Owens & Minor Inc (OMI) 2014 Q2 法說會逐字稿

Welcome to Owens & Minor's second quarter 2014 financial results conference call.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Craig Smith, Chairman and Chief Executive Officer of Owens & Minor. Please proceed, sir.

Good morning, everyone. Welcome to the Owens & Minor second quarter 2014 conference call. After I introduce my colleagues on the call today, we will review our results and take your questions. Here with me this morning are: Jim Bierman, our President and Chief Operating Officer; Randy Meier, our Chief Financial Officer; and Grace den Hartog, our General Counsel. Before we begin, Trudi Allcott will read a Safe Harbor statement. Trudi?

Thank you, Craig. Our comments today will be focused on financial results for the second quarter of 2014, which are included in our press release. In our discussion today, we will reference certain non-GAAP financial measures. Information about these measures and reconciliations to GAAP financial measures are included in our press release and in the second quarter's supplemental slide presentation, both of which are posted on our website. Also, our call today will be archived on our website.

In the course of our discussion today, we may make forward-looking statements. These statements are subject to risk and uncertainty that could cause actual results to differ materially from those projected. Please see our press release and our SEC filings for a full discussion of these risk factors. Finally, we'll be participating in several investor conferences in the fall, the RW Baird Healthcare Conference, the Morgan Stanley Global Healthcare Conference and the Credit Suisse Healthcare Conference in November. We look forward to seeing you on the road. Thank you. Craig?

Thank you, Trudi. Before I turn the call over to Jim and Randy, I would like to comment on yesterday's succession announcement. As you may have seen, I will be transitioning from my position as CEO effective September 1. Jim Bierman, our President and Chief Operating Officer will succeed me on that date and will also be appointed to the Board. I will continue with the Company as Executive Chairman and will remain actively involved in strategic planning and leadership development. I have devoted the majority of my personal professional life -- feels like my personal life too, to Owens & Minor. I have watched it grow from a regional distributor to a global $9 billion healthcare logistics services organization.

I have been very fortunate to have great teammates around me over the last 25 years. I am very proud of all that we have accomplished. Now is the ideal time for me to step aside as CEO after three years of investment that have strengthened Owens & Minor's leadership position in our sector. We are continuing to focus on our strategy of connecting the world of medical products to the point of care. We believe we are well-positioned to build on our proven core capabilities, history and strong balance sheet to deliver long-term growth and value creation. Jim has been a key executive at the Company for the past seven years and has the skill and experience to lead Owens & Minor. He has a deep understanding of the Company and its business.

Jim has led our response to the changing healthcare landscape and is directing the investments necessary to drive long-term growth and value creation. I want to truly congratulate Jim as he takes on this new role. I look forward to working with him in a new capacity. Last but not least, before I turn it over to Jim, I want to thank our customers, both manufacturers and providers, our investors and most importantly, our teammates for the support -- sorry, I knew I wasn't going to get through this -- you have all given me over the years. My time at Owens & Minor has been great and meaningful. I want to thank you. With that, I'll turn it over to Jim for his remarks.

Thank you for those kind words, Craig. I'm honored to have the opportunity to lead Owens & Minor at such an exciting time in its history. As Craig mentioned, Owens & Minor has become a vital supply chain services provider to the healthcare industry and is well-positioned to continue to grow and build on our proven core capabilities. The Company's solid foundation and bright future is due in large part to Craig's efforts over his 25 years at the Company, including the last 9 as CEO. I look forward to working closely with him. We're all pleased that the Company will continue to enjoy the benefit of his experience and insight.

Turning to the business at hand, I will provide details on our domestic operating performance and an update on the pending acquisition of Medical Action Industries. This was a highly productive quarter for our domestic segment. We consolidated two of our facilities in the Northeast. We are in the process of establishing a second regional distribution center, this one in California, all of which will increase efficiency in our distribution platform. Moreover, these are two of our larger facilities that serve significant customer accounts. Our investments include physical infrastructure upgrades, IT improvements and new inventory stocking capabilities.

These investments will not only allow us to further leverage our infrastructure, but also to better serve both our manufacturer and our provider customers now and into the future. During the quarter, we also celebrated with one of our large IDN customers, the completion of their new facility. Together, we moved into a new strategic logistics center as part of their new state-of-the-art health services complex in the Cleveland area.

We continue to pursue our strategic initiatives, which are designed in part to help us improve operational efficiency. The results show that domestic SG&A declined this quarter for the second consecutive quarter. Even as we incurred the costs related to the previously mentioned distribution center move, we believe that our efficiency and productivity improvements are taking hold. We witnessed solid revenue growth in the quarter.

As we have seen for many consecutive quarters, the growth was strongest among the largest provider customers and weaker or even declining among the smaller provider customers. While our desire to meet the needs of our larger more sophisticated provider customers drove the redesign of our sales and service model, we remain committed to serving all of our customers with our more complete and cost-effective service. Growth in revenue and expanding acceptance of our service offerings are evidence that our strategy is being validated in the healthcare market.

As we had mentioned before, we are now fully engaged in the transition of a large for-profit healthcare system. This new customer has both acute and non-acute points of care. So we are excited about the potential for growth as our relationship matures. After a delayed start, the conversion process is now underway. As is customary with all large customer conversions, we are incurring some onboarding expenses ahead of the conversion. As revenues with this customer build throughout the year, we should be able to gain greater operational leverage.

Turning now to the pending acquisition. As we recently announced, we entered into an agreement in June to acquire Medical Action Industries, a leading domestic producer of custom procedure trays and minor procedure kits. The transaction is valued at approximately $208 million including assumed debt net of cash. For their last fiscal year, which ended in March, Medical Action reported annual sales of $288 million, of which approximately 45% were sales to Owens & Minor. The transaction is expected to close in the fourth quarter of 2014 and is subject to customary closing conditions including Medical Action shareholder approval.

We're pleased that we learned on Friday, that the Federal Trade Commission has granted early termination of the HSR waiting period. So we are one step closer to closing the transaction. This acquisition supports our strategy of connecting the world of medical products to the point of care. Medical Action's strong capability in tray assembly complement our existing ability to offer unitized delivery services to the provider market. For those of you less familiar with this terminology, our unitized services involve providing a specific selection of products delivered to a unique stocking location for a particular patient procedure. The benefits for the provider and its patients are meaningful.

We are truly excited about the new ways we can serve both our provider and manufacturer customers with the capabilities Medical Action affords us. Our leadership position in healthcare logistics coupled with Medical Action's dedicated clinical sales force creates opportunities for enhanced growth in the domestic kit and tray market. While at the same time, Medical Action's strategy of providing product choice and flexibility to providers complements our logistics focused supply chain services. The acquisition also enhances our partnerships with manufacturers by providing continued market access and enhanced opportunities for products to flow through our unitized delivery services.

In fact over the past year or more, several of our manufacturing partners have been asking us to get into the kitting business. We are pleased to have signed a transaction with an industry leader as our solution to this opportunity. We have a long history with Medical Action, as their most significant channel partner. We are confident in our ability to achieve the identified synergies and to unlock the value in the combination. Our two Companies share similar cultures. We look forward to welcoming the Medical Action teammates to the Owens & Minor family.

Finally, I want to reiterate our three areas of focus in the domestic segment for 2014. First, the evolution of our physical network to meet the changing needs of our provider and manufacturer customers. Secondly, the creation of a single platform capable of serving both manufacturers and providers. Lastly, the expansion of our capabilities in the marketplace to help our customers achieve supply chain efficiencies. We are enthusiastic about our position in the healthcare market and about developing our service portfolio. We strongly believe the adjustments we are making in our business should position us for profitable growth in the future. Thank you. With that, I will turn it over to Randy.

Thank you, Jim. Good morning, everyone. Before providing a review of the quarterly results, I would like to say, congratulations to Jim as he assumes this important position. In working with Jim, I have found him to be a decisive, visionary leader. I look forward to working with him and the team as we continue to build our Company and expand our horizons. I would also like to thank Craig for his leadership and vision in leading Owens & Minor for so many years. His many contributions have put Owens & Minor in a strong position for the future. I am sure everyone on the team joins me in wishing Craig well as he embarks on this new phase of his life.

Turning to the business at hand, I would like to begin with the review of the financial results for the second quarter. Then I'll provide a briefing on the international segment. First, let's look at revenues. Second quarter consolidated revenues improved 3.1% to $2.3 billion when compared to the last year. The quarterly improvement was driven by a 2% growth in our domestic segment, which contributed revenues of $2.2 billion, as well as a 20% -- excuse me, 28% growth in the international segment, which contributed $118 million in revenues to consolidated results. As a reminder, fee-for-service business generally comprises approximately two-thirds of the international segment revenues.

As Jim mentioned, second quarter domestic revenues reflect stronger growth coming from our larger healthcare provider customers offset somewhat by declines from our smaller providers. Looking at consolidated gross margins, we reported $283 million for the second quarter or 12.24% of net revenues, reflecting an $8.9 million increase when compared to last year. This increase came primarily from growth in the fee-for-service business in the international segment. In the domestic segment, quarterly gross margin declined largely due to lower benefits from supplier price changes when compared to last year, as well as lower margin on our new and renewed customer contracts.

This reflects a continuation of the trends we saw in the first quarter. As for operating expenses, consolidated quarterly SG&A expenses were $226 million or 9.79% of revenues, reflecting a 28 basis point increase compared to last year. The increase in expenses resulted from the international segment, where we experienced higher cost to serve growing fee-for-service activity and increased cost to integrate and serve a significant new customer in the UK. As Jim mentioned, second quarter domestic SG&A was lower on both a dollar and a percentage of revenue basis compared to the prior year. Adjusted quarterly operating earnings excluding pre-tax acquisition-related and exit and realignment costs of $7.6 million were $44.7 million or 1.94% of revenues.

On a segment basis, quarterly domestic operating earnings decreased nearly $3 million to $48 million. The international segment reported an operating loss of $3.6 million for the quarter due to the factors we have discussed. For the quarter, pre-tax acquisition and related costs were approximately $3.5 million, while exit and realignment charges of $4.1 million resulted from the previously mentioned strategic initiatives in the international and domestic segments. In Europe, exit and realignment activities included initiating the closing of the Stuttgart office as well as staff realignment actions and the initiation of additional facility closures.

Actions taken in the domestic segment were related to the strategic initiatives designed to streamline efficiency and improve productivity, including distribution center closures and the establishment of a second regional distribution facility, this one on the West Coast. At this point in the year, we estimate that exit and realignment charges for the year will exceed our previous outlook, as we are taking more significant steps with our European operation given the recent performance. Our tax rate increased to 41.1% for the quarter. The increase was due to the impact of foreign taxes and certain acquisition-related costs that were not deductible. We would expect that the rate will remain at a similar level for the remainder of the year.

Operating cash flow for the year-to-date period was $73 million. On a consolidated basis, asset management metrics were stable including inventory turns of 10.2 times and DSOs of 20.6 days. Turning to the bottom line, second quarter adjusted net income was $25 million or $0.40 per diluted share compared with $0.46 per share for the second quarter last year. For the year-to-date, adjusted net income was $52.7 million or $0.84 per diluted share compared with $0.90 for the same period last year.

With that update, I would like to turn to our financial guidance for 2014. Based on our financial and operational results so far this year and our expectation for the remainder of the year, we now expect revenue growth to exceed 2% and adjusted net income per diluted share to be within the range of $1.80 and $1.90 for the year, which excludes acquisition-related and exit and realignment costs along with the impact of the Medical Action acquisition. With that review of our financial results, let's turn to the international segment and the actions we are taking with the Movianto platform.

The international segment posted a $3.6 million operating loss for the quarter resulting from the UK operation. The continued integration of a large customer plus reductions in other customer activity contributed to the operating loss. During the quarter, the UK team under the guidance of new Owens & Minor Europe leaders worked aggressively to stabilize operations with the new large customer. We made investments during the quarter in order to drive operational improvement in the second half of the year. So far these efforts have been focused on further integration, stabilization and overall cost control. We are seeing signs of performance stability with the large customer.

On a positive note, excluding the results of the UK division, Movianto was profitable for both the quarter and the year-to-date period. Based on the progress we are making, we anticipate that the Movianto platform will have a modest positive contribution during the second half of the year. As you can see from exit and realignment charges incurred during the quarter, we are taking more aggressive steps to rationalize the European platform.

During the quarter, we initiated the closing of the Stuttgart office and will be moving key administrative functions such as IT, finance and human resources to the UK. We intend to use Owens & Minor Europe platform to expand our business overseas and integrate any future acquisitions. We expect the Owens & Minor Europe team to identify opportunities for expansion while providing leadership in achieving improvements and efficiency and productivity throughout the European operations. Ultimately we believe Owens & Minor Europe will ensure consistency in our strategic and technical efforts while establishing a greater brand and marketing presence.

Looking ahead to the rest of the year with our European segment, we continue to build our sales pipeline. We are planning to onboard three new customers in the in the third quarter. We are transitioning the Movianto team and operations to more fully align with the Owens & Minor structure. The entire team is now reporting to Charlie Colpo, one of our most experienced operational leaders. While our near-term efforts have been aimed at stabilizing the UK division as quickly as possible, we remain focused on the future as we prepare our platform across Europe for the profitable growth opportunities.

Consistent with our efforts in the domestic segment, we are now focusing on three areas as we work to achieve sustainable, profitable growth. First, we continue to evaluate the physical network in Europe to ensure that it meets the needs of our customers and operates as efficiently as possible. Second, we are evaluating the IT infrastructure needs of the European network to ensure that we have the right systems to efficiently serve our business needs. Finally, we are looking to align our global capabilities and cross sell our services throughout the European platform. Thank you. With that, I'd like to turn the call over to Craig.

Janine, let's open it up for questions, please.

(Operator Instructions)

Glen Santangelo, Credit Suisse

Craig, best of luck to you in your new endeavors. Jim, congrats on the promotion.

Thank you, Glen.

Thank you, Glen

I just want to talk to you real quickly about the margins in both the segments. First, on the domestic segment, I feel like the GPO renewals was really a 2013 story. Now you're blaming maybe worse than expected margins on customer renewals and price inflation or lack of price inflation. I feel like we knew that the first half presented a difficult comp. So I guess I'm really kind of trying to probe to figure out what really surprised you intra quarter here, that really led to the lower than expected margin result?

Yes, Glen, let's talk a minute about the timing of the GPO renewals and really, as this business comes on. Because I do think -- we are -- as a quarter-to-quarter or year-over-year comparison, it takes four quarters to lap the comp from the prior period. I think although contracts were signed in the latter part of 2013, some of those contracts didn't actually take effect until the -- more closer to the beginning of 2014. As we've talked about on numerous occasion, not all large provider customers within a GPO have their contracts coterminous with the GPO renewal.

So I think we need to be careful about looking too literally at sort of the timing of a large GPO renewal and when the results continue to work their way through the system. That being said, going back to the essence of your question which is, where does the margin compare or relate to what we were targeting as we've thought about 2014. I guess my reaction to that is, quite candidly, we are lagging a little bit behind, not dramatically, but behind where we thought we would be. Some of that has to do with the manufacturer's side of our business.

We are seeing an unbelievable amount of interest in our offering from manufacturers. The number of manufacturers I met with over the course of this last quarter was significant. The interests in our offering are significant. But the timing on some of that is difficult to predict. I think quite candidly, as we thought about 2014 back in December of 2013, our expectations were that the market would move towards us a little quicker with some of our offering. The last point I'd make -- I don't mean to belabor this, but you know as us well enough, historically, if we had seen the relatively small gap in the provider margin, we would have been in position to reduce SG&A concurrently with that decrease with that gap.

I think right now we are in a somewhat unusual position that we have challenges we do see in that SG&A because of the commitment we have to onboard a large healthcare system. So we are carrying a bit of excess capacity while we onboard that system. As I said in my prepared remarks, we expect to achieve better, more optimal operational performance once the conversion is done. But it was a phenomenon that's kept us in the first half of the year from being able to reduce SG&A to match the more revised gross margin domestically.

Jim, I appreciate all those comments. Maybe I could just follow-up with one on the international segment. Last quarter, I think you commented that the onboarding cost of this significant customer in the UK was $1.5 million. I think that's what you spent in the first quarter. Is there a comparable number you can give us in the second quarter? I'm just kind of curious maybe if you could get a little bit more granular in terms of what the integration issue is, because I feel like this has been kind of six months.

So, I'm guessing, what really surprised you with respect to the integration? Or is the pricing becoming an issue? If you could just talk a little bit more specifically, because if you look at your new guidance, it still implies a reasonably significant ramp sequentially in the second half of the year, which I guess you're assuming margins in both segments are going to recover in the second half. Without knowledge of the UK customer, I'm not sure what gives you confidence that's going to be the case.

That's a good question, Glen. Let me ask Randy to comment both on the guidance side of it and then the UK margin issues.

Sure, Glen. With regard to the European margin, specifically what's going on in the UK, as we suggested in the first quarter, we had just began to onboard the customer in March. Those activities continued through the second quarter. We had similar costs, if not even slightly higher costs, as we went through that process in the second quarter. We've stabilized the situation with that customer. There was a fair amount of turmoil, not just on our side but with the customer in question here.

We're pretty pleased with all the activities and where we ended up at the second quarter. So we are -- remain fairly confident that as we move into the second half of the year, broadly, we'll start to see contribution to the overall earnings in the second half of the year. I think one other comment with regard to the UK, we also mention in the first quarter that we saw a reduction in customer activity even outside the single customer that we were onboarding. That has continued to persist in the second quarter.

We are taking fairly aggressive actions as we look ahead to make sure that we've got the appropriate sized organization in the UK to manage our existing book of business. So I think again, we'll be in a good position to improve the overall performance in the second half of the year. I think with regard to the broader gross margin and how it impacts earnings, as we've indicated back on investor day and throughout the first half of the year, that in large part this was going to be a second half of the year story. We continue to be reasonably confident that will materialize, as Jim indicated, with a few larger customers coming on board.

In the second half of the year, we've completed all of the activities around bringing on board a number of the GPO contracts that we signed last year. As we indicated on investor day, that we would incur some costs throughout the first half of the year. Again, over in Europe with the adding of three new customers in the third quarter and the ongoing efforts to improve the situation in the UK. As we noted in our remarks, the profitability that the rest of the network has, we feel fairly confident that we'll see positive contributions in the second half of the year.

Okay, thanks for all the comments.

Thanks, Glen.

Eric Coldwell, Robert W Baird.

Let me reiterate the congratulations to both Craig and Jim. Good luck with all the future initiatives. Really, I want to dig into a couple things here. First off, domestic growth, you made some comments -- obviously, we saw in the numbers a little better domestic growth. You've said, this quarter as well as in the past that larger clients are growing faster than smaller clients. I think that's very consistent with what you've said. But what I'd like to parse out here is, are you really seeing any inflection in the market overall? Or is the better than expected topline growth in domestic this quarter more of a situation of perhaps OMI taking net market share. I don't know if you can parse that out the way you have in the past, but you have been able to give us pretty good details in historic reports about what drove the revenue growth in the quarter.

Yes, Eric, great question. One that we deliberate here ad nauseam. Let me give an anecdotal comment, as we've met with a number of our provider customers over the course of the quarter, quite candidly, we're beginning to hear, in pockets of the United States, provider customers beginning to talk about an increase in utilization. The root cause of it is still somewhat speculative in that you have many forces coming together simultaneously. You have an improvement in the economy, which we have always said from the outset was critical to seeing the recovery in utilization. You certainly have the impact of the Affordable Care Act and the additional covered lives as being at least two of the drivers.

You have an element of pent-up demand coming out of the first quarter. Which of those are the true drivers, I'm not sure anyone will ever really know. The critical question you're alluding to is, the sustainability of this and is it -- are we, the industry, in position to make a call on this. We think it's premature. We think also -- Craig was sharing this with me the other day based on his 25 years of experience-- he was telling me that in similar economic downturns, what we've seen is about a six-month delay from the time that utilization begins to pick up before we see a full return to normal buying behavior through our channel.

Stated another way, I think there's going to be some unevenness as providers and, to a degree, manufacturers build up inventory once the trend becomes more sustainable. So a long-winded answer to your question. We think and believe we are taking share. We think and believe that our large customers are taking share from smaller customers. That's harder to specifically quantify. But I think it would be disingenuous for us to sit here and say that there aren't some underlying trends that are beginning to formulate within the industry.

That's helpful. Let me just shift gears quickly to Movianto with one additional question. It's nice to hear that Charlie's taking over more of the leadership activity there with Movianto. I'm curious if any of the past leaders that have been announced to the Street or introduced to the Street -- have any of those actually left the business? Or are they simply somewhat repositioned at this point?

Then what would be the Company's views of the long-term leadership agenda in international? Is this going to be a -- something that Charlie sticks with for the next three to five years? Or is he simply spearheading the resurgence of that business and then there will be somebody who steps in full-time to lead the international? I'm just curious, what the long-term thinking is in that segment?

Yes, Eric, I think -- first of all, I think we are so fortunate to have someone with Charlie's both experience and trust factor within the Company and his willingness to relocate to the UK to help work through this. So we truly appreciated his contribution. That being said -- you've known me and others on the call have known me long enough to know that I've worked through, in the history of my career, challenges in Europe before.

I truly believe that Europe needs to be run by Europeans. We will move forward with looking for a solution for that as it relates to the UK. I think that as Randy said, the rest of the Movianto business and European part is really operating pretty well. We're happy with the leadership and the efforts as it relates to Europe in general. But we do have a problem in the UK. We do need to solve that.

Okay, thanks very much. I'll get back in queue, if I need to. Thanks very much.

Thanks, Eric

Robert Jones, Goldman Sachs

Again, let me echo the congratulatory comments already made. I wanted to ask around the back half guidance and specifically some of the comments are on utilization. Even with the reduced outlook, it looks like the back half is implying somewhere around 20% growth over the first half. I'm curious, Jim, based on maybe some of the early indicators you're seeing around pickup in utilization. Is there any piece of the back half that is predicated on utilization getting better? I guess if not, asked the other way, is there any upside in your mind to where you see the business in the back half, if in fact, this early signs of utilization taking hold actually continues?

Yes, good question, Bob. I'd say that the major driver in our thinking on the back half of the year domestically is the full conversion of this large healthcare system that we've spoken about. I think that's the major impact. So that being said, if utilization was to significantly increase, we would have upside in the back half of the year.

Okay, great. Then I guess just if I could take a step back and ask one big picture question. It seems like around the domestic business pricing certainly has proven one tricky area to predict. But I think the broader backdrop over the last -- past several years has really been around a mix shift towards the larger providers and consolidation's obviously pushing that forward. Any sense you can give us today as you think about that evolution and where we are in it?

Yes. (laughter) This is just my personal view. I think we are still relatively early on in the consolidation affiliation play, quite candidly. I think it will play out for a while to come. It may take a different form than what we've seen, certainly initially. But I think there will continue to be consolidation in the marketplace. I do agree with your premise at the outset that this is a bit of a mix issue as one looks at a shifting landscape between customers.

Makes sense. Best of luck in your new roles.

Thank you.

Lisa Gill, JPMorgan

My congratulations as well. Craig, I'll really miss talking to you after all these years. I thought that maybe I would just start with some questions around the acquisition that you're actually making. Do you have any insights into the customer overlap between who you're serving today and Medical Action, who they're actually selling their trays and kits to?

Yes, Lisa, I think -- this is off the top of my head but the overlap is pretty good. We've enjoyed the relationships that we've had with Medical Action, geez, I think, Craig, it's been 35 years, right? So it's a long time relationship. In contrast to other manufacturer of kits, they do not compete with us for distribution services. So we've always enjoyed working together with them with a very complementary customer base.

So I guess looking at it from another direction though, do you see a broad-based opportunity to increase the penetration of their medical kits into the rest of your existing base?

Well, I think what we've found, Lisa, is that as we have responded to opportunities that have existed in the marketplace -- that we've found ourselves occasionally at a disadvantage because we don't have an offering in this space. So I think, yes, we are viewing this as having significant upside in expanding the joint Medical Action/Owens & Minor offering in the marketplace. I would also point out, and I alluded to this a little bit in my opening comments, but the offering is just as important or critical to our manufacturing partners.

They are asking for a solution in the marketplace for something that truly is product neutral relative to what goes into the kit. Our position as the distributor of choice for branded manufacturers definitely plays well with that. So we view it as the opportunity as being, yes, increasing the offering to the providers, but just as importantly, aligning ourselves with the manufacturers.

Okay, great. Then just, second, to your comments around utilization, is there any way that when you look at the utilization -- is it broad-based across all of your customers today? Or are you seeing specific areas of the country where you're seeing this increase in utilization? Or is it big hospital versus smaller hospitals? Is there any way for us to look at than more acutely?

Yes. I think as I tried to allude to before, I think it's pockets of the United States. I'm not even sure that I can be as specific as saying, it's the Southeast versus the Southwest. But it is pockets of the United States. It is definitely the larger systems. We serve a large number of the for-profits. I think their comments are to a large degree what we are seeing also through our systems on a broader scale.

Okay, great. Thank you.

Thank you, Lisa.

Robert Willoughby, Bank of America Merrill Lynch

I jumped on a bit late. I was wondering, did you speak to what drove the inventory spike? Is that the new customer onboarding efforts that you're anticipating? If so, can we reasonably expect the inventories to be converted to cash this year? Or will it take more time?

You know us too well, Bob. Yes, absolutely. We built inventory in anticipation for the beginning of July go live with this large customer. Completing a conversion of that magnitude seamlessly is absolutely critical to us. As you've seen in the past and allude to, we will build inventories in anticipation of that. Then we will drive those inventories down over the course of the remaining back half of the year. So that's exactly what you saw.

Okay. With the Medical Action deal, you mentioned the cost savings opportunity. Are there any working capital requirements or investment that business may need? Or are you able to harvest any capital out of that business, assuming it closes?

Yes. Robert, this is Randy. I think as we move forward, we don't see as having a significant working capital opportunity. Obviously, a slightly different business than what we are in terms of the way we move inventory. Given that a fair amount of their product moves through our existing channel today, we don't see that as being a significant issue going forward. On the other side of the coin though, I think we do have the opportunity to sort of manage this over the next 12 to 18 months in terms of integrating it into our overall system in a fairly seamless fashion.

No facilities opportunities, anything like that?

We've got the one facility up in Brentwood, their headquarters building that obviously would be duplicative to our efforts. Certainly, that's something that we are considering as we move forward.

Okay, perfect. Thank you.

Sean Dodge, Jefferies.

So staying on the Medical Action acquisition, you mentioned $10 million to $12 million in synergies by the end of 2016. Could you put some bookends around how much of that you expect to achieve in 2015? Or maybe even how accretive to EPS you expect it to be next year?

I think right now, given where we are in the transaction, it's a bit premature to give you some of the specifics on when we might achieve things on a quarterly basis. I think where we are right now is, we do expect this transaction to close this year. It would probably have very minimal impact on the overall earnings this year. We are confident in our ability to achieve an accretive transaction next year. I think where we were trying to go with the $10 million to $12 million is we would be in a position by 2016 to fully realize that amount on a run rate. So I think that you can sort of think about it in those terms.

Sure, okay. Randy, on the international side, you've been doing a lot of work to fill and right size capacity there. How close does the ramping of the large UK client and then the shuttering of the Stuttgart office get you to where you want to be? Or I guess asking it differently, where will utilization stand once that client is up and running and Stuttgart is closed?

Great question. I think a clarification on a couple things. The Stuttgart office is purely an office facility. It wouldn't have any real impact to overall capacity utilization rates. This was something that we recognized as far back as the acquisition. As we put our own structure in place and began to align the organization, it became a bit redundant. So we are taking steps to close that facility over the course of the next 6 to 12 months.

In other areas, we continue to look at the network and take steps to rationalize capacity, particularly in the UK business. We've got a bit of two different situations. We've got the onboarding of the new customer that we've been spending a lot of time with and have gotten stabilization, which certainly is contributing to improving the operating performance going forward. But we have run into a situation, particularly in the UK, where we seen a fairly significant slowdown in customer activity.

So we are in the process of evaluating our footprint in the network. We expect to take some pretty significant steps in the second half of the year to rationalize some of those facilities, which will have an effect of improving overall capacity utilization. We are pleased though with the three new customers that we are onboarding in the third quarter. We should see, as we end the third quarter, some incremental improvement in our overall capacity utilization.

Very good, thank you.

Steven Valiquette, UBS.

So Jim, congrats on the new role.

Thank you, Steve.

Craig, congrats on a great career.

Thank you.

So just for me, also just a couple questions here around the Medical Action deal. I guess first, you mentioned that the revenue synergies are excluded from the accretion guidance. So I'm definitely curious just to hear more I guess, at least, just conceptually about potential avenues for revenue synergies. So that's question one.

But then, number two on the flipside, obviously 45% of the company's product sales are distributed through OMI, so you obviously know the company well. But also 20% of the revenues are distributed through Cardinal Health. So just curious -- I just want to make sure there's no potential risk for lost revenue within Medical Action as result of your ownership. Hopefully, there's no channel conflicts. I just want to hear about both sides of that. Thanks.

Yes. Good question, Steve. Let me talk about the more philosophical impact on revenue and revenue synergies. Then answer the question on the channel issue. I think, as we think about the potential for revenue in Medical Action, I really go back to some of the comments I made earlier, which is the potential to partner with manufacturers to take our kitting opportunities to really a different level in the marketplace and really provide the acute care market with a different type of service. I think we are excited about this as an opportunity. We are excited about bringing it together with what we used to call our SurgiTrack offering into a more fulsome, unitized delivery offering.

I think probably to do justice to it, we need to talk in a more expansive setting, which I would say would lend itself more to investor day. I think as we begin to pull together these pieces and feel more comfortable sharing the details with the investor community, I think you'll see why we're excited about this as a great opportunity going forward. On the second part of your question regarding the business that Medical Action that goes through other distributors, this isn't unusual. We have situations, certainly, where other manufacturers who distribute certainly go through our channel. We would expect the same courtesies that are extended in going through their channel.

Okay. I look forward to future updates. Thanks.

David Larsen, Leerink Partners

Jim and Craig, congratulations to both of you on your new roles. Can you maybe talk a bit about -- you said one of your strategies going forward is delivering new products and services to the provider community. Can you expand on that a little bit? As care shifts to lower-cost settings, for example, doc offices and alternate sides of care, can you talk about any plans that may exist to meet that demand? Thanks.

Absolutely. So I think there are two examples of the expansion of products and services to the provider community. The first is the one that we've talked about today related to the Medical Action acquisition. But I would characterize as the ability to deliver a unitized delivery, which fundamentally is the delivery of a product of -- either bundled with other products for a specific procedure. The benefits to the provider customer include a greater transparency on the cost associated with the products that are consumed or used in conjunction with a specific procedure. So I think we're advancing down that path.

As it relates to expansion into the non-acute space. We've been very open that our strategy is to work with the large IDNs as the large IDNs expand their footprint through the entire continuum of care. We have positioned ourselves and fully intend to have capabilities to serve them as they expand. So we do have capabilities to reach medical office buildings and the doctor's practices as well as the non-acute sector. But we tend to focus our efforts in those areas as it relates to the large IDNs and their expansion into the non-acute space.

Great, thanks. That's great. Then, you mentioned there were three more clients coming on, I think in the third quarter. Was that in the international or in the domestic segments? Then can you maybe just talk a little bit about costs that might be tied to them? Or revenue that might be tied to them? Then you mentioned there's a slowdown in activity in the UK, can you just describe sort of what's causing that? Thanks.

Yes, specifically the three new customers are European. I'll have Randy, if he would, comment on that.

Sure. David, we are going to be onboarding three new customers, all three of which we've already been preparing for in terms of the activities that lead to onboarding. We've got one significant one coming on in one of our German facilities, another one up in Denmark. We are in the midst of having a long-delayed customer on board in the UK which will help contribute to the improvement in the second half of the year. So we do expect to see again some nice recovery as we go to the second half of the year.

In terms of where we are in the UK market, what we were alluding is we've just seen in our fee-for-service, particularly in the UK, some slowdown in pallet utilization in one of our customers which has led to some softness in the gross profit area there. As a result of that, we are looking the number of facilities and our cost structure to see if we can't right size our asset base and network, which is fairly extensive in the UK, to meet our current demand and reevaluate the ongoing business in the UK market.

Okay. That's great. Then just one last one, for the acquisition, I think you had $288 million in revenue with 45% of that in sales to Owens & Minor. I'm kind of assuming that Owens & Minor then turns around and sells those products to your customers. So in terms of incremental revenue, should it be about 55% of the $288 million?

Precisely, right.

The exact path.

Okay. Thanks a lot.

Thank you

All right, everyone. I want to thank you for calling in today. I want to thank you for your questions. We'll see you soon. Thank you.

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