Jul 29, 2008
Executives
Craig Smith - Pres & CEO Trudi Alcott - Director of Investor & Media Relations Jim Bierman - CFO Charlie Colpo - SVP Grace den Hartog - SVP
Analysts
Glen Santangelo - Credit Suisse Eric Coldwell - Robert W. Baird Robert Willoughby - B.O.A.
Securities Larry March - Lehman Brothers Alex Beck - Goldman Sachs Eitef - J.P. Morgan
Operator
Good morning, ladies and gentlemen. And welcome to Owens & Minor's second quarter 2008 conference call.
My name is, Sylvia, and I will be your operator for today. At this time all participants are in a listen-only mode.
We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions) As a reminder, this conference is now being recorded for replay purposes.
I would now like to turn the presentation over to your host for today's call, Mr. Craig Smith, President and Chief Executive Officer of Owens & Minor.
Sir, please proceed.
Craig Smith
Thank you, Sylvia, and good morning everyone. And welcome to the second quarter 2008 conference call.
We'll review our results and take your questions in just a moment. But first let me introduce my colleagues on the call today.
We have with us Jim Bierman, our Chief Financial Officer; Charlie Colpo, Executive Vice President; Grace den Hartog, General Counsel; Dick Bozard, Treasurer, and Olwen Cape, Controller. Now before we begin, Trudi Alcott, our Director of Investor & Media Relations will read a Safe Harbor statement.
Trudi Alcott
Thank you, Craig. Our comments today will be focused on the company's results for the 2008 second quarter, which are included in our press release.
The press release, as well as the related presentation, can be found on our website. In the course of our call today we will make forward-looking statements.
These statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Please see our press release and our SEC filings for a full discussion of these risk factors.
Finally, this conference call will be archived on our website. Thank you.
Craig?
Craig Smith
Thank you, Trudi. And let me call on, Jim, to brief us on financial results.
Jim?
Jim Bierman
Thank you, Craig. And good morning everyone.
We are pleased with this quarter results including record quarterly revenue and solid gross margin and earnings performance. We are seeing the positive impact of sales penetration with our largest customers as well as progress with new and acquired business.
As we grow our business, we are continuing to provide value-added solutions to our customers needs. Our goal continues to be to position our company for profitable, sustainable growth.
I will begin my remarks with an overview of the second quarter results. Second quarter 2008 revenues of $1.79 billion were $116 million greater than revenues reported in the second quarter last year; an increase of 6.9%.
Revenue gains this quarter resulted primarily from penetration of existing accounts. When analyzing the variants, we believe that product price inflation may have represented upwards of 150 basis points of revenue growth.
I would also note that on a sequential quarter basis revenues increased $42 million from the first quarter of this year; also primarily resulting from penetration of existing accounts. Year-to-date revenues were $3.55 billion, an increase of 5.4% when compared to the first half of last year.
As we look at the first half of the year, we are within our target for annual revenue growth. Second quarter 2008 gross margin was $190 million, an increase of $13 million from the second quarter of 2007.
When compared to the second quarter last year gross margin as a percent of revenues increased seven basis points to 10.60%. The improvement from the prior year resulted primarily from increased sales of value-added programs and services as well as a substantial increase in sales of our private label MediChoice products.
When compared sequentially to first quarter 2008 gross margin dollars increased but declined as a percent of sales by seven basis points. When looking at the sequential trends keep in mind that in the first quarter we received the benefit to gross margin of manufacture price increases.
As expected and as we indicated last quarter we did not see a benefit of that magnitude this quarter. For the first six months of the year, gross margin was $377 million, improved $26 million when compared to the same period last year.
As as a percent of revenues year-to-date gross margin was 10.63%, an increase of 18 basis points. The year-to-date increase resulted primarily from; improvement in the McKesson accounts, increased sales of value-added programs and services, and greater supplier incentives.
Second quarter 2008 SG&A expenses were $142 million, an increase of $8.1 million from second quarter 2007. SG&A expenses as a percent of revenue decreased six basis points to 7.89% as we leveraged our infrastructure over a larger sales base.
When compared to last year's second quarter, fuel costs increased approximately $1.3 million. When looking at SG&A results sequentially, expenses increased $4.4 million or seven basis points from the first quarter of 2008.
Factors behind the sequential increase included higher fuel costs and an increase in incentive compensation expense, including equity-based compensation which reflects improved results when weighed against certain performance based metrics, as well as an increase in the Company's share price. Year-to-date SG&A expense was $279 million, an increase of $2.4 million compared to the first six months of last year.
As a percent of revenues SG&A for the first half was 7.85%, an improvement of 36 basis points over the same period last year. When comparing our year-to-date SG&A results, please keep in mind that during the first half of last year we experienced costs associated with the transition and the integration of the acquired McKesson business, including approximately $7 million of transition fees paid to McKesson during the first quarter of 2007.
For the second quarter 2008 operating earnings were $42 million, increased $5 million from a year ago. Operating earnings as a percent of revenue were 2.33%, an improvement of 14 basis points compared to second quarter last year.
Year-to-date operating earnings were $85 million, improved $24 million when compared to the first six months of 2007, and were 2.4 percent of revenue. Interest expense, a component of net income but not of operating earnings, decreased $3.8 million in the second quarter 2008 compared to a year ago.
For the first six months of this year interest expense was $6.3 million, a decrease from the 13.8 million of last year. The decline in interest expense resulted from lower balances outstanding on our revolving credit facility and a more favorable interest rate environment.
In the first six months of 2008 the Company's effective interest rate was 6.4% on average borrowings of approximately $210 million. As compared with 6.9% on average borrowings of approximately $420 million in the first six months of 2007.
The effective income tax rate for the quarter was 39.4%, and for the year-to-date period the rate was 39.2%, consistent with our previous guidance and the prior year's annual effective rate. Net income for the quarter was $23.6 million, compared to $18.3 million a year ago.
For the second quarter diluted earnings per share were $0.57, improved from last year's $0.45. For the year-to-date period net income was $47.8 million, an improvement of nearly $19 million over the same period last year.
Earnings per share for the six months was $1.16, significantly increased from $0.71 in the same period last year. Turning now to our asset liability management efforts.
For the first six months of this year we reported cash provided by operations of $79 million, compared to $86 million in the same period of the prior year. DSO as of the end of the quarter was 24 days, improved from 27.9 days at the same time last year, and inventory turnover was 10.4 in the second quarter, compared to 9.4 for the second quarter last year.
Cash flows in the first half of the year were negatively affected by increases in accounts receivable and inventories, somewhat offset by the timing of payments for inventory. So far this year cash used for CapEx was approximately $10 million and we paid dividends of $16 million.
Finally year to date, we used cash to reduce our revolving credit facility by $62 million. Turning to our direct to consumer business.
We reported revenues of $23.7 million for the second quarter of 2008, and $49.1 million year-to-date. That compares to revenues of $27.9 million, and $54.9 million in the same periods last year.
EBITDA, a non-GAAP measure, was $3.5 million to date. There were approximately 182,000 DTC customers as of the end of the second quarter.
Taking all of these factors into account, let's turn to our guidance for 2008. As it relates to revenue we continue to target 2008 annual revenue growth in the 5% to 7% range.
As for earnings, you will recall that our guidance at the beginning of the year was $2.20 to $2.30. Based on the impact of manufacture price increases, the favorable interest rate environment coupled with our effective asset liability management efforts, we are now increasing our diluted earnings per share guidance by $0.10, to a range of $2.30 to $2.40.
Thank you. Now, I will turn it over to Craig for his remarks.
Craig Smith
Thank you, Jim. I'm going to make a couple of comments on the quarter.
And then, I'm going to bring up two or three items that I think are very typical of Owens & Minor and what we stand for that happened for the quarter. So, over the last five quarters we have reported strong results in revenue, gross margin dollars and earnings.
And we managed our long-term debt as we said we would. And I think we have executed operationally in the field as we efficiently served our customers and suppliers.
Now, we continue to see opportunity in healthcare to grow our business and provide the supply chain management solutions that make a difference. We are expanding our relationships with the former McKesson accounts and the new business we brought on last year late in the year.
And we continue to gain traction with introducing our value-added services to these new customers. And for example, we saw very strong performance year-over-year with the sale of our private label, MediChoice.
As we continue to position our company as a solution provider in the healthcare market, we are offering larger IDM's and hospital systems, supply chain answers and support they seek. I'm going to give you an example which we were very pleased to see that our Clinical Inventory Management program at the University of Wisconsin Hospital was highlighted in the July issue of Cath Lab Digest.
And in this article one of the hospitals clinical managers outlined the benefits of our Clinical Supply Solution, praising the easy-to-use inventory management features. And we feel we are making a lot of progress in the clinical supply area in the Solutions and the Technology that we offer.
So, I would encourage to you get a copy of that. As a partner we can help our customers improve the overall cost of providing healthcare.
And I believe that that makes a difference in the marketplace. And in fact we are very proud to count as our customers 12 of the 19 hospitals on this year's U.S.
News and World Reports Best Hospital list. So, we are very proud of that.
Serving our customers really remains our first priority. And during the quarter as you know we saw extraordinary flooding in the Midwest.
Our teammates in the area found creative ways to serve our hospital customers. Despite flooded roads and closed highways, our teammates drove through the night with emergency orders for our customers.
Teammates from our distribution centers throughout the Midwest worked to ensure that bio products and supplies reached our hospitals. In fact, the CEO of Iowa Health, one of our Integrated Service Centers, wrote to commend our team for their efforts during the floods saying, "We could not have served our patients and their families without your help."
And right behind the flooding, we saw that fortitude again as the eye of hurricane Dolly passed right over our distribution center in Harllingen in Texas. And although, we lost power temporarily, we were able to serve all of our customers without interruption.
Once again, our teammates worked around mother nature to meet the pressing needs of our customers. Time and again, I have watched as our teammates put aside personal concerns to serve our healthcare customers.
And at Owens & Minor, our teammates truly are the heart and the sole of our company. I want to thank our teammates for overcoming the challenges presented by these natural disasters, and all of our teammates for their efforts for a very strong, good financial quarter.
Finally, as I have said many times as a distributor, we constantly watch our performance in three key areas. You guys here me say this all year long.
We are focused on growing our sales, improving margin and managing SG&A. And this quarter, we are pleased with our results in all three areas.
Revenues were strong, gross margins improved, we continued to leverage our business over growing sales, and we feel we are well-positioned operationally, financially, and the strategically as we look ahead. Thank you and now we would be happy to take your questions.
Operator?
Operator
Thank you, ladies and gentlemen. (Operator Instructions) Your first question comes from Glen Santangelo from Credit Suisse.
Glen Santangelo - Credit Suisse
Yes, Craig, just a question for you and Jim regarding the price inflation you saw this quarter. I think if I heard Jim correctly, he sort of suggested it was about 1.5% in this quarter.
Is that year-over-year or is that up sequentially?
Craig Smith
I'll let Jim answer that, Glen.
Jim Bierman
Yes, we were looking year-over-year. In trying to get a feel for what we are seeing come through on the top line growth for price inflation.
And we think it's upwards of 150 basis points.
Glen Santangelo - Credit Suisse
And Jim, just kind of help me think about how that flows through the gross margin. Do you get the free -- the bump on your inventory every time there's a price increase?
Does that flow directly through your gross margin?
Jim Bierman
No, because most of our work, and Charlie can speak to this, also, is most of our business is contracted. It doesn't flow through that way.
But the difficulty, it's a complex calculation, the difficulty in getting it with a higher degree of precision is the issue of product substitution. So, prices can go up in a certain product class relatively significantly.
But if the hospital chooses to step down in quality or a different source of that product, it mitigates the price increase. So, certainly price inflation is an issue that is being felt across the board.
And we were attempting to try to quantify what we thought the impact in our revenues for this particular--
Glen Santangelo - Credit Suisse
And I guess -- all I'm trying to do is try to asset the impact of that price inflation on your gross margin. And then the one follow-up question I had for you, Jim was, you talked about additional private label sales of MediChoice this year versus last year, selling that through to the McKesson customer base.
Can you give us a sense for how far along we are in that process? Because I'm trying to think about gross margins in the back half of the year.
Jim Bierman
Sure.
Charlie Colpo
Glen, Charlie Colpo. MediChoice sales, as Jim and Craig say, were strong this period.
And we are continuing to increase new lines and continuing to penetrate the McKesson business. It's going very well with the ex McKesson customers.
So, MediChoice sales we would continue to expect to be strong.
Jim Bierman
And now on the manufacturing price increase component of gross margin in this quarter, it was, returned to areas of normalcy. It did not flow through like it did in the first quarter.
Glen Santangelo - Credit Suisse
Okay. Thanks for the comments, guys.
Craig Smith
Thank you, Glen.
Operator
Your next question comes from Eric Coldwell, with Robert W. Baird.
Eric Coldwell - Robert W. Baird
Thanks. Good morning.
Appreciate the comments on the total increase in fuel cost of $1.3 million. I'm hoping we can also get a metric on what you've seen with total costs to deliver over the last year or even the last few years.
Craig Smith
Well, Eric, we usually don't break that out as a component of the SG&A. I think we could maybe tell you that it's, the transportation piece as a whole.
Charlie is trying to jump in here to cut me off. So, I will let Charlie answer the question.
Eric.
Charlie Colpo
Thank you, Craig. We have obviously seen some fuel price increase.
And what we have been doing is spending a great deal of time and effort with our customers looking to improve our truck routes, and looking to change delivery schedules and optimizing our runs, so that we can offset some of these fuel price increases that we've seen the last six months. So, it's not been a one to one balance of it, but we have mitigated a good bit of that cost.
Eric Coldwell - Robert W. Baird
Okay. Appreciate the comments also on MediChoice in terms of the strength there and some of the drivers.
I'm curious whether we could get any kind of granularity on number of skews, percent of revenue, growth rates, something that we can actually tangibly hang our hat on in terms of gaining some perspective of contribution and momentum of that business.
Craig Smith
Yes. Second quarter last year to second quarter this year we've seen a 40% increase in MediChoice sales.
Eric Coldwell - Robert W. Baird
That's pretty--
Craig Smith
We have 1600 SKU's now.
Eric Coldwell - Robert W. Baird
1600 SKU's.
Craig Smith
Yes.
Eric Coldwell - Robert W. Baird
I don't suppose I can get that last metric on percent of cost -- percent of revenue?
Craig Smith
It's going well, Eric. The whole sales force also is picking it up and so we are gaining momentum across.
We focus a lot on McKesson accounts but I think the Owens & Minor accounts are picking up pace nicely on MediChoice too.
Eric Coldwell - Robert W. Baird
Great. Last quarter there were some comments about some operating expenses that may arise in the second half of the year related, I believe, to warehouse efficiency and automation programs, maybe some other DC investments.
Can you give us an update on where you stand with some of those incremental investments that you thought might temper your SG&A improvement in the second half?
Jim Bierman
Yes. I think those programs are continuing on.
I can't -- in all candor say that we have caught up to where we wanted to be. I think we are lagging back a bit.
But the pilot programs are most encouraging and we are feeling now as if we should begin to see the benefits as we move into 2009. And probably some continued expending going into 2009.
But it's premature to really talk about that at this point. So, we would continue to see in the back half of the year the spending.
And again, somewhat on a delayed basis from where we expected at the start of the year. All that's been factored into the revision in our earnings-per-share guidance that we've given.
Eric Coldwell - Robert W. Baird
Got you. And final question and I'll jump out is you have two GPO's that were originally targeted for renewal I believe in the second half of 2008.
Our understanding is that perhaps the premiere contract is coming in January, that maybe they've delayed the timing of that renewal. Can you give us an update on HPG and Premiere and I guess, context of timing and how you're thinking about that when you look at your guidance.
What impact that might have had on the guidance?
Jim Bierman
Well certainly, without going into details, we are working on the HPG agreement now and I believe it's scheduled to begin on, or around, September 1st. We are also working with Premiere on that agreement and, as you said, the start date for that new contract is scheduled to probably begin on or around January 1st.
Eric Coldwell - Robert W. Baird
Great. Thanks very much, guys.
Craig Smith
Thank you, Eric.
Operator
Your next question comes from Robert Willoughby from B.O.A. Securities.
Robert Willoughby - B.O.A. Securities
Thank you. Can you give us the diabetes patients number?
And in looking at the AR number, was there any issue with the diabetes business in the quarter? Did that contribute to any billed in that receivables number?
Jim Bierman
Sure, Bob. There were 182,000 DTC customers at the end of the second quarter.
Robert Willoughby - B.O.A. Securities
In the area of receivables, was there a build related to the DTC business?
Jim Bierman
No, I don't think there was. There was an impact in the second quarter, though.
We've been looking on a proactive basis for some of the reserving methodology that we used in, for that business, and continuing to fine-tune it over the course of a greater level of experience. And in the quarter, we did adjust the reserves upward in some of the methodology that we are using.
So, more than likely, reflect the impact of the patient pay component of that receivable balance in the current sort of economic environment that those patients are facing.
Robert Willoughby - B.O.A. Securities
Is that just bad debt going up, Jim? Is that the take away on that?
Jim Bierman
Yes.
Robert Willoughby - B.O.A. Securities
Okay. And can you speak to the action plan for the business?
It's been somewhat lackluster here for a few quarters. How do we jump start growth on that, or there were thoughts of getting into respiratory at some point, or where do we stand in terms of taking that business to the next level?
Jim Bierman
Yes. I think quite candidly, we've been operating over the overhang of uncertainty because of the confusion in place with the Medicare reimbursement and the Federal Government.
So, as we've looked at where investments should be made in areas to expand, it's been somewhat difficult to look real aggressively. And what we've chosen to do is continue to look operationally on where we can enhance the core business.
And I think an example in the changing the reserving methodology for bad debts is an example of that. Another area example is that we have begun to develop a sales force to expand the contact to acquire new patients.
So that we are not dependent on an advertising model per se. And I guess the final point, as the clarity on the Medicare reimbursement is become a little better known, is that we are actively engaged in discussions with suppliers on the entire business model.
So, as you can appreciate that sector of the marketplace was facing a large degree of uncertainty. And it's taken us awhile to work through it or at least know what the next 18 months are actually going to bring.
Robert Willoughby - B.O.A. Securities
And do any of those comments, Jim, have any impact overall on your thoughts on consolidation as a whole or just acquisitions as a whole? Is the company basically on the sidelines here for a bit, or are they still interested at getting at those affiliated physicians or other areas strategically?
Jim Bierman
Well, I think strategically, the company has said, and has said for a period of time now, that it's interested in expanding its distribution capabilities to different end users, as well as expanding the suite of products that we actually distribute. I think when we talk about different end users, though, I think the company clearly understands that it's footprint is acute care hospitals and that as we make a move, it would be more than likely adjacent to the segment of acute care hospitals.
And that is more of our sweet spot. We do understand that.
Robert Willoughby - B.O.A. Securities
Okay. Thank you.
Operator
Your next question comes from Larry March from Lehman Brothers.
Larry March - Lehman Brothers
Good morning, Craig and Jim, and Charlie, et al. So, two quick questions for you.
You rang some bells in my mind on MediChoice again, Mr. Smith.
So, it sounds like you've brought that up as an opportunity for, I guess, some continued growth. You talk about 40% in the quarter.
Could you put that in context? What kind of growth did you see earlier this year and last year?
And if I'm thinking about private label sales of say 15% of your total revenues. Am I way off in that assumption?
Jim Bierman
Yes, sir. You've got to remember that we've grown pretty dramatically here in the last two or three years.
So, as a percent to sales, MediChoice, from 15% is pretty high. I think, Larry, what we've seen is in the last six months, I think clearly part of the whole question of price increases in the commodity products have not hurt us.
I think we've done a much better job of resonating with customers and GPO's that MediChoice is not just our private label but a name brand. And we are more aggressively being allowed to bid on product categories within the GPO's.
And I think our sales force is being asked to come up with economic solutions that would help the customer either remain whole, or to get some -- of course, private label there's better margins for us. So, I think the environment is much better for us of the last six months.
I think the sales force is much more geared towards really moving the product. I think the quality of the product continues to improve.
We continue to really do a nice job. Charlie's group has done a nice job on sourcing.
And I think just across the board and with the economic environment, it's a good opportunity for us and it has proven out that MediChoice is a brand that we are really growing.
Larry March - Lehman Brothers
Okay. And then just in general, are you selling this product at what, roughly 5% discount to brand.
And is it fair to say that your margins are -- what 10% or 15% higher than a brand?
Craig Smith
Well, Larry, you're always good at getting down to the -- One is, I think, we don't discount the product per se. So I think our philosophy has always been something that is comparable, that something that they are already buying, that overall what we are trying to do is manage the overall profitability of the customer.
And what we are asking for is that customer to take a look at a bigger and bigger piece of the market basket that they buy from us through MediChoice. And we've had some success on that.
So, I really wouldn't get into how much margin we get on an individual product line because it does go vary by product category. Overall, we have a nice margin on that product.
We don't like to discount and we don't really need to discount. I think what the quality of the product that we have.
We started this four years ago and I think when anybody starts to get into this, you have to find the right sourcing, and the right strategy and the right manufacturers. I really believe that this year it's really starting to get some momentum.
So versus really trying to give you a number that everybody is going to get very mad at me in the room here at, I would say is that, it's growing nicely. I think we are in the right place and it's a good quality product that a lot of customers are taking a very hard look at or taking advantage of.
Larry March - Lehman Brothers
Okay. [Let me describe] a little bit, right.
Secondly then –
Craig Smith
Jim is actually looking out the window.
Larry March - Lehman Brothers
Secondly, around the pricing environment, you called out an extraordinary event in the first quarter which we talked about. The fourth quarter you also talked about some kick-in of some volume incentives and rebates given some of the inflation figures you've been seeing.
So, generally speaking, I'm used to seeing that in the fourth quarter. Year-to-date looks like you're still at a provision for LIFO reserve about $10.5 million, which is already well above where you were the last couple of years.
Is it fair to think that we are going to see a couple more million of boost in the LIFO, in the provision for LIFO reserve by the end of the year, or do you feel like you're about where you want to be?
Jim Bierman
Yes. That's a good question.
Well, certainly the provision in the reserve for LIFO is an estimate and as you approach year end, the calculation gets certainly further refined. Changing the -- additional manufacture price increases would obviously have an impact on what the LIFO number would be.
So, therefore, in a steady state nothing changes from where we are today. We would expect the LIFO provision, LIFO reserve, to stay as is.
I mean that assumes that the inventory and product mix stays the same. But to the degree there are price changes or inventory mix changes, the provision and the reserve for LIFO would certainly have to change.
Larry March - Lehman Brothers
Right. So, it wouldn't be a big surprise to see that kick up again at the end of the year but, again, too premature to talk about.
And then, finally, I'm a little unclear about DTC just from a standpoint of positioning. Relative to last quarter, are you happy with the bill that was passed with the 10% cut, 1109.
Do you feel like it's a mistake? Are you lobbying Congress to change it?
So, are you more pleased, or displeased, or still somewhat ambivalent as to the reimbursement environment there for your diabetes supplies relative to, say, what we talked about back in April?
Grace den Hartog
Larry, this is Grace den Hartog. I will respond to that question.
The short answer to your first question is, no, we are not very happy with the result. But having said that, it was the better alternative to what we felt like was a flawed fitting process and resulting award of contract.
So, we knew that we were going to have to pay for the delay and we worked with two other companies in the coalition and making contacts with Congress. So, we worked very hard to get the result that was actually came about.
And we are preparing for 2009 based on those results and hopefully we will work with CMS to develop a better program if you will, for the competitive bidding process going forward.
Larry March - Lehman Brothers
Right. So, you are not commenting about any impact until you give '09 guidance.
Is that fair?
Grace den Hartog
That's correct.
Larry March - Lehman Brothers
Okay. Do you have revenue numbers, Jim, for DTC in the quarter?
Jim Bierman
Sure. The revenue for the quarter was $23.7 million for the second quarter.
And that would put us at $49.1 million for year-to-date.
Larry March - Lehman Brothers
So it's down 15%. Do you have an EBITDA number?
Jim Bierman
EBITDA on for the six-month period is $3.5 million.
Larry March - Lehman Brothers
So, I guess once again, I think I asked the question last quarter. Do you really see this as a strategic asset given that your advertising expenses are going up, your reserve for doubtful accounts is going up, your revenues are going down, and there's more as a big head wind ahead of you?
Craig Smith
Certainly we realize that it's been a difficult period, both internally as we fix operations, and externally as we've had to operate under the overhang of a confusing reimbursement environment. And I think in both cases we are kind of working our way through the period of confusion and hopefully, there will be greater clarity as we move forward.
Larry March - Lehman Brothers
Okay. And so imbedded in your guidance today, are you assuming that DTC is earnings -- positive relative to '07, or negative.
Craig Smith
Yes. I'm not sure we are comfortable breaking it out in that level of detail.
We are definitely in the business to make money in the DTC business and we would expect that that business would demonstrate that sooner than later.
Larry March - Lehman Brothers
Okay. Very good.
Thank you.
Operator
Your next question comes from Randall Stanicky of Goldman Sachs.
Alex Beck - Goldman Sachs
It's actually Alex Beck before Randall. Good morning.
Craig Smith
Good morning, Alex.
Alex Beck - Goldman Sachs
Craig, at this point in time, how are you thinking about the remaining opportunity on the McKesson business in terms of further private label penetration or taking out more SG&A? What is left in terms of the profit opportunity at this point in your opinion?
Craig Smith
Well, I still believe we've got a lot of opportunity within the McKesson business and the new business that we brought on late in the year last year. And we are seeing good progress in the second quarter.
We see a lot of opportunities still on the programs and services. We are just getting started really on the MediChoice and, so, we think there's a good opportunity.
And if you look at account penetration for the quarter, and historically where we are on that, we think there's still a lot of good opportunities within the McKesson accounts, and then the new business that we brought on late in the third and the fourth quarter of last year. So, there is clearly some more opportunity to penetrate that business and then to also add programs, value-added programs and services and the MediChoice.
We are not done yet. We are right in the middle of that working it.
Alex Beck - Goldman Sachs
Great. Then a quick one.
It seems like interest expense was down sequentially in the quarter while the debt balance was up. Was that just timing of the borrowings, or was that rates, or is it something else here?
Jim Bierman
Yes. What we have, and you may recall, is an interest rate swap of instrument that's outstanding and it resets its rates on a six-month basis, April and October.
And so, the rate was reset in April. And it went from a 6.25% rate, to 3.75% rate.
So, the effect of the change was about 250 basis points which we saw begin to hit this quarter and will continue on next quarter.
Alex Beck - Goldman Sachs
That makes sense. And the final question, I don't think you guys provided upward cash flow guidance for the year but, sort of just thinking broadly, do you expect fully operating cash flow to be sort of above your net income level for full year 2008?
Craig Smith
Yes, we don't present that and I'm not exactly sure -- let me address it another way if I could and I think get sort of the -- the same answer. We had year-to-date we have operating cash flow of $79 million.
And what we saw this last quarter was an increase in our inventory levels. A slight increase on a dollar basis in receivables but that really relates as much to the increased revenue that we saw as much as anything else.
But we saw an increase in the inventory levels. And we think there is an opportunity to improve the inventory turns that we've been reporting or we reported this quarter.
Consequently, we would expect to be generating cash flow positive in the third and going into the fourth quarter. More in line with what you would reasonably expect given our volume of activity.
Alex Beck - Goldman Sachs
Sounds great. Thank you.
Craig Smith
Sylvia, we have time for one more question.
Operator
Thank you. Your final question comes from Lisa Gill from J.P.
Morgan.
Eitef Hyman - J.P. Morgan
Thanks. It's [Eitef Hyman] for Lisa.
A couple of follow-up questions. On the DTC business, I don't know if I missed it, but any reason for the 15% decline in revenue year-over-year?
Craig Smith
Part of it, I talked about the reserving methodology. Part of that relates to contractual allowance component.
And so the contra revenue account component calculation of contractual allowances, we will decrease that a little. I would guide to you our quarterly 10-Q, where we go into that in a little bit more detail.
It's a little complex to talk through the call. But that's offsetting a bit of it.
And the patient count is down a bit. We have not been in the market buying patient lists, or patient companies, that are ostensibly aggregation of patients over the last 18 months or so.
I think those are the two reasons why it's down a bit.
Eitef Hyman - J.P. Morgan
Okay. So, are you at the moment still advertising to gain patients and you have some national attrition.
Is that how it works at the moment?
Craig Smith
Exactly. And I think the advertising has stepped up over this last quarter and you will see it, and have probably seen it, on some of the -- both radio and television media that we use.
Eitef Hyman - J.P. Morgan
Okay. Thanks.
The second question, on the price increases. How are your customers generally reacting to this?
Are they -- I think one of the things you said is they might step down at a lower cost product. Is that generally the trend or do they in turn just pass those on to their patients or providers?
Charlie Colpo Eitef, this is Charlie Colpo again. With the inflation of 150 basis points they have not seen much and again, I would remind you that this business is mostly contractual with the manufacturers and the GPO.
So, we are not generally privy to the discussions of price increases with that arena. But in general terms, the price increase is hitting many products across the country today, not just in healthcare.
And if price goes up the hospitals accept that.
Eitef Hyman - J.P. Morgan
That's it. Thanks very much.
Craig Smith
Thank you.
Operator
Ladies and gentlemen, we have reached the allotted time for questions and answers. I will now turn the call back over to Mr.
Smith for his closing remarks.
Craig Smith
Thank you, Sylvia. Before we end the call, I do want to recap our conversation today.
Again, we reported strong results in revenue, gross margin and earnings. We are seeing progress in penetrating the new and acquired business we brought on last year.
We raised our earnings guidance for the year based on a strong performance to date. We worked daily on operational, financial and strategic goals as we seek new opportunities in healthcare.
And we continue to believe that the healthcare market represents significant and growing opportunity for us. We look forward to talking with you over the coming quarter at investor events and again, when we release third quarter results.
Thank you for your participation today.
Operator
Thank you for your participation in today's conference. This concludes the call.
You may now disconnect. Good day.