarily penetration. So we're still penetrating existing accounts. I would say the new business that we have brought on has been both from large players and small players. And what I would say is it's a mixture of some smaller accounts and some bigger accounts. And what we're still seeing is in the smaller accounts, they're- they're still fairly price sensitive with really looking at really stellar service and then the bigger accounts are really looking for something more integrated in terms of a combined distribution solutions engagement. So-- so we've gotten good traction off of really the investments we've made in OMSolutions over last two or three years. But to answer your question, the large percentage of the organic growth is still sales penetration and I've been talking so much I forgot what your first question was.

(Laughing in background) [What was] the gross margin? (laughing in background)

I-- I-- I had a little-- I had a little senior fade there for a minute, Lisa.

That's-- that's okay. (continued laughing in background)

I think what you-- obviously, in operating margin and in margin itself, our goals is-- are to get back to the historic-- the-- the historic levels we were at before the acquisitions. So I think traditionally, if you look, it's somewhere between the [10.6 and 10.8] mark. Clearly that's a goal that we're-- we're over a period of time working back to. When we get to it, I-- I'd hate to be kind of put into a corner or a box. So, I guess the first answer is are we satisfied with 10.5? No, we're not satisfied with 10.5. And, the goal, I mean-- I think I've said this on the calls before-- every Friday we have our management review and margin is one of the key indicators that we review every week, that we get updates from our field management weekly. So, the goal really is to try to get back to historical levels both on the operating margin and the gross margin as quick as we can. I-- I-- I just -- I can't really put a number on it because as we continue to take price, we may lose a little sales or-- or we may keep the account and that would of course have a much faster impact on the gross margin from that standpoint. If we lose business, obviously it's going to have a better impact on the SG&A. But, I would say that our goals here at the company are to get back where we were-- the whole reason why we did this McKesson deal was to take $900 to $1 billion dollars and get it to the Owens & Minor operating model as quickly as possible. And I'm giving you a very vague answer, but--.

Do-- do you think you can get there in 2008? I mean, is this something that is near term or is it a longer term goal? I'm not-- I'm not trying to paint you into a corner, I'm just trying to figure out over what period of time we should be thinking about this. Because, quite honestly, I mean our-- our gross margin [assumptions--] I know that-- that it beat your expectations, we just had them ramping a little bit sooner. So, I want to make sure going forward we have it more correct.

Yes, what I would say is in the first six months, if-- if you look at from-- just from a where we are for the year, clearly margin was the issue that we had the first six-- first six months of the year. And I'm not sure where you have us in your model. But-- but, we would like to see sequential improvement every quarter. I'd hate to say-- are we going to be 10.6 next quarter? I-- I-- What I'm feeling much better about is-- is-- is the 10.5 a solid number. And, we've spent a lot of time over the last month making sure that the 10.5 is a solid number, which the field management has absolutely committed to me that it is. So, how fast can we get it to10.6? We're-- we're-- we're moving as fast as we can. The-- the bigger number to me really that I'm really very pressing hard on is the the operating margin, getting that back to 2.4 to 2.5 as quickly as possible. So, I want us to be back where we were prior to the deal. And, I-- I-- I just -- I can't stress enough that-- that the margin -- the gross margin is-- is a-- just a top priority for the company. I think you saw some improvement in the second quarter, hopefully, we can get this thing back as quickly as we can. Again, it's just-- it's timing with some of these accounts. Some of them are fairly significant. And-- and the price is fairly significant that we're taking up and we did get the private-label done fairly quickly, which I was pleased so that should have some impact. But, I-- I'd-- I'd really hate to put kind of a stake in the sand and say it's going to be X third quarter, X fourth quarter. But--

No, I understand that. That's-- that's fair. And maybe if I can just add-- ask a bigger picture kind of question. Obviously, with-- with bringing Jim on, coming from Quintiles [who've done] a number of acquisitions and now looking at the diabetes direct-to-consumer business going into the recovery stage, should we think about Owens & Minor as a company that will make acquisitions in the next couple of years and what direction should we be looking for you to grow the company, because, Craig, listening to your initial comments you're talking about becoming a more broad based health care company. So, how should we be thinking about it?

Well, I think what we're really-- Lisa, we're-- we're I think even before Jim came on board, historically how we look at strategy, we're-- we're looking at what I would consider probably a broader based environment than what we traditionally looked at before. I-- We're not going out -- first and foremost I want to get this McKesson deal -- it's done-- I want to get everybody back in their jobs, which they are. I want-- I want the margins stabilized. I want the operating margin stabilized and then we will look at acquisitions. We're going to look at acquisitions in the core. The diabetes business -- I had to look back at that. I think we went way too fast on the acquisitions. So, Jim brings a whole different perspective of how we're going to look at forecasting and budgeting with his-- his auditor background. I mean he's-- he's really come in and-- and taken a look at all aspects of our business and clearly with his ac-- ac-- acquisition background, we are going to look at acquisitions. But, we're-- we've always been chronically conservative as-- as-- and we've kind of been pegged on -- I-- I-- we're not just going to go out and do acquisitions that don't make sense. We-- we've-- we've got a great infrastructure. It's how we leverage that, it's how we leverage our technology. But, I-- I would say that we will-- we will be looking at growing the business. We're-- we're not going to sit back and just say, okay, well [we've been--] we did the McKesson deal now so-- so we're going-- we're going to kind of go into slow mode for five years. But, I'll let Jim comment on that a little bit too.

[What--] Lisa, what I-- what I would offer is I think two hallmarks of the company and that is that with the recently completed McKesson transaction, the company has demonstrated its ability to-- to execute and to integrate a major acquisition and- and I think that is-- is-- is a major accomplishment and that should give some degree of comfort as the company may move forward into other transactions that they got this one and they got it right. Secondly, I would point out that the company is-- is very effective at-- at-- at partnering with other counter-parties. And an example there is its relationship with Perot and its use of technology in order to give itself a competitive advantage in the marketplace. So, I think those two aspects of the company or attributes of the company really position it well for a high degree of-- of operational success in the event that-- that it-- that it does identify transactions out in the future.

Great, thank you so much for the comments.

Thank you, Lisa.

And now our next question comes from the line of Robert Willoughby with Banc of America Securities.

Thank you. Craig or Jim, following up-- I think it was Eric's question-- the revenues for the DTC business. I mean, on a per [av] per patient basis down fairly sharply, but the operating earnings were up nicely. Can-- can you give us any color what-- what actually happened there?

I think that-- the-- the operating earnings improvement was a-- a direct result of the operational changes that have been made in management down at the -- at our DTC business and the-- the effect of a whole array of changes, improvements that they've made in SG&A. They're down head count pretty dramatically year-on-year. I think there are any number of-- of-- of a large list of relatively small operational improvements. But, when you aggregate them, it was significant for the quarter. And we're-- we're excited about that and excited that-- that they seem to have turned the corner operationally.

Are you still viewing the margins there as somewhat depressed relative to where they should be or-- or are we kind of-- is this a better rate to-- to model off of [year] going forward?

Yes. I-- I think-- I think we're probably in the correct ballpark. I-- I don't think we're going to see gross margin improve. I think they've done a-- a-- a very good job of-- of-- of really getting acquisition costs very good for their size. The opportunity has always been one to get everybody in one building which we've ultimately finally done. Two, to really kind of streamline the shipping process, which to me if you look at Owens & Minor-- I didn't quite understand how they had that. We've got it-- we've got it going the Owens & Minor way now. The reduction in head count. We also have-- have really seen kind of stabilization of the technology. The-- all of the improvements that are [done--] being done from a process standpoint and a technology standpoint are being driven by the operations people. So you've seen a slow down in the sales. But you're seeing an improvement. The other thing I would say is you're seeing a stability in the customer base where we had a high turnover in the customer base-- the customer base that we have has settled down which leads ultimately to a lower acquisition cost overall. The people that we're bringing on are sticking versus placing one order and maybe going to somebody else. So, the big thing is we've had our Owens & Minor people down there. We've got-- we've got two leaders down there that are doing very well. We have a new controller who's been there five months. He's still looking at everything down there and with a fresh set of eyes. So, operationally we're feeling very good about the business down there.

Is there a reason, Craig, [ave--] revenues per average patient did tick down year-over-year about 5% or so? Is there something going on on that [measure]? Is it just mix issues?

I think it's probably mix more than anything else. We're-- we're-- we're trying to get a better mix of different payers down there and so that is going to slow you down a little bit. I think it's just, philosophically, the whole way that they're going out to acquire the customer versus what we did back even in 2005. So, I think you're going to see probably lower growth, but-- but at least better earnings than what we've been putting on the books over the last several quarters.

And anecdotally, anything about DSO's? Was that part of the improvement in the quarter, for that business?

I believe it was.

It was. Sequentially. We're seeing a dramatic improvement with the technology enhancements that we've brought on and the trends have been-- been good with the receivables. So we're still have some room to grow to improve and we'll continue to do that as we go forward.

Lastly, I don't know if you threw out any additional de-leveraging plans? Is there a formal schedule or just opportunistic in terms of how you retire debt?

No, we didn't. In response to I think it was Lisa's question, we-- we-- we said that we would move to de-lever the company, paying off the revolver with excess cash in the short-term as we look at what the more optimal capital structure of the company may be going forward.

That's great. Thank you.

Thank you, Robert.

And our next question comes from the line of Jennifer Hills with Goldman Sachs. Please proceed.

Good morning.

Good morning, Jennifer.

Could you provide a little bit more color on organic growth trends? I know you had said [as a combination of penetration and new customers], but what are your expectations for those trends to continue through the remainder of the year and then into 2008.

Well-- I-- I think actually I knew we were going to get asked this question probably two or three times today. If you go all the way back to 2004, I went all the way back-- the organic growth has been somewhere between 6% and 8% since 2004. If you look at the last four quarters, we've been 8%, 9%, 11%, and 9%. So we're probably even a little bit higher than where we've been historically. But we've been pretty consistent over the last three years that we've been growing somewhere between 2% to 4% above the industry average per distributor. So I would just go back and look and say that over the last three to four years, we've been pretty consistent. Again, a lot of that -- the major percentage of that coming from penetration in existing accounts, probably the lion's share of that-- and then some new business that we brought on in late first quarter, second quarter, but I think you're going to see more of an impact in those in the third and the fourth quarter of this year.

Digging in a little bit on the gross margin and the GPO business?

Yes.

Just to make sure I understood. It sounds like there was a little improvement but not a lot of improvement from the first quarter? Can you talk about just the timing-- I know you mentioned there's an opportunity to sell additional products and services, primarily the private-label. Can you just talk about the timing? Is it something that you would expect to see in the second half of this year or is that something that could further out than that.

Well, I think what-- what we've talked about, Jennifer, is really a long term strategy of follow-the-patient and we-- we still at Access are primarily a diabetes business direct-to-consumers. So, what we-- what we said was is that some time this year we would validate that strategy of follow-the-patient and we're-- we're not done yet. We're-- we've done a lot of work on it. But, if you-- if you look at the Access business today, it's still primarily a diabetes business. So, whether we get into other disease states, I-- I would say where we are in the middle of the year, we probably would not add any disease states this year. So it's going to primarily be still a diabetes business. But long term, three to five years out is really what we're trying to validate-- is the different disease states that we would have. And-- but really again the first commitment priority that I made and that the company made was that we would get this Access business turned around and then strategically we would look at how [out--] how we operate outside the four walls of the hospital. So we're still working on that. And I wouldn't want to tip our hand. But, I mean, if you were to look at the diabetes business down at Access that's going to still primarily be a diabetes business probably through the remainder of this year.

Thank you.

(OPERATOR INSTRUCTIONS). And our next question comes from the line of John [Emrich] with Ironworks Capital. Please proceed.

Thanks, a couple of unrelated questions if I could as them separately? You talk about your operating margin goals-- can you talk a little bit about DSO and inventory turn goals either for year-end '07 or year-end '08 or if it's more appropriate because of the cash usage in the fourth quarter for the full year '07 or the full year of '08?

John, I think that would be giving more guidance than we're probably comfortable doing with any degree of specificity. We can talk in general terms though of what we'd like to see. I think getting down to the-- the 28 days at the end of-- of June was a great accomplishment. And if we move forth for the second half of the year in that general range, it would probably be acceptable coup-- if it's coupled with a reduction in the inventory area. So I think that's really [whe]-- the focus and the-- and the trending we would give you or direct you to for the remainder of 2007. At this point, 2008's premature for us to give much directional guidance. We would anticipate doing that later in-- of course in the year.

I guess, two words I wrote down are [two phrases] that you're working on it and there's opportunity. I didn't know if you're talking about inventory and DSO or just inventory.

I think the opportunity is more in-- in the inventory than the DSO. The-- again the mix of the McKesson business and the discipline that went behind [AR] for the hospital part of the business was probably not as disciplined as we are. So I think to underscore Jim, I think we're all very pleased that we're at 28 days. I mean, originally, I think we were talking 30, 31, 32 days and here we are at 28. So, knowing Dick Bozard, I-- I have to-- I have to buy him a lunch every time he beats a number each quarter. So he's -- but you know, 28 is pretty significant. If you look historically at the inventory turns, we've been around 10. So we think that's the opportunity for us. Again, we're kind of -- we're not kind of -- we're juggling this new business coming on. If I were to say there was a disappointment for me in the second quarter, it was around inventory. And the focus really will be to try and get back to the historical turns that we've had of 10. We really aren't putting a stake in the sand when we get there but I would say we've got a lot of opportunity on the inventory side.

And the last question. What drives the-- just remind me-- the cash usage in the fourth quarter? Is it everything in working capital?

Yes. It's somewhat just the seasonality of both our customers and-- and our suppliers and the difficulty in-- in-- in getting payments over the holiday period and-- and then the-- the-- the interest that the suppliers have in shipping prior to the holiday period. So, historically, as I've looked at the numbers I gather it's been an ar-- a time period of somewhat difficulty because of the seasonality of it.

Okay, well, I do hope you continue to make progress in the working capital. Obviously, that's cash that goes to pay down debt which lowers your interest expense, which is headed in the right direction. If you did nothing else, that would be accretive to the bottom line for the next six quarters, so--

That's-- that's a big goal for me. I can tell you. That's what we're-- the inventory -- we've got some work to do on the inventory.

I forgot, one last question. What is the other income number $1.38 million-- that's in there? Other operating income--?

Oh, that's finance charges that we break out separately from the other aspects of our revenue.

Got you. Thank you.

Operator, I think we're-- we're set to wrap this up.

Thank you. And I would now like to turn the call over to Craig Smith, President and CEO for any closing remarks.

Well, it was-- it was a-- a good solid quarter for Owens & Minor. We made a lot of progress. We made a lot of progress late in the second quarter. And we really feel like we've got momentum here at the company to-- to really push the company forward operationally. And we look forward to any questions you might have. And we look forward to updating you on our progress on the third quarter call. Thank you for calling in.

Thank you for your participation in today's conference. This concludes your presentation. You may now disconnect, and have a great day.