Owens & Minor Inc (OMI) 2010 Q2 法說會逐字稿

Good morning, ladies and gentlemen and welcome to Owens & Minor's second quarter 2010 earnings conference call. My name is Lori and I will be your operator for today. At this time, all participants are in listen only mode. We will be facilitating a question and answer session toward the end of this conference call. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes. I will 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.

Thank you Lori and good morning, everyone. Welcome to the Owens & Minor second quarter 2010 conference call. We will review our results and then 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 Chief Operating Officer, Grace den Hartog our General Counsel, and Drew Edwards our Controller and Chief Accounting Officer. Before we begin, Trudi Allcott our dIrector of Investor and Media Relations will read a Safe Harbor Statement. Trudi?

Thank you, Craig. Our comes today will be focused on Company results for the 2010 second quarter, which are included in our press release. The press release as well as related presentation can be found on our website And we will also archive this webcast of today's conference call on our website.

In the course of our discussion today, we may make forward-looking statements. Statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Please see our press release and SEC filings for full discussion of these risk factors and also please keep in mind when comparing this year's results to last year's we completed the sale of certain assets of our direct to consumer diabetes supply business in January of 2009. And thus it is shown as discontinued operations in our consolidated financial statements. Therefore, our discussion today will focus on continuing operations. Also when comparing results keep in mind during the first half of 2009 where we were engaged in transitioning business acquired in the Burrows transaction. And as a result of our three for two stock split on March 31st of this year all per share results presented have been retroactively adjusted for this spread.

As for our investor calendar in the coming months, we are participating in two investor conferences in September. Details are in our press release. We look to forward to seeing you on the road in the fall. Thank you. Craig?

Thank you. And I like to turn it over to Jim to brief us on our financial results. Jim?

Thank you, Craig. And good morning, everyone. Now that we reached the midpoint of the year, we have a better view of how present economic conditions are affecting our business. As we have been saying since our investor day last December, we believe that the most significant variable for our business in 2010 will be the overall utilization of health care services. For the first six months of 2010, we believe our results reflect a trend of consumers postponing or foregoing medical care as a result of continued high unemployment. In the past, some segments of health care have tended to reflect the impact of an economic downturn somewhat later than other industries. And in turn have also tended to lag the recoveries.

As we look at our results for the first six months of this year, we believe that we are experiencing that phenomenon in both our revenue volumes and in our mix of business. Consequently in looking at our financial results for the quarter and year to date, we fell somewhat short of our own targets. However, our results also demonstrate that we continue to operate our business with great efficiency. For example, strong expense management during the first half of this year resulted in operating earnings of approximately $101 million, an improvement of 14%.

Turning now to the detail of our results, second quarter 2010 revenues in excess of $2 billion were improved slightly from the prior year quarter, increasing the approximately $6 million or 0.3%. The increase in revenues resulted from a combination of increased sales of products and services to existing customers of $41 million, representing a growth rate of 2.2%, and from sales to new customers of $51 million. This $92 million increase in sales was partially offset by a decrease in sales to lost customers of $85 million. These customer losses were effectively the same customers as those discussed last quarter and therefore were anticipated.

When looking at the year date period, revenues increased approximately $27 million to just under $4 billion when compared to revenues for the same period in 2009. Revenues improved for the first half of the year from a combination of increased sales of products and services to existing customers of $100 million representing a growth rate of 2.8%. As well as increase in sales to new customers of $101 million. These year to date gains of $201 million were offset by a decrease in sales to lost customers of approximately $174 million.

We experienced a sequential decline in our existing customer growth rate from 3.2% in the first quarter to 2.2% in the second quarter. And an amount is that approximately 300 basis points less than our historical experience, at least since the McKesson transaction. We have analyzed variance and the data indicates that it is not uniformly distributed over our entire customer universe. Aside from geographical differences that are more obvious, the data indicates a significant relative dispersion once our customers are segmented by size. Our larger customers have growth rates upwards of 4% which is still below our historical experience but better than our average of 2.8% for the first six months of this year. More telling, however, was that the data indicated our smaller customers actually had negative growth for the period. Revenues from these hospitals decreased by slightly less than 2%.

Turning now to gross margin, gross margin as a percentage of revenues decreased 30 basis points from the prior year's quarter to 9.52%. Gross margin dollars decreased from nearly $198 million in the prior quarter to over $192 million for the second quarter 2010. The actual decrease of $5.5 million is due in part to $2.7 million of revenue that was recognized in the second quarter 2009 for which the cost of the revenue had been reported in previous periods. As we have previously explained, this revenue was deferred prior to the second quarter 2009 for which the cost of the because the contracts it relates to had various performance contingencies associated with them. And the second quarter of 2009, the performance was achieved and therefore the revenue recognized.

The second component of the decrease representing approximately $3.4 million was a reduction in gross margin dollars from our acute care distribution customers. This decrease reflects a shift in the mix of products they are purchasing as well as pricing pressures in the marketplace. When looking at year-to-date results, our gross margin dollars were $383 million, increased slightly when compared to the same period last year. The year to date increase resulted from the same factors that affected the second quarter results but was also offset by a lower LIFO provision resulting from less supplier price increases as well as revenue in 2010 from OM Health Care Logistics, our third party logistics business.

Turning now to our discussion of expenses. Second quarter 2010 SG&A expenses declined 7.2% or $10.4 million to $134 million, when compared to the second quarter last year. As a percentage of revenue, second quarter SG&A expenses decreased 53 basis points to 6.62%. The strong improvement in SG&A resulted from a decline in labor expenses including incentive compensation costs and lower IT outsourcing and consulting cost. Partially offset by increased costs associated with our third party logistics initiative. Also last year's second quarter SG&A included expenses related to the transition of the acquired Burrows business. When looking at year to date period, estimated expenses decreased $15 million to $269 million when compared to the same period last year. As a percentage of revenues, SG&A expenses for the first six months of this year were 6.74%, a 41 basis point improvement when compared to last year.

At this point in the year, we are very pleased with our SG&A improvement. As we look ahead to the rest of the year in our expectations for SG&A expense, we want to be clear that we expect to continue investing in our strategic initiatives, especially OM Health Care Logistics. This increase will be offset by continued lowered expenses for information technology outsourcing as a result of last year's main frame migration project as well as a decrease in incentive compensation when compared to the prior year.

For the second quarter, 2010, operating earnings increased 6.6% to $52.2 million compared to the prior year quarter. As a percentage of revenues, operating earnings were 2.58% improved 15 basis points from operating earnings in the same period last year. When looking at the first six months of the year operating earnings improved $12.5 million or 14% to $101 million when compared to the same period last year. As a percentage of revenues, operating earnings were 2.54% of revenues improved 30 basis points. For the second quarter and year to date, the increases in operating earnings were driven primarily by reductions in SG&A. As we have been saying for sometime, operating earnings will be a more relevant measure of our progress going forward as the evolving mix of our business including our strategic initiatives will have a greater effect on this metric.

Interest expense, a component of net income but not of operating earnings, was $3.5 million for the second quarter and $6.8 million for the first half of 2010. These were increased only slightly when compared to the same periods last year. For the first six months of the year, our effective interest rate was 6.6% on average borrowings of $210 million, compared to a rate of 5.9% from the first half of 2009 on average borrowings of $225 million. In June, we entered into a three year, $350 million revolving credit facility agreement. This new credit facility replaces our old $306 million revolver and secures a key element of our capital structure. However, due to changes in credit market conditions, the commitment fee on the unused portion of this facility and other related costs increased substantially when compared to the prior facility.

For the quarter and year to date, the effective income tax rate was 39.4%, only slightly higher than the tax rate in the same periods last year. Overall we continue to target the annual effective tax rate for 2010 to be in the range of 39%. Consistent with the previous guidance and the prior year's effective rate. Income from continuing operations for the second quarter 2010 increase by $1.7 million to $29.5 million or $0.46 per diluted share, when compared to $27.8 million or $0.44 per diluted share in the same period last year. For the year to date period, income from continuing operations increased $7.2 million to $57.3 million or $0.91 per diluted share when compared to $50.1 million or $0.80 per diluted share for the prior year period.

Second quarter net income per diluted share was $0.46 compared with $0.38 a year ago. On a year-to-date basis net income per diluted share was $0.91 compared to $0.60 a year ago. The improvement resulted from increases and operating earnings and the fact that last year we were investing in the transition of acquired business and exiting the direct to consumer business.

As for asset liability management for the first six months of the year, we reported cash flow from continuing operations of $183 million, compared to $123 million in the same period last year. Cash from continuing operations was positively affected by strong operating earnings, increases in accounts payable and decreases in accounts and notes receivable, which were partially offset by higher inventories. Inventory turns in the second quarter were 10.6 compared to turns of 10.4 a year ago. DSO was a record 19.8 days as of the end of the second quarter. Improved when compared to DSO at the same time last year of 22.6.

Cash use for capital expenditures in the first six months of this year was approximately $20 million. A higher level of investment when compared to $16.7 million in capital expenditures for the same period last year. So far this year, we have used cash for investments in our strategic and operational efficiency initiatives including improvements for the OM Health Care facility in Louisville, completion of the relocations or expansion of three distribution centers as well as investments and voice [PIC] system and customer facing technologies. During the quarter cash dividends paid were approximately $11.2 million. Cash used by discontinued operations was less than $1 million for the first six months of the year. That compares with $12 million in cash received in the same period last year, which resulted primarily from receivable collections offset by cost associated with exiting the direct to consumer business.

With that review of our results, I would likes now to turn to the remainder of the year. As we have passed halfway mark for the year, we have reflected on our trends, our goals and our performance against our targets. During the first half of this year, our business felt the impact of lower than expected utilization of health care services. Assuming there is no meaningful change to current economic conditions, we now believe that our full year revenue results will improve slightly when compared to the prior year. And we believe that our earnings per diluted share will likely be at the lower end of the previously stated range of $1.93 to $2.03. Now I will turn it over to Craig for his remarks.

Thank you, Jim, for that update. I believe with Jim's review of our results you should have a better idea of the internal and external forces that have affected our business so far this year. While there were challenges this quarter, I'm pleased to report that we continued to make progress in areas of position us well for the future. We remain focused on operational excellence, strong asset management, development of our strategic initiatives and continued operating earnings improvement.

When looking at our business so far this year, we see the impact of the economy, which we all recognize is slow to recover. In analyzing the overall mix of our business so far this year, we see the effect of lower utilization of health care services at hospital centers around the country. Our data shows lower relative volume growth at smaller hospitals when compared to larger facilities. A recent Wall Street survey of 300 hospitals supports what we are seeing in our data. In the survey, smaller hospitals indicated they faced a more challenging volume environment in the second quarter than the larger hospitals did.

In looking closely at our results, we see that while sales to smaller customers were weaker this quarter, volume with our larger customers grew at about 4%. We are encouraged by the consistency of revenue growth with our larger customers. These IDMs and health care systems that do a significant amount of business with us represent an important strategic opportunity going forward as we grow our business and expand our reach outside the acute care setting. These customers are more inclined to use our value added supply chain management services. These larger IDMs are growing by acquisition. In fact, a recent newspaper story reported that the pace of hospital acquisitions announced so far this year is the fastest in a decade. Also these larger systems are actively recruiting physician practices as they build their health care provider networks. We believe that our award winning service and innovative solutions are the right strategic fit for the top facilities around the nation. In fact, "US News and World Report" just published this year's best hospitals list and we are proud to report that we serve nine of the 14 honor roll hospitals.

Looking ahead, we mentioned last quarter we are expecting to begin on boarding sign new business this summer and that we had other potential business in the pipeline. Now, some of these conversions are completed and just had been completed. Some are underway and some have yet to begin. In fact, the largest of these customers is not scheduled to come on board until early 2011. As you may realize timeliness or time lines for these conversions can vary base on customer preference timetables and readiness. We will continue to work on boarding signed new business across the remaining months of this year. Today we believe we will begin to see the benefit of this new volume of business in 2011, once we have fully integrated these new customers and begin the process of penetrating the business.

Also this year we planned further investment in our developing strategic initiatives including OM Health Care Logistics. This team has done a fantastic job thus far. And they are actively working the sales side to fill the customer pipeline. Our Louisville facility is up and running and we are working enthusiastically to build this business. As for our ambulatory surgery center effort, we continue to work our plan. Our market base sales force is in place and we are reaching out to prospective customers. We have designated certain key distribution centers within our network to fulfill orders for the ASC market.

Our business is a complex mix of large and small customers products, programs and services, pricing models and supplier programs. Consequently, there are times and this is one of them that external economic forces will combine to affect our business. However, we see encouraging trends with our larger customers and we are preparing to convert new business which we believe will have a beneficial impact in 2011. As we look ahead, our focus is on sustaining award winning customer service that we are known for, maintaining operational excellence, continuing to create programs and services that improve the supply chain and invest in strategic initiatives that will hence operating earnings in the future. Our Executive team and our Board of Directors are enthusiastic about the future. As a matter of fact, just last week our Board approved third quarter dividend signaling their continuing confidence in our strategic direction. Looking ahead, I have great confidence that our talented teammates will continue to serve our customers and our Company to the best of their ability. Thank you and at this time we would be willing to take your questions. Lori?

Your first question comes from the line of Lisa Gill of JPMorgan.

Thanks and good morning.

Good morning.

Craig, maybe we could dig in deeper around Jim's comments on pricing pressure. Are you seeing that your competitors are getting a lot more competitive in trying to gain back some of that market share you have taken over in the last few years?

I think, Lisa, right now we have somewhat of a short term initiative or short term situation in the marketplace that health care reform is putting some pressure on some hospital systems throughout the country. What we are also seeing though is that there is pretty good delineation of customers that are pretty focused on price and then other customers that we have segmented out our larger customers, obviously we wanted to price but there are also really focused on process improvement, consolidation of purchasing services and looking at programs and services that will kind of take them into the future. So I think you are seeing a little bit of short-term concern maybe on these smaller and mid-sized hospitals that aren't quite sure how health care reform is going to fit them. The other thing is we are seeing in these smaller hospitals some product category pressure around the OR products, which is we usually get a higher markup on. So we are doing well on the commodity products. It's some of the OR products -- we can dive down pretty granularly in our account. So, I would say that there's been a little more pressure, I don't see wholesale, we go through a normal bidding process. But I would say there is a little more pressure than we have seen than probably in the past.

And secondly, historically we have talked about physician office expansion in trying to get into that market. Can you maybe give us an update as to what you have been able to do over the last quarter and if you are seeing any pull through? One of the things we are hearing about is some of the IDNs now going back and starting to buy physician practices. Are you seeing the pull through of any of that business?

Well, let me first of all say as you know we have three strategies. The third strategy is to move into the nonacute care market and I would say we've made great progress on the ambulatory surgery center business and we are starting to grow that business with the sales force we have. We are now talking with larger IDNs and it's not just buying practices but it's also recruiting physicians right out of school. So, we're going to see this trend continue. We are making progress. I think this is going to be something that we want to invest in but we don't want to do an old or traditional model. We want to do something different that lifts our acute care market in these larger systems. We made some progress. We have some targets that we're talking with. I believe over the last three months, and you know that I go out and talk with a lot of customers, this is going to continue to grow as these customers really start to seek out either market share or a larger regionalization of their system. This is something for us that is moving up. We have been heavily involved in OM Health Care Logistics and ambulatory surgery center. We wanted to get that right. We are now taking a good hard look at physician practice. We don't want to do it the way we are currently doing it today. We have physician business. We want to do it in a new way that's more cost effective for our customers and really more profitable for us.

Okay. Great. Thank you for the comments.

Thank you.

Your next question comes from the line of Eric Coldwell of Robert Baird.

Thank you. Good morning. When you say that smaller customers are down 2%, larger customers up 4%, can you clarify what your referencing? Are you talking about patient admissions, patient average day of stay, purchasing volumes or simply talking about your revenue contribution from those accounts? How should we think about that?

Eric, this is Jim Bierman. As we looked at the data that we have for our universe of customers, those metrics are predicated on revenue that they are generating with us. We obviously looked at the obvious anomalies that may have existed in any of the variances such as acquisition of hospitals and adjusted accordingly. We think it appears relatively representative of what we are seeing in several independent studies and reports that others have issued relative to the industry.

Okay, thank you. And going back to the account losses that you referenced in the prepared remarks and have talked about for several months. Can you just add more color on what is driving the account losses? Is there any comments seen in terms of size of accounts, geography, type of health care institution, whether it's one competitor that's primarily been making end roads with those accounts or whether it's spread across a number of competitors? Do you have any details that could shed light on the account losses?

Sure. I think as with any business there are various reasons that you may choose not to retain a given customer. And I think there are various factors we take into consideration and as all of you know and we have spoken several times profitability is certainly one of them. Risk profile and the potential for an account to actually grow and develop over time are other factors that we take into consideration. So I think if you look at the bulk of the accounts that have been lost and explanation for them, more often than not it's a profitability perspective. But also we concluded in several instances that those particular customers have limited growth opportunity in the marketplace. Final point I would make on that area is that we began this process late third quarter going in to the fourth quarter of 2009. We are coming on to -- we have a little more to go but we were coming on to a lapping period where these accounts have basically run through the numbers of a 12 month period. So as you think about this, it should be somewhat less impactful going forward.

Okay. My final question for now is, and I'm sorry if I missed this, but did you or could you quantify the magnitude of the new business you referenced on today's call to give us a sense on what kind of contribution you might be expecting in calendar 2011 from the known wins or those that have a high probability of closing?

Eric, excuse me, Charlie Colpo. We don't qualify the gains or the losses in that sense until they actually come on to the book. What we can say is that we have brought on some business at the end of the second quarter and the signed business is still the sign business in coming on. The biggest of which will be early in 2011. But that's pretty much as far as we will go with that.

Your next question comes from the line of Richard Close of Jefferies.

Yes, thank you. Maybe hitting on the on boarding of these customers, so are we to take that as compared to your second quarter comments that some are going to come on at the end of June and then in July. Now you are saying the largest will be early 2011. Are you little behind what you originally expected on that front?

Let me take that one. Richard, there is, I would say we are a little behind on the June and July customers that we talked about. Now we did transition one fairly large in the middle of the quarter. These are larger systems that have some complexity to it. You are not always spot on the date that you think you are going to be able to do that. There are some technology challenges that some of these customers have where you get everything, all of their files cleaned up. There is a timing issues in some instances with the competitor and in making sure that the service levels stay intact during that transition time. I would say we are a little bit behind on the June/July business that we had signed, but I don't think we were that far off. We've got business signed. We were on boarding that business and then we got the 2011 business that is a whole separate chunk of business that we have not really talked about before.

And then I guess as a follow-up to that, you answered a question. So these tend to be possibly the larger customers. The customers that you are saying right now in your current mix are growing at that 4% level. So you analyze I guess potential new customers to make sure that they fit your profitability expectations and growth expectations.

That's exactly right. These are accounts that we believe that we can up sell. They will look more and more at our programs and services and that ones that we expect to grow well into the future.

Okay. And then I guess a final question here with OM Logistics. You had mentioned break even by the end of the year. Just want to make sure that you are still on track with that. And then on the physician side in talking about that business and expansion, is that moving up in terms of maybe your focus based on your comments to Lisa's question?

Rich, on the OM health care logistics just to clarify and I think if you go back and look and see what was said on investor day, what we characterized our target for this year for OM Health Care Logistics was that by the end of the year it reached a revenue run rate that would be break even. And so it has not achieved a break even performance at this particular point in time. Nor quite candidly has it achieved a revenue run rate as we sit here today that is break even as one thinks about 2011. That being said, we are seeing a lot of interest and activity in that offering. And I think at the last earnings call Craig referenced the fact that we were to host an open house in Louisville and we had a huge turnout for that and a lot of follow-up interest and discussions on potential partnering opportunities with suppliers to become customers. At this point, we have not achieved that.

Relative to the physician office initiatives, I think Craig's comments to Lisa's question were consistent with what we said no for almost two years in terms of sequencing the events we need to get OM Health Care Logistics at a more critical mass. We need to solidify the initiative around ambulatory surgery centers and then the natural progression from that will be to migrate into a broader offering for physician offices. All that being said, we recognize the market is moving ahead as larger IDNs do acquire and grow their physician practices and we are running in parallel with them in order to meet their needs.

All right. Then I guess final with respect to the physician side, do you think you are moving fast enough to please your larger customers as they consolidate the physician market? Just trying to get a sense of do you think you will be able to be in lock step with them? Or do you risk losing customers if you don't have that service up and going fast enough?

Well, let me answer this. I'm not sure the large customers today have a set model in their mind how they would like their owned and managed physicians to be serviced. I think it's a tremendous opportunity for somebody like us who has a clean slate to be able to sit down with these larger customers and design what they have. I can say there are some consistent trends through these larger systems that I'm talking to. So there is a lot of consolidation. There is affiliation, there is management, there is ownership. And so you know we can do that business today. That's not the way we want to do it in the future. We want a new model that is going to support these owned and managed physicians. And the customer is willing to work with us and look at transportation, look at a formulary and look at the different things that impacts that business. So I don't think there is a rush at this point. I think they want to make sure their doctors are happy, that they take care of their patients and are willing to work with us. I think you know me well enough that nothing is ever fast enough. I like to be moving faster.

I am happy with the progress with OM Health Care Logistics and the ASC group and I think we will have the right model for the doctor business. We chosen to build that business and invest in that business. This is something that our customers are going to be in for a long period of time. And we want to make sure the model is right for not just one customer but a large set of customers. So we are making progress. I always like to move along a little faster. But I'm not even sure some of our customers may be ready today to have the exact answer on how they want this to look. I think it's a learning exercise for both us and for our customers as we move forward.

Alright. Thank you very much.

Your next question comes from the line of Steven Valiquette of UBS.

Thanks, good morning. Just wanted to touch base on the SG&A for a minute, as it came below the guidance. You are doing a good job of controlling the costs but do you think that run rate is sustainable kind of lower than where the previous guidance range was? The previous guidance was 6.9 to 7.05. That's the first question.

Yes, Steven. We looked at that and the characteristics of some of the improvements that we made. And we feel quite candidly that it is -- we will come in below the previously stated targeted amounts that we shared with everyone as of investor day. As you think about that and you think about sustainability, let me caution as you look to 2011 and onward I'm not sure that this level of performance is sustainable into 2011/2012 and beyond. The couple factors coming into play here are not the least of which are some of the benefit on a year on year basis for this year is a difference performance level for the incentive plan and we would expect to as we achieve better performance going forward to be -- have those results reflected also. Even more importantly, is the impact of the OM Health Care Logistics cost structure on SG&A. And I think that will become clearer as we finish up this year and begin thinking about 2011. As it relates to 2010, yes, we feel relatively comfortable with the results that we posted so far being representative of what we could achieve for the remainder of the year.

Okay. Now somewhat tied into that, just trying to get a sense for the gross margin of the new business you are adding on to the back half of the year. Even with some healthy reductions and SG&A and what you said about the top line and looking at where current gross margins are, it seems still somewhat challenging in the modeling to get the EPS even into the lower end of the EPS guidance that you sustained for the full year. So, you would have to do well over a dollar of EPS on the back half of the year. It's kind of a struggle to get there unless I'm missing something. But is the gross margin contribution on the new business higher than the corporate average? Or is there some other variable we aren't taking into consideration?

No. I think you assessed it well. I think that the gross margin as we bring in the new business and we think about the gross margin for the remainder of the year, we had put forth a targeted amount again at investor day of a gross margin in range of 9.6% to 9.75%. And we are trending right now at the half year mark close to 9.6%. We do have historically experienced some recognition of supplier incentives in the back half of the year that would tend to cause gross margin to potentially increase a bit as well as the fourth quarter we tend to have historically seen a phenomenon of manufacture price increases and some impact there. But more than likely the gross margin will be in the range that we've talked about before which would mean that the results in order to achieve the earnings per share we are talking about, the SG&A results have to be in line with what we talked about. I would say one thing, though, for what it's worth. And that is that in some of these larger IDNs and customers we are bringing on, the new business, they do have characteristics that are a little different and that is obviously they have more purchasing power in the marketplace. They certainly have potentially more growth potential and that's why we are interested in them. But they also have economies of scale associated with serving them. So it is possible where you have a situation where gross margin decreases in some capacity. But you are able to recover it through more economies of scale and serving that business. Therefore operating margin improves. We hopefully will be seeing that as we move forward. We certainly have seen it in the first half of this year where we continue to improve operating margin.

Okay. That's helpful.

Your next question comes from the line of Glenn Santangelo of Credit Suisse.

Hey, Craig and Jim, thank you for taking my question. I wanted to follow up with you on the revenue growth rate a little more. You said in your prepared remarks, Jim, that the larger customers are growing at 4% and smaller ones are at negative 2%. Was that just for the second quarter, if it was I'm curious how that changed since the first quarter?

Yes, those statistics were just for the second quarter, Glen. What we saw on the existing customer base in the aggregate was a 100 basis point decrease in revenue from the second quarter to the first quarter. So sequentially. And that can be explained for various things that are somewhat seasonal in the first quarter. But it was a result that was outside what we were hoping for and certainly what we were targeting.

Hey, Jim, you saw 100 basis points sequential quarter decrease but yet you decreased your revenue guidance by 5%. I'm curious, is there anything else other than a slower economic recovery imbedded within your guidance reduction? Because basically if I look at it now, we don't have the number of your net new business wins, but it looks like your business organically is growing in negative territory, is that a fair assessment?

No, I don't believe that's true at all. I think that for our existing customers we are seeing continued growth. It went from 3.2% in the first quarter to 2.2%. As we said, at least the last quarter and numerous investor presentations we made since then, we have little to no control over that aspect of our business. I mean, that's the buying patterns and the utilization of our customers. So we did see this phenomenon occur and then the question as we sit here today is "What is the expectation for the remainder of the year?" And as we said, absent any change in the economy or buying patterns of consumers of health care services, we would expect this to continue for the remainder of the year.

So just if it I can summarize, you organically your customers are growing a couple percent but now guiding revenue flat for the year so am I to infer from that that the customer losses are greater than any incremental customer wins?

Well, I think, Glen, what we had said in the first and second quarter we had that lost business that we were basically washing out through the first half of the year and then Jim's remarks were we would see little of that impact in the third and the fourth quarter going forward. So we had a little bit of an uphill climb in the first and second quarter. You have to factor in the lost business, too, which was pretty significant. Again, it was business we chose for the most part to walk away from and I think that direct reflection to some degree in our operating earnings and our operating margin is that we walked away from that. But again you have to kind of throw that lost business in there, too, which had a significant impact on us. We had an uphill battle in the first and second quarter. Not only were we fighting slower utilization in December, we said we were going to be washing through this business and we pushed through most of that through the first six months of the year. Most of it all now.

I appreciate that commentary. If I could just ask one quick follow up on gross margin.

Sure.

Jim, I think in your prepared remarks you called out a $3.4 million reduction due to a shift in mix of pricing pressure which by my calculations probably cost you 15, 16 basis points of gross margin in the quarter. Am I think being that correctly? Should I just assume that mix change in pricing pressure remains prevalent throughout the remainder of the year.

Yes, Glen. I think as we reflect on a $3.4 million variance on fundamentally a $200 million book of business being the gross margin and literally hundreds to over 1000 accounts, it becomes a little difficult to parse how that $3.4 million gets allocated. We have seen a reduction in some of the purchasing of higher end programs and services by some of these hospitals as they also, as Craig referred to, are under pricing pressures and think being how they can cut costs. And we recognize that some decisions on some of the programs and services that we could offer to help reduce supply chain costs are being deferred or delayed a little bit while hospitals consider what the pay back and the cost of that effort may be. So I think overall, yes, we are seeing a bit of a mix change. But again, to put it in context, $3.4 million on just under $200 million is a little tricky to draw a conclusion as to longer term trends.

Okay. Thank you.

Your next question comes from the line of Robert Jones of Goldman Sachs.

Good morning, everyone. This is Verdell Walker on behalf of Robert Jones here at Goldman Sachs. I had a quick question on the MediChoice product line. Can you provide an update on MediChoice and more specifically has the growth of that private label line been impacted at all by utilization trends that you've seen elsewhere in the business? Thanks.

Sure, this is Charlie Colpo. We are up to 2600 products with MediChoice today and still growing at double digits although low double digits. I would say that we are seeing an impact as our volumes have slowed this year. The growth in Medichoice has slowed somewhat too because in the first quarter we were in the mid, mid-single digit or double digit growth rates.

And just a quick follow-up if I might. Are there any thoughts from the Board on authorizing a share repurchase in the future? Or still just a plan to stick with dividends as preferred method of returning cash to share holders?

Sure. We are a dividend paying company. We been one since 1930. Our Board of Directors is committed and believes in the dividend as an approach to returning cash to the share holders. From time to time we look at capital structure and consider other vehicles of returning cash to share holders such as a share repurchase program. At this point in time no authorization has been made. No program has been initiated. But it's a technique that is reviewed from time to time and the Board may change its mind at some future time.

Okay. Thanks so much.

Your next question comes from the line of Bob Willoughby of Banc of America, Merrill Lynch.

Good morning. It sounds like you are still committed to funding the growth initiatives despite the softer revenue outlook that you are seeing. Can you give us any sense and maybe you kind of hinted at some of it, but anecdotally what's left in terms of what needs to be done for OM Logistics and move into the ambulatory site market and secondarily, what kind of costs associated with these ongoing efforts?

Robert, this is Charlie Colpo again. In terms of the 3PL. We've got a building in Louisville. We have systems up and running and we have a group of customers today that we are working through and are actively pursuing new business. And so what is lacking right now is customers. And that's something that we are really pushing very hard on. And we feel like there is a real story there for our customers and what we have to offer them. We are still very excited about it and still believe it's the right thing to do. In terms of ambulatory --

I'm sorry, Charlie, were there three buildings that you ultimately needed for the to reach break even or one facility that will take care of the whole efforts nationwide?

Bob, let me put a little color on that. We have one building today which is servicing several of our customers today out of OM Health Care Logistics. I think as the opportunity arise and the requirements of some of these suppliers could potentially move us into some other buildings. I think what we had said is long term over several years is we might have three buildings, one on the west coast and one in Louisville and one other. That really gets down to specific customer requirements and what they are looking for. What I would say is the investments in technology have been made. The investments in people have been made. We made the investments in Louisville so we had the ability and capability to take business on today. As we continue to work the lists, supplier list, the requirements might change for that, but obviously the size of the customer or the customer's needs would help fund us to help us move into other buildings.

On the ambulatory surgery center we have a full sales force ramped up in specific areas in the country. Then as I had said in my remarks, we have some designated distribution centers which are currently in our network today that are doing that business. So don't think of it as 50 operating units. Think of it as some key centers that are actually doing that business and we have signed some new business on that. And we are continuing to invest in that and ramp up.

Robert, there is one to make sure. I know your focus is on what the capital expenditure and cash flow needs of the businesses may be, there are aspects for example and this is just one for the ambulatory surgery centers where we haven't totally sorted out what the delivery network will look like and we may potentially own aspects of the delivery system that is different because as we all acknowledge the delivery to ASC is different than a delivery to an acute care hospital that we haven't made at this point the necessary investments. As these businesses evolve, we will react accordingly and look at what the level of investment may be necessary.

Wonderful. Thank you.

Operator we have time for one more question.

Your next question comes from the line of [Elliot Feldman] of Barclays Capital.

This is Elliot Feldman filling in here for Larry Marsh. Most of my questions have been answered at this point, but getting back to cash at this point. It has been a pretty good cash flow generation for first half of the year. Wondering if you can give us color on how we think about this pattern of cash flow generation for the back half of the year. And you touched on the dividend policy a little bit, but sitting on close to $160 million in cash. Can you give us any kind of current capital allocation plans for kind of the second half of the year as well as 2011?

Let me take the second half of the question first. We look at our capital needs and our cash position and on a regular basis. We have and we were pleased that we were successful in establishing a new revolver agreement, new credit facility for an amount of $350 million and in doing so we also looked at sort of the current trend of companies in how much cash they maintain on their balance sheet and what their capital needs may be. And I think at this point we are comfortable with our relative position. We do think that there are opportunities for either partnering with some of our customers or acquisition of companies in tangential ancillary areas that will be beneficial to the Company so we are looking aggressively at those kind of opportunities. As you think about the cash to be generated during the second half of the year, my only comment would be if you recall other points in time where we bring on new customers particularly those of any size, we do tend to see an experience where we increase our inventory levels in order to make sure our fill rates are at levels that have been committed to those customers and that the transition can go seamlessly as possible. So I think and if the opportunities that Charlie spoke of in the pipeline of new business come to fruition that we might see some short term interim use of capital as inventories build a little bit, but again as we seen historically we tend to drive those inventories down post transition.

Okay, thanks.

Thank you.

Ladies and gentlemen, we have reached allotted time for questions and answers. I will turn the call back over to Mr. Smith for his closing remarks.

Well, I want to thank everyone this morning for dialing in. And I want to thank you for your questions, your excellent questions. And we look forward to sharing results with you at the end of the third quarter. Thank you and we will see you soon. We will see some of you in September. Thank you.

Thank you for your participation in today's conference. This concludes the call. You may now disconnect. Good day.