Owens & Minor Inc (OMI) 2012 Q2 法說會逐字稿

Good morning ladies and gentlemen, and welcome to the Owens & Minor second quarter 2012 earnings conference call. My name is Kevin 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 presentation. (Operator Instructions) As a reminder, this call is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's calls, Mr. Craig Smith, President and Chief Executive Officer of Owens & Minor. Please proceed, sir.

Thank you, Kevin, and good morning, everyone. Welcome to the Owens & Minor second quarter 2012 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 Operating Officer; Drew Edwards, our Interim Chief Financial Officer; Grace den Hartog, our General Counsel; and joining us today is Robert Snead, our Operating Vice President of Corporate Development, who led our efforts on the Movianto transaction. Before we begin, Trudi Allcott from our Investor Relations team will read a Safe Harbor statement. Trudi?

Thank you, Craig. Our comments today will be focused on financial results for the second quarter of 2012, 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 risks and uncertainties that could cause actual results to differ materially from those projected. Please see our press release and our SEC filings for a full discussion of these risk factors. Thank you, Craig?

Thank you, Trudi, and I'd like to call on Drew Edwards to brief us on the numbers, and then Jim Bierman will provide an operational overview. Let's start with Drew.

Thanks, Craig, and good morning everyone. Let's take a look at our second quarter financial results. Revenues for the second quarter improved $54 million or 2.5% to $2.19 billion when compared to last year's second quarter. For the year-to-date period, revenues increased $148 million or 3.5% to $4.4 billion when compared to the first six months of 2011. The increase in year-over-year quarterly revenues resulted primarily from growth in sales to existing customers, while the year-to-date revenue growth mainly came from both increased sales to existing customers and new customers.

On the gross margin front, our year-over-year gross margin percentage for the quarter declined 47 basis points. However, on a sequential basis, gross margin was about the same as the first quarter of this year. The reason for the decline in the year-over-year quarterly gross margin percentage is similar to what we discussed last quarter, which is primarily the result of changes in our customer mix, including lower margins from large integrated health networks as well as competitive pressures. As we had discussed in the past, achieving synergies and optimizing performance on large integrated network accounts can take time. Cost control continues to be a bright spot for us. Second quarter SG&A declined by $6.1 million and was 45 basis points lower as a percentage of revenue compared with last year. This improvement more than offset the year-over-year decline in gross margin dollars and percentage.

The factors that contributed to favorable SG&A performance for the quarter were, first, a $4.3 million improvement in fee-for-service operating expenses. You may recall that at the same time last year, we were incurring expenses for the transition of a major 3PL customer. Second, a $1.8 million decrease in traditional distribution operating expenses despite an increase in related revenues of $54 million. Our improvement in traditional distribution costs were due to the realignment steps taken in the fourth quarter of last year as well as a keen focus on managing expenses. The story on SG&A for the first six months of this year is the same as the story for the second quarter with expenses declining $1.4 million on revenue growth of $148 million and more than offsetting the $1.1 million gross margin dollar decline that occurred during the same timeframe.

As part of our strategic initiatives, we continue to invest in our infrastructure, which resulted in a $300,000 increase in depreciation and amortization expense to $8.5 million for the second quarter. Year-to-date depreciation and amortization was $17.1 million, essentially unchanged from the year before. The changes in depreciation and amortization primarily resulted from investments in warehouse equipment technology and leasehold improvements, partially offset by lower amortization resulting from the expiration of non-compete agreements.

Now taking a look at other operating income. On a net basis, we had income of $600,000 for the second quarter compared to a loss of $500,000 last year. This year-over-year improvement for the quarter of $1.1 million was due to higher finance charge income of $500,000 and lower corporate development expenses of $500,000. For the first six months of this year, other operating income on a net basis was $2.2 million compared to a loss of $500,000 last year. This year-to-date improvement for the quarter of $2.7 million was primarily due to higher finance charge income of $700,000, income of $500,000 from a class action settlement, and lower corporate development expenses of $1.1 million.

Now turning to second quarter operating earnings. For the quarter, operating earnings increased 4.2% to $53.2 million for an operating earnings margin of 2.43% versus 2.39% in last year's second quarter. On a year-to-date basis, operating earnings increased 3% to $105 million for an operating earnings margin of 2.39% versus 2.4% last year. The quarter and the year-to-date improvements in operating earnings were primarily driven by our cost reduction efforts and lower corporate development expenses, which more than offset the decrease in gross margin dollars. Interest expense, a component of net income but not operating earnings, increased by $500,000 to $3.5 million for the second quarter, an increase -- and increased slightly to $6.9 million for the six months when compared to the same period a year ago.

For the first six months of this year, our effective interest rate was 6.5% on average borrowings of $214 million compared to a rate of 6.4% from the first half of 2011 on average borrowings of $211 million. The effective income tax rate was 39.4% for the quarter and year-to-date period compared to 39.3% and 39.2% for the same periods a year ago. Net income for the second quarter increased by $1 million to $30.1 million or $0.48 per diluted share, an increase of $0.02 compared to last year. On a year-to-date basis, net income was $59.5 million, an increase of 2.7% from the prior year period. On a year-to-date basis, diluted EPS was $0.94 for an improvement of $0.03 when compared to the year before.

Moving on to asset liability management, which has been another bright spot for us this year. DSO declined to a record low of 19.5 days and inventory turns were at a near-term high of 10.8. These improvements combined with operating earnings resulted in strong cash flow from operations of $143 million for the first half of 2012. So far this year, expenditures have been devoted to operational efficiency initiatives including information technology investments. Our capital spending year-to-date of $18 million is a bit off pace of our planned level of $50 million, primarily due to timing. Thank you. Now I will turn it over to Jim for his remarks.

Thank you, Drew, and good morning everyone. As you just heard, many of our key financial and operational measures improved both during the quarter and for the year-to-date period. We are beginning to see results from renewed financial and operational discipline system-wide. Revenue growth on a year-to-year basis was good for both the quarter and the year-to-date period. We were, however, disappointed in our second quarter revenue growth when compared to the first quarter of this year. We reported a sequential decline in revenues from the first quarter of 2012. Analysis of our results indicates that there were two factors at work. First, growth with existing customers was flat when compared to the first quarter, and lost business outpaced new business in the second quarter.

As we sometimes see in the individual quarter, there is some churn among our accounts, and this is not an unusual pattern of activity. Craig has challenged all of us to grow our business 100 to 200 basis points above the market as we have done so historically. We remain committed to achieving that goal going forward. Of greater effect was the fact that sales with our large IDN customers were flat for the quarter on a sequential basis. We did not experience price or volume increases as we might have expected. We have some -- we have seen some recent indications from Wall Street research reports and other healthcare company comments that utilization of healthcare services was slightly softer in the second quarter when compared to the first quarter of this year. Analysis of our results seems to validate this thesis. However, I would note that to date, our revenue growth is within our targeted performance for the year. This recent trend has caused us to pause and reconsider our revenue outlook for the year.

Regarding the new Novation contract, we are in the sign-up period in advance of the September 1 start date for the new contract. As an authorized Novation distribution agent since 1985, we look forward to serving the Novation members under this new contract. The sign-up process is underway, and I personally want to thank those Novation customers that have once again shown their trust in us by committing to us as their prime distributor partner.

Our expense reduction efforts for the second quarter were excellent. We reduced SG&A by more than $6 million and reported SG&A as a percentage of revenues of 6.88%. The organizational realignment steps we took in the fourth quarter of 2011 have helped reduce our expenses and are expected to continue to benefit our expense profile for the remainder of the year. I'm very pleased that we have achieved this reduction even as our revenues increase. Our teams have embraced a renewed expense management discipline while focusing on growing our business and pursuing new opportunities.

Looking ahead, we are pleased to report that we have just signed new agreements with Penske Truck Leasing and Penske Logistics, consolidating our fleet under one vendor. Under this arrangement, we expect to achieve sustainable net savings for our delivery fleet for years to come. Through advanced onboard technology, we can improve emissions, drive time and fuel consumption, which will enhance our sustainability efforts company wide. And the new technologies will enhance driver safety. Our drivers are on the front line of our interaction with our customers and a major differentiator for us in the market. Improving their safety and effectiveness is of the greatest importance to all of us.

During the quarter, we achieved another milestone as we refinanced our soon-to-expire revolving credit facility. The new $350 million facility has a five-year term with two one-year renewal options. Because the financing environment was more favorable this time around, we achieved a better pricing, more flexibility, and the ability to borrow in foreign currencies.

Operating earnings this quarter continued to improve. We understand that our operating model depends on us getting it right in each of our distribution centers, and that means optimizing operations in each of our 48 facilities across the country. As an example, the influx of new business late last year has caused several distribution centers in our Western region to miss operating margin targets as they incurred expenses necessary to accommodate customer conversions. We are working with these teams to achieve these original targets, but this process takes time.

Overall, our teams are adjusting to business conditions and making the necessary changes to optimize their operations. As an example, our teams did a superb job in bringing down inventories by 7% since the end of the year. That represents a reduction of nearly $60 million in inventory even with solid business growth. This reduction demonstrates our teams' ability to normalize operations with new customers once they are on board. Converting receivables to cash was also a bright spot for us this quarter as we achieved an all-time low DSO of 19.5 days. Consequently, we generated strong operating cash flows of $143 million on a year-to-date basis. With everything we do, we maintain our focus on creating long-term value for our shareholders. Accordingly, during the first six months of this year, we returned more than $35 million to our shareholders, almost $28 million in dividends and another $7.5 million from the Board-approved share repurchase program.

Before we discuss our outlook for 2012, I want to comment on the Movianto transaction. We are very excited about this transaction, which will make us a significant third-party logistics player in Europe and put us on the global stage. Movianto today serves 600 pharma and medical device customers in 11 countries from 23 logistics centers. The transaction will bring the management team and 1800 teammates into the Owens & Minor family. For Owens & Minor, this is a strategic platform deal with existing capacity for growth. Our intention is to keep the network and the teams intact as we serve the existing customer base and build the business. Because the services offered by Movianto and OM Healthcare Logistics are highly complementary, we will be able to leverage the investment we have made to date across a wider spectrum, giving our manufacture customers integrated 3PL services in Europe and the United States.

As we said in our press release, we are targeting this transaction to be earnings neutral in 2013 and accretive thereafter. Now that we have a signed agreement, we will be working on conducting the necessary closing activities and satisfaction of certain local legal provisions. We look forward to closing this deal in the third quarter.

As we contemplated our outlook for the remainder of 2012, we recognize that certain factors have come into play since we first issued our guidance for 2012 back in December of 2011. The factors we have taken into consideration when thinking about the remainder of the year include the themes we have just discussed today. They include flat sequential revenues with our large IDN customers when we had originally expected a bit more sequential revenue growth. Because we now believe our revenue volume will be lower for the full year than originally thought, we must reasonably expect that we will be on the lower end of our MediChoice goals and, due to the competitive pressures in the market and the anticipated softer volumes, we believe our targeted supplier incentives may be lower in 2012 than originally targeted. Taken together, these factors point to a slightly slower growth in profitability year than we had originally planned for our US-based operations.

Adding further complexity to our outlook for the remainder of 2012 is our pending transaction. Movianto's 2011 revenues were in excess of EUR300 million. Our 2012 revenues will be positively impacted by the actual -- by the acquisition. The actual amount, however, will be dependent on the date of the actual closing. Dilution of earnings-per-share related to the transaction is targeted to be between $0.10 and $0.15 per share, much of it transaction related costs. As for our revised guidance for net income per diluted share for the year, we are targeting a range of $2.04 to $1.98 excluding the dilution associated with the pending Movianto transaction. Thank you, and I will turn it over to Craig for his remarks.

Thank you, Jim. And as Jim said, we are very excited about the Movianto transaction, and Movianto is one of the few 3PLs in Europe that is focused exclusively on healthcare. It is considered to be a leading provider in the market. Now, I have been saying consistently for two years that we would make investments in the core strategic sourcing, the 3PL business, and joint ventures with our business partners. We have also been saying that we would expand beyond our US borders, and now we have accomplished that goal. This acquisition will open a very big door for us in Europe and will put us squarely on the map in the global healthcare 3PL space. Since this is a strategic platform acquisition, we intend to assume the customer contracts, the management team, the facility leases, and of course, the teammates.

Movianto is an exceptional fit for Owens & Minor in many ways. Our cultures are very similar. Both teams are excellent operators and very customer focused, and I have to tell you, I have spent a time over there in Europe with three of the managing directors. I spent a half-day with three of the key managing directors. I have to tell you that they are very experienced operators and they are very focused on the customers.

Also, the other piece that I'm very pleased about is that Movianto places a very high premium on its teammates and their well-being just as we do. The CEO of Celesio has said that he believes that Owens & Minor is the key to driving Movianto's successful development and called it a positive solution for all concerned. Movianto offers a suite of services that are highly complementary to OM Healthcare Logistics. We anticipate putting Brian Shotto who now heads up OMHCL in charge of our new global offering. We are very fortunate that Brian and members of his leadership team have extensive healthcare 3PL experience and they have also operated in the 3PL space in Europe. We are very confident the two teams are prepared for this expanded opportunity.

As for the operating environment in Europe, we feel that this is an opportune time for this transaction. The majority of Movianto's revenues today are generated in the United Kingdom, Germany and France. Movianto is a solid strategic cultural and operational fit for Owens & Minor, and the European healthcare market offers attractive demographics. Also, our supplier customers have been asking us -- when are we going to develop our global capabilities? As we told one supplier just recently, our entry into the global market was not a question of if, but a question of when, and now that day has come. We are energized by the opportunities ahead and believe that this is the right transaction at the right time for Owens & Minor.

Turning to our domestic business, as Jim said, we are very pleased with much of what we achieved during the second quarter as there were significant bright spots. Our team in the field and at the home office have done an exceptional job in achieving these operational improvements. They are applying a renewed discipline in these areas of historic strengths for the Company. I would also note that these are areas of performance where we have an element of control. We have less control in areas such as healthcare utilization. As Jim mentioned, we are currently seeing a flatter growth trend among our larger customers that we have seen recently.

As many of you know, I'm on the road quite a bit in our operating units and meeting with CEOs and hospital personnel throughout the country, and in talking with hospital CEOs in recent weeks, they stress the same themes. They are not expecting dramatic change in the near-term. They believe the market is very competitive. They are working to drive their costs down to meet reimbursement levels, and they continue to seek our help with innovative supply chain solutions. One thing is for certain. Just like our hospital customers, we will work within the environment we face today, and we will focus on improving the things about our business that are within our control.

Before we take your questions, I would just like to say a final word about our results this quarter. Again, we reported continuing improvement in inventory levels and strong asset management. Significant expense reduction and strong operating cash flows. Now some months ago, I brought Jim into the COO world because we value the financial discipline he brings to operations. We are very pleased with the results so far. As we move forward, our teams remain focused on improving profitability and advancing our strategic initiatives, and I have to tell you, we are very excited about entering the European healthcare market, which clearly puts us on the global map. Thank you, and we would be happy to take your questions. Kevin, you may open the line questions.

(Operator Instructions) Glen Santangelo, Credit Suisse.

Thanks. Craig, just a couple of quick questions if I could. I just want to make sure I understand what you're saying about revenue growth. Basically you're saying it's going to be sequentially flat in the back half of the year, which pretty much assumes now no growth year-over-year, so does that assume that volumes have now turned negative and basically with the benefit of some level of price inflation we're getting back to zero? Is that the right way to think about that?

Glen, this is Jim Bierman. I think your interpretation is not far off. Let me add a little bit of color if I could to the comments that we had made earlier. I think as we look at the first half of the year, we are very pleased that the actual revenue growth was within the original guidance and the targets we had set out of 3% to 5%. But as we look towards the back half of the year, based on the second quarter experience relative to first quarter, and looking at the comparable revenue in the third quarter of 2011, which it would be the comp and the fourth quarter of 2011, we did not see the continued rate of growth that we saw for the first half of the year. So therein lies the observation and comments relative to that.

What makes it further of greater complexity is the addition of the transaction. So we will pick up Movianto's revenues after the date of close, so that could be four months, could be five months of the remainder of this year. Those revenues would be reported. We don't really want to go down a path of beginning to report a with and without basis where we report results with the transaction, without the transaction although we understand -- in order to understand the year, there's going to be some element of that. So our outlook overall includes all of those factors, and we've shared that with you qualitatively.

I appreciate those comments, Jim. I guess what I'm trying to assess here is the impact on gross margins, because the story the past couple of quarters had been that your IDN customers were growing faster, which is why you continued to surprise us with respect to better than expected revenues, but the gross margins came in lower. Now it looks like the revenue growth has kind of stalled, which maybe suggests that some of your customers aren't growing as fast, but yet, to get your new guidance range, we have to assume some pretty compressed gross margins as well, and it kind of -- I don't know how you think about that relative to also thinking about you got the Novation and premier renewals there staring at you in the second half of the year.

Absolutely. I think again, we have been open and candid in discussions on gross margin. Gross margin to date for the first half of the year has been below where we had targeted at least in December of 2011. One of the issues has been that again, for this quarter, we saw very little improvement in the fee for service business vis-a-vis a year ago. So our original targeted amounts expected a higher level of fee for service business as you well know, but for the benefit of those that know us a little less well, there are basically a handful of areas where we generate fee for service revenue. Our OM HealthCare Logistics business is one which is a fee-for-service business, but just as importantly in the variance is our OM Solutions consultancy business. So those businesses in the softer markets and softer economy that we've seen haven't achieved targeted performance.

I appreciate all those comments. Craig, if I could just ask one more, then I will jump off. I just want to talk to you about the transaction. Kind of looking at the multiple you paid, it seems to us depending upon what percentage of the company you actually bought, it looks to be about 11 to 12 times operating profit, and so how do you think about the decision to enter Europe now amidst all that uncertainty paying a double-digit multiple like that?

Glen, let me maybe take you back to why we see this as an opportunity. First of all, it's a strategic investment. If you look at the progress that we have made with OMHCL in the United States, I think we've done a tremendous job over the last six months. But we have a fairly significant investment in terms of technology and the build up of that business. And if you look at the business in Europe, as I said, they have great managing directors in the bigger businesses, but they have a tremendous opportunity to grow that business throughout Europe, and I think they are getting some momentum.

So I think across the board, you have to look at this transaction -- one we have manufacturers who have asked us for a global footprint which -- we answered that question. I think two, we bought a business that has capacity with great leadership. And I think three, it gives us a better opportunity here in the United States to leverage the investment that we make. We've got a great operation year the United States. Our opportunity really is now to grow the top line and the fee for service. As Jim told you, we're little bit behind budget.

I have to tell you though, the last six months, we've done a phenomenal effort of really getting the US -- the domestic business on track, and I think by making this investment and really coming up with a global opportunity to ship to 80 countries across the world, I think this really gives us an opportunity to start to ramp up and leverage the whole initiative. I think if you look at the European market, as I said, the majority of this business is really in the United Kingdom, Germany and France. So we feel that we've got -- and we also in Switzerland and several other countries that are doing well, so I think across the board, this was an opportunity for us to get into Europe at a time that we could significantly get in at a better price. I think personally we got it for a good price. And secondly, get the opportunity to grow that business, and Robert, you might want to add a little bit or --

No, I think you said it well, Craig.

I just want to say thanks for the comments. I appreciate all the detail.

Robert Jones, Goldman Sachs.

Thanks for the questions. Just trying to get a better understanding of the specific services that Movianto offers relative to what you do domestically. Maybe just some clarity around what their split is amongst pharma versus med/surg, the more traditional med/surg, and then just along those lines -- obviously doesn't sound like the synergies are going to come from consolidation of distribution centers or cost-cutting, so maybe if you could just talk a little bit about the potential revenue synergies that this addition creates for Owens & Minor.

So this is Robert speaking here. The business in Europe is actually quite diversified and has a good mix of both pharma, medical devices, generic biotech, over the counter, and export businesses as well. In addition to that, the back inside of it in terms of distribution points is also quite diversified as well. Shipments going to wholesalers but also to pharmacies and to hospitals and physicians to patients and export. So despite the parent company today being quite focused on the pharmaceutical and the pharmacy business, this business is very much focused on the full spectrum of healthcare and has very strong relationships with the manufacturers that it supports. That is entirely consistent with our strategy in the focus of our OMHCL business here domestically. It is looking across the entirety of the healthcare spectrum.

And in addition, you asked about the services and capabilities. These are also really mirror capabilities on both sides. It was amazing when we looked at their list of capabilities and combined it to ours, pretty much everything was the same with the exception of rebating, which is a US phenomenon and not something that happens in Europe. So whether you're talking about warehousing, transportation, all sorts of business process outsourcing and value-added services, repackaging, collection of AR, et cetera, these are all capabilities that we have, and they have specialty solutions as well. I would add one thing that is pretty unique and an interesting asset that the business in Europe has is cold chain storage. We have that here domestically, but their business has it fully integrated in terms of an owned fleet and the ability to take the product from the manufacturer get it all the way to the pharmacies and the physicians or the hospital in a temperature controlled environment exactly to the manufacturer's specifications.

I appreciate all the detail. Just if I could switch gears over to the gross margins -- obviously, again, below the historical levels, and you guys referenced some of the same culprits as last quarter with customer mix and competitive pressures. I guess maybe one for Jim. What needs to change here, specifically around the customer mix, in order to get the margins expanding again? It seems like the consolidation amongst the provider group is continuing if not accelerating, and that seems to be what's clearly weighing -- in part weighing on the gross margins. I'm wondering what exactly needs to happen in order to kind of right the ship there.

Not to be argumentative, Bob, but I think the ship is pretty right. But I think there is room for improvement. And I think what we've said in the past and will continue to say going forward -- gross margin is important. It's part of how you calculate the model on our business model or reporting model. But the real importance lies in the operating margin. So the operating margin improved year-over-year and improved sequentially.

And so we have said consistently that the key to the new model with these larger IDNs is really focused on our ability to managed SG&A in a different fashion. They're requiring a different kind of a service model, and we're adjusting to that as we move forward. And it'll take some element of time. But I do think we showed both sequential improvement in operating margin and year-over-year improvement in operating margin. And I think it speaks to the beginning of seeing some incremental success in how we serve these large customers.

That's totally fair, and I didn't mean to take anything away, obviously, from the cause containment. It's been clearly impressive over the last several quarters, so thanks for all the details.

Robert Willoughby, Bank of America.

Craig, I think I was told years ago by a prior management team if the creek didn't rise, you'd make our healthcare conference, so I'm not exactly sure how you plan to manage the crossing of the Atlantic, but seems like an interesting transaction. It requires minimal consolidation. Can you at least speak to the profit margin? I think Glen had an estimate, but is that something you can help us with? And is there any kind of capital investment needed in the business, and what's a run rate in CapEx for the business?

Bob, let me take the operational piece of that, because I was over there and spent some time looking at the operating units. I think to date, they've done a pretty nice job of investing in the buildings that they have and getting set up for capacity and growth. So at least, I think, from a building standpoint, I think we're in pretty good shape. I think also from a technology standpoint, we're in fairly good shape over there too. So I would just say from an operational standpoint looking at the business in totality, I would say we're all-in-all from a CapEx standpoint in fairly good shape. I'll turn the financial part of the question over to Drew.

From a CapEx perspective, I think we're good. We bought a business that has got plenty of capacity. The capacity has already been put in place with [past] CapEx, so right now we're at the point where you've got a high level of fixed costs, so from an operating margin perspective, the absolute margin is not as important as the incremental operating margin. And as we fill up the excess capacity that we have in those facilities, the incremental operating margin will be very robust. So that's part of the value play here.

Is there a CapEx number, though, for the business going forward?

No, we'll deal with that when we get to their conference call in the third quarter.

Okay, and you mentioned capacity for borrowing euros. Are you -- what is going to be the debt payments, what will be the cash portion of this deal?

We'll use the cash that we got on the balance sheet to finance this transaction.

Okay, no debt being taken down.

Correct.

Eric Coldwell, Baird.

First question is on the domestic fee for service business. I think in the prepared remarks, you said a $4.3 million OpEx reduction year-over-year. Could you give us a sense on the revenue change? Was it up, down, flat, order of magnitude, and did that business hit break even or make money in the quarter?

You mean the OMHCL part of the fee for service business.

Well, maybe that and then the totality including consulting.

Year-over-year -- I'm sorry, Eric, you were breaking up there a little bit and I guess I wasn't sure of the $4.3 million where the source of that was, but let me specifically answer your question on the fee for service revenue. Fee for service revenue for the second quarter when compared to the first quarter was basically flat. There was a $400,000 increase year-over-year.

And for the year-to-date, the fee for service revenues are up $7.5 million, and that's primarily because of bringing on the new large customer for a 3PL business last year. In terms of where the business stands today, the 3PL business in the United States today is near the break-even level.

Eric, what I think I had said earlier in the comments is I think operationally, the OMHCL business is in great shape. We've made the investments, I think I've been pretty clear over the last three to six months, our opportunity is in to bring in new sales, and so that is where the focus has been. And part of the [routine] behind this acquisition with Movianto is to really try to start to leverage some of these manufacturers on a larger scale basis versus individually by a division of a manufacturer, so we've been out already talking to manufacturers about opportunities. So the business itself, the OMHCL business, is in very good shape. Brian has done a great job with his team getting the expenses in line, which was really the challenge when he came in October, and I think the opportunity now is to get the topline going so that we can offset the investments that we made over the last three or four years and really get that thing cranking. And that really has been the focus of the team as we have been looking over the last six months.

If I could shift gears quickly. We had a chance to look at the Celesio numbers and as they report Movianto, it looked to us as though the revenue there in US dollars might have been higher than what was indicated on the call, although I might have to revisit foreign-currency exchange at the time, but that being said, you say in the press release you are the taking majority but not all. I'm hoping you could give us a better sense on your expectations for the order of magnitude of revenue you're taking on over the next 12 months once the deal is closed. Second of all, are there any accounting differences, because they do have a separate revenue and gross margin line whereas I understand your ACL business's revenue is gross margin 100%. And then third, if we could just get a better sense on timing of when you expect that to close. Thanks.

Sure. This is Jim Bierman again. On the timing, let me work backwards on that. On the timing, we had the normal closing customary type things that we need to work through, but because we do not have operations in Europe, that process will be much expedited. As I think I answered to one of the previous questions, we would expect closing to definitely occur sometime in the third quarter, and we could have four or five months of Movianto revenue in our results. On the nuances of the accounting differences, I will defer to Drew on this, as to how they report revenues versus GAAP.

On a consolidated basis under IFRS and under US GAAP, the revenue amounts should be very similar. And as Jim indicated in his opening comments, the 2011 revenues for Movianto, which would be on a US GAAP basis that would be included in our consolidated financial statements was roughly EUR300 million, and you see a number that is greater in the Movianto annual report since we did not buy the entire business.

Okay, so the difference appears to be because you're not taking the majority. And then I guess, just if you could give us a sense on where you think revenue is over the next 12 months -- once the deal closes. The run rate post close.

At this point, I think that's a bit premature, Eric. I think we will have greater clarity after close. And as we talk about this in relation to 2013.

Okay. Final question is, with December of '11, you gave gross margin guidance of 10% to 10.25%, SG&A guidance starting at 7% of revenue. Obviously, those numbers are not going to be the final outcome. Are you going to provide an update on that or should we just use the trend in the comments to get to our own estimates here?

No, I think at this point -- yes as we have done -- as a practice we provided an outlook at Investor Day of what we're thinking and what we are targeting in those areas to help in the development of models. As we've said consistently, our actual guidance revolves primarily around earnings-per-share, and I would encourage and suggest that you take the qualitative comments we've made in the trending, and I think you can develop what the gross margin and SG&A would look like for the remainder of the year.

Okay. I will drop off. Thanks.

Larry Marsh, Barclays.

Thanks, good morning, everyone. Craig, maybe first on topline. I know you've always over the years been aggressive in saying we want to take share, you've done a good job of doing that. As I think Jim pointed out, this is the first quarter in many, many years where I remember seeing such a big drop sequentially. You attribute some of this to the macro environment. And I guess some of this is timing on customer wins and losses, so in your mind, are you fully on track to get that 100 to 200 BPS of margin -- topline expansion with marketshare gains this full year, or do you feel like you are behind in that goal? And how much of the drop -- can you be more specific on how much of the drop sequentially came from lost business?

Well, Larry, let me maybe talk about this at a macro level. I think this year is -- from a utilization standpoint, we continue -- a lot of companies in healthcare continue to really see either flat utilization or a little bit of utilization. We have actually done some drill down on some of the operating room product categories that we have, and those look either relatively flat or down also. So trends that we're looking at are probably a little bit slower than we had seen in the past, and I would reiterate again that we still are within our guidance that we gave at the beginning of the year, and we knew -- and I'm going to talk a little bit more about this. Something that we really haven't talked about on the call as much as we have really been working on manufacturer profitability also, and so there is an element there where we are working with our supplier partners around profitability, and that has some impact also on the topline in terms of how we deal with our manufacturers going forward.

So I really think it's a combination of a slowdown on utilization. Anytime there is a major sign up like Novation and Premier, that has a tendency to also kind of slow things down a little bit for six months. And so we're in the middle of this thing and it will be signed September 1. We will be through that. I would also say that 2.5 years ago, we had a slowdown in topline and then came back very strong. So I would look at this as one quarter and perhaps another quarter going forward. I think the problem that we're maybe leaving a little bit of a question mark is how much of the Movianto sales is going to impact us this year.

This is utilization start to pick up. We've seen very little inflation this year also, so it's not just about whether you are taking business from somebody. There are several components that go into this, and so I would say it's an element of several things, Larry, versus whether we are winning or losing business like we have historically done in the past. And you know, there's a lot of people very focused on taking their cost down right now from our provider standpoint. So a lot of the things that we are working on is helping them reduce inventories, more efficient operations. I'm giving you a pretty -- it's just not a simple yes or no answer. And so our focus if you are asking me -- am I happy where I am, I'm kind of a sales guy in my heart. I'm an operations guy too.

So clearly the focus is very much on sales. I would also say to the folks on the phone, you know, we had some challenges around SG&A and margin, and we have leveled the margin off sequentially, and we are working very hard on margin, and if you remembered -- I'm giving you a long-winded answer, Larry, but I know you like me to give a little color here. If you remember back at Investor Day, we talked about how we were going to work on operations, improving efficiencies. We were going to work on margin improvement. I think we had a little bit of an aberration there at the end of the year going into the first quarter, and we're coming out of that. To me, all the fundamentals are in place, and as you and I have talked before, it's a three-legged stool, so if you are focused on operations and margins, sometimes the sales might not be quite where you want the operations and the margins. So I think we're feeling pretty good about where we are in the margin and stabilizing the margin, we're doing a phenomenal job on SG&A, and now the focus is really around the sales and how we can grow that over the next year to [two months].

Thank you, Craig, for the details. Two other quick ones. Moving onto -- I just -- I'm still unclear, what percentage of the business are you acquiring?

This is Robert, Larry. We're acquiring the vast majority of the business. There were two areas where -- the good part about this business, and as you know with carve-outs of companies, there's a wide range, ones that are highly integrated and ones that are relatively separate. This was a very separate division of Celesio. It had separate management and separate operations even in the field, and there were just a couple areas where that was not necessarily completely the case, and so those pieces are remaining with the parent, and we're taking all of the rest.

So is that 90%, 95%, 80%? What's the ballpark?

Those are directionally correct.

Right, and I guess -- I know you guys have said in the past that what you'd like to do is, if you have capacity in Europe, then US suppliers are more likely to use you. Do you believe that's going to be the case, and do you feel like you're going to be able to sign up one or more new customers [besides] of the US because of your European presence?

Larry, I'll try and give you a little shorter answer on that one this time. The answer is yes, we do think that there is probably one or two or more manufacturers that would look at us now with this global footprint and think that's an opportunity. If you really start to look at numbers for US-based companies, a lot of the growth in their topline, what little growth they have, is basically overseas. So we think this is an opportunity to follow the manufacturers as they look to expand their markets.

Okay, and just on the Penske outsourcing relationship, Jim, I think you -- or Drew, you talked about substantial net savings over the term of the contract, and that's effective later this month. Can you quantify how much that would mean in annualized cost savings to you guys?

I think it's significant as we look to 2013 and beyond, and I think we'll have more comments around that as we begin to put 2013 within context. I think its impact in 2012, just given the timing, and the conversion of the unit to Penske, is really pretty minimal.

Jim, is that several million dollars in '13, is it $1 million, $2 million, $3 million, $5 million, $10 million? How do you even ballpark the magnitude?

Directionally, you're close on that.

Oh, here we go. (laughter) Take my number. All right, that's it.

Steve Valiquette, UBS.

Couple of questions here. First, in the Celesio annual report, they disclosed that Movianto had down operating income in 2011 versus 2010 for -- they said a whole bunch of reasons in Spain, Portugal, Denmark and Germany. But later in the report, they said they hoped that Movianto EBIT may grow in 2012. So I guess my question is, are you in a position to disclose year-to-date, mid-year through 2012, is Movianto showing EBIT growth so far this year or are some of those events still taking a toll like they were last year?

We're not going to give you at this point where they are year-to-date. We'll talk a lot more about their results once we complete the transaction, and we'll talk about it a lot more in October. That being said, I think just to restate the points that have been made on the call, the key to this is the capacity that they presently have, and the potential that exists. So we're a little bit less interested in what's existed in the past and totally focused and excited about what the new Movianto as owned by Owens & Minor can do in the future.

Somewhat tied into that, just trying to assess the profitability, I guess I'm curious -- the $0.10 to $0.15 EPS hit from the deal -- how much of that is kind of one-time in nature just from closing costs versus just the run rate of the operation? And the reason why I ask is I'm just trying to do some back-of-the-envelope math here where if your cost of the acquisition -- essentially, if you're financing this with cash, you sort of have foregone interest income. That's kind of a lower hurdle to jump over to make this deal accretive versus dilutive, so I'm just surprised that it's dilutive. I'm just trying to better assess the profitability of the business. Is this much lower margin than what we might think? Just trying to understand that whole level framework around how much of that dilution is one-time versus its true run rate.

First, on the $0.10 to $0.15 diluted impact for this year, the majority of that, more than half, is transaction costs, and that's associated with -- we're putting in a new structure in Europe. We don't have one, so there's probably a little bit higher of legal fees, tax consulting and some other costs that we're going to have associated with this transaction that sets us up for future growth and other transactions in Europe as we move forward. As for the operating margin question, as I mentioned earlier before, it's not really the absolute operating margin. We have capacity in place. We're buying a business with significant capacity -- unutilized capacity. It's a high fixed cost business, so as you fill up that capacity, the incremental margin that you get that drops to the bottom line is fairly robust.

That's helpful, thanks.

Operator, we have time for one more call.

David Larsen, Leerink Swann.

Can you give any color around -- you mentioned a couple of customer exits in Q2. Can you say how many there were, maybe two or three large ones? And was the Department of Defense in any way one of those?

Let me clarify, David, because this is important. We have not lost the Department of Defense as a customer. They continue as a customer. What has happened with the Department of Defense is that well over a year ago, they entered into new contracts with their distributors, and those contracts became effective at various points in time during 2012, but the DOD remains a customer of ours. As an editorial comment, I would say that the Department of Defense -- its impact is decreasing because of the size and complexity of these larger systems that we've talked about that are presently becoming more impactful. But the DOD is a very valued customer of Owens & Minor, has been, and we are proud and pleased to continue to serve them into the future.

The comment on the phenomenon on business churn, which is the addition or loss of net new business, we didn't talk about several or anything like that. We just said that in this particular quarter, lost business outpaced new business. And that will happen on a quarter to quarter basis at various points in time. And that's the experience we had this particular quarter. The significance of it relates more to the fact that growth with our large IDNs was fundamentally flat, otherwise it would've been a non-event, but because the growth with large IDNs was flat, it was worthy of commenting to the investor community.

Just one more quick one if I can, you've got $2 billion of these large IDN contracts. Could you maybe talk about the performance fees or performance metrics, and I think Jim, you are heading that initiative up. How is that going? Can you provide any sense of timing or any color around the implementation of this new contracts? Thanks very much.

Absolutely, I would be happy to. It's important that we get the operating model to support these customers right, and right is first and foremost that operationally we achieve the performance metrics that are embodied in the contractor that have been agreed to and are the expectations of these large customers. We have revamped our service model to be more focused and more nimble and more directly responsive to these large systems. There is an operational challenge in that the systems cut across various geographies of the United States. We tend as many companies like us tend to be organized, our resources are deployed and controlled geographically, and these customers have because of the breadth of their business span many of our geographies.

So it becomes absolutely critical that we have a model that is responsive to their needs and enable them to have a single point of contact with a senior member of the organization to serve them. And that has all been put in place and is working well from our perspective, and I believe the feedback we are getting from our customers from their perspective. But these are complex organizations, they are adding new members on a regular basis, and we are converting new business accordingly. They are expanding into nonacute areas, and we are adjusting our service and delivery model to work with them as they expand into these areas. So it is an exciting and challenging time, but we are squarely focused on these customers and getting the model right.

Thanks very much.

I'm not showing any further questions. I'd like to turn the call back to Mr. Smith for closing remarks.

Thank you everyone for calling in today. We look forward to seeing you over the next several months and talking to you about this new and exciting transaction. And we look forward to seeing you soon. Thank you.

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