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Edited Transcript of OMI earnings conference call or presentation 6-Nov-19 1:30pm GMT

Q3 2019 Owens & Minor Inc Earnings Call

MECHANICSVILLE Nov 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Owens & Minor Inc earnings conference call or presentation Wednesday, November 6, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Chuck Graves

Owens & Minor, Inc. - Director of Finance & IR

* Edward A. Pesicka

Owens & Minor, Inc. - President, CEO & Director

* Michael Wayne Lowry

Owens & Minor, Inc. - Senior VP, Corporate Controller & CAO

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Conference Call Participants

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* Anne Elizabeth Samuel

JP Morgan Chase & Co, Research Division - Analyst

* Brett Richard Gasaway

UBS Investment Bank, Research Division - Equity Research Associate of Healthcare

* Erin Elizabeth Wilson Wright

Crédit Suisse AG, Research Division - Director & Senior Equity Research Analyst

* Jack Rogoff

Goldman Sachs Group Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to Owens & Minor's Third Quarter 2019 Financial Results Conference Call. My name is Gigi, and I will be your operator for today. (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. Chuck Graves. Please proceed, Mr. Graves.

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Chuck Graves, Owens & Minor, Inc. - Director of Finance & IR [2]

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Thank you, operator. Good morning, everyone, and welcome to the Owens & Minor Third Quarter 2019 Earnings Call. I'm Chuck Graves, and on behalf of the team, I'd like to read a safe harbor statement before we begin.

Our comments on the call today will be focused on financial results for the third quarter of 2019, which are included in the press release we issued earlier this morning. We will also be discussing certain organizational changes which were included in a separate press release. Please note that certain statements made on this call are forward-looking statements, which are subject to risks and uncertainties. These forward-looking statements are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. All statements made on this call today other than statements of historical facts are forward-looking statements and include statements regarding our anticipated financial and operational performance.

Forward-looking statements made on this call represent management's current expectations and are based on information available at the time such statements are made. Forward-looking statements involve numerous known and unknown risks, uncertainties and other factors that may cause our actual results to differ materially from any results predicted, assumed or implied by the forward-looking statements.

The company has explained some of these risks and uncertainties in its SEC filings, including in the Risk Factors section of its annual report on Form 10-K and quarterly reports on Form 10-Q. Except as required by law or the listing rules of the New York Stock Exchange, the company expressly disclaims any intent or obligation to update any forward-looking statements. Additionally, in our discussion today, we will reference certain non-GAAP financial measures, and information about these measures and reconciliations to the most comparable GAAP financial measures are included in our press release and our quarterly report on Form 10-Q.

I am joined this morning by Ed Pesicka, our President and CEO, and who will provide commentary on the third quarter results and outlook for the business as well as recent organizational changes; and Mike Lowry, SVP, Chief Accounting Officer and Interim Chief Financial Officer; who will discuss our third quarter results; and Jon Leon, SVP and Treasurer.

Now I would like to turn the call over to Ed, who will start things off this morning. Ed?

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Edward A. Pesicka, Owens & Minor, Inc. - President, CEO & Director [3]

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Thank you, Chuck. Good morning, everyone, and thank you for joining us on the call today.

After spending significant time with our customers, supplier partners and teammates since joining Owens & Minor earlier this year, it became clear we need to make changes to strengthen the alignment of our organization with the needs and demands of our customers and the marketplace.

This morning, I announced these changes, including Mark Zacur as Chief Commercial Officer and Jeff Jochims as the Chief Operating Officer. Our new structure will speed decision-making, enable us to more quickly and efficiently provide the best solutions in the industry and more closely integrate the needs of our customers. Mark and Jeff and our entire team remain keenly focused on serving our customers and on our ongoing productivity and efficiency initiatives to drive operating improvement for the benefit of all of our stakeholders.

In addition, I am pleased to welcome Andy Long to our team as Chief Financial Officer. I have known Andy for many years, including working closely together at Thermo Fisher Scientific. He is a dynamic leader with deep financial acumen and skilled in a wide range of business models including distribution, manufacturing and services with experience in health care, life science, biopharma and industrial sectors.

I also want to thank Robert Snead. We appreciate Robert's long and unwavering commitment to Owens & Minor and his willingness to assist in this important transition.

So let me move on to the results and performance of the third quarter. I will provide my perspective on the third quarter performance, and Mike Lowry will discuss the third quarter financial results in detail in a few minutes.

We had another successful quarter. I'm excited to announce that we had back-to-back quarters with significant sequential improvement. Here are just a few of the highlights from the third quarter.

First, we saw continued sequential growth in both operating income and EPS compared to the previous quarter. Our operating income grew 57%, while adjusted operating income grew 15%. Related to EPS, net income per share increased by $0.20, while adjusted net income per share increased by $0.10, both increasing by 100% or more.

Second, we continue to generate strong operating cash flow. We generated $110 million worth of operating cash flow in the third quarter alone, and the combined second and third quarter operating cash flow was over $200 million. These cash flow results were driven by improvements in both operating income and working capital management. And I'd like to emphasize that we were able to improve key major working capital metrics while at the same time improving service levels.

Third, I am pleased to report that we continued to strengthen our balance sheet. We reduced our debt by $72 million in the third quarter. And over the last 2 quarters, we have reduced our debt by more than $130 million. Based on this, it should be clear that we are committed to deleveraging the balance sheet. In addition to the debt reduction, we have invested nearly $40 million in capital improvements in the business so far this year, along with many other incremental noncapital investments.

Fourth, we continue to improve our service levels. As a matter of fact, our service levels are now back to the historical high levels that Owens & Minor is known for. To better understand this, let me share a few examples with you.

First, our shipping accuracy is now nearly 99.9%. So let me put this into perspective. If you would order products from Owens & Minor every day for nearly 3 years, you would receive an incorrect product or quantity only once over that period of time.

Next, we are proactively working with our external supplier partners on initiatives such as advanced shipping notice with pallet level information along with other initiatives. This collaboration has resulted in improved inbound scheduling and receiving, which factors into improved productivity and improvement of both fill rates and on-time delivery. This strong performance and consistency of our service gives us confidence that many of the past service issues have been resolved. However, we will continue to drive additional initiatives to further improve and provide innovative services.

And fifth, Byram continues its strong performance in the fast-growing home health care segment. As you can see, these 5 items just discussed, it is clear that our teammates are actively embracing our focus around serving our customers and driving productivity, resulting in improved profitability and service.

While I am pleased with the positive momentum in the business, we must continue to maintain our diligence and focus that we have displayed over the past 2 quarters to mitigate the impact of customer nonrenewals and Fusion5. For the remainder of the year and into 2020, we will continue to focus on profit improvements to offset revenue headwinds related to the previously discussed customer nonrenewals. In fact, this quarter, we began to feel the revenue impact of the large customer exit mentioned in the first quarter, and we expect to see additional impact from this customer exit in the fourth quarter and in next year's comparisons. We will continue to mitigate this impact through productivity improvements, new customer wins and an ongoing mix shift into more profitable, higher growth businesses.

In addition, as we have mentioned previously, timing of revenues related to our early-stage, value-based care management business, Fusion5, continues to be a variable. And we expect it to have an impact of $0.06 per share on our 2019 annual financial guidance. Mike will provide additional details in a few minutes.

You may recall, I mentioned in the last earnings call, 4 areas that we need to prioritize to stabilize and grow our business. So let me provide an update on our progress.

First, I continue to challenge our team and myself to drastically increase our intensity while maintaining a high level of intention on serving our customers. Appointing Mark Zacur as the Chief Commercial Officer is an example of the importance of customer focus. Mark will be responsible for aligning Owens & Minor go-to-market strategy, enhancing the company's ability to adapt to the changing health care landscape and offer the best and most relevant solutions in the industry.

However, I want to be clear. I will personally continue to make customers our priority. I will not let up. I will continue to engage in significant interaction with our customers, including customer meetings, quarterly business reviews and RFP presentations. We, as an organization, will continue to listen to our customers, deliver on our promises and never take customers for granted.

Second, as evidenced by our announcement today, we have been successful in bringing in world-class talent into the organization as well as promoting from within as appropriate. The announcement today is an example of our ability to continue to bring in this level of talent as well as structure a more streamlined organization capable of executing our strategy while increasing the speed of our decision-making. Doing so enables us to more quickly and efficiently provide the best solutions in the industry and more closely integrate with the needs of our customers.

Third, the vast amount of data that we collect is now being used to drive operational efficiencies, profit improvement, along with improved and innovative services to best serve our customers. We will discuss this more in the future quarters.

Finally, we are instilling a higher level of accountability and authority to honor our commitments to our customers, stakeholders and teammates.

In closing, I am pleased with the positive momentum in the business. Looking forward and excluding Fusion5, we expect sequential improvement trends from this quarter to continue into the fourth quarter, albeit at a much slower pace. In addition, we expect the appropriate use of working capital to invest in both holiday and flu inventory buy to provide assurance that in the first quarter of 2020, service will remain at the required levels. Also, we expect continued customer focus with diligence around productivity initiatives to drive operating improvements in our core businesses, the distribution channel, our product manufacturing, our home health care and our acute care services.

While we are ahead of the long-term recovery plan I envisioned when I joined in March, we recognize that there are still significant amount of work ahead. We will not take our customers for granted, and we will provide the highest level of customer focus while maintaining industry-leading integrity.

Finally, I'd like to take this opportunity to welcome Mark Beck and Bob Henkel to the Owens & Minor Board. Their leadership experience and operational expertise will add depth and perspective to our board.

Thank you for your time today, and I will now turn the call over to Mike for a discussion of our third quarter results and outlook for the rest of the year. Mike?

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Michael Wayne Lowry, Owens & Minor, Inc. - Senior VP, Corporate Controller & CAO [4]

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Thanks, Ed, and good morning, everyone. Today, I'll start with a review of our third quarter financial results and then comment on our outlook for the year.

For the third quarter, revenue was $2.4 billion, a decrease of 2.7% compared to prior year. Year-to-date revenue was $7.34 billion, a 0.7% increase compared to last year. Foreign currency had a negative impact on revenue growth of 30 basis points for both the quarter and year-to-date. The decline in the third quarter was from lower Global Solutions revenue partially offset by growth in the Global Products segment. As a reminder, we acquired Halyard on April 30, 2018. Halyard sales from January through April 2019 were $255 million, net of $71 million of intercompany sales. I'll provide further comments regarding revenue a bit later when discussing segment results.

Net income for the quarter was $1.2 million or $0.02 per share and adjusted net income for the quarter was $12.2 million or $0.20 per share. Year-to-date adjusted net income was $19.3 million or $0.32 per share. On a constant currency basis, adjusted net income per share was $0.22 for the third quarter and $0.34 year-to-date.

Now let's look at our segment results for the third quarter. Global Solutions third quarter revenue was $2.15 billion compared to $2.24 billion in the prior year. This decline was primarily in our distribution business, partially offset by strong revenue growth in Byram and solid growth in our manufacturing solutions business in Europe. The distribution revenue decline was primarily from customer nonrenewals including the initial impact of the large customer transition that was mentioned earlier this year. We expect this transition will be completed during the fourth quarter, which will be a headwind for the balance of the year and through 2020.

Segment operating income for the quarter was $26 million compared to $24 million last year. This increase was primarily from gross margin expansion, consistent with the change in our revenue mix among our business lines partially offset by increased expenses to support revenue growth in these business lines.

Turning to the Global Products segment. Third quarter revenue was $360 million compared to $350 million last year and operating income was $17 million compared to $28 million last year. Operating income was negatively affected by revenue mix, margin pressure and foreign currency, partially offset by favorable commodity price trends.

Now let's turn to cash flow and the balance sheet. In the third quarter, we generated $110 million of operating cash flow. Consistent with the second quarter, operating cash flow was driven primarily by working capital improvement and increased operating income. In fact, $200 million in operating cash flow has been generated over the last 2 quarters. As Ed mentioned, the fourth quarter is typically not as strong from a cash flow perspective due to seasonal impacts on working capital as we build inventory for the flu season and for the holidays to ensure continuity of supply for our customers.

Total debt was $1.61 billion at September 30, representing a reduction of $72 million compared to the second quarter, and we have paid down $130 million of debt in the last 2 quarters. Deleveraging the balance sheet continues to be one of our top priorities. Overall, we are pleased with the third quarter results and the continued progress we're achieving quarter after quarter in operations, working capital management and debt reduction.

Let's turn to our outlook for the rest of the year and the catalyst for our guidance adjustment, which is Fusion5's revenues. During last quarter's call, we mentioned the following related to Fusion5's revenue. First, a large portion of Fusion5's projected revenues are based on savings achieved under the CMS bundled care program known as BPCI Advanced. Second, we expect it to realize revenue associated with the first 6-month period of the program during the fourth quarter of this year. And third, these initial revenues are difficult to predict, and this has indeed been the case.

To date, CMS has not released the information necessary to record the savings-based revenue during the fourth quarter. Therefore, we are left to estimate less Fusion5 revenue in the fourth quarter, and this will have a negative impact to our previously issued 2019 financial guidance of about $0.06 per share. In summary, the company now expects 2019 adjusted net income per share guidance to be in a range of $0.60 to $0.65, which excludes the impact of Fusion5 and foreign currency.

Thank you. And with that, I'll turn the call back over to the operator to begin the Q&A session. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Erin Wright from Crédit Suisse.

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Erin Elizabeth Wilson Wright, Crédit Suisse AG, Research Division - Director & Senior Equity Research Analyst [2]

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Great. How should we think about the impact from the large customer loss that you previously announced? I guess how much of it was in the quarter? And then how should we think about the quarterly progression of that impact? And when will we fully lap that impact, I guess, in next year?

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Edward A. Pesicka, Owens & Minor, Inc. - President, CEO & Director [3]

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Yes. Thank you, Erin. So the way we should think about it is in the third quarter, we began -- that biggest business began moving away. That will completely finish out in the fourth quarter, and then it will continue to last in through next year. So that's really the way to think about it. What we've done is we've continued to look at ways not necessarily in the short term to offset the top line but continuing to drive different productivity initiatives to mitigate the impact on the bottom line of that.

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Erin Elizabeth Wilson Wright, Crédit Suisse AG, Research Division - Director & Senior Equity Research Analyst [4]

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Okay. All right. And then on Fusion5, can you break down what the revenue impact is? And how we should be -- I'm just trying to figure out how we should best model that over the next few quarters here and how much of it is a timing issue versus not and how we should think about that into 2020 as well.

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Edward A. Pesicka, Owens & Minor, Inc. - President, CEO & Director [5]

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Yes. So Fusion5 really has a very -- has a minimal impact on revenue. And the way to really think about it is, on modeling it, is the fact that we're actually waiting for the government, CMS, to provide us the data and the information and the reconciliations really for the first group of data, that being the episodes of care that we handled between October of last year and March of this year. That should be coming sometime in December potentially. And I think from a transparency, we wanted to openly disclose the fact that we -- the timing of that may be delayed. It's already been delayed several times. So that's really what's related to that $0.06 per share. It's really the timing and our ability to do the reconciliation. But going back to the initial part of the question, from the top line, it has very -- it has minimal impact from a revenue standpoint on the top line.

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Operator [6]

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Our next question is from Lisa Gill from JPMorgan.

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Anne Elizabeth Samuel, JP Morgan Chase & Co, Research Division - Analyst [7]

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It's Annie Samuel on for Lisa. As we look to 2020, I guess could you just give us a little bit of color on how to think about headwinds versus tailwinds as we build out our models between lapping the Fusion5 and currency? Anything else to think about?

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Edward A. Pesicka, Owens & Minor, Inc. - President, CEO & Director [8]

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Yes. So I think as you start to think about 2020 on this -- and I've already talked about the nonrenewal of a large customer that will have an impact for really the first 3 quarters plus into 2020. But -- and I think when you think about 2020, it's going to be the continuation of looking at driving mix -- from a bottom line standpoint, driving mix shift, continuing to drive productivity in the business and starting to win business and recognizing the fact that when we win business, it does take several quarters of time. There is a delay in the lag until that business starts to translate into revenue for us because of the transition time periods. So I think the way to think about that is that larger customer nonrenewal continues on through the first 3 quarters of next year.

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Anne Elizabeth Samuel, JP Morgan Chase & Co, Research Division - Analyst [9]

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Great. And then just on the currency. Looking at the full year guide, the $0.60 to $0.65, how much currency is being excluded for the full year?

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Edward A. Pesicka, Owens & Minor, Inc. - President, CEO & Director [10]

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I'll let Mike take that.

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Michael Wayne Lowry, Owens & Minor, Inc. - Senior VP, Corporate Controller & CAO [11]

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So for the third quarter, we had a $0.02 impact with -- from currency. And actually, year-to-date, it was that same adjustment. There was nominal foreign currency impact for the first half of the year. And our projections indicate that currency will be about $0.02 or $0.03 a share in the fourth quarter as well, and that would be a headwind. But again, it is difficult to predict. But that's our expectations at this point.

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Operator [12]

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(Operator Instructions) Our next question is from Robert Jones from Goldman Sachs.

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Jack Rogoff, Goldman Sachs Group Inc., Research Division - Research Analyst [13]

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This is Jack on for Bob. Just looking out to 2020, another one on that. How are you guys thinking about the Byram business? And if you could provide just any detail or numbers around the opportunity there? Can you guys flag that as a good guy this quarter?

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Edward A. Pesicka, Owens & Minor, Inc. - President, CEO & Director [14]

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Yes. So Byram continues to perform. We expect the business to continue to perform into next year. The benefit of that business has been -- continued to provide top line growth. But also the profile of that, that impacts us because it has -- the mix shift of that business actually helps us overall from a profitability in the company. And then we don't -- historically haven't disclosed individual business units and/or segments of our business individually.

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Jack Rogoff, Goldman Sachs Group Inc., Research Division - Research Analyst [15]

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And just a more tactical thing. Anything worth flagging just on like commodity input costs and flu as we approach the end of the fiscal year?

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Edward A. Pesicka, Owens & Minor, Inc. - President, CEO & Director [16]

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Yes. So we're anticipating flu to be your traditional flu season here in the fourth quarter. And then the commodity impact that we saw in the third quarter, we expect it to be relatively consistent into the fourth quarter. So we don't expect any major significant differences in that between Q3 and Q4.

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Operator [17]

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(Operator Instructions) And our next question is from Kevin Caliendo from UBS.

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Brett Richard Gasaway, UBS Investment Bank, Research Division - Equity Research Associate of Healthcare [18]

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This is Brett Gasaway on for Kevin Caliendo. Could you comment a little bit on the acute care volume trends during the quarter? A competitor in the market said that there's some strong utilization coming in 3Q. I just want to get your take on what you've been seeing in the marketplace.

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Edward A. Pesicka, Owens & Minor, Inc. - President, CEO & Director [19]

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Yes. From that standpoint -- well, first of all, thanks, Brett, for the question. From that standpoint, we traditionally, in our business, if you look at it, you do see a ramp-up in the third and fourth quarter as people get closer to their full deductibles. So we anticipate that and we see that in our base business that -- in our acute care business, that lift as people get to their full deductibles. So we saw some of that in the third quarter, and we expect consistency with that going into the fourth quarter.

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Operator [20]

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

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Edward A. Pesicka, Owens & Minor, Inc. - President, CEO & Director [21]

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So I want to thank everyone for the time this morning. As I close out, very, very pleased with this quarter and the fact that we were able to significantly improve our earnings per share by increasing it by more than 100%. And I don't want it to be overlooked, the amount of work that's been done on both the balance sheet and operating income, enabling us to drive significant paydown of debt, reminding everyone that we paid down $130 million of debt in the last 2 quarters and generated nearly $200 million of operating cash flow, both from working capital management as well as operating profit improvement into the second and third quarters combined, which enabled us to pay down that debt as well as invest in operating initiatives that we have in place.

I look forward to talking to everybody after the fourth quarter, and thanks for the time today.

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Operator [22]

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