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PSS World Medical, Inc. (NASDAQ:PSSI)

F09Q03 (Qtr End 01/02/09) Earnings Call

January 29, 2009 8:30 a.m. ET

Executives

Rob Weiner - Vice President Investor Relations

David Smith - Chairman, CEO, President

Gary Corless - COO, Executive Vice President

David Bronson - CFO and Principal Accounting Officer

Anaylysts

John Kreger - William Blair & Company, LLC

Lisa Gill - J.P. Morgan

Robert Willoughby - BAS-ML

Lawrence Marsh - Barclays Capital

Glen Santangelo - Credit Suisse

Randall Stanicky - Goldman Sachs

(Andrea Bece) - Stroders

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the PSS World Medical fiscal 2009 third quarter conference call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question and answer session.

(Operator instructions). As a reminder this conference is being recorded Thursday January 29, 2009. I would like now to turn the conference over to Rob Weiner, Vice President Investor Relations, please go ahead, sir.

Rob Weiner

Good morning, thank you Shawn. Good morning everyone, thank you for joining our fiscal year 2009 third quarter conference call. Today on the call our speakers are David Smith, Chairman and CEO, Gary Corless, Chief Operating Officer, and David Bronson, Executive Vice President and CFO.

We issued our release last night for the quarter and the release and our financial workbook for fiscal year 2009 third quarter are available on our web site at pssworldmedical.com. The financial workbook contains GAAP and non-GAAP measures that provide greater detail into each business.

I'll read the forward looking statement. During this call we may make a number of forward looking statements regarding revenue, gross margin, operating expenses, operating margins, earnings per share, and other matters that are not historical facts.

These statements involve a number of risks and uncertainties that could cause actual results to differ materially from what is expressed or forecasted. For a list and descriptions of certain of these risks and uncertainties we refer you to the forward looking statement disclosure in today's press release—last night's press release and to the other information provided in our most recent form 10-K and other SEC filings, copies of which are available from the SEC, from the investor relations section on our Website, or from us here in investor relations.

The company wishes to caution listeners of this call and its replay to not place undue reliance on any such forward looking statements which statements pursuant to the Private Securities Litigation Reform Act of 1995 and as such speak only as of this date.

The company also wishes to caution listeners that it undertakes no duty or is under no obligation to update or revise any forward looking statements. Let me also remind you that we may reference certain non-GAAP financial measures in an effort to provide additional information to investors.

All non-GAAP measures have been reconciled to their related GAAP measures in accordance with SEC rules. You'll find reconciliation charts at the end of our financial workbook and our form 8-K submitted to the SEC. For our call today we will follow our formal remarks by a Q&A session as prompted by the operator.

We will limit the call to no more than one hour in duration and be mindful about our reporting companies and a busy week. I am now pleased to turn the call over to David Smith, our Chairman of the Board and Chief Executive Officer, David.

David Smith

Good morning. Thank you for joining us. We will deliver a quick and informative call this morning. Last quarter I described how the Chinese believed it is a blessing and a curse to live in interesting times. I can think of many other words this week like fascinating, sad, unpredictable, and challenging.

We are a company blessed by fate, fate to serve the alternate site healthcare system and customer. We are blessed previous strategic decisions to fanatically focus on customer innovations and solutions and have investments in operational efficiencies.

In this environment of pain and unprecedented disruption it's difficult to feel and harder to say but I like our position. I feel great about our strategic direction in investments. We simply can't feel guilty about doing what we're paid to do, maximize shareholder returns and take care of our customers and people.

We simply are making customers healthier, our people are winning on the streets, and our programs and solutions are effective. We are changing and adapting, relentlessly focusing on customers and people. And we believe we will emerge a stronger company.

We have proven time and time again that we are quicker and more nimble than our competition and have clearly grown revenues faster. We are removing costs from our business while we are investing in gross strategies and solutions.

Our guidance for this fiscal year is consistent at $0.94 to $0.96 EPS. We've accelerated investments and infrastructure and operational efficiency with capital and P&L spending. We've dealt with hurricanes, deflating dollar, rising commodities, and gas prices now to see commodity prices reverse.

And we are even beginning to see overseas containers shipping costs decline. We've seen consumer savings impact office visits and discretionary procedures matched by our customer's need and willingness to listen to solutions that impact cash flow.

Our solutions and programs were built on the belief that our customers would face more economic stress than ever before. These initiatives have not just been timely they have been critical to the health of our customer and allowed us to drive a bigger stake into the heart of our competition.

During the call Gary Corless, our Chief Operating Officer, will review these programs for both businesses and then David Bronson will review the balance sheet and financial results. My last three topics are physician revenue, strategic planning for fiscal 2010, and a Washington update.

On the physician's side we've planned on more revenue in the quarter due to more selling days. We failed to anticipate two things, first Christmas and New Year's Day fell on Thursday. And it seemed everyone used the next Friday to spend time with families.

Second, Friday after Christmas, New Year's Eve, and Friday after New Year's, January 2nd, were three of our four extra billing days in the quarter. Basically our business was dead the last weeks of the holiday or the last two weeks of the quarter.

However, the week starting January 5th or the next Monday very, very, very busy. Winter has cranked up and most likely flu season. Now just the opposite on the elder care side where extra days in the quarter represented patient days in nursing homes and home care neither were closed for the holidays nor the Friday's after.

Strategic planning for fiscal 2010 has begun. The environmental factors are less clear than any other year I remember at the beginning of this process. However, in many ways for us it's simpler and more focused. Expect to see continued growth at two times the market and concentrations and focus on targeted clinical and business customer solutions, operational simplicity that drives efficiency, expansion of our sourcing depth and breadth, utilization of our capital structure for acquisitions of companies that can expand our customer reach or our product and service expansion in our core business, E-commerce expansion and a continued focus on compensation alignment.

We will reduce costs, expenses, and investment that can no longer be justified. We will look to take advantage of market layoffs to harvest talent for the market in specific areas of need, and, of course, manage our cash flow and balance sheet with enthusiasm.

Now, a Washington report, first if you believe everything coming out of Washington and the Federal Reserve you could walk to China and back on the spending, money flow, future taxes, and potential inflation.

It's hard to know what to believe but the next few months should be very enlightening. For the short term and mid-term healthcare does not look like a bad place to be especially the alternate site.

Inside consensus believes general practice physician's incomes will not be cut. The SCHIP renewal expansion and changes to qualifications for children's healthcare is an early indication of spending mentality.

The change represents an increase for participants and funding of 54%. Also serious discussions and support is building for opening access to Medicare coverage at 50 to 55 at a higher premium rate. This move is seen as a plug in the hole for the coverage on the opposite age bracket of SCHIP.

The new Obama stimulus has an $88 billion bailout for state Medicaid programs. Early in our planning process we perceived a potential weakness in customer credit worthiness in certain states. The proposed $88 billion is a very significant fix. There is another twenty some billion for healthcare in the plan.

There is $2 billion for a National Coordinator of HIT, there is $17 billion for HIT, there is a billion for physician incentives for using electronic formats. However, it's still too early to understand how this will be implemented or who will get it and when.

One thing is for certain, I'm happy our strategic planning will not be completed until March or April. By then we will have a lot more visibility into these issues and opportunities. Regardless of what changes are contemplated or made we have a proven track record and an organization that embraces change an innovation.

And we have a significant list of investments and returns that are at the ready. So stay tuned. Now I'll go to Gary Corless, Chief Operating Officer, to review some of the programs for the quarter. Gary?

Gary Corless

Thank you, Dave. I'd like to thank everyone for your time.

I'd like to start by asking all of you a question that I ask our people every day. Is when is it most important to have a good partner, in good times or in challenging time? Although this environment presents many challenges, it also plays to PSS's strengths, a face-to-face and focused partner.

I'll give you a brief overview of key focus areas for PSS and Gulf South, and why they're working in this environment. It is the most important time to be in front of the customer, talking about his or her challenges, with the most complete offering of solutions. Our approach is to strengthen them by helping them improve their care, grow their revenues, control their costs, and improve their inefficiencies, which includes collecting cash.

First we'll cover PSS, let's talk about how we help them control their costs. One way we were able to do that effectively is through our brand, Select. When faced with the increasing cost of running their businesses, they are more open than ever to our in-house brand of Select. We continued the strong growth in the quarter, coming in at 17%, with Select Diagnostics leading the way at 26%.

Controlling costs is important, yet patient care and practice revenue are even more important. How do we do that? We do that through our equipment and our laboratory diagnostics offering. A good example of this from the quarter is our rep and customer right here in Jacksonville, Bob Horne (ph), who calls on Nephrology Associates.

While discussing their business, we learned that their aim was to make their experience with their patients more efficient. It became clear that insourcing the diagnostic testing they had been outsourcing to commercial laboratories would help accomplish that.

After adding a laboratory capable of chemistry, hematology, and amino acid testing, and a lab information system, they have already seen a marked increase in efficiency, patient satisfaction, and income that was previously going to the commercial laboratory.

This is a good example of how our approach and our comprehensive (inaudible) offering continue to deliver for the physician and our manufacture partners. We completed our Q3 lab zone blitz successfully, with $39 million in equipment, and still growing, and 15% growth in branded lab diagnostics, a strong example of the power of face-to-face and focused.

Lastly, we strengthened our PSS customers by helping them improve efficiency. And one way we do that is through our E-commerce Solutions SmartScan and MyPSS. They also helped us free up our reps to sell, as one of our rookies, Clarissa Carneyna (ph) says, "If I'm taking orders, I cannot talk about anything new. It's given me more time to sell equipment, and I've doubled my book of business in showing PSS."

Or our customer, Megan, who is a lab technician in Florida Cardiology Associates in Port Charlotte that says, "To do an order takes me five minutes, tops. Before, it took me 30 minutes to an hour. I literally save three to four hours a week."

As Dave told you, in Q2 we hit a year-long goal of 35% of revues back in September, with E-commerce as a percent of revenue. We continued success by signing with over 4,000 more E-commerce customers in the third quarter, and now we're up to over 38% of our business. They continue, these E-commerce customers continue to buy more, place larger orders and grow faster than non E-commerce customers.

Now, for a minute, we'll talk about Gulf South. Gulf South continued strong growth of over 16% in total, with home care leading the way at over 24%. Our home care efforts were focused in the area of point of care testing and our brands. In the area of point of care, we fully trained 100% of the Gulf South sales force in coagulation testing and placed close to 400 meters.

A good example of the power of this blitz is our representative Justin Thickbaum (ph), who showed Harmony Home Heath in Chicago the benefit of using the Rose (ph) coagulation meter, and was rewarded with their coagulation business, plus wound care, plus (inaudible).

Our Q3 brand focus spanned home care and skilled nursing facilities, and grew 39%, led by our QUINTET Glucose meter, with over 2,000 placements. A good example is Gulf South sales rep Randy DeMott (ph), who lost the glucose business to a competitor eight months ago, and with our QUINTET glucose meter he was able to walk right in and get it back, plus more.

Lastly, our momentum program, which contributed to our skilled nursing facility growth of 14%, enables our (inaudible) customers to leverage their Gulf South purchases for things they value, like caregiver education.

In the quarter, we added 138 more customers, and now we're up to over 300 members. A good example is our Gulf Sales rep, Brian Stegall (ph) of North Carolina, who'd been calling on a competitor's account for over four years, with no success, until he introduced Momentum, which opened the door. It is a different and valuable program.

Thank you very much. We will continue to leverage our strengths that are more appropriate than ever. David?

David Bronson

Thanks, Gary, and good morning, everyone. So this morning, Dave has talked about our views on the economy and our position in it, and how we're adding value to the healthcare delivery system in the alternate site market.

Gary's updated you on our go-to-market strategies and programs, and how we are increasing our value to our customers. I'd like to talk about two other important elements of our overall investment thesis, and how they're creating, and will create, shareholder value as we go forward.

First is operating margin expansion. As you recall, our operating margin expansion for this three-year plan consists of leveraging revenue growth, sourcing a more profitable mix of high-quality products for our customers, and becoming ever-more efficient in our distribution and back-office operations.

In the quarter, we continued to make good progress in all three of these areas, and the result was a consolidated operating margin of 6.1% which, if not an all-time high, is certainly a high in the last ten years in our current configuration and this, in spite of the fact that our overall same-day revenue growth slowed somewhat in the quarter.

Operating margin improved by 90 basis points from the same quarter last year. The physician business reported 9% for the quarter, of operating margin, and the elder care business came in at 5.4%. Consolidated operating income grew by over 30% from prior year.

Sales of our Select brand products grew by 18% in the quarter on a consolidated basis, and are up 27 1/2% for the year. These products now account for 14.6% of our overall revenue mix. We're selling over 1,300 SKUs with the Select label, sourced from 10 countries and 69 manufacturing plants, all producing these products under very strict quality assurance standards and inspection.

We also continue to expand profitability with the branded manufacturers whose products make up the other 85% of our revenue, as evidenced by the successes Gary mentioned in marketing and promotional programs. With the help and support of these manufacturing partners, we're driving costs out of the supply chain, especially in the areas of rebates, contract management and freight.

We continue to leverage revenue across our distribution infrastructure and corporate overhead base. For the quarter, 14% of incremental revenue dropped through to the operating margin line. Year-to-date through the third quarter, that number is 9%, in line with our expectations.

Beginning at our investor day last year, and over the last couple of quarterly calls, we've been talking about our business simplification strategy, designed to formalize and recognize the efforts of our organization to improve operational efficiency, through a combination of focus and alignment, process redesign, and the investments in technology.

Our people have really got behind this initiative, and we're seeing some real traction. I recently, in the last couple of weeks, visited four of our branches on the West Coast. It was very gratifying to me to see the level of involvement and enthusiasm our folks are bringing to this initiative.

I know some of you will be wondering about the impact of fuel costs on us this quarter. Remember that 90% of the fuel we buy is diesel, which is not down quite as much as gas, and that our fuel surcharge is also tied to national average prices, and so automatically adjusts as fuel comes down. However, from Q2 to Q3 we did see a decline of about $400,000 in net fuel costs.

Overall, we feel that our margin expansion plans for this year, and our three-year plan, are very much on track. Now turning to the balance sheet, we continue in this environment to monitor very closely the creditworthiness and payment patterns of our customers.

Consolidated Days Sales Outstandings, or DSOs, for the company, came in at 42.4 days, an improvement of one day over the last quarter, and two days from a year ago. These are the lowest DSO's we've at, at least in the seven years I've been at the company, and they reflect both the focus and the determination of our people to manage this asset aggressively, as well as, the value that our customer puts on our overall product and service offering. There are much easier credit terms out there from our competition, but our customers are sticking with us because of the value that we provide.

Similar to Q3 of last year, we did invest in a layer of inventory in anticipation of product cost increases. This inventory layer will work through the system over the next three to six months, and each individual buying decision in this category meets or exceeds our 30% return on committed capital hurdle rate. This added about a day-and-a-half to days-on-hand, compared to prior quarter, but it's even with days-on-hand from a year ago.

The timing of this buy-in, along with the timing of an income tax payment in Q3 that we originally contemplated in Q2, resulted in negative operating cash flow of $6.9 million in the quarter. However, today we're reconfirming our goal of $73 to $77 million for the full year. We ended the quarter with very strong cash position at $214 million, thanks to having completed the convertible debt offering this past summer at favorable terms.

Now, speaking of that convertible debt, I think most of you are aware that the gap accounting rules for convertible debt are changing. This change affects PSS and all other companies that have convertible debt, starting in the first quarter of the next fiscal year. For us it will be the June quarter.

This change requires issuers of convertible debt to reflect in their P&L's not the rate of interest stated on the coupon and actually paid by the company but an estimate of what the straight deck market rate would have been at the time of issuance.

Now it's a little hard for me to explain how that improves the accounting, but the result is going forward that we will be recording a non-cash interest charge in our P&L and we’ll also be restating prior years again to increase non-cash interest expense. The new rules require restating the prior year’s results for comparability.

The amounts for PSS will be as follows, for fiscal year ‘08 or our last year will be restated to increase non-cash interest expense by about $5.9 million. Fiscal year ‘09 this year, will be restating results when we adopt this change to increase non-cash interest expense by $10.8 million and the increase in non-cash interest expense for FY10 or our next fiscal year will be approximately 7.7 million.

On none of these amounts will be materially impacted by whether or not any of our 2004 bonds are redeemed or called this coming March. As most of you are aware holders of those 2004 convertible bonds have a one day PRID (ph) option on March 15, about a month and a half from now.

Subsequent to that date any bonds still outstanding are callable by the company. We issued the new convertible last summer in anticipation of the old bonds being put to us. We don’t know at this time whether that will happen or to what degree. If it does happen, we do have the liquidity.

The decision on whether or not to call over the next few months, any bonds that are not put to us in March, will depend on what opportunities are out there to profitably deploy capital and the relative availability in costs of sources of the capital.

Now just to sum up, before we open the call to questions. I really believe that PSS is well positioned to respond appropriately to the unique challenges of these (inaudible). I think our focus on this market, the needs our customers and the flexibility and agility of this organization will allow us to adjust to modify our business strategy as the new economy emerges.

I’m very encouraged by the continued demonstrated ability of our team to get behind and effectively execute our strategies. Thanks very much.

Unidentified Company Representative

Operator, we’re ready for questions.

Question-and-Answer Session

Operator

(Operator instructions). Thank you and our first question comes from the line of Glen Santangelo with Credit Suisse, please proceed with your question.

Glen Santangelo - Credit Suisse

Yes, thanks. Hey David I just wanted to follow-up on some of your opening remarks when you were talking about you know the slow, same day revenue growth in the physician business, you kind of you know suggested that the last probably two weeks of December was really slow.

I was wondering if you could maybe elaborate on that a little bit more and maybe get us a sense for how big of an impact that might have had and then you know kind of as a follow-up to that.

I mean what are you seeing in the physician market, you know do you think that you know there really is a slowdown in that market and hence you know we should be thinking about you know a depressed kind of same day revenue growth rate as we look at it into ’09 and are you seeing any change in the business mix in terms of what you’re selling the physicians?

Maybe less equipment or just any sort of color would be helpful, thanks.

David Smith

Okay and we’ll kind of all chime in where we see appropriate. First you know we really did miscalculate something in the days, the Fridays after the holidays were completely dead, there was no business done. Of course the holidays there were no business done, so we were doing pretty well October coming into December and then the last two weeks of December just were a ghost town.

So what I would tell you is it was a very slow holiday and then the next Monday you know our printers were melting. So all I will tell you is what we picked up January kind of you know put me back at ease. I was nervous thinking all kinds of thoughts during the holidays and then felt much more at ease once January started.

We also had a decent winter last year with flu you know some sickness in the quarter, we had a pretty healthy year this year, winter really didn’t even get started until Christmas when people were trying to go home for the holidays and I think that might have had something to do with.

It started to slow down I would say absolutely where it comes to discretionary spend where people are making decisions to have voluntary procedures. That business is dramatically off. And I would say you know when the banking collapse and all the bad news was in the market, people were saving money.

We’ve gone from negative savings to positive savings as an economy, so Americans are trying to save. But I would tell you that the other side of that as people start to worry about losing their jobs, they’re going to go use their benefits and we’re going to have some updraft from benefit utilization.

I would tell you that I’ll let Gary talk to the mix but I would just say our customers are very, very open to listen to ideas that help generate cash flow and procedures in their practice to try to make up for anything that they’ve lost from a discretionary spend standpoint.

Gary Corless

I would add, Glen, that is very consistent with Dave and I think it’ll take more time to gain some clarity from the trends. You know we see you know some trends that contradicts some conventional wisdom, in some cases where you may see consumables that are solo per day. I think the today’s point be a little bit more time will clarify you know the holiday impact.

At the same time where most people were predicting equipment business you know would be flat our declining it's actually continuing to grow to out point about the avenues we have strengthen you know our physician offices. So it’s going to take a little bit more time I think to get some clarity from the trends.

Unidentified Company Representative

You know fortunately freeing up sales force bandwidth with our E-commerce so our people have time to talk to our customers. Fortunately we have all this equipment and all these products and programs to be able to articulate to the doctor a way to improve their practice revenue or cash flow and it’s working and what I tell you is our competition is retreating in many of these areas.

They’re seeing it very difficult and they’re not putting resources behind it and they’re actually going down and we’re doing just the opposite, we’re actually going up in some of these categories and some of these areas. So just like you, I kind of watch everything every month, December was unusual, at least the holiday portion of it, January figures normal. So I’ll wait until February/March and then tell you.

Glen Santangelo - Credit Suisse

Okay thanks for the comments Dave.

Unidentified Company Representative

Okay.

Operator

And our next question comes on the line of Lisa Gill with J.P. Morgan please proceed with your question.

Unidentified Analyst

Hi thanks to (inaudible) for Lisa. I guess Dave just following up on that question, you mentioned you know the physician revenue did pick up starting January 1 and you know it light of that you maintain your guidance and so I think you’re waiting for (inaudible) to show up but is there any way you could perhaps quantify what the you know what the pent up demand was starting January 1 that you missed out on.

And then a second question is related to surgery setting market that you said you had started targeting. Could you provide an update on how that initiative was progressing and perhaps what their contribution was in the third quarter, thanks?

Unidentified Company Representative

Okay, I’m not sure that we picked up and I don’t know that we would even know or know how to track whether we picked pent up demand or whether there were orders but the customer just didn’t bother to give us that were sitting there versus its flow from the patients. I don’t know how we even would begin to track that with the 100,000 places we deliver to and all the things that go on in the business.

It’s just not a factor that we look at even though that we beautiful information to have. I wouldn’t have known what it was last year to know, to judge whether it was more or less though. So what I would just tell you is the business it picked up immediately in January. The second part of that I’m not – I wish I had the number.

Are we getting our forecast for service centers?

Unidentified Company Representative

I don’t have the figure in front of me. I know that the surgery center business continues to grow.

Unidentified Company Representative

Yes.

Unidentified Company Representative

I just was with our top 25 PSS reps the last few days and John Hughes out of the Virginia says he continues to bring on. I think the trade opposition now is our value proposition. And this challenging time, matches up extremely well, with physician offices and so he was talking to me about trade off of his time and thinking you know that he can pursue physician offices and then probably even help them even more than spending time there. So it continues to grow.

I think a lot of our focus will go to the physician office especially during these times that we can help more of them than our customers can be frankly.

Unidentified Analyst

Okay that’s good thank you.

Operator

And our next comes to the line of Randall Stanicky with Goldman Sachs please proceed with your question.

Randall Stanicky – Goldman Sachs

Great thanks for the question. Hey guys just on the margins of the shipping backed from shipping costs was helpful, can you just maybe give us a little bit more color on the relative benefit as we think about some the moving parts whether it be trying to label efficiency or as you said shipping?

And then the second part of that was there any costs that are being (inaudible) shipped to the next quarter that perhaps didn’t hit in this quarter?

Unidentified Company Representative

Okay, first the shipping – container shipping is something we're seeing the market now. I don’t know that we've got any benefit of that last quarter. It's just starting to show up and it will probably be for the rest of the year and into next year.

So that's very positive for us. So we've dealt with rising costs everywhere. Now we're starting to reverse. So I'm really happy about those kind of things. As far as the cost that would be shifted to next quarter I don’t think we ever do anything like that.

So if anything we aggressively you know are ahead of some of our spend in our and are you know pushing things forward to grow the business so Randall I would say kind of just the opposite. I would say we're aggressively spending on our initiatives rather than waiting and we would not delay anything.

There is probably significant amount of profitability in our inventory line on the opposite side. So we probably have a lot of inventory profit sitting in the costing of the inventory that we have. So where we made an investment was just the opposite to probably restoring income rather than storing costs.

Does that? Is there another point to that?

Unidentified Company Representative

I was just going to add that you know if your question is was there anything unusual in the quarter, that was not.

Randall Stanicky – Goldman Sachs

Technically yes. Okay that's helpful. And let me just ask one more question, guys on the (inaudible) signings can you give us an update there on where we were in the December quarter?

David Smith

Yes, absolutely. We did 260 closes, that’s almost double of anything we've done in the past. A very run rate there. That product continues to be a very good conversation to have with the physician.

We've added support from Athena for our field of about 12 or 13 people. The transition, we really need to finish accomplishing or to make is to have those people be able to sell rather than just ride along with us.

So, I think there is great potential to increase the run rate. I think that we're continuing to work together to get to that point. Our doctors are receptive to it. We're really helping the cash flow of those physicians so we've got very good testimonials.

We've even saved doctors from bankruptcy so I think that product will continue to see good momentum.

Randall Stanicky - Goldman Sachs

And the targets were a thousand is still on track at this point?

David Smith

Yes. I would say we got off to a slow start. No doubt about it in the first quarter where we were still organizing our people and that hurt us. Our people are going forward. I don’t know if they're going to quite get to the thousand. I think that will be the one goal that I'm short on this year as far as a number.

I think everything else will be ahead of target. That may be one that I miss. But it's going to be close.

Randall Stanicky - Goldman Sachs

Okay. Great.

David Smith

I mean we're going to try to push to the end.

Randall Stanicky - Goldman Sachs

Great. Thanks a lot, guys.

David Smith

Okay.

Operator

Our next question comes from the line of John Kreger with William Blair. Please proceed with your question.

John Kerger - William Blair & Company, LLC

Thanks very much. Can you just expand a bit more on the equipment sales experience that you saw in the quarter in both segments? To what degree is that financed and was that proven to a challenge at all?

David Bronson

On the equipment side, on the physician business, we – you know the statement was made I think in previous calls. It's not like a base rate where its growth on top of a bases. Each new transition is exactly that.

We did $39 million worth of equipment on the physician side. It was everything from power tables to laboratory, not a lot of laser, but that would be in the down category. So you know strong – it was growth.

We replaced every deal we did last year and then some. On the Gulf South side, we don't really refer to that as much equipment wise, to be honest with you, but Gulf South is moving more into some of the point of care testing which is one of the fastest growing categories in the fastest growing area of home care.

So the growth in the coagulation meter placement, the growth in the Quintet glucose meter placements was I think a strong for both optimum and point of care testing.

David Smith

The other part of your question was on financing. The ratios that we've seen historically generally held. We didn’t have any deals turned down because of financing. Our two leasing equipment partners continue to be very interested and supportive of this marketplace.

David Bronson

I would say probably tighter and harder to get a lease than it was a year ago but it's not impacting our ability to grow our equipment. The solutions that Gary's team are providing the doctor especially in this last leg of lab zone, our competitors are retreating from lab and we're attacking lab because it’s a way to offer the doctor better patient care and better cash flow and its working.

Unidentified Company Representative

We just to work a little harder to get some of the deals done. Yes, because it gets a little bit tighter but we're getting the deals done. Then to the point of competitors backing as away, one of the things we're benefiting is getting our unfair share of vendor support as Dave mentioned.

As competitors back away from this area, they're coming to us to achieve to achieve their growth goal so that helps us in the area of equipment.

John Kerger - William Blair & Company, LLC

Great. Thank you.

David Smith

I mean it just still want to grow.

John Kerger - William Blair & Company, LLC

One separate question, if you think about to last May when you gave the guidance, the three-year guidance, obviously a lot has changed since then. Can you just spend a minute talking about which of those changes has helped versus hurt your business and how does augment out as we start thinking more about fiscal 2010?

David Smith

Yes. We've just started that process and unfortunately it won't be finished until April or May and which is kind of what I was leading to with the Obama and the Congresses and the spending. In trying to sort through that, I think we're a little blind as to how some of things are going to impact next year.

Clearly a lot of our costs are coming down on the product side and the commodity which was hurting us from a sourcing and distribution standpoint. Diesel and gas coming down. I think you clearly have lower pressure on salaries right now.

You can find people in the market at effective rates. So the environment itself is improved for being able to control your costs. Your physician customer revenues, your disposals have probably slowed down a little bit because of discretionary spend.

At the same time, they're willingness to listen has dramatically improved. And our ability to talk to them has dramatically improved because of some of run rate and the run rate we have on our E-commerce platform.

So there is a lot of pluses and minuses. I don't get to reset my three-year plan personally, so I'm kind of focused on it. What I would tell you is we're just getting into the planning. There are definitely pluses and minuses.

The one thing we have going for us is we have people that talk to customers every day. We have people that are considered part of the customer's business. They'd be lost with it.

We have an organization that is nimble, very quick. We're very aggressive. We're very innovative. And we don't take no for an answer. So I like our chances. I like our positioning. I like our strategy. I like our confidence competitive landscape.

I like the fact that we got a strong balance sheet. And we are struggling around this. So I'm kind of fired up by the whole thing. Yet I have to be very humble because this is a tough time for a lot of people.

So I would just say I'm ready.

David Bronson

One thing I would add is we set the three-year plan with some visibility and some awareness that we were looking at a slowing economy and certainly not what we've seen but if you remember, Dave was pretty bearish at the Investor Day in terms of overall economic growth and a lot of bearish got built into, not only our numbers but our philosophy and how we approached the business and how we manage head count, and how we manage investments, and hurdles rates that we use.

So I think we're – a lot of that was factored in to our three-year plan.

John Kerger - William Blair & Company, LLC

Great. Thanks very much.

Operator

Our next question comes from the line of Andrea Bece (ph) with Stroder's. Please proceed with the question.

Andrea Bece - Stroder's

Hi, two questions please. One what was CapEx in the quarter and has that changed for the year? Secondly, can you just give those for your physician segment and your Elder Care segment?

David Smith

Okay. We're looking up the page as we speak. Five million for the quarter on CapEx. Okay. And what's the target for the year?

David Bronson

Twenty-five to 28.

David Smith

Okay. Are we on that track?

David Bronson

Yes. We're at 20 million total for the three quarters.

David Smith

Which is a big acceleration of what we were originally going to do in the year to advance some of our development items for operational efficiency, for sales force automation, for customer automation.

So we've been taking advantage of this market and our financial strength performance and accelerate some of these programs so that we get some dividends in '10 and '11.

Andrea Bece - Stroder's

Thanks.

David Bronson

DSOs by business, I show for the Physician Business 39.5 and for the Elder Care just at 49.

Andrea Bece - Stroder's

Okay. Thanks. Then where was from (inaudible) weaker?

David Smith

Okay. Two areas. One that inventory build and layer that we added. And remember we did one of these last year. The one we did this year was a little bit because there a little bit more opportunity and vendors were offering us opportunities to buy in advance in cost increases.

We always do that with at least 30% return on committed capital hurdle rate. And all of these buy ins meet or exceed that. The second area was we had a $7 million tax payment in the quarter that we originally thought would be in Q2 and because of the hurricanes, we had an opportunity to extend that payment that was a federal program and we took advantage of that just to get some flow on the cash flow.

I think – if not in my prepared remarks, certainly in the Q&A last time, I talked about that. So that was $7 million.

Andrea Bece - Stroder's

Okay. Thanks so much.

David Smith

So you're on track for the year?

David Bronson

Yes. We are on track for the year. We're pulling the right levers and making sure that we will hit the number for the full year.

Andrea Bece - Stroder's

Okay. The number for full year again?

David Bronson

Seventy - three to 77 million.

Andrea Bece - Stroder's

Okay. Thanks.

Operator

And our next question comes from the line of Robert Willoughby with Bank of America. Please proceed with your question.

Robert Willoughby - Bank of America

Hi was there any change in the Athena health stake in the quarter or since then?

Unidentified Company Representative

Early in the quarter we did sell on the stock market I think about 30 or 40,000 shares. We saw that there was pressure on the stock and so we stopped that program. So what you see in the cash flow I think is about $.4 million or $400,000 of gain from sale of those shares.

Robert Willoughby - Bank of America

Okay and did – if you look at your inventory days 2004, 2005 you're in the low – the high 30's, low 40's margins obviously were lower. They're now higher but the inventory days are up. Is the trend now essentially completed there or is this a steady state level for inventory days on an annual basis or does that continue to tick higher?

Unidentified Company Representative

No, I think you'll see it come down this next quarter because we'll sell off that layer of sort of buy-in inventory.

Robert Willoughby - Bank of America

But on an annual basis though, Dave, is it sort of low 50's is where it should steady stay on a trailing 12 month basis?

Unidentified Company Representative

You know as we've talked about in the past Bob as we've launched Select we wanted to have very high service levels on the Select products so we've maintained higher safety stock levels on Source products.

I think now both with from a critical mass standpoint, as well as, from a comfort level of the product and the quality of the product that we're seeing I think you will see – be able to you know trim some of that safety stock as we go forward.

I think also you know as I mentioned in terms of working with manufacturers to reduce supply chain costs there will be opportunities to trim out some inventory. We have not put any quantification on that but I think you will see us continue to make you know incremental improvements in our inventory.

Robert Willoughby - Bank of America

Okay and just lastly when do you envision the restated financials being available?

Unidentified Company Representative

Well, first quarter of next year, in our June quarter, is when we'll adopt a standard and so we will at that time we will restate results from nine and eight and you'll see it reflected in our P&L.

I think you know going forward we'll talk about both GAAP EPS and cash EPS to help people compare our numbers to others who don’t have converts in their capital structure. Now some of our competitors do have converts and they'll probably be doing the same thing.

Robert Willoughby – Bank of America

All right, is it your expectation the first call consensus will move to a GAAP number or how are you thinking about that?

Unidentified Company Representative

I don’t know, nobody's adopted it yet. I think the first quarter of this year is the first time that calendar companies will be adopting it. So we'll see what the – how the Street responds to that.

The people and the analysts that I have talked to say that they will probably be looking at both.

Robert Willoughby - Bank of America

Okay. That’s great. Thank you.

Operator

Before we proceed to our next question ladies and gentlemen, as a reminder to register for a question, please press the 1 followed by the 4. And our next question comes from the line of Larry Marsh, with Barclays Capital. Please continue with your question.

Larry Marsh - Barclays Capital

Thanks. Good morning. Gary, good hearing from you. And thanks for the update. Just one clarification, then on further elaboration for you Dave Bronson, on the change in the reflecting the non cash interest expense. I’ve put in context what are the implicit interest rate assumptions you would have to make to come up with that whatever it is, $10 million this year, and $7.7 million next year, compare it to what your actual rate is?

Dave Bronson

Great question. On our old convert, our coupon rate is 2 ¼%, and the implied interest rate at the time that we issued that in2004, I think is 6 1/4%.

Larry Marsh - Barclays Capital

Okay. So those…

Dave Bronson

I am being corrected. 6 3/4% on that one.

Larry Marsh - Barclays Capital

So that’s the assumption that you’re using to readjust your numbers as you provided today?

Dave Bronson

That’s right.

Larry Marsh - Barclays Capital

So that’s roughly 400 basis point spread?

Dave Bronson

Yes. On the new convert that we issued this past summer, which by the way will be the only one that affects us going forward, is the coupon rate is 3 1/8% and I think the implied interest rate that we will be using will be a little over 8%. 8 ¼%.

Larry Marsh

Right, so when would that start to impact your fiscal '09 numbers?

Dave Bronson

The new convert will impact our 10 going forward. The reason that the old convert, and I don’t want to get into it, the reason the old convert doesn’t affect 10, is that you amortize that difference over the 5 years of the non call. So, really, by the end of this year, really by March 15th, we’ll be done with that. And it won’t have an impact on going forward, even if the bonds are still outstanding.

Larry Marsh - Barclays Capital

Got it, right. So the point is that we decide whether your to raise the debt at 8% or is that the right number, or is 3 1/2% the right number, or somewhere in between, it sounds like.

Dave Bronson

Yes. You know, it’s hard for me to really agree that this is better accounting. Theoretically, what you would see, if in fact, you are going to have a higher interest on a debt, then you would also have less shares, but that’s not the way new accounting works.

Larry Marsh - Barclays Capital

I see. Yes. Now it makes sense, and I think that’s why, cause if you sort of think about it, you’re guidance and your 3 year guidance range is based on your general assumption, so under this new number, you know, is going to be a lot different. And then, so it’s really in my view, not a reflection of you missing your targets but a reflection of how you’re having to account for this converting to the new rules. So, thanks for this elaboration. Any flu vaccine in the quarter?

Dave Bronson

We did. I think that we said that we would get $.01 to $.02 of impact of EPS in the blue, we had $.01 in Q2, and I think that it’s just under $.02 for the full year.

Larry Marsh - Barclays Capital

Okay. So, I know that you had said, I know that last quarter, you gave us $1.2 million in revs, at least it was broken out in the Q, and I think you had said that your goal was to get to at least 2 million doses this year, so it sounds like you have met that target?

Dave Bronson

Just under.

Larry Marsh - Barclays Capital

Okay. All right. Two of the things, if I could, it sounds like maybe for Gary, I know at the analyst you ran through some of the goals and Dave, you talked about it as well select, your target was to grow that 20%, it sounds like that is definitely ahead of plan. I think drug, you had said 15% to 20%. My guess is that is a little low. And then lab equipment and diagnostic, you know up to the 3%, can you just confirm where you are versus those targets?

Gary Corless

Well, I’ve got one more quarter. But lab equipment and lab diagnostics will probably be in line, I think disposables will be a little less than we expected, because of the economy. And yet, I don’t know what it is going to be in the 4th quarter. On select, are we a little behind on Select?

Unidentified Company Representative

Yes

Gary Corless

We are just a smidge behind on select. And that, I would think relate to the disposables being down on the physician side also. So, you know, it's very manageable. I think our forecast or our goal for the year is very achievable. I think we're going to be plus and minus on each of those categories. And that's kind of what you expect every year that some things do a little bit better than others.

We anticipated a downturn. I didn't see the banking side collapse so that kind of threw a monkey wrench into things. And for next year, you know, we're going into our planning process not assuming we're changing our expectations. So that process has started and I'm sure next year I'll be able to say the same thing. I'll have things that are ahead or behind what I tell you in May.

Larry Marsh - Barclays Capital

Yes, that's fair. And just (inaudible) and again I think sort of clarification a little bit on the quarter, but just if we sort of look at how we define this revenue per selling day was, you know, bumping along in that sort of high, mid to high single digits. Obviously this quarter it was a little less than 3%.

And so as you think about, you know, the fourth quarter, I know you're not trying to guide to a particular number, but, you know, from the standpoint of ballpark I do think it's, you know, sort of that, you know, kind of that three, you know, 2 to 3% range in your mind, Dave? Or is it going to be back in your view kind of mid, single digits in this market?

David Smith

Yes, I think December was an anomaly. I think the last two weeks were unusual. I think three of those four days that we got were wasted because of just the way things fell. I haven't gone through March and April, I mean, February and March, but my guess is and my estimate and my expectations and my thought process is that's why I made the call – the statement on the call, you know, that Monday and January has been busy. But I think that December was an anomaly. You know, it couldn't be at that level if that was the case. It would have to be higher.

Larry Marsh - Barclays Capital

Okay, great. And then just so I make sure the message is clear in my mind, getting feebler by the day, by the way. You know, basically you're saying the fourth quarter results based on your guidance would be down $0.01 to $0.03 versus the year ago March quarter. Obviously four fewer selling days, you know, versus, you know, versus last year.

But, you know, why would it be down so much or is that just you, you know, confirming you're already getting guidance, you know, given you actually had a very strong earnings number this quarter?

Unidentified Corporate Representative

I think it's – we're confirming our full year guidance as of $0.94 to $0.96 and…

David Smith

You know, Larry, it's really a great question. It clearly – we clearly have fewer days. It does impact us in a normal time when we have those or don't have those. I don't see the advantage in trying to guess is it going to be a penny or something better than what we thought or trying to peg the number.

It's better to just stay where we are, keep our heads down, keep moving towards, you know, what we're accomplishing with our customer and know that we've got four less days, know that it's a crazy world out there and just stay with our guidance and make everybody happy.

Larry Marsh - Barclays Capital

Got it. That makes sense and finally just a quick leverage and for Gary on the QUINTET. You know, you had mentioned 2,000 placements in the quarter and you had mentioned an example where your sales person pulled back the count with the introduction of that.

Are you sizing, you know, how big of a product is this in terms of average selling price and then could you elaborate why would a customer pull back the business, you know, with the QUINTET meter?

Gary Corless

That customer on that example had switched, you know, from us to a competitive meter, when our sales representative went back in with our QUINTET the customer saw the benefit in our meter and, therefore, switched the glucose business back to us plus some other business.

So really just the feature in benefit of the product I can tell you that we expected and we're pleased to see that the unit is selling at a maximum brand price. So our – the reagents, the strips, all that is not even – is not being sold at a discount, but being sold on par with national brand manufacturers.

So I don't have long-term goals in from of me, Larry. I will tell you that is that we believe that we didn't have a comprehensive enough offering to really – to meet the needs of this growing diabetes, you know, epidemic and thought that by adding our own brand we could not only help more customers, we could improve, you know, control of our own destiny and our profitability here.

So I believe that this will be big. It's early on. But it was significantly over 2,000 placements and the diabetes market itself is, you know, is a $70 billion market and just in stirps. So you know how much of that can we get? Let's just say we had a real good start.

Unidentified Corporate Representatives

Larry, I was hoping you were going to get a number out of him because the big fight in here is I think it's ten times bigger than they're willing to commit to me. So I was hoping you'd get a number.

Larry Marsh - Barclays Capital

I tried.

Unidentified Corporate Representative

More than it is today.

Unidentified Corporate Representative

You're better than that, man. Come on.

Larry Marsh - Barclays Capital

Well, you know, Corless is pretty tough. So I gave it my best shot. Okay, great. Thanks.

Operator

Just a reminder there are no further questions at this time. No one else are in the call back queue. Please continue with your presentation or closing remarks.

Unidentified Corporate Representative

Thank you very much. We are very focused on our forecasted goals. In this world we live in we're very happy that our customers find value in us and our people are very excited every day in what we're proposing and what we're doing.

I feel very good about where we're going and I believe we're going to perform very well for our customers, our people and our shareholders. So thank you all very much for your time and look forward to reporting fourth quarter. Thank you.

Operator

Ladies and gentlemen, that does conclude today's conference call. We thank you for your participation and ask that you please disconnect your lines.

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Source: PSS World Medical Inc. F09Q03 (Qtr End 01/02/09) Earnings Call Transcript
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