Owens & Minor Inc (OMI) 2007 Q1 法說會逐字稿

Good morning ladies and gentlemen, and welcome to the Owens & Minor's first quarter conference call. My name is Shaquana and I will be your coordinator 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 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. Please proceed, sir.

Good morning, everyone. Welcome to the Owens & Minor first quarter conference call. We will review our results and take your questions in a moment. But first let me introduce who is on the call today. Jeff Kaczka, Senior Vice President and CFO; Charlie Colpo, Senior Vice President of Operations; Dick Bozard, Vice President and Treasurer; Olwen Cape, Vice President and Controller and Grace Den Hartog, our Senior Vice President and general counsel. Before we begin Trudi Allcott, our Communications Director will read a Safe Harbor statement.

Except for any historical information material discussed today may constitute forward-looking statements that involve risk and uncertainties that could cause actual results to differ materially from those projected. These include the ability to assimilate the operations of an acquired business, the potential loss of key personnel, intense competitive pressure such as pricing within the healthcare industry. It may also include the success of direct marketing programs and attracting new customers, the ability to retain existing customers, changes in customer order patterns, changes in healthcare laws and regulations and changes in government including Medicare reimbursement guidelines, as well as private insurer reimbursement amounts. The ability to maintain product suppliers, product price increases by suppliers and other factors discussed from time to time in reports filed by the Company with the SEC. The Company assumes no obligation to update information contained in this call today.

Before we begin one housekeeping item, we have added a brief supplemental presentation to our website, and you can find the slides at Owens&Minor.com under the Investor Relations section. And this conference call will be archived on the website for three weeks. Thank you. Craig.

Thank you, Trudi. Jeff is going to give us a look at the numbers, and then I am going to make a few written comments, but I'm also going to make some personal comments on the conversion of the McKesson business and then talk about what is ahead for 2007 before we take your questions.

Thank you, Craig, and good morning, everyone. Clearly the highlight for the quarter was the rapid and successful transition of the McKesson business. We converted this business very quickly in just 5.5 months and had great success in retaining the customer base. I'll give you some insight into the financial impact of the transition, but I will defer to Craig to give you more color on this highly successful effort. So let's turn to our results. We are off to a very fast start this year from a topline growth perspective.

Revenue for the first quarter was $1.69 billion, up 33.6% over last year. This includes $282.5 million from the McKesson acquisition. But what is even more impressive is that if we exclude the McKesson contribution, organic revenue continued to grow at a rapid pace, up 11.2% for the quarter. And this was achieved while expending significant effort on the McKesson conversion. I think this really salutes our strong sales team and the clear leadership position that we have established in the Med-Surg acute care marketplace.

Diluted earnings per share was $0.27 compared to $0.41 last year, and net income for the quarter was $10.8 million compared to $16.5 million from last year. Pre-tax dilution from the transition of the McKesson business totaled approximately $8.1 million or $0.12 per share in the first quarter. This net dilution includes clearly identifiable items, such as transition fees paid to McKesson, warehouse personnel, warehouse leases, travel and IT expenses. The reported dilution does not reflect the impact of inefficiencies for the rest of the business that such a large scale conversion causes. Of course, this impact is reflected in the total company results.

Transitioning so much business so quickly affected every distribution center around the country as we redeployed teammates to hot spots, brought in many new teammates who are still in a learning curve and use stopgap measures, such as airfreight, overnight delivery service and temporary help in order to meet our high customer service levels.

Turning to other results, operating earnings for the first quarter were 1.5% of revenue compared to 2.4% in the first quarter last year, and of course this does include the impact of the transition. Gross margin for the first quarter was 10.4% of revenue compared to 10.8% last year, reflecting the short-term impact of the conversion of the acquired business, as well as the effective new agreements with GPOs. As we turn our efforts to improving pricing quality and selling value added services, we expect this to improve over time. The impact of these efforts will likely begin to show more in the second half of the year.

SG&A for the first quarter was 8.5% of revenue, up from 8.0% last year, driven primarily by expenses related to the McKesson transition. This, of course, is expected to improve significantly now that the transition is complete and we turn our attention to leveraging our operating capabilities and infrastructure. In subsequent quarters we will not incur transition related expenses, such as service fees paid to McKesson, some additional personnel costs and increased travel expenses.

Turning to asset management, inventory turns came in at 9.2, down from 10.3 last year but consistent with the fourth quarter, while DSO was 29.7 days compared to 25.5 days in the first quarter last year, but actually improved slightly sequentially from the fourth quarter. Operating cash flow in the first quarter was only a small outflow of $3.3 million. In light of all the transition business and the organic growth, we are very pleased with our progress in asset management; we still have some work to do here, but we already have momentum and we are confident we will see much more improvement.

We have experienced a somewhat higher level of bad debt expense associated with the McKesson portfolio, but our credit management team is the best in the industry, and we are actively applying our expertise to our new portfolio. Our guidance for 2007 is unchanged. We anticipate revenue growth in the 15 to 20% range and diluted earnings per share in a range of $1.85 to $1.95 including the impact of the acquired McKesson business.

Due to the timing of the McKesson acquisition revenue growth will be strong in the first three quarters while earnings growth will accelerate in the second half of the year. So in summary, revenue growth was outstanding at 33.6%, including 11.2% organic growth, the transition of the McKesson business is complete, and this is a tribute to the efforts of many Owens & Minor teammates around the country. We have now turned our attention to fine-tuning this new business, which offers us a great opportunity for the second half of the year and of course we have a solid outlook for 2007.

Thank you, now I will turn it over to Craig.

Thank you, Jeff, and good morning, everyone. As you have heard this was really a very busy quarter for us. I would almost say it was probably hectic based on the fact that I was able to visit roughly 8 to 10 of our operating units in the first quarter and watching them really work to complete the conversion of the McKesson business and at the same time grow our organic revenue at really a strong pace. In fact, we've never had a quarter where we brought in more than 30% new business all at once. Let me give you a flavor of what we accomplished with this large-scale conversion.

This was a well executed project involving many of our best people. Even though we launched the conversion on October first last year, we chose to save the biggest customer conversions for the end of the period. Consequently in the final days, 90 days of the conversion, we actually transitioned three-quarters of the business. So far we have maintained the customer base, only losing the customers we expected to lose at the beginning of the process. Of the 10 facilities we acquired we expect to keep four. We added a facility in Chicago, and we will be closing one more facility this year.

We had 600 teammates assigned to the transition working on the day-to-day management of this task, but in one way or another practically everyone at Owens & Minor pitched in to help, and they did a great job. I would like to thank our teammates, especially the transition team, for successfully beating and we thought six months was pretty aggressive, we actually finished this thing in five months and a week, the conversion timeline goal and for making this conversion a success.

As we look ahead with this new business, our task is to leverage our network and our capacity so that we capture the value in this acquisition. Now we will work with our customers to help them become more efficient in terms of AR, pricing and contract compliance. We are going to maximize our distribution network. We are in the process of reducing our expenses, and we'll introduce our value added services into the mix. Finally, our expectations for this new business, including the organic growth are embedded in our guidance for 2007 and our guidance remains unchanged.

Now let's turn to a couple of other topics. Looking at the gross margin compared to last year, we started this year with much of our business in new contracts, including the Broadlane contract, which kicked in February first. We brought on more than 30% new business compared to last year's first quarter, and we transitioned the bulk of the three-quarters of the McKesson business in the first quarter. And as a result we do have some work to do on margin.

Looking ahead with the fluctuations of inventory moderating we see our cash discounts normalizing in the second quarter. We expect to see improvement in freight cost, and we had a lot of freight moving around in the first quarter to keep our customer satisfied, to make sure that we did not become exposed to some competitors with lower service levels. As I said before, I was out in several operating units in the first quarter, and we were moving a lot of freight around to make sure that we hit the service levels that our customers have come to expect from us.

Now our new Broadlane contract gives us the opportunity for the first time in seven years to sell MediChoice to our customers through our Broadlane customers. We are working on the McKesson price files, the local contracts, and we are in the process of moving McKesson private-label to MediChoice, which is more profitable. We are also moving the McKesson business to EDI transaction sets. We were a little surprised that EDI is not used as heavily in the McKesson customers as it is in the Owens & Minor customer, and we are moving to get those customers on EDI transaction sets as quickly as possible.

Also, now that the conversion is finished, our 600 transition teammates are now back at their regular jobs doing what they do best. We will begin to gain leverage by using our systems, our processes, our facilities and finally our people all back in their current positions doing what they do best. This will allow us to drive margin improvement as we look ahead to the second half of the year. We are going to continue to work on improving asset management; I think personally that was a very positive story for the quarter. Our asset management improved sequentially from the fourth quarter. We really saw that probably happening more in the second quarter, and we saw some improvement in the first quarter. We saw roughly $100 million swing in operating cash flow from the fourth quarter. DSO improving sequentially, with so many new customers and our inventory turns holding steady.

Turning to our direct-to-consumer business, our customer count for the quarter was 177,000. We had no surprises and our remediation efforts with daily operations at Access continue, and we are making progress. I am going to make a few comments on competitive bidding which we've had a lot in the last six months. CMS or the Centers for Medicare and Medicaid Services announced the rules, and let me just give you an update. CMS launched competitive bidding for certain medical products in the 10 MSAs -- that's metropolitan statistical area -- we actually have been doing a lot of work on our customer count and where they are, and this will only affect a very small percentage of our customer base. The bidding process and the pricing really will not -- the pricing will not be implemented until 2008. We view the first round really as not a threat to our business.

Now what is ahead for the rest of the year? Our task is to capitalize on the opportunity presented by McKesson. It represents in excess of about $900 million in revenue. You can see I am standing to the $900 million in revenue primarily around contract compliance. We are going to look at unprofitable accounts. We are in the process of doing that now. So we are going to continue to say that the conversion will be about $900 million. As you might imagine, bringing these customer accounts in line won't happen overnight. In general, whenever we bring new customers on board we go through a period of sinking up pricing files and contracts, but I believe overall once we get this done it will be a great opportunity for our customers and us to work on value added services.

We are currently working on our core SG&A improvement, which we told you all last year we improved on. That is the core strength of our Company. We are in the process of doing that now, and we are very comfortable with focusing on SG&A and driving that down. I have to tell you this was a herculean effort with this conversion; to do it in six months was aggressive. To do it in five months and one week, we felt that the service was because from a discontinued operation we needed to move that last 40% very quickly. And our people worked very hard to beat that deadline. Now it might have cost us a bit more, but it was the right thing to do. These customers are under our roof now, and we are working just intently on the next phase of fine-tuning this business.

Thank you and we would be happy to take your questions.

(OPERATOR INSTRUCTIONS) Glen Santangelo, Credit Suisse.

Close enough. Craig, how are you? I just had a couple quick questions on some things you said. You said you had a lot of freight moving around in the quarter. Where do those freight costs show up? Do they show up in your cost of goods sold or your SG&A line?

It shows up in the margin, Glenn, cost of goods.

Okay, it is in cost of goods. And what about some of the bad debt attached to some of the McKesson business that you alluded to? Is that in cost of goods, as well?

No. That actually ends up in SG&A.

All right. And then just quickly moving onto the GPO businesses that you referred to in the press release, you kind of re-signed Novation, which started September 1. So we should have seen some of the impact of any repricing in the December quarter. Is that correct?

That is correct.

Okay, so would it be fair to say then that maybe some of the pressure in this quarter was attributed primarily to Broadlane?

I would say it's a combination, Glen. We had several questions asked over the last six months about the McKesson business. We were fairly comfortable where we felt those margins were going to end of up. Again, they needed a lot more work than we thought they did. The EDI interface, it doesn't sound like a big deal, but to get the pricing accuracy correct they had a lot more local contracts. I would say their core strengths really wasn't file maintenance on their pricing files, and so that was probably not where we expected it to be. Also the cash discounts we had a ramp up on inventory, heavy inventory in the fourth quarter and the third quarter. So we didn't see the cash discounts in the first quarter, which is directly attributed to margin. And then we were a little more aggressive on the Broadlane contract, but they have really chosen to be a good partner. And they are allowing us to sell MediChoice products, as I said, for the first time in seven years. They are really working more also, Glen, on the value added services with us. So we are going in jointly with customers and talking about value added services, which will also enhance margin and that contract started February first.

And just my last question, then I will jump off; this is for Jeff -- Jeff, is it fair to say that we should start to see the cash flow from the inventory reduction starting in the second quarter?

Sure, Glen. I think, as I mentioned in my comments, we expect to see continued improvement from an asset management perspective both on the inventory side, on the receivable side. We did already see some of that improvement throughout the course of the quarter, particularly in the second half of the first quarter. So we expect that to continue. The inventory turns are still at 9.2, and I think if you look historically we've gotten that over the 10 range. So that does represent opportunity.

Okay, perfect. Thanks a lot for the comments, guys.

Larry Marsh, Lehman Brothers.

First of all, let me say I share the great sorrow of you, Charlie and others there around what happened earlier this week at Virginia Tech. It was really tragic. Congratulations, Craig, I guess you and your team on about beating your target of the six months. That is great to hear. Let me drill down I guess a couple of things. First of all, your topline growth even excluding the McKesson business was very strong. How are you defining market growth these days? And what are you suggesting were the biggest contributors to the big upside and what your internal growth was versus what I would assume you think market is?

Larry, we did a lot of work on the 11% growth, 9% of that came from sales penetration. And what we have talked about really over the last couple of years is, and I think going back to the McKesson business once we get this pricing stabilized and the service levels, we are much more aggressive in terms of penetrating current business because we think that is one from an SG&A standpoint of course the most efficient way to do that. Also from a ten-year standpoint the longer you are an account the ability to sell more services, MediChoice all of those programs. So we worked very hard on existing business growing that and growing the sales.

So when you look at 9% to the 11% is sales penetration, and this is a story that we have been talking about for a long period of time. So this is really nothing new for us in terms of what we do. So we are going to continue to work to look at product categories. Charlie's group is very aggressive at what new productlines we can add, our reps are always asking for more business in the accounts, and if you look over the last several quarters our strength is really been on sales penetration. We track that. We track that quarterly. We track that annually. And we feel we get better sales penetration probably than any distributor in the marketplace. I think that really plays to our branded strategy of being neutral. We are not a manufacturer. So whatever the customer, whatever the customer wants, if they are an efficient manufacturer we're going to work with them to bring them into the system.

Just to be clear, so you are suggesting then market growth would be about 2%?

It is actually higher than that. Again, as each quarter to quarter as we add business, it is hard each quarter to say that a certain percentage is going to be 2% or 4%. We did bring some business on in the fourth quarter that is now fully up and running and functional in the first quarter. And that will fluctuate a little bit. And I think if you look back over several quarters -- I don't have the exact number in front of me, but it is probably somewhere between 2% to 4% in new business.

Okay, and then I know in the past couple of quarters you have also benefited from some competitor disruption. Would you, as you look at your business, say that you still benefited from some competitor disruption in the first quarter?

Well, you know me, Larry. I usually don't talk about the competitors too much. I think -- I honestly believe this is a wonderful time for Owens & Minor. We have got great programs and services. We are talking to customers all over the country in terms of what we have to offer. And as I always tell our people, where our biggest threat is if we don't listen to our customers and we don't continue to improve, that really is the threat to Owens & Minor. So we are just very focused on what we do day-to-day. We want to get this conversion completely settled. It is, but now what we want to do is grow those McKesson customers. And we just think it is a great opportunity for the Company right now from a people standpoint, a technology standpoint and just the book of business.

Second question, just is around specificity on next steps now that you've I guess converted McKesson business. I think you talked about it in your prepared comments sinking up pricing files and contracts and aligning the transaction sets through EDI. Is that a work in -- are you still doing that, and if so, when would you anticipate that being fully sinked?

I'll let Charlie -- Charlie is chomping at the bit here to jump in, so I'll let Charlie, he is hanging over his chair here so go ahead, Charlie.

Well it is a work in progress, and it is, Larry, a very complex job to get the McKesson files sinked up with our files and get the customer to agree. And it has been ongoing since we started this conversion. But obviously it has intensified now that the actual conversion is complete. So we are going to push very hard and have a very strong effort to get this thing done as quickly as possible. We also have plans in place to get the MediChoice converted away from the McKesson private-label. And we are just going to manage the lower margin accounts, and we are going to also manage the contract compliance of the new business. And again, Craig mentioned the EDI process and that will go very quickly, too.

So just from a timetable standpoint Charlie, would you anticipate that being done over the next say month, the next two months, next four months? Could you be more specific?

We will be complete by the end of the quarter.

By the end of this quarter?

Right.

Okay, very good. And finally, just a little bit of clarification on the gross margin. As we did the numbers it looks like if you back out some of the assumption of margin on your diabetes business and the McKesson business, your gross margin is done maybe 40, 45 basis points maybe more versus this year, first quarter last year. You alluded to some of the things that may have impacted that. Could you elaborate a little specifically? Would you anticipate that rebounding this quarter with what you define to be cash discounts and MediChoice programs or is that something that you think is going to take toward the end of the year to get a healthy balance in?

Larry, we did mention that the two main impacts year-over-year, first quarter of this year versus first quarter last year were the new GPO agreements and the impact of the McKesson; Charlie just described some of the activities that will take place in regard to the McKesson. And that we would anticipate to see some of the impacts more in the second half of the year as opposed to the second quarter. Same with the GPO agreements. Historically when we've had new agreements the margin starts out a bit low as we sell in MediChoice, other services and so forth that tends to mature over time. And that would be a little bit longer term.

I think, Larry, the biggest opportunity for right now is the SG&A piece and us to really drive that. And as you know us very well, we are very good at that. And we are going to move very quickly on the SG&A piece. Sometimes the margin takes a little bit longer. We do think there is some opportunity short-term on the margin, but we think really short-term SG&A is the big opportunity.

Okay. Thanks.

Lisa Gill, JPMorgan.

Hi, it is actually [Arthur Farene] in for Lisa. Craig, you had mentioned the total revenues you are still expecting from McKesson are about $900 million, and we've seen two quarters of just north of $280 million. So is it an element of some conservatism on your part or do you actually see your revenues potentially declining in the back half of the year? And then secondly, what is your MediChoice penetration for some of your best accounts just in terms of where your peak penetration gets to?

Let me answer first of all the reason why again I am sticking to the $900 million is, and I think we did $282 million in the fourth quarter. So you know the run rate is a little higher, but I would say this is a great opportunity for the Company with where we have our sales growth to really go back and jettison or take-up some unprofitable business. And any time you've got billions of dollars of sales you've got to be looking at your total book of business, and we are right in the process of doing that now. I would hate to change the forecast after the first quarter of slamming all this business in without really taking a really strong look. And now the good thing is we've got everything on our system. So we know exactly the profitability of all these customers, and we were doing a little guessing over the last six months just because somebody was managing the price and the margin for us. So this is now really the opportunity with 100% visibility of all these operating units and all these customers is to see where we could either take some price up, again getting our margins back in line, or really probably looking at the credit worthiness of some of these accounts.

So we are sticking to the $900 million. This gives us some time to really look at this whole book of business and as you know, you've been following us a long time, this is something that we normally do in the time of business is we go back and look at customer profitability and make sure that they are at the acceptable corporate ranges that we have. So it may be conservative, but I would rather be conservative and do the right thing and look at the -- maintain the profitability of the Company than to take the number up and then three months down the road we jettison some business and it gets back to the 15 to 20 range that we gave you for the year.

And given revenues were essentially flat sequentially did you jettison any business in the first quarter?

No, but the revenues -- the overall revenues.

Just for McKesson business.

Oh, the McKesson business, I'm sorry. You had us all looking at each other on that one. Again, we did not have everything on our system. And really the number one priority, most people thought we were going to do this in a year. When we said we were going to do it in six months everybody thought we were crazy and to do it in months. Our main goal has been to not have customer disruption, to maintain the service levels. We had a lot of competitors going into these accounts trying to get them to come over and now that we have everything on our system, we can really take a hard look at this business. And really what we feel long-range the opportunity is, is again sales penetration, programs and services; so even if we take it down to $900 million we think there is an upside opportunity to penetrate the accounts, which McKesson did not have what I would say the penetration that we have in our accounts. So we did not jettison any accounts. We did lose some business that we expected to during the conversion but we did not lose any business due to the conversion.

Secondly just on MediChoice what is the peak penetration kind of get to?

We never break that out separately. It is still a low percentage. The nice piece is that it is at a much higher margin than our normal business. And we see the opportunity; our private-label was more profitable than the McKesson private-label. So we see that there is an opportunity to get the profitability up, which is very good as it is right now on MediChoice. MediChoice is growing very nicely, and it is still a small percentage of our business but still has some strong growth. And really the upside is, is now that we can sell our Broadlane accounts.

I'm sorry to jump on late, I was wondering if I could just log in one last question here. When you talked about the GPO agreement with Broadlane as well as renewing with Novation you talked about some value added service opportunities. Can you give us a little bit more color as to what type of opportunities they are and the expectation over what timeframe that you'll be able to realize some of those?

On the Broadlane, I don't, probably most people don't know that. This was a very traditional relationship between Broadlane and us from the standpoint it was traditionally a supplier/customer relationship of cost-plus bulk distribution to the hospitals. And really around price driven, a lower price, bulk delivery twice a week to the hospitals. What Broadlane has chosen to do is to allow us to sell PANDAC, Q-Site, WISDOM, all the services that we have that we have upside to, along with MediChoice. So the relationship there has really moved from what I would call a transactional relationship to more of a joint partnership to help their customers drive their overall process costs down.

And I think the mix of their customer base has changed from the standpoint that they are bringing larger IDNs into their system. So they also see it as an opportunity to work at a higher level with their customers to drive process costs down. From the Novation standpoint we have always been allowed to sell programs and services. I would say we are much more aggressive on the MediChoice piece with the Novation customers, and that is probably the upside. We have always been able to sell PANDAC or Q-Site or SurgiTrack or any of those programs. So probably even in the Novation accounts, although it is not sanctioned, we've seen some growth in the MediChoice.

And you have a good question, Lisa. On the programs and services, those usually take a little bit longer because you are primarily dealing with several different decision-makers in the hospital. So that can be six months or nine months. What is nice is when you have the GPO working with you in compliance to get these customers on board you might be able to move that up a little bit faster. The MediChoice can be a lot faster than that. That can be a thirty-day sale or a sixty-day sale. I guess what I am saying is depending on the service or the profitability instrument that you are talking about it could be anywhere from 30 to 90 days.

Thanks for all the color.

Terri Powers, Robert W. Baird.

Good morning, everybody. This is Terri in for Eric. Craig, first of all, thank you for all of the color that you provided related to the gross margin performance in the quarter. That was very useful. I wanted to come back to you guys on SG&A. You indicated that is the real near-term opportunity. And I guess what I wanted to focus on is obviously given the additional McKesson business, clearly there is even more leverage opportunity just due to overall volume.

So I am wondering if maybe not necessarily near-term but longer-term do you think you can get to SG&A levels as a percent of revenue that are actually below what you guys were doing before you acquired the McKesson business and had been continuing to improve that expense level in the core business?

That's a reasonable expectation, Terri. We just did some work on our sales for FTE and sales per square foot first quarter of last year versus first quarter of this year, and even with everything going on and the expense that we had in the first quarter and all the movement and the additional space we had, we were up very nicely on -- which is a huge barometer for us as we track our business. Actually, that is really your two leverage tools is your sales per FTE and your sales per square foot to a large degree. And both of those are up first quarter of this year over first quarter of last year, even with everything that was going on in the quarter.

We think there is, clearly from a freight and a delivery standpoint, we have the inventory in place. We are reducing the inventory even from an interest standpoint. We should see some very nice reduction in SG&A over the year. Transition fees are completely gone. So we think that is a big opportunity for us this year.

That's great color. Thank you very much. And I just wanted to quickly follow-up on the director consumer business. Can you provide the revenue and operating profit for that business during the quarter?

I think that is actually in the filings.

The revenue for the quarter is $26.9 million, Terri, and the operating profit was actually a loss of $983,000. I think you will see that in the filings. Be aware that normally, and we explained this last year, normally the first quarter is the weakest quarter of the year. In addition, that operating profit line includes some cost actions that we'd taken including closing a facility that will improve the cost structure as we go throughout the year. No AR surprises this quarter.

I think the goal there, Terri, is to get everybody in one building through these acquisitions. We didn't get the synergies we wanted, and we are now moving very quickly to get everybody from multiple buildings into one building. And we've made a lot of progress in headcount down there, and we are going to continue to focus on really making that an efficient business. And Dick has been down there a lot. Grace has been down there a lot. I've been down there. And we are getting comfortable that things are settling down there.

Thank you very much for the color.

Jennifer Hills, Goldman Sachs.

Can we dig into the cash flow a little bit deeper? You had indicated that there is an opportunity to take working capital out. Can you be more specific on the timing of that? And then what the uses of cash would be, such as CapEx expectations, payment of debt?

Yes, Jennifer, obviously as a distributor our investments are in inventories and receivables and those clearly represent the biggest opportunities from a cash flow perspective. The DSO is up at -- it is down from the fourth quarter from 30.5 down to 29.7, but as you know historically or at least for the last couple of years we were down at the 26 range. So as we employ our best practices to this new McKesson portfolio we would expect some improvements there and steady improvements as we go out throughout the year.

The inventory, we are already seeing rapid improvement; we saw that decline from the middle of the quarter. Certainly now with the conversion complete all the business under our own roof and employing the best practices there we will see continued improvement in the inventory throughout the year. So the timing of the asset management should be immediate and steady throughout the year.

And then what about CapEx expectations?

CapEx, we don't provide guidance specifically on capital expenditures. Traditionally if you look in the last several years if you remove the unusual, such as the construction of our new home office, we traditionally spent in the 15 to $20 million range in CapEx. This year it could be slightly higher than that range because of some work still on McKesson conversion and some of the facilities but not much different than that.

And what about the outlook for paying down debt and as far as that relates to interest expense?

That comes along with the operating cash flow at the end of the quarter, which is more or less a high point for us; the revolver balance was at $254 million. As we see those asset management improvements and the accretion, we should expect that revolver to come down in conjunction with that and therefore the interest expense.

One more question on the direct to consumer. You had talked initially about that being a platform to go into other direct-to-consumer products. Where are you in the process of thinking about doing that?

I think last quarter I talked a little bit about that, Jennifer. Our first goal was really to get the AR stabilized and get everybody in one building, which we are making progress on. And in parallel with that we are doing a lot of work, and really from a strategy standpoint don't want to go too much into this because I just, I think we are maybe looking at the marketplace a little bit different than some other people. But we've made progress on that, not necessarily from a disease management state, but from a multiple delivery state to other pieces of business.

And we have got two people internally that are working on that. And I don't think that is completely built out, but I am pleased with the progress that we have made over the last three months in how we are going to do our follow-the-patient strategy in that. And the first thing, though, the first commitment was to get the AR stabilized, get people in one building, and we're making really good progress on that.

Second piece my commitment was, was to strategically finalize this, follow the patient strategy, and we are moving -- we do not want to make any mistakes on this. We had a couple of trips last year on the AR piece, and we want to make sure we do this right. So we are making progress, though.

Thank you. That's all I had.

John Emrich, Ironworks Capital.

Just two quick questions. The tax rate was a little higher in the quarter than I was looking for. What is a good number to use for the rest of the year and the future in general?

I think if you look historically where we have been around that 39 to 40% range. This quarter wasn't much different from that, just slightly below. So we don't provide the specific guidance on that, but we have no reason to believe this year will be significantly different than the past.

Okay, and I know you were talking about bad debts a couple of times and I apologize if you clarified this already but I missed it, the bad debt comment was associated earlier in the call with the McKesson business. Can you just talk about bad debt trends in Access?

There were no surprises with Access in regard to the bad debt. We have put in some fixes to the process, and we feel very confident. As we talked about those issues last year it really related to a time period in the past where there were some breakdowns in the process, and that has been handled.

I would call no surprises a positive trend.

I would agree with you definitely.

Thank you very much.

Jeff Allen, Silvercrest Asset Management.

Craig, in the recent past here you've talked about I think the fact that some of the sales strength has come from penetration, increase sales penetration and more specifically that you are penetrating more kind of higher value type of products. And I just want to ask you a question about how that might relate to gross margins in the sense that costs the same to move a box of gloves as it does to move a box of stents. And so of course mathematically if you charge the same fee for both of those things, then that would tend to pressure the gross margin if you are increasing the sales of higher value products because the denominator is getting bigger. So is that -- am I thinking about that the right way?

Excellent question, and it will probably take me thirty minutes to answer it, so I'm going to try and -- because there are several ways that you can price that product. One is through activity based costing, which a large percentage of our business is on. And most of our, what we call our integrated delivery networks are on. So that is more of a fee for service pricing mechanism. Then there is the traditional cost-plus buy sell, which actually to your question would be actually better for us. Because of the bigger dollar. Unfortunately most of them are doing activity based costing, which is still good. Doing activity based costing because you still get the product cost.

And then the third piece is consignment or cross dock. So in those three pricing mechanisms there is different ways that we would price that. And there are different ways that the customer wants to have that. If they are in one of our integrated service centers they may look at it as a cross dock or an activity based costing. If they are a stand-alone catheter lab hospital or a heart hospital they may want that in a different capacity. So there is really three different pricing mechanisms that we put to that.

The good part is it shouldn't really depress margin. So we should either get a reduced cost or efficient cost. We should either get at least the product cost or we should get an increased pre fee, or we get a bigger chunk of the buy sell. So you can kind of look at that four different ways. We look at this mathematically. We look at the profitability of the customer, and really long-term this would be a whole supply chain initiative which we are driving without getting too much into strategy here. This is a whole opportunity from a supply chain standpoint to really kind of drive our customer's cost down, improve visibility and efficiency to the manufacturer and to long-term improve our profitability.

So I said thirty minutes. That probably took nine, but it is a good way to round out our portfolio and it helps us on the penetration piece. It just depends on what pricing mechanism -- this is not GPO driven. This is provider driven. So it is really our large systems that sit down with us and say, okay, let's go down and sit down with this manufacturer and tell them how we are going to do this business together. So it can be a variety of ways.

And you said it doesn't really pressure the gross margin but do you mean that it wouldn't pressure it in percentage terms or just in absolute dollar terms?

It would really get down to operating margin because if you don't get the efficiency on the back end there is really not any reason for us to be doing this. So you might not see a bump on the topline margin. What you would see is some improvement in the operating margin. And again, this is a small percentage of our business that we are focused on that we are growing. So you wouldn't see a huge impact today if we were driving more of the direct sales. Our goal is to add more long-term.

So in any case it wasn't a meaningful contribution to the gross margin decline in this.

Oh, no, no, it really was down to cash discounts, the Broadlane agreement and really trying to get this McKesson business to where it needs to be.

Okay, thank you.

Let's have one more question.

There are no further questions at this time. I will now turn the call back over to Mr. Craig Smith, President and CEO, for closing remarks.

Thank you everybody for listening in. I just cannot tell you the excitement that we have here now that we have got this McKesson conversion behind us. We've got a lot of tired people, but we got a lot of happy people. And of course now the real work starts from the standpoint of getting the expenses down, getting the pricing right and getting the margin up. And we are looking forward to telling you how we did in the second quarter here in a couple of months. Thank you.

Thank you for your participation in today's conference; this concludes the presentation. You may now disconnect, and have a good day.