Owens & Minor Inc (OMI) 2011 Q3 法說會逐字稿

Good morning ladies and gentlemen, and welcome to Owens & Minor's third-quarter 2011 earnings conference call. My name is Christy, and I will be your operator. At this time all participants are in 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 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, Christy, and good morning everyone and welcome to the Owens & Minor third quarter conference call. We will 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; Grace den Hartog, our General Counsel; and Drew Edwards, Controller and Chief Accounting Officer. Before we begin, I am going to ask Trudi Allcott from Investor Relation Team to read a Safe Harbor statement. Trudi --

Thank you, Craig. Our comments today will be focused on Company results for the third quarter 2011, which are included in our press release. The press release, as well as the 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 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 fourth quarter, and we are hosting our annual investor day on December 7. These events are outlined in our press release, and we look forward to seeing you on the road in the weeks to come. Thank you. Craig --

Thank you, Trudi. We decided this morning we are going to do things a little bit differently. I'm going to kick things off this morning, and what I want to do is I want to give you perhaps a little bit more insight and look at our markets, our customers and the status of some initiatives that many of your are familiar with. And then I am going to turn it over to Jim to give you the results for the third quarter. The quarter's revenue results were solid. I would say even with the challenging market conditions across healthcare. As Jim will explain, our revenue this quarter came primarily from existing customers. Now, fortunately, our customers, especially the large IDNs, are continuing to grow by taking market share, acquiring smaller competitors and adding non-acute care services and physician relationships. As for the hospital environment -- as all of you know I travel quite a bit. I had a very heavy travel schedule this quarter, and I met with several customers. And, while these executives aren't pointing to any dramatic changes into the market this year, they continue to focus on driving down their internal costs to meet expected and lower reimbursement levels.

Now, as the larger systems take market share, they do increase in complexity. They are really looking for partners who can drive some kind of meaningful change in the supply-chain. And we approach this market with a combination of what I would call operational excellence and advanced supply chain management solutions. And we happen to think we are well-positioned to help these larger IDNs improve performance and improve cost. Now, as we said last quarter, we are actively preparing for the conversion of a major new customer group in the fourth quarter. This is a group of large IDNs we will serve from 13 distribution centers spanning 9 states. And, while we already fortunately already had business with certain IDNs within this group, more than half are new customer relationships. The size and geographical reach of this group means this conversion will be nearly as complex as the integration of a large acquisition. Consequently, during the fourth quarter, we will invest in a necessary amount of inventory safety stock as we typically do in integrations, and we will be incurring some additional warehousing expense to accommodate this group.

As our teams manage these rolling conversions, we will also incur expenses for travel and teammate over-time, and, as a reminder, the revenue benefit will be mainly seen in 2012. And I have to tell you, traveling as much as I have this last quarter, I started to think back historically where we were 5 years ago. And five years ago typically a $40 million customer would have been a very big conversion for us. Today, however, that is not the case. We do small-scale conversions routinely without much disruption to our operations, but converting multiple IDNs of this size all at once is a big event, and we are committed to investing in a smooth conversion to ensure strong customer relationships for the long haul. We are very pleased to welcome this customer group on board. As a partner, we are closely matched with their strategic goals as we build our businesses together.

Now, turning to another important initiative, we are well underway with OM Healthcare Logistics, our third-party logistics business. We decided it was time, and the time was right to bring on additional strategic leadership to help take this effort and the team to the next level. Just last week we brought on a new leader, Brian Shotto, as Corporate Senior Vice President for Specialty Services. This is an officer level position, and that gives you an idea of the importance we place on OM Healthcare Logistics now and in the future. Brian comes to us with more than 20 years experience in healthcare third-party logistics. He has worked both for UPS and FedEx and does have experience in the Americas and European Union. Brian has brought a very deep expertise in distribution strategy, strategic accounts, business development and operations. Turning to another important project, I am pleased to report our joint venture for sourcing in China is proceeding according to plan. We have named our joint venture Mira MEDSource and we are working steadily with our partner, Amsino Medical Group to launch operations. We have an experienced sourcing leader in place, and she has assembled a team with expertise in quality assurance, sourcing, logistics and finance. The offices in Shanghai opened last week, and we expect to be operational in short order.

Looking at our business from a broader perspective, I want to bring you up to speed on certain changes we are seeing in our market and our customer mix. And this is something I have been talking about over the last 2 to 3 years, but it's coming to fruition very quickly. We have signed approximately $4 billion of business with both new and existing large-scale,IDN customers. We targeted these IDNs based on the growth potential and market share gains that we seek in our partners. Because these are large-scale and what I would call high revenue customers, the volume generated generally represents a lower gross margin profile. However, I would say that these large IDNs are also more likely to use our value added services such as OMSolutions Consulting, SurgiTrack, PANDAC, Low-Unit-Of-Measure and Private Label. In light of these IDN characteristics, our home office in field management leaders are evaluating our existing organization and developing plans to streamline and improve operational efficiency for the bottom line to support our customers. As their strategic needs and their geographic profiles change. Our success in improving operating margin depends in part on the efficiencies we expect to realize from the changes we are making.

Therefore, as an initial part of our realignment efforts, we will recognize exit costs in the fourth quarter associated with closing two facilities, and Jim will provide more detail in his remarks. As we work on this realignment and our strategic initiatives, we will continue to serve our healthcare customers with award-winning customer service and operational excellence. We believe we offer healthcare customers the best distribution and supply chain management services in the market. We are positioning our company with strategically focused IDNs that are serving growing markets. We are also expanding the role we play with suppliers, and we are rapidly developing sourcing capabilities. Now, in light of all this, I want to thank our teammates who come to work every day prepared to do their very best for our customers and our company. Finally, our annual investor day is set for December 7 in New York. Our investor relations team will provide additional details in the near term. Thank you, and I would like to call on Jim for his review of our results. Jim --

Thank you, Craig, and good morning everyone. Now that we have 9 months of financial and operational data, we see that trends have been fairly consistent this year. Even in challenging market conditions, we demonstrated exceptional quarterly revenue growth relative to our sector. We are pleased that we continue to attract additional large healthcare systems to our mix of customers. We believe these customers value our distribution capabilities and our supply chain service offerings. However, as these larger IDNs have come to represent a greater portion of our customer mix, we recognize that corresponding changes to our network and our service model are in order. During the quarter we also saw improvement in expense management and, therefore, earnings. At the same time we continue to advance important strategic initiatives such as the OM Healthcare Logistics business and our new sourcing joint venture in China. Turning now to our discussion of the third quarter and year-to-date financial results.

For the third quarter 2011 we achieved record quarterly revenues of $2.18 billion, improved 5.5% when compared to the prior-year third quarter. The $113 million increase in revenues resulted from a combination of increased sales of products and services to existing customers of $89 million and sales to net new customers of $14 million as well as an increase in our fee-for-service business of approximately $10 million. When comparing the first 9 months of 2011 to the comparable period last year, revenues increased 6.3% to $6.43 billion. For the first 9 months revenue growth resulted from a $305 million increase in sales to existing customers, a $53 million increase in sales to net new customers and a $20 million increase in fees from our fee-for-service business. Based on our performance in the first 9 months, we believe revenue growth for 2011 will be in excess of 6%, when compared to last year. For the third quarter of 2011, gross margin dollars increased 6.2% to $217 million. As a percentage of revenues, gross margin increased 7 basis points to 9.95% of revenues when compared to the prior year period.

Quarterly, gross margin benefited from an increase in fee-for-service revenues of 46 basis points, primarily from OMHealthcare Logistics and OMSolutions services. These gains were partially offset by lower margins on new customer contracts, representing 18 basis points and supplier incentives that were 9 basis points lower than when compared to last year. As for the year-to-date period, gross margin dollars increased 7% to $644 million when compared to the same time last year. Gross margin, as a percentage of revenues, increased 9 basis points to 10%. The year-to-date gross margin percentage includes a benefit of 29 basis points from greater revenues from fee-for-service business. These gains were partially offset by lower margin on new customer contracts accounting for 8 basis points, a decrease in supplier incentives of 5 basis points and a greater LIFO provision representing 4 basis points. Turning now to expenses -- third quarter 2011 SG&A expenses increased 8.3% to $153 million when compared to the third quarter 2010. As a percentage of revenues, third quarter SG&A expense increased 18 basis points to 7.02% of revenue. SG&A increased by $8.4 million for expenses associated with our fee-for-service business. Also, SG&A rose by $2.1 million for increased labor costs and $1.3 million for delivery expenses relating to revenue growth in our traditional distribution business.

As for the first 9 months of the year, SG&A expenses increased 9.1% to $460 million in comparison to the same period last year. The increase in SG&A for the period included $19.1 million for fee-for-service operations, including costs associated with the conversion of a major customer; $12.9 million in labor costs and $4.9 million for delivery expenses to serve business growth in excess of $350 million in our distribution business. But we believe the real story this quarter is the sequential improvement in SG&A. On a dollar basis, SG&A decreased sequentially by $3.5 million while, as a percentage of revenues, SG&A decreased from 7.33% in the second quarter to 7.02% of revenues this quarter. We were very pleased with the improvement in expenses this quarter which occurred even as we continued investing in important building blocks for our future. As we said last quarter, we intend to explore growth opportunities from time to time in the form of acquisitions or strategic partnerships. Expenses associated with these activities are reported in the other operating income line item of our income statement. In the third quarter we reported expenses of less than $1 million related to establishing our new joint venture in China. Also during the quarter, we received proceeds relating to a settlement of a class-action suit of $2.2 million. Therefore, other operating income for the third quarter of 2011 was $3.1 million, increased when compared to the same time last year.

Operating earnings for the third quarter 2011 increased by $3.2 million to $58.5 million when compared to last year's third quarter. As a percentage of revenues, operating earnings were 2.69%, essentially unchanged when compared to the year before. Year-to-date operating earnings increased 2.5% to $161 million when compared to the same period of 2010. As a percentage of revenues, operating earnings for the first 9 months of the year were 2.5% compared to 2.59% last year. For the quarter the effective interest rate declined to 6.4% on average borrowings of $212 million. The effective income tax rate for the quarter was 39.4%, while for the year-to-date period, the tax rate was 39.3%, consistent with our previous outlook. Net income for the third quarter 2011 increased by $1.9 million to $33.4 million or $0.53 per diluted share, compared to net income of $0.50 per diluted share in the prior-year third quarter. For the first 9 months of the year, net income increased by $2.5 million from the prior year to $91.3 million. On a per diluted share basis, net income increased to $1.44 for the first 9 months of 2011, from $1.40 for the same period last year. As for asset liability management, for the first 9 months of the year, we reported cash flow from continuing operations of $30 million.

I would point out there was an increase of $78 million in drafts payable reported in financing activities, which is a factor you should consider when thinking about our operating cash flows. If we were to adjust it for the current year-to-date period, operating cash flow would be approximately $108 million. Inventory turns in the third quarter were 10.3, compared turns of 10.2, 1 year ago. DSO was 20.6 as of the end of the third quarter improved when compared to 21.3 days at the same time last year. As for capital expenditures in the first 9 months of this year, we used cash of approximately $25 million. Expenditures this year have included investments and strategic and operational initiatives including warehouse equipment for our facilities, certain customer facing technologies and leasehold and operational software improvements. So far this year we have returned more than $54 million to our shareholders, including $16 million for our stock repurchase program and $38 million in dividends.

With that review of our results, let's look at the remainder of the year. I would like to set the stage for the fourth quarter of this year and for our investor day, where we will provide further insight into how we intend to position Owens and Minor for the future. As you will recall our earnings guidance for 2011 targeted earnings per diluted share in a range of $1.95 to $2.10. Through the first 9 months of this year we reported earnings per share of $1.44 which implies we would need to achieve earnings per share of $0.51 in the fourth quarter to accomplish the bottom end of the guidance range. We believe that would be achievable excluding the fourth quarter exit costs that Craig mentioned. These costs are approximately $12 million for actions taken to date. We also believe the trends Craig referenced will require a bolder course of action by everyone in our company as we finish out 2011 and enter 2012. All of us, especially the leadership team, are intently focused on that task. We intend to further elaborate on these developing trends and our plans for the future at our December investor day. Thank you and we would be happy to take your questions. Christie --

(Operator Instructions)

Lisa Gill, JPMorgan.

Thanks very much for all the details. Craig, could you maybe just talk a little bit about the environment. You're talking about bringing on some very large IDN customers, so, number 1 can you give us some idea of how big that revenue is going to be in 2012? And I know it's early -- I know you will give guidance in December, but should we be thinking about '12 as being the re-basing year, or are you going to get that all out here in the fourth quarter, and we've re-based going into 2012?

That's a great question, Lisa. It probably will be somewhat difficult for me to answer. Let me go to the environment, and maybe that will give you a little bit better idea why we are working on this. It really became very apparent to me, probably in late fourth quarter of last year as we brought on other large IDN, that systems and are continuing to become bigger, reaching out geographically into multiple states, bringing in systems that perhaps are not like-minded, so there is a lot of work when these systems come together on technology, on labor and resources, on standardization and centralization. What I believe I am seeing, and I don't like to be the first trend setter, but it's becoming very apparent that these systems are moving very quickly to centralized materials management so decision-making is becoming into one central location. Standardization is starting to take place a lot faster. I think that is somewhat accomplished by everybody getting on one materials system. So, as you look historically at Owens & Minor, who is 129 years old, we have been probably more in tune to a local market of medium to smaller size hospitals.

Our job over the next few months -- several months, as the leadership team, is to maintain our customer-centric focus, but start to deal with these systems centrally in the requirements that they are asking centrally for all of their hospitals, their 5, their 20, their 50, their 100 hospitals in how to respond. So that means some work with our sales force. That means the way that we call on these customers on a larger basis will start to change. Fortunately, we have been in the process of doing this. So, I think the first step was the closure of these 2 facilities. The other challenge or opportunity that we face is, we are seeing bigger swings of business. Geographically, we might have to reposition a facility or, unfortunately, close a facility because business has moved from one geography to another. Now, the good part is we don't own our buildings. We don't own our trucks. So we have some flexibility in our systems to be able to move very quickly.

I wouldn't say we are done. Investor Day is 5 weeks away. I think we are going to have a much better picture for everybody around the initiatives we are investing in, which we think are going to support these bigger and larger IDNs. And then, how the Company has looked at each other over the last 5 -- well, it's actually over the last several months, and we would like to roll that out and have time, versus doing this on a conference call of 30 minutes-- have a full 3 or 4 hours where we can go really into depth about the environment, about the change of the customer and their requirements and how the Company is responding to it.

Okay. I guess just as a point of clarification -- as we do think about the fourth-quarter numbers, you talked about -- Jim talked about the $12 million of incremental costs. Are you now thinking that the fourth quarter we should be thinking about in a $0.30-something range -- $0.30 range, $0.32 to $0.35 if we were to take that versus your former guidance range? Is that the right way to think about?

Fundamentally, Lisa, yes. I think one needs to factor in the additional charge that we talked about, the $12 million, into any earnings per share expectation for the fourth quarter. The $12 million, just to re-state, are for actions that have been taken to date in the fourth quarter.

Okay, great. Thank you.

Glen Santangelo, Credit Suisse.

Jim, just to follow up on your comments on the $12 million -- you said that actions taken to date -- I mean, there's still 2 months left in this quarter. Is the obvious assumption that you are going to continue to spend throughout the entire quarter?

I think the assumption, going back to what Craig said earlier, is that we are in the midst of looking at the totality of our approach to serving these new large IDNs. Again, as we talked about, we think the context for understanding these changes in our approach probably lends itself a bit more to a forum such as Investor Day than anything in a short, more abbreviated session like this one. So, we are actively looking at all aspects of the business, and we will update where we are when we get together in the first week of December.

Jim, maybe if I could just follow-up with you with a question on margins. If I go back to Q2, the Company generated a higher level of SG&A, and you sort of cited last quarter that it was basically for some business that was going to be on-boarding soon. And then, obviously, the SG&A dips down this quarter where last quarter the gross margin looked good. And then this quarter, now the gross margin has come in lower than expectations, and you are sort of citing that's the transition to the IDN. So, could you just help me think about the change that we saw in the expenses from 2Q to 3Q between your gross margin and your operating margin -- or your gross margin and your op expenses?

Sure. On a macro level, the second quarter was significantly impacted with the increase in our fee-for-service business, primarily OM Healthcare Logistics and the conversion of a large customer there. And that had a corresponding impact on both the revenue and, therefore gross margin, and the SG&A where those costs resided. I think the third quarter of this year is probably more representative of a trend that could reasonably be expected, as we saw changes occur from the second quarter to the third. And, quite candidly, the impact of the fee-for-service business, the change between second and third quarter was not as dramatic as the change between first and, say, second quarter.

Okay, and maybe just my last question, and then I'll jump off. I just want to make sure I understand your realignment plan a little bit better. It sounds like, Craig, if I heard you correctly, there's going to be extra inventory that you have to buy. There's going to be over-time for some of the workers, travel, obviously, and then you are closing or moving 2 facilities. Are those all the major issues that we are looking at?

Yes, but I think we are also, Glen, maybe perhaps reserving the right over the next 4 or 5 weeks to get everything clarified and coming back to that, but I think you hit pretty much every -- we've got a huge customer coming on. So, we're in the middle of that through December, and then you've got basically realigning some divisions. We are taking a look at some things in the home office, in the field. We are also looking at our sales effort and how we can better support these larger IDNs. We want to make sure -- so, to be honest with you, Glen, there may be some redeployment of resources and a shift on how we deal with these larger IDNs because they are centralized. You could look at perhaps an IDN and say where we had 5 people out in 5 hospitals, we might have a different group of people that are calling on headquarters in terms of business development, logistics engineering -- some things like that. We are in the shift to that is that there may be some reallocation of expense to these larger IDNs and supporting them in their efforts of standardization, centralization, and the utilization of better technology and how they approach their supply chain. So, there's going to be a little bit of shift, but we are right in the throes of that -- reallocating some of the resources, too.

Okay. Thank you.

Larry Marsh, Barclays Capital.

Thanks, and good morning. Craig and Jim, you're teasing us to all come to this analyst day, so I can't wait. (laughter) Craig, we talked a lot about this large new customer relationship, but I'm trying to remember, and we talked about it on different occasions. Have you been in a position to size this relationship in terms of revenues or duration, and could you put in context what's different about this versus your other relationship? Does it accrue up to a GPO pricing matrix, or does it have its own pricing dynamics that are different from a typical GPO relationship?

I think what I'd like to do because we are still actually -- this is a multi-IDN. So this is not one large group with hospitals throughout several areas. This is multi-IDNs that came together on their own, and they have actually been working together for about 2 years. I think we are either the second or the first large contract. But, again, Larry, this is as much about large systems coming together as a commitment at a very high level of, if you are either all in or all out.

There is, I guess, if you wanted to call it GPO-type approach, when you're all in or all out, expectations are a little bit higher when you are a partner. I will say this was an arrangement where we have opportunities on all of our programs and services to go into these IDNs and help them improve operational costs. So, it's not just a cost-plus arrangement. I think that is the first thing we should probably get on the table. We're going to have an opportunity to bring all of our resources to this group. I'm going to be a little careful here, only because we have taken the high road the last 3 or 4 years to really not go in and name specific customers.

I think, again -- I guess we are teasing you about Investor Day again. I think you will get a better flavor for what we are doing with this, but I would say this is as very much as big as last year, I guess, when we were teasing you in fourth quarter 2010 that it was a large system. This system is every much the size of that, but I think the opportunities, again, will be around OMSolutions. There is a very high interest in OMSolutions and a lot of the other programs that we have.

So, it is fairly significant, and we should probably spend a little more time on that on Investor Day. But, it's not just about throwing out a low price, it's about systems coming together and committing to themselves and then really putting it out there that they're going to be completely committed. And we see this as an organization that's going to really -- we will be the first of many what they call partners. That's the other thing -- it is moving from a vendor relationship to a partner relationship. And I think you know me pretty well. I've never really liked the word vendor, either people that Owens & Minor deal with or how we are dealt with. And this is, truly, another large system that we are going to be right in the middle of it with them -- working with them to improve their operating costs overall.

Sure. Yes. I understand. You were sort of alluding to alteration of the business model in some ways. So, to me, it sounds like you're obviously saying we are going to have a bigger scale. It's going to require some upfront investments. It's not necessarily going to be driven by higher, necessarily, GP, but the overall return on this over a 3- to 4-year period of time. Your view is clearly the way you justify it. I guess to elaborate on that -- with these systems coming together we have seen pretty aggressively almost without exception they are partnering with hundreds of physician groups. So is part of this new relationship that you are going to be a solutions provider both to the inpatient and the outpatient provider?

I would say this one is so new, that will be on the radar screen somewhere down the road. I do believe on some of these other systems we are having those conversations, though. And I feel fairly comfortable to say relationships that we have been in a year, to 2 years to 3 years -- those are conversations that we're having with those IDNs. We are kind of still, I guess, in the honeymoon with the new group. Plus, the other thing is this is a multi-IDN system, so we will probably have individual conversations with each one of the IDNs on how they want their doctors' business handled. But I can tell you that the other IDN systems that we have signed or re-signed over the last 3 years -- we are having conversations about their owned and managed physicians.

Okay. Thanks. Two other quick things, then. As part of this process -- you've talked about the 3PL business being in a position to get scaled to show profitability. I think you had said last year you hoped it to be next year. Is this -- are you going to give us an update as to where you stand on whether it's going to be P&L positive at analyst day, or can you say that you are comfortable it's going to be in the black next year?

Sure, Larry. I think, again, we would defer a more fulsome explanation of the third-party logistics business until Investor Day. That being said, just to reiterate Craig's earlier remarks -- we are excited about the new leadership that we have recruited to join the organization to lead OM Healthcare Logistics. I think Brian does bring a new strategic focus to the group; and I think that, as we move forward, we are definitely excited about the opportunities and, hopefully, we will be able to express and share at Investor Day where we see some of those opportunities.

Right. So I read that as it wasn't working too well under the current management, obviously, because you talked a lot about the existing management team as being very capable.

I think, Larry, there is a question of execution and tactics, and then there is leadership around strategy, and I think I would underscore what Jim just said. I think Brian is going to bring a whole new look at how he looks at this business, and I tell you, I have only spent a week with the guy. He is out really right now in Redlands and Louisville visiting the divisions. I will tell you that the week I spent with him he's just got a whole different slant on how he is going to look at this. I think what we are saying is we've gotten it to a point where we've got a big customer in, things are settling down, and now were going to take OMHCL to the next level.

Okay. Then, finally, just a clarification, the $12 million to me sounds like it's a facility closing cost and associated expenses -- associated with that. Are you in a position to break down what the $12 million is comprised of, Jim?

Not at this point, Larry. That being said, you're not -- I think your interpretation is pretty close.

Very good. We will see you guys in December, thanks.

Robert Jones, Goldman Sachs.

Thanks for the questions. Just to build off of the shift towards the larger customers, as these IDNs continue to grow, Craig, I was wondering if this changes your M&A approach at all. For instance, would you be looking to bolster your service or consulting offering to better service these larger networks?

Yes, Robert. I think we've been pretty -- I think we really have not changed our 4 initiatives since last Investor Day, which is around -- I think very importantly -- acquisitions in the current space that we are in today, looking at joint ventures either with suppliers or customers. So, obviously the investment with Amsino and Mira is an example of where we would spend that money.

We did acquire a small technology company in the first quarter of this year that is still designed around "bolt ons" for technology to help customers make better decisions, so we are actively looking in that market. And so really our approach to the marketplace in M&A has not changed, and I do believe we have felt fairly strongly -- as I said it was becoming very apparent in the fourth quarter of last year that this was more than just a trend -- was that where we were going to basically make our investments, was to either salute these larger IDNs or, honestly, to get into the 3PL business, which we think at some point, long term, will also support these larger systems as they become more regional and geographic. We are still pretty well holding to where we said we were going to invest in fourth quarter last year, and we have made some of those investments. And we will continue to look at those markets as we go forward to support these larger IDNs as they continue to grow.

Just to follow off of that, too, in relation to a question that was asked earlier on your increased exposure to outpatient just given the consolidation that's gone on at your customer base. Do you have the infrastructure necessary -- I know you said it's kind of early stages -- do you have the infrastructure necessary to actually distribute to those more remote outpatient or physician office facilities?

Well, as we have said, and we will continue to say, the physicians that we are going to support are the owned and managed physicians, which in many cases is either on campus at the hospital or in the surrounding marketplace. At this point we do not have an interest in supporting 1- and 2-doctor practices in either rural or regional areas. Where our focus has been, again, is around these large IDNs that are buying practices fairly close to the facility so that they can follow the patient into the bricks and mortar. We have invested extremely heavy in Low-Unit-Of-Measure automation over the last 2 years, which completely salutes the non-acute care market, which is not pallets big box -- it's small units of measure.

We are moving forward on our physician initiative, and it will be around these larger 100-physician practices. But, really, for us, with the way our network is set up, we would not be interested in pursuing 1 and 2 doctors -- geographically it would just be very difficult for us to do that to date. So, we are focused on these larger physician practices. We are focused on surgery centers, clinics, imaging centers -- anything that supports the larger IDN. You've got to remember -- in these larger systems we already have 200 and 300 ship-to's that may not necessarily be on campus. So, to add another 20, or 30, or 40, or 50 ship-to's within an area is very easy for us to do, and especially now with automation -- Low-Unit-Of-Measure automation -- it is very easy for us to be able to expand that footprint.

That makes a lot of sense. Jim, just one quick housekeeping, I know in the other operating income expense line, I think you had about $2.2 million from the settlement, and I think you mentioned $1 million from China. Obviously the settlement goes away, but I was wondering if you could give us any sense of how we should be thinking about that line item going forward?

Sure, Robert. Traditionally and, obviously, we would continue with this, the other operating income line is primarily finance charge income, and that is the primary driver. However, in the course of the 9 months, we have had transaction costs that we spoke of -- a little bit this quarter, more last quarter, that have been recorded in that other operating income account ; and then, in this particular quarter, the settlement of the class-action suit. So, traditionally, primarily you should think of it in terms of the finance charge income offset by some amount of transaction costs. Unfortunately, the transaction costs are going to be increased and decreased given the nature of activity and opportunities that we see, but that is presently how we report it

Thanks for the clarification.

Steve Halper, Stifel Nicolaus.

My question has been answered, thank you.

Steven Valiquette, UBS.

When you think about these new IDN opportunities, how much do you focus on the return on invested capital when embarking on these projects, and what is the ROIC target for these new initiatives?

I don't think we would share that publicly at this point in time and, yes, being a distributor and having the extent of our working capital tied up with our customers, we are very focused on what our returns are on total invested capital.

Okay, two other quick ones here, as far as the top-line momentum you had so far in 2011 -- it's been pretty decent. Are there preliminary reasons right now why that could be sustainable or maybe will not be sustainable going into 2012, as far as big puts and takes or the way you think about right now without really giving any guidance, just trying to get a sense for the sustainability of the current run rate?

Yes, I think I would characterize our current year performance at being exceptional. I would not say necessarily it is a normalized performance, as we look year to date at 6.3%; that is outstanding. That being said, and not wanting to get ahead of ourselves, because we do have the Investor Day where we will look at the entire of 2012 and the components of it, I would say this -- we did see this quarter, as we did last quarter, a 4.3% increase in activity with existing customers. And I think as other companies begin to report their third-quarter results, we are expecting that will appear to be a higher level of utilization than many see.

Again, as we have talked about in other quarters, we've looked at that again this quarter to see if we can develop a trend, and it does appear that the phenomenon that we called out a while back, of this growth being more concentrated in our larger customers while the smaller customers are actually losing share, does continue. And I think, relative to our entire strategy and all of the comments that Craig has made today on the shift in the business, it does validate that the big will continue to get bigger, and that may be the part of the trend that is sustainable going into 2012 and 2013.

Okay -- final question -- if I heard this right, it sounded like you so far don't have a sense or don't want to give a sense for how much extra cost you may have in 4Q '11 over and above the $12 million that you already called out -- it sounds like it's mainly for facility closures. Is there any sense for the size and scope of what the extra costs could be? Are we talking about something that could be multiples of the $12 million -- so it's $20 million, $30 million, $40 million or is it just a fraction of the $12 million? Just something to give a sense for the size and scope without nailing down the exact numbers I think would definitely be helpful.

I think at this point we have identified that which we take action on to date. I think as we also said at the outset that we would, absent these efforts, expect the business to come in within the range of our previous guidance, and I think we bounded the range pretty decently, as a matter of fact.

Okay. That's it for me.

Operator, we have time for one more call.

David Larsen, Leerink Swann & Co.

With this new large IDN that's coming on -- I think you said maybe half of that system will be new and maybe half is an existing customer. For the new piece -- or the piece that is new -- when does that revenue start to land on your P&L? Is that 4Q '11?

Yes, we are guiding -- no, actually we are guiding you more towards first quarter of 2012. We are in the middle of, David, getting this all set up and lined up. You've got to remember this is a multi-IDN deal, so we had to sign multiple agreements with IDNs. Some of it, we are in the process of converting. Some of it will be late in the quarter, and I really think what you're going to do is look at this really being more of a 2012 event versus a 2011 event.

Okay. When you say multiple IDNs, it's not all the same hospital system? These are multiple hospital systems?

These are large multiple hospital systems that have come together as one system. They have made a commitment to each other that they will act as one and will work towards standardizing all of their partners -- supplier partners over the next several years. I believe we are the second partner that they have picked in this period of time. These are not 5 small 5 hospital IDNs. These are all multi-hospital IDNs that have come together as one and made a commitment to each other that they will act as one. Our experience has been that they are acting as one, but we also still have separate agreements with each one of them for purposes of the way that they are set up legally.

It would probably take maybe say two quarters or so to sort of streamline this new structure? Is that a reasonable way to think about it? Maybe two or three quarters -- I mean it's a never-ending process, I know, but most of the heavy lifting would probably be done within two quarters do you think?

No, I don't, David, and I think we will have greater clarity on Investor Day, but I do think that one of the phenomenons we have seen with the earlier large systems that we have brought on is that these contracts are very similar in essence to the complexity of, say, a GPO contract. And, much like we have seen in those situations, it takes a while to work through the contracts and really get them to an optimal level of performance. And, I think, that is a message that we are going to reinforce when we get together in December. Because I think there is an under estimation of the effort necessary to -- on our part to get these contracts, these relationships, to a normalized run rate over a period of time.

Okay. Just one last question. Can you talk about the sales process that you went through to win this deal? It sounds terrific -- it sounds great. It just sounds like the process may have been a little bit unique. Was it --?

I don't think it's unique. I think as these things get bigger, the longer it takes. This isn't an RFP that they put out in 30 days and you responded in 30 days. You are talking months.

We are working on customers that are not -- we are working on non-customers now, it probably may not come to fruition for a year or 2 years or may never come to fruition, but, especially with this being a multi-IDN system, it took a very, very long period of time to get that. We had a big group. I was personally involved. Charlie was personally involved. We had several people personally involved. We had people at the local level, at the regional level, at the system level and at the multi-system level. It was what I would call a huge team win for Owens and Minor, and it was a multi-sales effort to get this in.

Okay. And then, was there any significant change in the Department of Defense revenue sequentially?

Not significant, David, however we continue to see a trending decrease, but not significant enough to call out separately. Clearly, things are winding down in the Middle East, and we are seeing an impact on that.

Thank you.

There are no further questions at this time. I will now turn the call back over to Mr. Smith for his closing remarks.

Thank you, Christy, and thank you for everyone listening in. We are looking forward to seeing you all on Investor Day, December 7, and we think we have got a great opportunity to share some initiatives with you and an update of the Company. Thank you. Have a good day.

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