Owens & Minor Inc (OMI) 2011 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Owens & Minor second-quarter 2011 earnings conference call. My name is Brooke, and I will be your operator 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 call. (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.

Thank you, Brooke, and good morning, everyone. Welcome to the Owens & Minor second-quarter 2011 conference call. We will review our results and take your questions in just 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.

But 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 Company results for the second quarter of 2011, which are included in our press release. The press release, as well as a supplemental slide presentation, can be found on our website at www.Owens-Minor.com, where we will also archive the webcast of today's call.

In the course of our discussion today, we may make forward-looking statements. These statements are subject to risk and uncertainty 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.

As for our investor calendar, we are participating in 2 investor conferences in the third quarter. These are outlined in our press release, and we look forward to seeing you on the road in the weeks to come. Thank you.

Craig?

Thanks, Trudi. And I'm going to ask Jim to brief us on our financial results. Jim?

Thank you, Craig, and good morning, everyone. Now that we've reached the midpoint of 2011, it is helpful to reflect upon our financial performance compared to our outlook for 2011, as presented at our December investor event. We anticipated increases in revenue when compared to 2010, due to our success in signing new customers. The performance to date has exceeded our outlook, due to a greater level of revenue growth from our existing customers. However, the financial benefits of this growth have been offset by increased costs to convert and service new business. Let's turn now to the detail of our results.

Second-quarter 2011 revenues improved $112 million, or 5.5%, to $2.13 billion, when compared to the prior-year quarter. The increase in revenues resulted from a combination of increased sales of products and services to existing customers of $82 million, representing a growth rate of 4.1%, and from sales to new customers of $110 million. This $192 million increase in sales was partially offset by a decrease in sales to lost customers of $89 million.

As we further analyze the quarterly revenue results, we've observed a softening trend in government purchasing activities. When comparing this quarter to last year's second quarter, we experienced a decline of $8 million in Department of Defense purchasing. And in a sequential quarter comparison, we saw a $22 million decline in sales to the DOD. Significantly, revenue growth from our existing and new customers more than offsets these decline in governmental sales. The Defense Department continues to be a valued, long-standing partner. However, we recognize that an emerging trend of reduced government spending further validates our strategic decision to partner with large, growing IDNs, giving us customers that are best positioned for future growth.

When looking at the year-to-date period, revenues increased approximately $266 million, or 6.7%, to approximately $4.3 billion, when compared to revenues for the same period in 2010. Revenue improvement trends in the first half of 2011 resulted from a combination of increased sales of products and services to existing customers of $216 million, representing a growth rate of 5.4%, as well as increased sales to new customers of $213 million. These year-to-date gains of nearly $430 million were offset by a decrease in sales to lost customers of approximately $173 million.

Gross margin dollars increased $17 million, or 8.6%, from $199 million in the prior-year quarter to more than $216 million for the second-quarter 2011. The increase in gross margin dollars resulted primarily from increased sales. As a percentage of revenues, gross margin for the second quarter was 10.14%, increased 29 basis points when compared to the same period last year. The 29 basis point improvement in gross margin resulted primarily from a 33 basis point increase in fee-for-service revenues, partially offset by 6 basis points resulting from lower margin on new distribution customer contracts.

When looking at the year-to-date results, our gross margin dollars were $427 million, increased $31 million when compared to the first half of 2010. The increase in gross margin dollars resulted primarily from increased revenues. As a percentage of revenues, gross margin for the year-to-date period improved 11 basis points to 10.03%. The improvement was driven by a 19 basis point increase in fee-for-service revenues, related to both our third-party logistics business and our supply chain consulting services. Offsetting factors included declines resulting from lower margins from new distribution customer contracts accounting for 4 basis points, a greater provision for LIFO resulting in 5 basis points, and lesser supplier incentives as a percentage of revenues for 3 basis points.

Turning now to our discussion of expenses. Second-quarter 2011 SG&A expenses increased 12%, to $156 million, when compared to the second quarter last year. As a percentage of revenue, second-quarter SG&A expense increased 42 basis points to 7.33%. The $17 million increase in SG&A resulted from the following -- $8.4 million for fee-for-service operations, including costs to convert new third-party logistics business; an increase of $4.3 million for labor costs, including incentive compensation; an additional $1.9 million for delivery expenses; and $1.3 million in consulting expenses.

For the year-to-date period, SG&A expenses increased $27 million, to $307 million, when compared to last year. As a percentage of revenues, SG&A expenses for the first 6 months of this year were 7.22%, an 18 basis point increase when compared to the prior year. The year-to-date increase in SG&A was driven by an increase of $11 million for labor costs including incentive compensation costs, $10.7 million for fee-for-service operations including costs related to the conversion of new third-party logistics business, and $3.6 million in delivery expenses.

As you may recall, our OM Healthcare Logistics team began converting and servicing the CareFusion business in April, so the expenses for this effort were included in our SG&A results for the quarter. We have said all along that this is a major, phased conversion, not unlike the conversion of a large core-business acquisition. As is our culture, we will spend what is necessary during the transition to ensure that we have a good, solid customer relationship going forward. As we work our way through the conversion, we continue to target a break-even run rate for our third-party logistics business in 2012. Although we do not intend, and are not required, to report OM Healthcare Logistics' financial results separately, for purposes of clarity during this period of transition, we note that year-to-date we have an operating loss from the third-party logistics operations of $4.5 million, which is approximately $1 million greater than the loss in the prior year.

As we've been saying for a number of periods, recent investments in our infrastructure have resulted in an increase in depreciation and amortization expense. For the second quarter, depreciation and amortization expense increased $1.1 million, while year-to-date, the increase was $3 million. These increases resulted primarily from depreciation and amortization of warehouse equipment and leasehold improvements, both for our traditional distribution centers and our 2 OM Healthcare Logistics facilities, as well as amortization of certain customer-related technologies.

Also, as we have consistently said, we intend to capitalize on certain growth opportunities through acquisitions and strategic partnerships. Consequently, we reported an increase in transaction-related costs of $1.1 million for the second quarter this year and $1.7 million year-to-date when compared to the prior year. These costs related to efforts expended in developing a model for partnering with large complex customers, and are reported as other operating expense. We are committed to being a source of solution for our customers' supply chain needs.

Turning now to a discussion of operating earning results. For the second-quarter 2011, operating earnings declined by $1.1 million to $51 million, compared to the prior-year quarter. As a percentage of revenues, operating earnings were 2.39%, declined 19 basis points from operating earnings in the same period last year. When looking at the first 6 months of the year, operating earnings increased slightly to $102 million, when compared to the same period last year. As a percentage of revenues, operating earnings were 2.4%, a decline of 14 basis points. For the year-to-date, gains in operating earnings from greater sales were offset by increases in operating expenses.

Interest expense, a component of net income but not of operating earnings, decreased to $3 million for the second quarter, and $6.7 million for the first half of 2011, when compared to last year. For the first 6 months of the year, our effective interest rate was 6.4% on average borrowings of $211 million, compared to a rate of 6.5% from the first half of 2010 on average borrowings of $210 million.

For the quarter, the effective income tax rate was 39.3%, and year-to-date the rate was 39.2%. These compare to a tax rate of 39.4% for both of the same periods last year. Overall, we continue to target the annual effective tax rate for 2011 to be in the range of 39%, consistent with our previous guidance.

Net income for the second-quarter 2011 decreased slightly to $29.1 million. For the second quarters of both 2011 and 2010, net income per diluted share was $0.46. On a year-to-date basis, net income was $57.9 million, increased slightly from the prior year. On a year-to-date basis, net income per diluted share was $0.91 for both years.

As for asset liability management for the first 6 months of the year, we used $35 million of cash in operations, compared to $183 million of cash provided in the same period last year. Cash from operations was negatively affected by increases in accounts and notes receivable, higher inventories, and decreases in accounts payable. I would note that there was an increase of $74 million in drafts payable reported in financing activities, which should be considered when thinking about our operating cash flows. Therefore, if we were to adjust operating cash flow for drafts payable, operating cash flow would be positive for the year-to-date period, at about $40 million.

Inventory turns in the second quarter were 10.4, compared to turns of 10.6 a year ago. DSO was 20.6 days as of the end of the second quarter, compared to 19.8 days as of the end of the second quarter last year.

Cash used for capital expenditures in the first 6 months of this year was approximately $14 million, compared to $20 million for the same period last year. So far this year, we used cash for investments and warehouse equipment for our traditional distribution centers and OM Healthcare Logistics facilities, as well as investments in certain customer-facing technologies.

For the year-to-date, we have returned more than $30 million to shareholders, $5 million in relation to our stock repurchase plan, and $25.5 million in dividends.

Now that we've reached the midpoint of the year and have the benefit of 6 months of data, we are refining our guidance for 2011. Based on our performance in the first 6 months of 2011, we are increasing our targeted revenue growth for 2011 to a range of 4% to 6% when compared to 2010. We believe that net income per diluted share for the full year will be near the lower end of the original range provided of $1.95 to $2.10.

Now I'll turn it over to Craig for his remarks.

Thank you, Jim. I'm going to take a few minutes more than I normally do to talk about our business, our investments, and our market, so please bear with me.

You know, with 6 months behind us, we are pleased with revenue growth, especially compared to the sluggish growth we observed across healthcare last year. We believe that our customers are moving forward despite lingering softness in the economy. They are acquiring smaller facilities, extending their service reach, and actively serving the healthcare needs of their communities.

Now, while we are often asked to make a call about healthcare utilization, we can only point to our results, which demonstrate that revenue with our mix of customers has been solid so far this year. We continue to build our relationships with the nations largest IDNs. These hospital systems rank among the best in the US. Out of the 17 hospitals on the Best Hospitals Honor Roll just published by US News and World Report, 11 of them are Owens & Minor customers. These large IDNs are optimal customers for us, as they are willing and eager to take advantage of our supply chain management expertise.

As for our earnings results, we believe the investments we have made this year support our strategic direction in the long run. As Jim explained, you see evidence of these investments in our financials in 3 distinct areas, which distinguish this year from last. Now first, OM Healthcare Logistics, our third-party logistics business, initiated the conversion of the CareFusion business. Second, this year we have been actively investing in acquisition-related activities, consistent with our strategy, and our intention to be the partner of choice for large IDNs. And third, we completed the conversion of a major IDN customer earlier in the year, and we are now serving this multi-state system from 17 distribution centers. So at this point, I'd like to take probably a little deeper look into those 3 areas I just talked about.

Turning first to the third-party logistics business. As we have said, the scope of the CareFusion conversion is roughly equivalent to the conversion of a large core-business acquisition. Large-scale conversions like these take time, they take effort and investment to ensure success. Those of you who know us well, understand that we will invest to ensure a successful conversion and a healthy customer relationship down the road.

The OM HCL team launched conversion of CareFusion in April, right on schedule, and transitioned the first wave of their products. These included V. Mueller interventional specialties and respiratory products. As with any large-scale conversion, it took time for the work flow to settle into what I would call a normalized process. And at this point, the day-to-day activities are approaching a steady state, and both teams from both companies are focused on optimizing processes.

Turning now to acquisition-related activities. This year, we engaged consulting teams to help us investigate and position certain types of customer joint ventures. We believe these projects will enable us to offer an expanded range of options to large multi-state IDNs or regional customers in the future. Also, we are actively looking at potential acquisitions and a variety of joint venture opportunities. Identifying the right opportunities can take time and investment in the near term. But we believe acquisitions, along with select joint ventures with suppliers and providers, are a viable approach to expanding our market opportunities, our margins, and our presence in healthcare.

In fact, I'm pleased to report that we have just signed an agreement with Amsino Medical Group, a privately held healthcare products manufacturer. Under the agreement, we will establish a joint venture designed to provide sourcing services for our private label offering. As majority partner, Owens & Minor will provide initial start-up capital to establish the new entity, which will be based in Shanghai, China. The joint venture will handle manufacturer identification and qualification, regulatory compliance, quality assurance, logistics and shipping management. We believe that this expansion of our sourcing capabilities will improve service, quality, and value to our private label customers. Amsino is already a MediChoice supplier, and has provided medical products into the US and global markets since 1993, and has facilities in China.

In the third area of investment, we completed the conversion of a major IDN customer early in the year. At this point, we have fully integrated the customer, and we are serving its facilities in various states from multiple distribution centers. As with any large conversion, this project required investment in inventory, teammate hours, and new warehousing space prior to the conversion to ensure a smooth transition. With these large IDNs, we see opportunities for joint ventures and partnerships, as well as avenues for the outsourcing and consulting services we provide to the market.

I'm also pleased to report that we are now in the process of finalizing a new agreement with a significant new IDN with facilities in 3 states. The conversion is tentatively scheduled for late in the fourth quarter of this year, and demonstrates that these large complex IDNs believe in the value that we bring to the relationship. Our offering is the right solution at the right time at the right place for healthcare today.

Now just let me take a minute for a few housekeeping items. We frequently get questions about GPO contract renewals. I'm pleased to report that all of our pending GPO contract renewal dates have been extended, and are now scheduled for 2012, 2013, and 2015. The Premier and Novation renewals were extended for 1 year and are now set for late in 2012. The Broadlane, MedAssets and HPG contracts are set to renew in 2013, and Marinette will renew in 2015. With these deadlines all pushed into next year and beyond, we hope this puts to rest any near-term questions about renewals. You should consider these contracts to be business as usual until the renewals.

Also before we end today, I'm pleased to report that during the quarter we were named to the 2011 CIO 100 by CIO Magazine. This award recognizes businesses that exemplify the highest level of operational and strategic excellence in information technology. This award is quite an honor for us. With information technology, our goal has always been to empower our teammates, enhance service to customers, and improve the cost and complexity of the healthcare supply chain. I want to congratulate our teammates around the nation for achieving the important recognition.

In looking at the rest of the year, we remain focused on continuing to work through the CareFusion conversion, enhancing our sourcing capabilities, growing our business at a steady and reasonable rate, and as always, managing our expenses, even as we invest in our business for the future. As always, I want to thank our teammates for their efforts in the second quarter. We had a lot of activity and a lot of hard work, and our teammates remain very focused. They continue to develop our offering in the market, serve our customers with distinction, and focus on the future.

Thank you for your patience. And operator, we would be happy to take questions from our listeners.

(Operator Instructions)

Larry Marsh with Barclays Capital.

Good morning, Craig, Jim and the rest of the team.

Craig, at your analyst meeting back in December, you put out that big up 3% to 5% revenue goal, and I was a little skeptical. So you've proven me wrong. So congratulations on the new business.

Thank you.

Let me ask you two things, really. First of all, it seems to me the shortfall, as you talk about low end of guidance is really, as you say, on the investment side of your GP was in line with what I thought, and even the 3PL investment was pretty consistent with what I had thought. And your distribution costs seem to be in line, if not coming down, with Jennifer and some other things. As you talk about the, I guess, $8.4 million of incremental investment, how much of that is really 3PL, as you think about it, and how much of that is just these implementation costs, both for the big IDN and new initiatives? And let me follow-up from that.

Yes, Larry. Let me break down once again, and for those that maybe didn't hear it the first time, of the increase in cost that we saw on a quarterly basis compared to the prior year was about $17 million. $8.4 million of that related to fee-for-service operations, which would include the OM Healthcare Logistics and the conversion activities associated with CareFusion, as well as our consulting business which is the OM Solutions business.

I think it is difficult to take that component and parse in greater detail how much was directly conversion-related versus normalization. I think, as we've said consistently, we spent what was necessary to complete the conversion. And I think, as Craig and I have both said in numerous situations over the last several quarters, that we will have more data points going forward over the course of the year, as we truly hone the operational side of this business to achieve optimal efficiency.

The other piece of the $17 million increase was $4.3 million for labor cost, which does have a component that includes incentive compensation. I would think a component of that increase definitely related to the conversion of new business over the course of the quarter, and particularly when you think about the impact of the very large IDN we brought in towards the beginning of the year, end of last year.

I think right now that's the best we have in terms of visibility on those components. And in both cases we would expect to see some element of improvement towards the back half of 2011, as we move to a more optimal efficiency model.

Great.

And just to elaborate from that, Jim. If you think about that in terms of overall SG&A and put in context of last year, when your SG&A was down 4% or 5%, is any of that component, you as you think about it, kind of a catch-up from really ratcheting down SG&A last year or is this just all incremental to new initiatives?

And then I guess around 3PL, do you have an updated view? I know you talk about break even for 2012, but beyond that is there other variables associated with that P&L impact that could swing that in one direction or the other, such as the implementation of a new facility on the East Coast, or do you feel pretty comfortable that your expenses on 3PL are now kind of in line with what you would hope?

Let me take the first part, which is are there unusual items that were deferred last year that are being incurred this year. I would say generally, no. I would say generally what you are seeing is increased investment or cost associated with initiatives related to 2011. The one caveat I would offer is in the area of incentive compensation, where amounts are being accrued at current amounts that were greater than the corresponding amount in the prior year.

As you think about the OM Healthcare Logistics, I think we in the near term would be looking to normalize and improve upon the operating results, at least through the remainder of 2011. I think all of us would stop short of saying that there may not be the necessary investment as new customers come on and opportunities present themselves. But I think again in the near term, we understand the opportunity that we have afforded through the CareFusion relationship and the need to optimize our performance in the facilities that we have today.

Okay.

And then just the other question for Craig is really on the customer side. You mentioned, I guess this morning, a new relationship starting in the fourth quarter and some of the opportunities there. As you sort of think about it, it seems like your strategy is to partner and be deeper with kind of the winners in the IDN world and those who are taking share. Can you elaborate a little bit about the nature of this new relationship and perhaps how it came about? And is this a competitive win from another supply chain company? Any other details would be great.

You know, I think we've taken a pretty objective view of announcing wins and losses, but I will probably color this a little bit, Larry, since you asked. And this is something we've been working on for a period of time. It's an account that we have wanted for a period of time. I truly believe that this will be one of the winners as we come through this, come out the other end. And so I think for us, fortunately, it was what we would consider a big win for us.

I think what really was, again, what kind of pushed us over the goal line there was a combination of, I think, operational excellence, obviously in today's environment you have to be cost effective on price, but I do think that OM Solutions played a pretty big role in this. And I think this customer saw a huge opportunity for them in several areas around logistics, around some technology tools and probably some standardization in several other areas.

So I think where we've really been really focused, Larry, the last 2 or 3 years on these big players, obviously you have to be in the ballpark on price, but you really have to be able to reach out to these large systems and offer multiple opportunities on cost efficiency. So I was very pleased with this and I think they are going to be a great customer going forward for us.

Okay. All right, very good. I will stop there. Thanks.

Thank you, Larry.

Thanks, Larry.

Lisa Gill with JPMorgan.

Last quarter, Craig, you had attributed some of the revenue growth for -- based on the customer size. You were saying that larger customers taking market share from smaller customers. Number one, can you talk about are you still seeing that trend?

And then secondly, just help us understand a little bit about the makeup within your customer base. We've seen surgical volumes continue to be weak. If those volumes were to come back, do you anticipate that revenue growth could be even better? Or is it just that the supplies that you are selling today, surgical volumes aren't exactly tied to them and you're just gaining market share because of the large versus the small? Help us to maybe understand that a little bit better.

Thank you, Lisa.

I think consistently what we have been saying, and I think that begin to play out about a year ago that we validated with really doing a deep dive on our customers, is that the growth is in the larger systems and the negative growth is in the smaller systems. And we continue to see that happen today. And I think that then you get a direct result of either alignment or management or somehow tying into these bigger systems as they continue to grow.

I think the other thing is, Lisa, the bigger systems have the ability to invest and expand, not necessarily in buying more hospitals, but in clinics, surgery centers, physician practices, a lot of the things that will probably, over a longer period of time, make them more influential in the markets that they serve.

So one, we do continue to see the larger systems growing. Really our product mix has not switched, but I think who's getting more of the surgery percentage of the procedures are the larger systems. So I don't think it is a dramatic increase growth in these large surgery centers. It is more around really more of a standardization and centralization, more penetration. They want more on our trucks. They want to continue to aggregate and really drive cost efficiencies. I believe, personally, they are utilizing their technology better than they ever have before. And I think you are going to continue to see that these large systems, I think we've all seen, all you have to do really is look at the newspapers or these trade journals every month, is that they continue to get bigger.

And I think, you know, the nice thing for us is they are becoming more efficient in terms of process improvement, utilization and technology. They are asking for resources from OM Solutions. And so, I would just tell you, we did a focus group last quarter. I'm going off here a little bit. But we had a large customer who had a multi-billion dollar budget, and he basically said you know, with where Medicare is and where I've got to get to get to Medicare, I'm going to probably have to take 10% to 15% out of my total budget, and I can't do it on price. And we are hearing that more and more.

So, fortunately the last 2 or 3 years where we had been focused, we feel that it is paying off for us here in the short term and for the long term, also.

And I guess two quick follow-ups to that.

One, I think historically, Craig, you have given us growth of small versus large, and you talked about the negative number for those small hospital. Is that still true that the small hospitals are trending on the negative line?

And then secondly, can you talk about what you are seeing as far as acquisition trends within the IDNs. Are you seeing them to continue to ramp-up buying physician practices? And when they do buy the physician practices, are you now serving those physician practices as well?

I will answer the second question, part of the question, and I will let Jim answer the first part of the question.

I think what you're seeing is yes, there is still acquisition. But I'm also starting to see, Lisa, affiliation or management. So that growth is still happening in the smaller hospitals, but I'm hearing more and more where they are allowing other smaller systems to come in and utilize either contracts or services from the bigger systems. So it is a combination of both.

Physician market is still up high on our radar. I think the question is, Lisa, as they continue to buy these practices, I think the first, really, goal and objective of these systems is to get the physician incorporated into their system, get them comfortable with how they operate, and then start to work with them on supply chain and computers and printers and everything else. But I think the first -- what we've started to learn is that, that first foray is to really get them in and get them acclimated in the system. Then the second opportunity is really around helping them drive cost out of their system.

And so we continue to have conversations on the physician side, and it is with the larger systems that we continue to have those conversations with. We've seen a little bit of a lag, probably with -- not on the acquisition piece, the acquisitions are still going on. A large number of physicians coming out of school are being employed by the hospitals. But there is a little lag period after the acquisition. It is almost like a honeymoon, I guess. What we are finding is, it's probably not in the first 6 months to a year, but maybe in the year to 18 months that they start to help take cost out of that practice.

And Lisa, just a brief comment on the phenomenon that we observed and reported in the first quarter, where we had our largest customers significantly outperforming the smaller customers, and in fact, the smallest customers were having negative growth. We only do that analysis periodically. It is relatively in-depth and takes a fair degree of effort to do. However, that being said, as we looked at sort of a trending and the indicators, there is absolutely nothing to indicate to us that, that phenomenon that we saw and commented on the first quarter isn't continuing on today.

Okay, great. I appreciate the comments.

Thank you, Lisa.

Glen Santangelo with Credit Suisse.

Yes, Craig, just two quick questions.

It sounds like you were able to extend Novation and Premier out a year in each individual case. Can you kind of describe how that conversation went? You sort of said that it's basically business as usual. Did they just let you extend the existing terms for year and ask for nothing in return?

(Laughter) Good question, Glen.

(Laughter) Glen, this is Charlie Colpo. I would say that there were some discussions and there were some negotiations. And that is about as far as I will go.

Okay. So basically, there's going to have to be some more significant discussions this time next year, it sounds like.

We've extended the agreement for a year. So in 2012, we will have some more negotiation.

Maybe if I could just ask one follow-up question on the expenses then. Jim, in the beginning of year, you sort of suggested that SG&A would be in that 7% to 7.25% range. Clearly, you're above that this quarter. And we, obviously, spent a lot of time talking about the elevated expense level. Should we assume that those elevated expenses are going to continue in the back half, which is what's driving you to the bottom of the EPS range, somewhat making that 7% to 7.25% a little bit outdated from a guidance perspective?

As we said last year when we talked at investor day, we give guidance in really 2 metrics. One is revenue and the other is earnings per share, and we do that on an annual basis. However, for purposes of trying to help facilitate the creation of various investor and analyst models, we do share at investor day what our outlook is on a couple of the major components of our income statement.

SG&A on an average for the year is within the range that we had put forth as a target at investor day. Again, as we've talked about, we are positioned to drive greater efficiencies through the cost structure that we have towards the back half of the year. So at this point in time, I think our thinking around both the gross margin and SG&A are embodied in our guidance in earnings per share.

Okay. That's fair enough. Thank you so much.

Thank you, Glen.

Robert Jones with Goldman Sachs.

Hello. This is Verdell Walker standing in for Robert Jones. I just want to ask a couple quick questions on the Amsino private label.

Can you talk about the timing around this arrangement and maybe what categories you are targeting, new categories from the current MediChoice line? And also, just like looking ahead, is this kind of the modus operandi going forward for private label?

Sure. We are very excited about the newly announced relationship with Amsino and having operations now in Shanghai, China. We think that the benefit of this directly relates to what we had been asked from our customers, our provider customers, to offer a broader suite of products, to offer them at a price competitive point without sacrificing quality whatsoever. And the founder of Amsino, Dr. Richard Lee, is well respected in both China and here in the United States and, we think, an outstanding partner.

It is premature to, at this point, to begin to identify the categories of expansion. We will be doing so more as we think about 2012, towards the end of this year. But we are positioned in this joint venture such that we would expect it to have an accretive benefit to our earnings as we move into 2012 and beyond. It is a significant opportunity for us and as I said, we are excited about it.

Great. And just following up, can you possibly quantify any of the associated costs with the Shanghai operation for the JV?

Sure. I think from the -- probably the most important perspective or question would relate to what are the capital needs. And although we are not prepared at this point to disclose the actual capital dollars, I think it is important to keep in mind, this is a service-based business that we are creating, this joint venture. And as a service-based business, its capital needs are relatively small. We won't own any manufacturing in China or anywhere else.

So we would expect, again, the joint venture's ability to generate incremental profits to be more -- to exceed the amount of operating costs, certainly over any reasonable length of time.

Great. Thank you very much.

Robert Willoughby with BoA.

Jim, on the Amsino, is there a new income statement line item that will reflect your ownership interest in that JV, or will it just be consolidated somewhere and we won't see that?

Well, we're a majority owner of the joint venture so its results will be consolidated. There may be a minority component, depending on materiality, that would be disclosed and would be visible. That will depend on sort of as the size of the joint venture grows relative to the size of the overall company.

Okay. And just refresh us, is there a cash flow target for this year?

Overall, for the consolidated company?

The whole enchilada.

Yes, the whole enchilada.

I think the way to think about this year, Robert, is that, as we've talked about historically, a normalized level of cash from operations would be in the range of $100 million to $150 million, thereabouts. That's easily what we've either done or exceeded in the last handful of years. This year may have some challenges as we look towards the back half of the year, in part because of the size and complexity of the client relationship that Craig referred to and the fact that, as you well know, when we start contemplating and setting up for a conversion of a large IDN customer, we do tend to build inventory.

That being said, I think longer term we do have an opportunity to continue to generate additional cash flow from reducing our current level of inventories and improving our inventory turns. And I think as things normalize into 2012, that is the opportunity that you'd see us execute on.

And remind me, Jim, for the 3PL initiatives that you've launched here, you do not take title -- there's no great inventory requirement on that side that you are holding CareFusion inventories, is it? Sill on CareFusion's books?

Absolutely, Rob. You are absolutely correct. The nature of the relationship for the third-party logistics business is we do not take title and we have a fee-for-service relationship. Correct.

Great. Thank you.

Thank you, Robert.

Steven Valiquette with UBS.

Just trying to get clarity here on a couple of numbers. I think if I heard you right, I was kind of surprised at the incremental year over year loss in 3PL year-to-date was only $1 million. I think you said it was $4.5 million loss year-to-date this year and that was $1 million greater loss than the year-to-date in 2010. So I guess first, is that correct?

And then, is there any clarity on whether that loss might have been greater in 2Q than it was in 1Q, just given how the numbers shook out? The fact that you guys grew EBITDA 7% year over year in the first quarter and it was kind of flattish in the second quarter, I would have figured the loss would have been greater year over year in 3PL. So just try to get more color on that. Thanks.

Yes, you heard the numbers correctly. We lost, year-to-date, $4.5 million in the OM Healthcare Logistics business and that is $1 million greater than the loss in the prior year. I don't have, and I don't think we intend to provide, that data on a more granular level. But it does, I think, indicate the level of additional effort that was extended during this period of conversion.

So I guess without giving the numbers, can you just say it might be more qualitatively with that loss maybe a little bit greater in Q2 than it was in 1Q, just to get the sense for direction on that?

Sure. During the conversion process? Yes. Absolutely.

Okay. That's helpful just to kind of reconcile the numbers.

Okay. Thanks.

David Larsen with Leerink.

Can you guys talk about the role of commodities in the quarter, commodity prices. Sorry if I missed that, I signed on a little bit late, in the cost of goods and also SG&A, please?

Yes, David. I'd be happy to.

In contrast to the first quarter, where commodity prices increases had a significant impact on our LIFO provision, we did not see a similar kind of event in the second quarter. And that isn't unusual. We tend to see those changes tend to occur in the first and fourth quarter. So that phenomenon was a bit more normalized.

In the area, the other area where we would see commodity prices impact us in our income statement, as you might expect, would be in the delivery area, fuel costs and then third-party freight costs. And in that area, we did see year-to-date, we're $3.6 million above where we were for a comparable period in 2010. And in the second quarter, it was $1.9 million component of that.

Okay, great.

And then, has your outlook for the year changed at all with respect to commodity prices? I mean, commodity prices, I think, are improving a little bit, or is it pretty much as expected?

I think we've made a point of saying that we do not predict the movement of commodity prices. At best, what we do is to try to articulate what our modeling is predicated on, in terms of an assumption. And so as we look for the remainder of the year, I would say our EPS guidance does take into consideration what we feel the back half of the year may look like. Sure.

Okay, great.

And that just last question, is there any more color you can give on the Department of Defense contract or the change there? I think one of your competitors recently announced a pretty big win there. Did that have any impact on you guys?

The numbers that we shared on the Department of Defense, I think, have no -- were not impacted by the new contract award at all, as far as we know, but I do think reflect and represent the changing trend for the government spending. And the interesting point, we felt, was the fact that we were able to more than offset a $22 million sequential decrease in those revenues, with increased penetration and expansion of our services to our existing customer base. And we thought that was notable.

Great. Thank you very much.

Operator, we have time for one more question, if there are any.

At this time, there are no questions.

I will now turn the call back over to Mr. Smith for closing remarks.

As we've said, it was a very busy second quarter. We made a lot of great investments, long-term, for the Company. We look forward to getting back out on the road and updating you on those investments, and continue to move long-term for the Company's direction.

Thank you, and we will talk with you all soon. Thank you very much.

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