Owens & Minor Inc (OMI) 2007 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Owens & Minor third quarter 2007 conference call. My name is Michelle, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes. I would now 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, sir.

Good morning, everyone, and welcome to the Owens & Minor third quarter 2007 conference call. We'll review our results and take your questions in a moment, but first let me introduce my colleagues on the call today: Jim Bierman, our Chief Financial Officer; Charlie Colpo, our Senior Vice President of Operations; Dick Bozard, Vice President and Treasurer; Olwen Cape, Vice President and Controller; and Grace den Hartog, our Senior Vice President and General Counsel. Now, before we begin, Trudi Allcott, our Director of Investor and Media Relations, will read a Safe Harbor Statement. Trudi?

Thank you, Craig. Our comments today will be focused on the company's results for the 2007 third quarter and year-to-date results 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 make 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 in our SEC filings for a full discussion of these risk factors. Finally, this conference call will be available on our website for the next three weeks. Thank you. Craig?

Thank you, Trudi. Let me call on Jim to brief us on financial results. Jim?

Thank you, Craig, and good morning, everyone. This quarter, while we have been celebrating our 125th anniversary, we also marked the one-year anniversary of the McKesson acquisition, a significant milestone for Owens & Minor. We have made steady progress throughout the year integrating this significant purchase. You will see this progress demonstrated in our results, especially in sequential comparisons. Highlights from the quarter include: another quarter of double-digit revenue growth, 28% when compared to third quarter 2006, and 30% year to date; dramatic improvement in net income, up 47% to $21.2 million for the quarter, an improved 16% sequentially; and excellent cash management trends, with very strong operating cash flow of $116 million for the quarter and $200 million for the year to date. Achievement in these areas illustrates our underlying efficiency, ongoing operating discipline and strong relationships with our customers. As we turn to earnings, please keep in mind certain factors when comparing results to last year. Third quarter 2006 earnings were negatively affected by a pretax adjustment to the reserve for doubtful accounts in our DTC business of $4.5 million. And third quarter 2006 earnings were also reduced by approximately $1.3 million of expense associated with the McKesson transition. And when looking at year to date comparisons, keep in mind 2006 results also include a second quarter pretax charge of approximately $11.4 million related to the early retirement of debt. And 2007 year to date earnings include the first quarter pretax dilution, estimated to be approximately $8.1 million related to the transition of the McKesson business.

Now for our results. For the third quarter 2007 diluted earnings per share were $0.52, improved sequentially from $0.45 for the second quarter this year and also improved from $0.36 last year. Year to date diluted earnings per share was $1.23 compared to $1.03 last year. Revenue was strong again this quarter, increasing 28% over the prior year quarter to $1.69 billion. This was also a slight sequential increase from $1.68 billion in this year's second quarter. Obviously the acquired business was the main factor in this strong growth, adding approximately $249 million in revenue, but we also experienced solid organic growth and began to recognize revenue from customers added during the course of the year. We recognized a slight decline in revenue from the McKesson acquisition. As we had anticipated from the start, certain customers did not plan to stay with us, and we have also parted ways with some customers over credit and profitability issues. We have been successful in attracting new business. We are currently preparing to bring on yet another large new customer in the fourth quarter. Of course, bringing on this and other new business resulted in a compounding of expenses as we prepared for the new customers, including hiring warehouse teammates in advance of conversions, linking systems and building inventory prior to the conversion. This process has contributed to the slower than expected pace of expense reduction this year. Year to date, the McKesson business has added nearly $800 million in new revenue, bringing our year to date revenue to $5.1 billion, an increase of 30% compared to the same period last year.

Gross margin for the quarter was 10.57% of revenues, a decrease when compared to gross margin of 11% in the third quarter last year, but slightly improved when compared to second quarter's 2007 gross margin of 10.53%. The decline from 2006 resulted largely from the impact of contract renewals with our GPO partners. We are pleased with the positive gross margin trends for the quarter, but you should note that our gross margin results will fluctuate from quarter to quarter as they have historically. As for the year-to-date results, gross margin was 10.5% compared to gross margin of 10.9% last year. The year-over-year decline in gross margin is attributable to factors we just discussed.

For the quarter, SG&A was $131.4 million, or 7.8% of revenue, a sequential improvement from second quarter SG&A of $133.5 million or 7.9% of revenue, and also improved on a percentage of revenue basis from SG&A in the third quarter last year. For the first nine months of the year, SG&A was 8.1% of revenue compared to 8.2% last year. While we have improved expenses each quarter this year, we have not yet achieved the level of synergies we had expected from the acquisition. Our pace in achieving synergies was slowed somewhat by the effect of the extraordinary sales volume on our day to day operating efficiencies. For the third quarter, depreciation and amortization expense increased approximately $900,000 year-over-year, resulting primarily from capital additions to accommodate the acquired business.

As for operating earnings for the third quarter 2007, we reported operating earnings of $40.9 million, or 2.4% of revenues, a sequential increase from $36.7 million or 2.2% of revenues in the second quarter this year, and an improvement over $25.6 million or 1.9% of revenue in the same period last year. Actually, this is our third straight quarter of operating earnings improvement. This achievement is a direct result of the hard work and commitment of our teammates, who work every day to manage our business efficiently while providing our customers with the support and service they expect. Our direct to consumer business contributed approximately $1.2 million to operating earnings this quarter on revenues of $26.6 million. Year to date, operating earnings were $2.5 million on revenues of $81.5 million. The customer count for the quarter was 187,000.

Turning to nonoperating items, net interest expense decreased to $5.4 million this quarter as a result of improved asset management. That's a $1.2 million reduction from the second quarter, as we had reduced long-term debt. The tax rate increased to 40.4% from 39.3% last quarter and 37.5% a year ago. The change in the tax rate was driven by an increase in tax accruals for interest related to potential tax liabilities. Consequently, for the third quarter 2007, net income was $21.2 million, improved sequentially from $18.3 million in the second quarter of this year, and also improved from $14.5 million last year. Year to date, diluted earnings per share was $1.23 compared to $1.03 last year.

Now turning to asset liability management, this quarter, receivable DSOs were 29.5 at the end of the quarter, up slightly from second quarter's 28 days and also increased when compared to the last year. Inventory management was a success story for us this quarter with inventory turns improving sequentially from 9.4 in the second quarter to 9.8 turns this quarter. That is also improved compared to turns of 9.7 at this time last year. We continue to focus on efficient inventory management, as this is a key driver for improving our overall productivity. As a result of this strong asset management, we reported $116 million in operating cash flow in the third quarter. Consequently, we paid down our long-term debt to $231 million. I would point out that we have reduced our long-term debt by half in the last six months. Looking at the first nine months of the year, our operating cash flow was $202 million compared to $31 million for the prior year. Our capital expenditures were $20.4 million in the first nine months of 2007 compared to $19.2 million in 2006. As we turn to the next quarter, I would like to remind you that we have historically used cash in the fourth quarter of a year.

Turning to our guidance for 2007, we believe that revenue growth will exceed 20% for the year. We also now believe that diluted earnings per share for the fourth quarter of 2007 will be similar to third quarter 2007 results. Factors that will likely affect fourth quarter performance include upcoming moves and consolidations in our distribution network, slower than expected cost savings, and expenses associated with bringing on new customers. In summary, this quarter we continued integrating the acquired business and began converting new business. We delivered sequential improvement on key quarterly measurements. We remain focused on achieving additional synergies from the acquisition, and we reported exceptional operating cash flow. Thank you. Now I will turn it back over to Craig for his remarks.

Thank you, Jim. I'd like to provide a little insight into Jim's financial review. I do want to discuss our perspective of the fourth quarter, then look ahead a little bit operationally. All in all, I felt third quarter results were very positive, and we accomplished much of what we said we would do over the quarter. Now, we have essentially completed work with our McKesson customers on improving pricing files, accounts receivable, and contract compliance. I think we made excellent progress on inventory management and continue to work on leveraging the acquisitions. We reported sequential improvement in key financial measurements such as revenue, operating margin, and operating cash flow. These positive results are impressive considering that we've managed what I think is precedented revenue growth, brought on new customers, and continued to fine-tune the integration of a major acquisition. Efficient asset management is one of the hallmarks of Owens & Minor. We're very proud of our progress so far this year.

One of our biggest success stories I feel has been our ability to generate significant operating cash flow. In fact, the third quarter cash flow was our best performance since the first quarter of 2005. Consequently, I want to acknowledge our teams in the field and at the home office who have accomplished a great deal this year while managing through what I would clearly call significant change. We could not have achieved these positive results without the effort of our dedicated teammates.

The phenomenal growth we've experienced this year, even above the acquired business, has prompted changes in our distribution network: expansions in some locations and consolidations in others. Consequently, we find ourselves lagging behind our cost reduction goals we established for ourselves at the beginning of the year. Therefore, we believe our fourth quarter will be a solid quarter but not where we had hoped to be. And factors affecting the fourth quarter include the extraordinary volume of revenue growth this year. The unplanned signing of new customers, literally triple and really almost four times the usual number of distribution center moves due to growth and changes in our customer base, and a slower than expected pace in achieving expense synergies from the acquisition. Our immediate focus, now that we are into the fourth quarter, is on making the investments and improvements that will support us as we begin 2008. These investments include finalizing changes in our distribution network, including closing two more McKesson facilities and consolidating square footage leased for the transition, achieving a reduction in FTEs and completing the onboarding of new customers signed this summer. We believe the investments we've made this year and will make in the fourth quarter will make our operations more efficient, giving us a strong foundation for next year.

As I look ahead, I see that we are doing what's right for the company in the long term at a pace that works for Owens & Minor. Fundamentally, this business is about the relationships we forge with our customers and our suppliers, and the trust we place in our teammates. Our hospital customers depend on us every day for delivery of critical healthcare supplies. In turn, we depend on our teammates to support these hospitals while also growing our business in an efficient and productive way. As you know, we run a very lean operation at Owens & Minor. In fact, I was out visiting five of our operating units last week, and this means that every teammate has to work hard and work smart in order to keep our business running efficiently. I know what we ask of them isn't easy, and I'm proud of what our team does every day. I want to thank our teams in the field and at the home office for the work they've done and what we have all felt has been a fruitful year but a very challenging year. From a business perspective, longer term we are focusing on achieving consistent progress in our financial results, continuing to grow our company, and expand our reach in the growing healthcare market. Finally, we would like to invite to you our Investor Day which we are planning for December 5th at our Baltimore facility. It's one of our newer facilities, state of the art. We expect to provide 2008 guidance at this event, and you'll receive more information soon from our Investor Relations team. I want to thank you, and we would be happy to take your questions.

Thank you. (OPERATOR INSTRUCTIONS) Your first question comes from the line of Glen Santangelo of Credit Suisse. PLease proceed.

Just a couple quick questions. Jim, I wanted to follow up on some of your comments. You said that you've added $800 million in new revenue this year. Could you split that out between what's included in the McKesson number versus what might be other revenue?

The $800 million I was speaking of was the McKesson impact. So it was three quarters over the nine months of McKesson we've reported.

You alluded to the fact there's some new customer wins which explains why you're incurring these costs in the fourth quarter. Could you give us a sense of the magnitude of some additional new business wins?

Well, Glen, let me use one example of a ramp-up, and actually we have a couple of new customers ramping up in the fourth quarter, and one significant one in the third quarter. But the one that actually facilitated a move, an unplanned move for us, was in the Southeast. Probably going to be one of our more advanced logistics. It's a combined OM solutions, enterprise sales, core sale customer. And to give you some flavor on that, we had to add about 45 teammates at least 60 days in advance, and it forced us on a physical move that was not planned. Good news, we won the customer and we feel like it's going to be, one, a great partner, long-term partner. We signed a long-term agreement with them. But did it impact us from a physical move that we did not have planned. Part of the challenge that we've had this year -- as we're ramping down headcount in some of our facilities, we are ramping up headcount in some of the facilities that we did not plan to ramp up in. And three of the moves in the fourth quarter, two of them are because of new customers that we've had to do a physical move and add headcount on to. So good news is, we're getting some big wins. Part of the challenge is we're not getting the expense synergy that we had hoped. We had hoped the dust would settle in April and May, and then we could work through the rest of the year really on fine-tuning the operations. And good news is we've added a lot of -- we've added some new business here in the last half of the year which has forced to us do some moves and ramp up some people. We've made a conscious decision. I made a conscious decision to get all of this done in the fourth quarter, so that we could come out strong next year and have as least disruptive year in terms of moves or ramping up of headcount as much as possible and work on efficiency and productivity next year.

Craig, just to follow up on that, is it your sense that any distribution center moves or changes or headcount additions, based on what you know right now your business to be, should be fairly minimal in calendar 2008?

Well, ordinarily I would say -- let me just give you an idea. Typically we do one or two moves a year. We have -- we will have done eight this year. So I wouldn't say we won't do any moves next year, but it will certainly not be eight. It would be back to our normal one to two and then really focusing on headcount next year. And headcount also counts overtime and temporary help. We basically eliminated all temporary help this year. Where we are focused now is overtime, which we've seen come down, but we've also had physical inventories. We had a lot of inventory moving around in our units because of the McKesson transition. So we want to make sure that we really spend a lot of quality time making sure that we get our inventories as accurate as possible. That has hurt us on the overtime piece. That's when I went out and visited our five operating units last week. All of them had gone through physical inventories. All of them felt that it had gone well, that they had accounted for everything. But it had attributed to some additional overtime for them for this year. So hopefully next year we get back to normal physical moves, one or two a year, and we continue to work on the overtime and really get the units back to where they're efficient and productive.

Thanks for the comments, Craig.

Your next question comes from the line of Robert Willoughby of Banc of America Securities. Please proceed.

Craig and Jim, I guess maybe along those lines, you're not really ready to comment on '08 specifically. But given some of the change, some of the investment here, you'd have to think here that it's a slower ramp to the year? Or is it just impossible for you to tell at this point?

Slower ramp this year?

In '08, than maybe we would have otherwise normally expected.

Well, I think what we would do, Robert, again, at the Investor Day in early December, would try to give guidance for '08. That gives us the next six weeks to get through these moves. I believe we'll have the two new customers fairly well on ramped and ramping up. I would feel more comfortable at Investor Day giving as much color and guidance on '08 as we possibly can, rather than today.

Okay. It does sound like you have some confidence that there's kind of a finite period for this change and investment that you referred to, then.

If you -- again, if you look back at what we did this year, we've added about 30% new business into our operating units, and I think we still made the right decision of getting all this business on boarded in six months. We had competitors coming after our business. We had competitors coming after our sales force, and we felt we had a good plan in place. I still think it was a good plan. We just didn't anticipate that we were going to have almost 10% additional growth in the first three quarters. It's somewhere around 9.7%. So we had been fighting an uphill battle, primarily around getting our expenses down and letting the dust settle in our operating units. So I think we'll have a better feel early in December. We made the decision to get this done this quarter, and I think long-term for the company is going to be the right decision.

And just two other quick ones. Have you seen any opportunity emerge for the DTC business with the sale of the PolyMedica asset? Anything appearing on the horizon there? Can you give us a sense of what percentage of cash flow -- the numbers have been good there. What has come from the McKesson consolidation? Is there much left on that front to achieve? Where are you in that process?

On the cash flow, if you want to, Craig -- on the cash flow, Robert, I would answer that we've pretty much achieved what we set out to achieve in that area. I think the movement this quarter was outstanding and beyond what we reasonably were expecting originally. On the Access Diabetic business, we certainly are monitoring what's going on in the marketplace, and we're pleased with the rate of improvement in our operations, and we think that what is happening in the marketplace only speaks to the value of the asset that we have.

Okay. Thank you.

Your next question comes from the line of Larry Marsh of Lehman Brothers. Please proceed.

Thanks and good morning. I guess it is unusual to have to talk about an earnings shortfall with more new business than you could have imagined. I guess that's good problem to have. Craig, I guess maybe I'd like to get you to drill down here, just a little bit on the extra costs that you're alluding to. You're now saying you're going to have eight different facility switches this year, up from normal one or two. How many of these were -- did you and Charlie originally anticipate when you announced and completed the McKesson acquisition, and how many of these are incremental to that?

I'll let Charlie answer that, since he was --

We figured, of the eight, that four were planned and due to the McKesson move. And then since then another four that just were not as a result of the McKesson acquisition.

And just to give -- I think your other part of your question was, Larry, you've got IT syncs, you've got warehouse space, usually ramp-ups, and in a couple of these because they were in divisions that it was unplanned, a lot of times you can absorb smaller chunks of new business and spread the cost out. Two of these were pretty dramatic, where we really had to go out and get space and ramp up. You just can't hire 40 people off the street and expect them to start pulling hospital supplies the day the agreement starts. So we've had to add some additional teammates and have them trained just because of the impact that it would have on the operating unit.

So the -- right. So the four unexpected -- sounds like two of those have popped up here in the last quarter with these wins?

That's correct.

Okay. So how would you -- I know you don't want to be too specific on these new customers, but it is a little unusual for me to think about a customer win that immediately requires hiring a lot of new people. I mean, you usually think of it as more volume through a fixed cost facility.

Right.

So maybe elaborate a little bit -- what is that -- are you actually having to open a new facility to service these two accounts?

Go ahead, Charlie. Charlie wants to jump in here.

I can tell.

These facilities, Larry, are what I would call smaller facilities, so they are a material event to these facilities. So that is why we're ramping up in terms of labor, in terms of inventory, and that's why we didn't have adequate space to take those on. Your premise is right in most of the times where we would be able to absorb this.

And then so would you describe these as, what, opportunities that are long-term in nature that provide consulting and services that are just foot to be very profitable for you guys, and were these unexpected RFPs that just came to the market that you really didn't anticipate ever winning?

Well, I would say that there is a great opportunity in these accounts, first of all. I wouldn't say there was an unexpected RFP. We were aware of these RFPs. In fact, we've delayed making decisions on one of those facilities until we knew for sure which way that RFP would go.

Right. Okay. And do we at least characterize these as GPO-based relationships or no?

No, these would be more integrated delivery network decisions. They belong to GPOs, but again, as we say almost every quarter, our relationship is with the individual hospital, and then the GPO does have an impact. Both of these would be individual IDN decisions, really outside of the GPO realm.

Two other things. Along with that, Craig, it sounds like on top of a lot of new business that you've brought on, with McKesson, obviously you've said the opportunity is such that you can pull on incremental new business, which creates even more change in the organization. What is it that gives you great certainty that that you can handle all this and this is the right move to bring it all on while you can this year as opposed to just sort of sticking to the McKesson business?

Well, these would be customers that we would be very proud to have as Owens & Minor customers. We're proud that we have all of our Owens & Minor customers. I think the surprise a little bit, Larry, is that if you go back to the original guidance, we felt we were going to have a good sales year again, then focusing the last six months on getting the business in -- to Charlie's point, we thought we could do in that in most of our network. We had a couple surprises. What I want to make sure is this does not linger into next year, that we get everything done as much as possible. You can never say everything done, but as much as possible in the fourth quarter, so that we have a good year next year. Our people already are at Mach speed through this year, and so we want to finish that up and really start focusing internally on infrastructure and really maximizing the profit in our operating units next year.

Okay.

It was good decision to make for the company. Just to drag this out another three or four months with some more physical moves, we could have done that. We're just going to get it done this quarter and get the ship right and move forward.

Okay. I got it. So I don't know if you can be this granular, but if you had chosen not to bring on this incremental new business, it sounds like you had a couple of surprises anyway. Would it be fair to say that the $0.10 sort of reduction in guidance you're communicating today would have been a good bit less than that, or --

Larry, I can't look at the business that way. You have to -- when an opportunity comes forward -- we've done a great job of walking away from some price customers. We've done a great job of walking away from some credit customers. These are good, big, long-term customers. It's like looking at a shopping center. These are anchor customers that are going to anchor our operating units long-term, and that's how we have to look at it is -- good news is, we got them. I wouln't call it it bad news. Challenging news, you've got to absorb them in a year when you're already absorbing a lot of business.

Okay. Then two other real quick things. The sales force update you gave us last quarter, is that still pretty much --

I knew you were going to ask me that. I figured that was going to be your first question. I've had Charlie scrubbing the numbers here.

Thought I'd surprise you.

That's an easy one. I figured you'd let me off a little bit easy. I'm right on my numbers what I told you last quarter.

Okay. Finally, it looks like you got paid $16 million. Was that an adjustment for the purchase price for McKesson, or what was in that the quarter?

As you might expect the contractual terms of the agreement with McKesson had a settling up feature generally at the end of the 12-month period of the transaction. And when you're shifting this much inventory and other things coming back and forth, that settlement feature is relatively large. And you're absolutely right, the final settlement was in that range, which was a cash payment to us.

Which meant what? The value of the inventory was a little less than you thought? The value of the business, extra costs, or a combination of all three?

No, I think it's all inventory related. It wasn't the alternative nature.

All right, thanks.

Thank you.

Your next question comes from the line of David Veal of Morgan Stanley.

Thanks. Just to follow up on Larry's question, it's a high-class problem to bring on 9% organic growth plus all the McKesson business. Just wondering if you are seeing any recent changes in the competitive environment that would suggest that kind of 9% share gain type organic growth wouldn't continue into 2008.

Well, you've got to go back and look historically, David, where we've been, and I think it's been somewhere between 6 and 8. Again, I think what I have said over the last two or three quarters -- we're in a very good -- we're very fortunate that we got the 9.7. I think what we provide and what we offer to customers right now is what customers are looking for. But I would go back and maybe look at historical volumes. I think it's just -- with the McKesson business and the new business, this has been just a very unique year for us in terms of all the revenue and the new good customers that we brought on. But historically, I think we've been somewhere in the 6 to 8% range over perhaps the last three years.

Sure. And so that 6 to 8% range -- that would be reflective of that one to two moves per year number that you talked about earlier?

Right.

Sounds good. So basically you're happy with kind of the network footprint that you have, being able to absorb to kind of organic growth that you might see next year?

Correct.

Thank you.

Your next question comes from the line of Jennifer Hills of Goldman Sachs. Please proceed.

Good morning.

Morning.

Can you dig into margins a little bit further? I just want to understand -- I understand there are costs with the new business coming on line, but is there anything from a pricing perspective that would linger into next year once you resolve the up-front costs?

No, really where we've been working, Jennifer, which we've been pretty consistent about too, is on the supplier side, trying to provide more opportunity on the margin on the supplier side -- either taking price up. We did add some manufacturers through the McKesson acquisition. We're now rationalizing the SKUs again. So from a customer price perspective, that probably would not have impact next year on these new customers. We see the opportunities as really working more selectively with our suppliers next year and working on rationalizing the number of SKUs that we've added on the McKesson side.

Okay. Then just digging a little bit more into your comment on synergies -- at this time, do you see the synergies coming in lower than expected, or is it just a timing issue?

I think primarily it's a timing issue. We've made good progress. We did reduce our SG&A quarter over quarter. I think we'll see -- we'll have a better picture going into Investor Day once we get through these inventories on the overtime. We've seen some good reduction in some of the operating units that we've expected. We did make a management change in one operating unit, and we are seeing improvement there because it wasn't coming fast enough. So I would say -- I would typify it as a timing issue from that standpoint.

You have talked about being able to get the margin of the McKesson business close to or at the historical margin over time. Can you give a little bit more color on where the differential between those two are at this point and how long you think it will take for those to narrow?

Jennifer, I think -- this is Charlie. I believe that the -- we said in the past that McKesson margins were very comparable to ours, and that's exactly what's playing out now. Obviously we want to continue to move them forward in more programs and services, and that will also be a focus of ours, but right now we are in that range of being very comparable.

That's all I had. Thank you.

Thank you.

And your next question comes from the line of Joel Ray of Davenport & Company. Please proceed.

Good morning.

Good morning, Joel.

Pretty much all of my questions have been asked. I just have one little tidbit, and that is your tax rate was a little higher in the quarter than what I had been looking for. Could you discuss in a little more detail what was involved there and what the outlook is going forward on that?

Yes. Joel, as you know, the third quarter is a quarter that tends to have variability to begin with, and that's because that's the time most calendar year taxpayers file their tax return for the previous year. So there's an element of true-up with that. In addition, as I said in the remarks, we did adjust the tax rate this year for an increase in our tax accruals related to interest on some potential tax liabilities that exist. I think we would reasonably expect the rate to more normalize as we look to fourth quarter and for the year to date, but we did record the adjustments in the third quarter.

Can you be a little more specific about how large those adjustments were?

I don't have the dollar amount. Generally we're looking at 39.3% last quarter, jumping to 40.4% this quarter. So not a huge amount of dollars to come up with that.

Okay. Thank you very much.

Thank you.

And your next question comes from the line of Eric Coldwell of Robert W. Baird. Please proceed.

Thank you and good morning. Question on the direct to consumer business. We haven't talked about that today because of the other topics, but you clearly had another quarter of profitability here, yet revenue was down sequentially, and I think your patient count was effectively flat. I'm curious if you can give us an update on what's happening in that business at large, and then maybe some specifics about your recent management changes, facility moves, and new strategy. Thanks.

Yes, I'll talk about the numbers and maybe strategy in management moves Craig can address. But on the revenue side, we did see a reduction, a small reduction quarter to quarter. We haven't been acquiring companies, customer lists in this particular area. All of the growth that we've experienced has been either through advertising or through improved retention. We have seen improved retention. As you well know, management has been focused on fixing the operational problems there. And we are beginning in the third quarter -- the cost structure was up a bit, as we begin to increase the efforts in the sales area. And spending, again, in advertising and obtaining new customers.

Let me just make a comment, Eric, on the management changes. Actually, that has been fairly stable since the first of the year with the majority of the management team in place. We did hire a new sales leader who has been down there for about two months, and we feel that she's got a longstanding history of being in this business, and in being in the nonacute care business, and so we -- we're expecting her to grow the business down there. She needs to get her feet on the ground a little bit, and then -- but we do have a new person that is heading up the sales, primarily people we had brought in were to stabilize the operations, make sure that the infrastructure is there, the finance and operations people, and now we've added the sales component.

Craig, as you look at that business, I know there have been strategies to maybe leverage your sourcing power, also to possibly expand into other therapeutic fields. Can you give us an update on those initiatives?

I think they are talking -- they are getting some what I would call non consumer orders, and Eric, I'm probably just not prepared to talk about it today. We're trying to get through the bidding process. We're right in the middle of budgeting for next year. They are looking at adding some different lines for next year, and expanding that business, and I'm probably a little bit uncomfortable really going into that. Maybe we can give you some more color in December at Investor Day and the budgeting process will be fairly complete at that time, and we can talk a little bit more about strategy early in December.

Good. Thanks, Craig.

Thank you.

and your next question comes from the line of Lisa Gill of JPMorgan. Please proceed. Hi, thanks. It's Atif Rahim in for Lisa. Just a quick question on the McKesson revenue. This is the third quarter we've seen them come down. Could you just give us an idea of where you stand versus your goals? Is this kind of the expected voluntary attrition that you wanted to go, and you've seen customers leave, or is this something else? And what are expectations for next quarter from this specific segment?

Well, I think we're going to be almost exactly to the dollar where we said we were going to be. The run rate should probably level out right at about $1 billion. We had said we would either probably lose or walk away from about $200 million, so the run rate will probably be right at about $1 billion. It's a little higher. I think we said $900 million. But we should still be very well within that range, somewhere between $950 million and $1 billion.

That's great. If you look at what's causing the shortfall next quarter, there's really two issues. I think you talk about, one is the cost savings coming in lower than expected, and two is the higher business that you've won. So if there's any way you could split the two out and give us an idea of what -- how the mix is between the two for the next quarter?

No, we can't really do that at this point. You are right, those are the areas that we're focusing on, but I think it would be premature to go into any amounts at this point.

Okay. How about cash flows? 4Q is usually down. Are we expecting operating cash to come in positive for the year, or would the new inventory that you have to build up generate negative cash flow for the full year, operating cash?

For the full year we would definitely expect to be positive. But we do expect the fourth quarter to more than likely be a use of cash as inventories will build as we approach the holiday period.

Okay. All right. That's it. Thank you.

Thank you.

And your next question comes from the line of Gregory Macosko of Lord Abbett. Please proceed.

Yes, thank you. Just with regard to the organic sales of the existing operations prior to the acquisition and the merger, could you give us a sense of what that growth rate was in the quarter and sort of year to date basis?

Well, I think Craig was talking earlier, and generally year to date it's around 9%, is what we're seeing.

And that's -- so that's kind of within the -- your customer group then?

Right.

Yes.

Okay, thank you.

Operator, let's take one more call.

Thank you, sir. And your final question comes from the line of Todd Beiley of Kayne Anderson. Please proceed.

The acceleration of the internal growth rate and the winning of these two new customers -- to what extent do you attribute it to the bigger merged entity that has either more capabilities, more reach, deeper supply? Or is the fact that the two of you combined a contributor to this good business?

No, I think philosophically these were two customers that saw value in how we supply advanced supply chain logistics solutions. And we were fortunate to win that business in what I would call -- again, we have the enterprise sales force, which is a new sales force, the core in OM Solutions -- those were a combined approach that the customer saw value in going long-term with us on.

And could you -- now that you've owned this business for nearly a year, could you talk about positive and negative surprises from the merger with what you've got today?

Well, I think actually to a large degree we're not surprised with what we got. I think we're right where we felt we were going to be from the sales standpoint. We kept, for the most part, the customers that we wanted to keep out of the $1.2 billion that we brought over. I would say off the top of my head, we're actually very pleased. I think the surprise was really -- nothing related to the conversion is the fact that we've added some new customers outside of that, and we had -- we felt we had a very strong plan in place to convert 15 to 20% sales growth. And we're way over where we said we were going to be. That's a nice surprise, but the other part is we've had to absorb and swallow about 30% sales growth through the first three quarters. So we -- that's why we want to get this done through the fourth quarter and get on with getting back to where we want to be pre-acquisition. So I would say we really didn't have a lot of surprises. I guess probably the biggest surprise might have been the pricing, but we got that pretty well fixed in early in the acquisition, and other than that, I wouldn't say that there was really anything earthshattering from a surprise standpoint.

When you say pricing, what do you mean?

Well, what we have been saying for the last three or four quarters was that there were some pricing -- the way that they handled pricing and the way that we handle pricing is completely different. And if you remember two or three quarters ago, if you were on the call, the business was coming in at a lower margin. And if you heard one of the people on the call before earlier, we're now back to where we thought the business was going to be.

Thank you very much.

Thank you.

And that does conclude the question and answer session. I'll now turn it back to management for closing remarks.

Thank you, Michelle. I want to thank everybody for listening today. We would love to see you all at Investor Day in early December, where we'll give you some more guidance, and we're quite proud of our facility in Baltimore. They do a lot of work for the government there, and we have some advanced logistics solutions that we do out of that operating unit. We'll probably have a customer come and speak, and we're looking forward to a great turnout at Investor Day. Thank you.