Owens & Minor Inc (OMI) 2008 Q1 法說會逐字稿

Good morning, ladies and gentlemen. And welcome to the Owens & Minor first quarter 2008 conference call. My name is Katie, 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)

I would now like to turn the call over to your host for today, Mr. Craig Smith, President and Chief Executive Officer of Owens & Minor. Please proceed, sir.

Thank you, Katie, and good morning, everyone. Welcome to the Owens & Minor first quarter 2008 conference call. We'll review our results and take your questions in a moment, but first let me introduce my colleagues on the call today: Jim Bierman, our Chief Financial Officer; Charlie Colpo, Dick Bozard, Olwen Cape, and Grace den Hartog. Now, before we begin, Trudi Allcott, our Director of Investor and Media Relations, will read a Safe Harbor Statement. Trudi?

Thank you, Craig. Our comments today will be focused on the Company results for the 2008 first 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 uncertainty that could cause actual results to differ materially from those projected. Please see our press release and our SEC filings for a full discussion of these risk factors. And finally, this conference call will be available on our website for the next three weeks. Thank you. Craig?

Thanks, Trudi. Let me call on Jim to brief us on the financial results. Jim?

Thank you, Craig. And good morning, everyone. We are pleased with this quarter's record earnings and the progress we have made with our operational initiatives as we continue our efforts to position the Company to achieve profitable, sustainable growth. I will begin my remarks with an overview of the first quarter results. First quarter 2008 revenues were $67 million greater than revenues reported in the first quarter of 2007, an increase of 3.9%. The comparison to the first quarter of last year is impacted by the trailing effects of the McKesson acquisition.

Some of these accounts which were being served in the first quarter of 2007 were not retained during the year. Offsetting this was the net new business we added during 2007. Revenues associated with the McKesson accounts that were not retained approximated $30 million in the first quarter of 2007, decreasing to 3 million by the fourth quarter of 2007. Despite this, our first quarter results are within the range of our overall expectations. First quarter 2008 gross margin was $187 million, an increase of $12 million from the first quarter of 2007 and significantly better than we had targeted for the quarter. As a percent of revenues, first quarter gross margin increased 31 basis points to 10.67% compared to first quarter last year. The improvement from the prior year is primarily due to our efforts during 2007 in bringing the McKesson accounts up to our pricing standards.

Interestingly, when compared to fourth quarter 2007, gross margin increased $1.9 million or 8 basis points. As we discussed last quarter, we were expecting a sequential decrease in first quarter gross margin due to the seasonality of volume purchase incentives, as suppliers typically measure growth incentive programs at calendar year end. However, this quarter we did realize a greater than expected benefit from manufacturers' price increases. In our industry, there is a practice under which distributors receive the benefit of manufacturer price increases for amounts the distributor holds as inventory and for amounts on order. This profit is realized by claiming a larger rebate from the manufacturer when the product is sold.

The impact on first quarter 2008 gross margin was approximately $3 million greater than the amounts we were targeting. We do not expect to see a similar benefit in the remaining quarters of 2008. First quarter 2008 SG&A expenses were $137 million, a decrease of 5.7 million from first quarter 2007 and less than the levels we were targeting for the quarter. As a percent of revenues, first quarter SG&A expense decreased 65 basis points from the same period in the prior year to 7.82%. A significant aspect of the variance was the cost incurred in the first quarter of 2007 for transitioning the McKesson accounts, including transition-related payments to McKesson of $6.7 million.

SG&A expenses in the first quarter of 2008 were also positively affected by decreased selling costs as we realigned our selling efforts during 2007. When compared to fourth quarter 2007, SG&A expenses decreased slightly by 600,000, or 5 basis points. As we discussed last quarter, we were targeting a slight seasonal increase in SG&A expense dollars when compared to fourth quarter 2007. The seasonal adjustments we targeted were recognized as expected. However, we did experience some delays in the spending we anticipated for certain operational initiatives we are undertaking. Naturally, we are expecting financial benefits from these initiatives to increase both revenue and operating margin in future periods. We are now targeting these initiatives to increase SG&A expenses towards the second half of 2008, with the financial benefits beginning to be realized during 2009.

First quarter 2008 operating earnings were $43.2 million compared to 24.8 million a year ago. Operating earnings as a percent of revenue was 2.46%. Interest expense, a component of net income but not of operating earnings, decreased $3.7 million in the first quarter 2008 compared to a year ago. The decline in interest expense resulted from the reduction in the average debt outstanding during the period, as well as decreases in interest rates. The effective income tax rate for the quarter was 39%, affected by the statutory filing date for corporate income tax returns. Overall, we are targeting the annual effective tax rate for 2008 to be 39.5%, which is consistent with the previous guidance and the prior year's effective rate. Net income for the quarter was $24.2 million compared to 10.8 million a year ago.

For the first quarter, diluted earnings per share were $0.59, improved from last year's $0.27. Again, to put comparisons in perspective, during last year's first quarter we were engaged in the transition of an acquired business. As you look at our first quarter asset liability management, we reported cash provided by operations of $108 million for the quarter. Contributing factors included: Accounts receivable increasing by less than a million dollars; inventory increasing by $26 million; and accounts payable increasing by $82 million. Cash used for capital expenditures was approximately 5 million, and cash dividends paid were 8 million. We used cash to reduce our revolving credit facility by $76.5 million and drafts payable by 21 million.

Now, turning to our direct-to-consumer business, we reported revenues of $25.4 million for the first quarter of 2008, a slight decline from 26.9 million for the same period of 2007. EBITDA, a non-GAAP measure, was $2.6 million. The DTC operating earnings for the quarter were positive, improved from last year when we posted a loss of $1 million. Turning to our guidance for 2008, as Craig said in our press release, we're off to a good start for the year, and the first quarter results put us within the range of our previously stated annual guidance. Now let me turn it back over to Craig for his remarks.

Thank you, Jim. Now that Jim has provided you with some insight into the numbers, let me take a few minutes to talk about the quarter, what we're seeing in the marketplace and how we're positioned for the year ahead. As Jim said, we are obviously very pleased with our results this quarter. Historically speaking, this is the strongest quarterly earnings we have ever reported. On top of that, we are pleased with ongoing operational improvement and with solid underlying performance in measures such as SG&A and asset management.

Preparing our quarterly results allowed me to reflect on where we were just a year ago. Now, at this time last year we had just completed a very hectic six-month transition period for the McKesson acquisition. Bringing a billion dollars in new business into our network was no small feat. With these new customer accounts came new teammates, new facilities; and, as we have said before, certain challenges. Pricing files were out of sync and supply chain management practices were different than ours.

But we worked very hard throughout the year to bring the pricing files into line and to accustom new customers to our way of managing the business. As we demonstrated with each successive quarter, we have more than accomplished our goals in integrating this business into our distribution network and our systems. Although this took time, our fundamentals are greatly improved compared to a year ago.

For example, we paid down over 200 million on our long-term debt compared to last year. We lowered our net accounts receivable by $104 million. Our cap ratio at 25.3% is half what it was a year ago at 45.4%, and our return on assets and return on total equity are also greatly improved. Turning back to this quarter, on the reverse side as Jim explained, we're about where we thought we would be for the quarter. Based on trends so far this quarter and our plans for the year ahead, we're comfortable with our annual guidance.

The opportunity for us this year is in penetrating our existing accounts. With the new business that came on board in late 2007 and the McKesson business, we see opportunity for further growth with these accounts. We have started to achieve success in selling value-added services such as PANDAC, WISDOM Gold and SurgiTrack to our new customers. This year, we also expect to invest in our teammates and in our operations. We know that the key to strong customer relationships is the knowledge and expertise of our teammates, as well as the efficiency of our operations.

For our teammates, we are introducing an expanded leadership development program this year; and as for our infrastructure, we intend to invest in operational initiatives that we believe will lead to improvements in our warehouses and improved Customer Service. Even with these investments, this year we see opportunity to improve expenses as a percent of revenue. We constantly have our eye on achieving efficiency gains and lowering operational expenses.

As for what we are seeing in the market today, our customers continue to ask us for our help in improving their supply chain. Our challenge is to continue to serve our customers with the knowledge, supply chain expertise, and product mix that can make a difference in the healthcare supply chain. As we see our customers, our goal is to achieve continuous improvement as we also seek to expand our role in the healthcare arena. Our ability to partner directly with our healthcare customers and suppliers opens the door for us to provide advanced solutions such as asset management, information management, and outsourcing. As pressures increase on our customers, we are well-positioned to help them. We are at the right place at the right time with the right tools, people, and infrastructure that can make the difference.

Just a few -- a couple of personal comments. We are obviously very pleased with this quarter. We are making very good progress in leveraging the McKesson acquisition. We managed our SG&A effectively despite rising fuel costs. Asset management continues to be one of the cornerstones of the Company, and we are very pleased with the quarter. Thank you. Now we should be very happy to take your questions. Operator, Katie?

(OPERATOR INSTRUCTIONS). Your first question comes from the line of Eric Coldwell from Robert W Baird. Please proceed.

Thanks. Good morning. Can you hear me.?

Yes, we can hear you, Eric.

Great. Thank you. First off, just housekeeping. Jim, I missed your comments on the DTC business. Could you give us revenue and EBIT, and patient count at the first quarter, please?

Sure. I don't have the patient count, Eric, but let me give you the other numbers, and I can give you directionally patient count. Revenues for the quarter -- first quarter of 2008 were $25.4 million, and that is compared to 26.9 million for the first quarter of 2007. EBITDA for the first quarter of 2008 was 2.6 million. Operating earnings for the first quarter were positive, and a year ago they were a loss of about a million. Directionally, there is a slight decrease in patient count, but I don't happen to have that number here.

Okay, and the EBIT you say is positive, but I assume that is immaterially so, given that you're not giving the exact number?

Yes, exactly.

Okay. Great. I guess big picture, as we've listened to a couple of your suppliers' calls recently, J&J and Abbott, we're getting kind of conflicting messages from the suppliers in terms of market trends and whether or not the economy is weighing on their orders and what they're seeing from the distributor purchases. Can you give us some sense on your take on the difference in those calls? I know you guys have heard them and listened to them, and I'm just interested on what your take is on what the manufacturers are saying today.

Eric, let me take that one. You know, you can pull numbers from a lot of different reports. Basically on the information we used through February -- and as you know, a lot of the items that we sell are consumed in the operating room -- surgery trends seem to be what we would consider to be stable, so you know, I don't -- we don't see a dramatic increase or decrease. They seem to be holding fairly well.

I can say anecdotally -- as you know I am out talking with a lot of CEOs every quarter. The first seven weeks of the year -- and I was primarily in the southeast, the Northwest and the southwest; I take these swings through different parts of the country. Now, this was before the flu season hit in the third week of February. I was getting some information which I was not asking for. What they were telling me is that their census seemed to be a little light or their admissions seemed to be a little light. Now, I can't really speak to that for the last four weeks of March and the first week of February, but the number that we really look at is surgery trends, and that seems to be stable at this point through the end of February.

Great. Thank you very much. And final question for now, and I might come back in later, is there were some comments about operating expense initiatives that are under way this year and how that might -- I think if I heard you correctly might lead to a little spike up in SG&A versus what you originally thought in the second half. Could you give us some sense on directionally what kind of an impact we might be looking for and maybe some details on what those initiatives are?

Sure, Eric. I think directionally we were expecting on a dollar basis the SG&A expenses to increase towards the back half of the year, and you know, as we sat here a quarter ago, our hope was that some of these initiatives would be a little further along and we would be recognizing more of the expenses even in the first quarter. The initiatives have to do primarily with improving and increasing the automation capabilities and the process improvements that exist in the warehouse distribution system. And we're pretty excited about this initiative, and Charlie is leading the way in attempting to improve -- make sustainable improvements in the operating performance of the distribution network.

Jim, would you expect SG&A to sales ratios to still show some improvement versus the ratio in 1Q but maybe not as much as originally targeted, or are you actually signaling that you expect SG&A to be up as a percent of sales?

No. As a percent of sales we would tend to think that we remain comfortable with the overall guidance that we gave at the beginning of the year where we would begin to see an improvement over the back half of last year's performance. This was merely a directional guidance as to dollars quarter on quarter.

Okay. Thank you very much.

Katie, are you still there?

I am sorry. Your next question is from the line of David Veal from Morgan Stanley. Please proceed.

Great, thanks. Hey, I'm just trying to understand a little bit further the kind of seasonality that we might expect the balance of the year. Could you -- you made mention that there were $30 million of McKesson business that was not retained in the first quarter, 3 million in the fourth. Can you give us round numbers for the second and third quarter just for modeling purposes?

No. I don't really have that at my finger tips. Again, it was to provide sort of the directional explanation as you looked at quarter on quarter or similar quarters year-on-year was what the notion was behind it.

Is it fair to say that it's -- is it fairly linear, though?

I think so.

Yeah, I think fundamentally it is.

Okay. And then in terms of the gross margin line, so we've got $3 million in pricing benefits this quarter that won't recur. Are there other items that we should be thinking about as the year moves along?

Well, no, other than as we have said now on two successive quarters, there is a degree of seasonality with the volume purchase incentives because many of those programs are calendar year based, where you have to establish or reach a certain level of performance in order to qualify for the incentives, so there is a bit of a second half of the year bias or even a fourth quarter bias, which again we had talked about last quarter as we finished up the fourth quarter.

Sure. Absolutely. Okay, and one last question and I will hop off. But in terms of working capital management - obviously, you've done a great job managing the DSOs down. What can we think about or how should we be sort of thinking about the forecast? Is there room for that -- to take that lower? Can we squeeze out a few more dollars there?

I think any potential that may exist may be more on the inventory side than the DSO side. I think we're running out of room on the DSO side to continue to have the improvements that we've had.

Great. Thank you very much.

Thank you.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Joel Ray from Davenport. Please proceed.

Joel, are you there?

Yes, I am.

I think we're having a little problem with the phone. We just wanted to make sure you were there.

I am. I would like to ask you a question if I could.

Yes, absolutely.

We've had developments on the whole issue of competitive bidding on the diabetes side, and I was wondering if you've had a chance to evaluate your strategies going forward for that business now that we know that there are some changes coming in July of this year?

Joel, this is Grace den Hartog, and I have been following the competitive bidding results. Access was a weight listed bid winner, and what we are doing now, we're involved in several coalitions that are attempting to educate and inform the congressional legislators of the impact of the bid results as we currently know them to be, and I might add that the award winners have not yet been announced publicly, and CMS does not intend to make that announcement until the second week of May, so we're still operating a little bit in the dark as to who the actual award winners will be. But we know enough to know the national players are working together in a variety of coalitions, as I mentioned, to educate the congressional legislators as to the potential consequences of the results as we now know them to be.

And just to put a financial color on it, Joel, the initial round of bidding has a relatively insignificant impact on the base of business in our DTC business; and consequently, a relatively minor impact on what the potential financial effect could be this year or even going forward relative to this aspect. Obviously, there is a bigger component; and I think just the final point on this would be I don't think the results of the -- as they stand presently have really changed our strategy related to this operation.

I take it that all of the -- from what you know today with what's gone on with the program, all that is factored into your existing guidance?

Yes.

Okay. Good enough.

Thanks, Joel.

Your next question comes from the line of Larry Marsh from Lehman Brothers. Please proceed.

Good morning. It's always an honor to follow Mr. Ray. And my questions won't be as [INAUDIBLE], but I would like to ask two things. First, just the rebate call out in the first quarter. Again, you say about 3 million more than you would have thought, and I am just sort of reflecting back. I never recall a first quarter rebate recognition that's this magnitude, and I am just wondering what particular to this year would have, you think, caused this? Is it a change in how you're forced to recognize rebates? Is it just something unusual in the market or what would it be, you think?

Well, Larry, I have been doing this a long time, and I would agree with you, it has been quite a while since we've seen this in the first quarter., And I think it is really related to price increase based on the rising fuel costs. Latex is going up dramatically, and resins. And as probably we're seeing -- we're not quite sure where this is all going to end up in terms of price per barrel, so I think really the manufacturers, I wouldn't say their backs are to the wall, but the rise of transportation costs, the rise of resin in and latex, I think really prompted several manufacturers which we've not seen -- I was saying this morning -- I can't remember when we've seen this number of price increases in the first quarter. It has been a long time. And I think it was just to the point where the manufacturers really had to take the price increases and more or less let the chips fall where they may with the end-user, which is the customer, so it -- I haven't seen this -- I was thinking at least in five years and probably longer than that, so you know, it did catch us a little bit by surprise that we saw this many price increases going into this year.

Interesting. So as you think about it, I guess the offset of that might be some increase in your own fuel costs that I guess you would have to absorb, but it sounds like those are fairly modest in comparison to the tick up in price; so net net as you think about it, Craig, rising fuel costs, I won't say it's a net positive to you, but it certainly doesn't seem like it is a head wind, especially as you reflect upon these price increases.

Well, and I would look at first quarter, we did see fuel costs improvement or fuel cost increases, and we were able to absorb those by offsetting other parts of our SG&A. As you remember, a pretty big percentage of our businesses is on activity-based costing, so there is an ability to pass that on. Some of our larger customers who are probably better educated on supply chain is allowing for pass through on fuel; and of course as we renegotiate contracts, obviously this is becoming much more of a sensitive issue as we move forward renegotiating or negotiating new contracts. So I think overall with the fuel increases that we had in the first quarter, we were still able to show really good improvement on the SG&A and absorb whatever fuel costs we had that we had increased in the first quarter.

Okay. Secondly, just to follow up with I guess a question Eric asked, which is just sort of the tone of the market. I mean, certainly anecdotally a lot of concern about funding costs for hospitals, you know, some back and forth on census. Your point is on surgical procedures, don't see much of an impact, but is there anything from a customer standpoint that you could see that could catch you by surprise here as you go into the back half of this year that may be a result of some of these macro issues they're facing?

Well, I think the one thing I was a little surprised in the first three months, and maybe it was a little bit naivete on my part, but there is pressure on Medicaid with cost cutting in different states. I think to some degree, it primarily hit around -- there is some tie in to the real estate challenges that we're seeing in terms of tax dollars, so there is some pressure in some parts of the country.

Again, I believe, though, we're in the right place with the right tools with our larger customers that are really focused on supply chain. They're really working on improving their supply chain, and I think we're in the right place to help those customers. So I don't really on the radar screen today anticipate in the last six months anything coming out of left field at us, but I was -- in my discussions with a lot of the CEOs, there has been some questions about Medicare, but I think we're well-positioned for that.

Okay. And two other quick things. Just back on diabetes here for a bit. It seems like if you reflect back a year or so ago your decision was really to kind of cut the cost infrastructure, but not continue to invest in building that business in terms of share, and I think Jim talked about some sequential reduction in patient count. With some of the outcome of competitive bidding, i.e. you're not one of them as it stands in terms of winning bidder, do you think there are more opportunities to cut costs in that business or do you think you're about as far as you can go? And even post competitive bidding, are there other ways to sort of nix down your own supply cost there?

Yeah, we're looking at that in a lot of detail, and that is exactly where we are focused. You know, we're pleased that the entity is now EBITDA positive, cash flow positive, even though it is maybe earnings neutral. The opportunity there is to look at ways to improve margin on the sort of mix of products that they have. We've seen a fair degree of variability on the respiratory suite of products which we're evaluating and looking at constantly, as well as we're looking at the way we go to market to obtain new patients, new customers. The advertising model has definitely gotten more expensive, and we're selectively using that model, but supplementing it with a bit of a more direct sales force model that we think mitigates some of the risks associated with it. So I think the bottom line is we'll continue to see improvement, sort of marginal improvement, if you will, in the overall performance of the entity in this environment.

Sure. And just, you know, as you sort of think about it strategically, it just seems like this is such a minor part of your business, given the strength of everything else, if you're sort of breaking even, you're obviously not building the business and given changes. I'm just sort of wondering what - strategically, what's the rationale for still being exposed in the industry?

Right now, we're pleased we've turned it around operationally. We're certainly aware of other changes that are happening in this space in the marketplace, and I think we continue to look at various options going forward.

Okay. And finally real quick, I don't mean to hog the call, but just Craig, you and Charlie as you think back, I mean, here we are with the McKesson business fully integrated here. I mean, is it fair to say that this has been a real success for you in terms of more retained business than you thought and sort of less hiccups than you thought, or would you just sort of characterize it as this business has come in net net about like you had thought, because it certainly seems like it has been a nice positive surprise on the retained business side.

I think that the biggest surprise for us, Larry, is the leveraging that we were seeing earlier in the year than we anticipated. I think there is still opportunity there in the McKesson business in terms of sales penetration and programs and services. I think if we were to say, in reflection of that looking back, you know, we still see Charlie sitting here to my right. He is about ready to jump in here any second -- but as we -- as I think we see this business, the upside opportunity is the retained business, as you know, and we've talked a lot about this publicly, is our ability to take a new account or existing account, penetrate it, and I think there is still some very good opportunity there. We're seeing our first PANDAC customer, our first SurgiTrack customer, our first WISDOM Gold customer, so we're going to push that pretty hard.

And on the new business that came on in the third and fourth quarter last year, remember we had all this -- not noise but just all the physical moves and the people we were adding, and to just bring on that business along with the McKesson business -- and I think people forget, we added hundreds of millions of dollars in new business in the third and fourth quarter. There is still a huge upside opportunity on the new business that we brought in now that the dust has settled, and I think the investments we're making in the warehouse and Customer Service -- we're making some great investments in our Customer Service that's going to help us penetrate those accounts better.

Good deal. Thanks so much.

Thank you.

Your next question comes from the line of Robert Willoughby from Banc of America Securities. Please proceed.

Good morning, ever living in Larry Marsh's shadow here. Actually to Larry's question, you know, sort of why be in that DTC business, assuming that you kind of stay there status quo, I mean, where else do you have really to deploy the kinds of cash flow that you are generating? Are there new strategic directions here on the horizon?

Yeah. I think, Robert, that certainly as we look at the opportunities that are out there in the marketplace, there are a significant number of them. You know, quite simply, I think we have an opportunity to deliver the suite of products we have to different end-users, so to expand the end-user base beyond our concentration in acute care hospitals, and without -- we don't have the luxury of time here to go into a lot of detail, but that definitely is an opportunity that exists, and then we also have an opportunity to expand the suite and characterization of some of the products that we have with existing customers as we move potentially into, say, more of the clinical area. I think those areas -- those two strategic directions have us very excited and could be -- generate a significant return on any capital that's deployed.

Jim, to the first point, I guess, I am assuming, though, you still want to stick with entities somehow affiliated with the hospitals? I mean, we're not talking about new distribution niches that are completely removed from that hospital presence?

Exactly. I think that leveraging off of the incredible national footprint that we have with our acute care relationships is really the key to the success in this next step, and we'll be looking to accomplish that, correct.

Okay. And just another issue possibly for Craig, looking at fuel costs, you appear to be fairly well insulated from some of the increases there; but obviously healthcare costs for the employers is a key issue. We're seeing problems in the managed care sector today. What is Owens & Minor doing year-over-year to manage down that healthcare cost trend?

Our healthcare costs or the hospital's healthcare costs?

Your own employees.

Our own employees -- we have instituted a wellness program. We have health screenings every quarter for all of our teammates. We give incentives for wellness, a reduction in payment of insurance costs. We added a state of the art workout room here that I can tell you is very heavily used from Monday through Saturday. We're only closed on Sunday. We have experienced trainers. I would be amazed if we probably took all of our teammates here and counted the pounds reduction, I think it would be pretty dramatic, to be honest with you, year-over-year. You know, we have a no-smoking policy. We give incentives to our teammates to quit smoking. We bid out on a regular basis our healthcare -- our insurance companies. I think the one challenge we have is we have about 4,600 teammates. We're probably still considered somewhat of a small entity to insurance companies, so really what we do is to prove to the insurance companies that we deal with that we're improving our teammates' health and their well-being, and so that is a very high priority for the Company.

Interesting. And actually some of those things sounds like costs actually increase somewhat. I mean, can you speak to --

Well, you know, I think overall if you look at the average of what other companies are going through, I would say that we are below that median, so the investments that we have made have paid off, and I would say overall our insurance costs -- if you were to take all of the workout room and the trainers and the incentives versus what we're paying on a monthly basis for insurance for our teammates, I would say that we are still under the national median for increases on an annual basis. I have been very pleased. We've done -- we use our insurance providers to come in and make recommendations. We're working very aggressively on Workman's Comp with safety programs, and so it is not just to get the insurance costs down, it is to get our overall liability and our insurance costs down across the board.

Great. Thank you.

I am glad you asked that question. We're very proud of that. We don't toot our horn very often on that.

Great. Thank you.

Thank you.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Lisa Gill from J.P. Morgan. Please proceed.

Thanks. It is Arthur (INAUDIBLE) in for Lisa. Jim, I was just wondering if you can provide some more color on the SG&A costs that got postponed, perhaps the magnitude of the costs that you were expecting this quarter that got postponed out to the balance of the year, and then I have a second question related to revenues.

Yeah. I think -- I am not sure I can comment any further than sort of directionally the way I did. We were down on a dollar basis 600,000 compared to the fourth quarter of 2007. When we talked in terms of the first quarter 2008 a quarter ago, we were expecting SG&A expense dollars to slightly increase. So we were slightly down. We had expected a slight increase, and I think that kind of gives you a range of where we actually had come in.

Okay, so maybe about a million higher is where you would have been? Is that off the ballpark? Or --

I think it is within the range.

Okay. And then secondly on revenues, you've guided about 5 to 7% for the full year, and this quarter was just under 4%. I think [current] penetration is definitely one of the areas you're gunning for. How is -- you know, where is this mainly going to come from? Is it mainly just the McKesson business or is it within your existing base, too? And what's the process for new competitive wins this year?

Well, let me say that, again, and I think one of the comments that I had made earlier, it's more than the McKesson business. It is the three to 400 million in new business, I think, that we brought on, so you're really talking about a billion four that we have the ability to penetrate at a higher percentage, so it would be the new business -- so it would be the new business. You know, we continue to existing business, back to Jim's point, of making the investments in the technology that we have in the hospitals. You know, we still feel we've got an opportunity in existing hospitals to penetrate with some of the new technology and some of the new markets we're working in. So the 5 to 7, we came back and said we're comfortable with that.

And we think for the year that that's something we're still comfortable with, and we do think a lot of it will -- you know, I think as we have been asked year over-year over year, you know, we have grown our existing business nicely, and now we have this new book of business to put on top of that. So right now on the horizon, as you know we've got the two GPOs up for bid later in the year. That's progressing along. There is not a whole lot on the radar screen. As soon as I say that, then something comes up for bid. Basically it just --we're in the hunt all the time for new business, so we have this new enterprise sales force that basically is out working on competitive accounts every day, and so we're not just counting on the existing or the new book of business. We want new customers. So we're aggressively out in the marketplace going after that.

Okay, that's great. And then, final question. You know, your activity-based costing does give you some ability to pass on the fuel costs. Could you give us some -- you know, any numbers around what percentage of your existing customers are -- you know, pre-McKesson customers -- are on activity-based costing and what's the kind of trajectory for bringing on the McKesson customers on to activity-based costing?

Yeah, we were tracking somewhere before McKesson somewhere between 38 and 40%. Obviously, when you add that much business on, your percentage drops pretty dramatically. So we have an opportunity there with the activity-based costing with the new McKesson customers. I think that's a new concept for them. Really what we've worked on is operational improvements, we've got the service stabilized with them. Now we have the opportunity to push the activity-based costing, so it is still a fairly significant piece of our business is on activity-based costing, and most of our larger, more sophisticated customers use that as their pricing model.

Okay. That's excellent. Thanks very much.

Okay. Operator, we have time for one more question.

And your final question comes from the line of Eric Coldwell from Robert W. Baird. Please proceed.

Thanks for letting me jump back in. A couple of questions from balance sheet and cash flow. You know, Jim, as I look at the very detailed press release from last night, we saw the increase in your LIFO reserve. I am hoping you can help marry for us what's going on. We've got a more than doubling of LIFO reserve in the quarter. How do we marry that with your comments on price increases that have transpired early this year, and could you give us some color on what you're expecting for LIFO reserves for 2008?

Yeah. That's an excellent question, Eric. And without getting into somewhat of the arcane rules around LIFO and inventory valuation, let me try to present sort of a broad overview. With the extent and the nature of the manufacturer price increases that we experienced in the first quarter, in a perfect world with no changes in inventory amounts, you would see for every dollar of price increase a corresponding dollar of increase in the LIFO reserve, so there would tend to be a correlation between the two on a one to one basis in an environment where there are no changes within inventory.

If you look at the first quarter of 2007, where the provision for LIFO reserve was 4.8 million and it increased to 10.5 million for the first quarter of 2008, that really speaks to the magnitude and the significance of the manufacturer price increase impact that we saw in the first quarter, and again speaks to why we hadn't anticipated the increase any better than we did, and that I had already spoken about. Again, assuming that there is little to no manufacturer price increases for the remainder of the year, and assuming that the mix of inventory stays basically the same as it is at the end of the first quarter, you would not expect to see any significant change in the provision for LIFO reserve over the course of the year.

Thanks for the color, and then just last question here, on the guidance I think that was delivered, commentary delivered at the Investor Day, there was some commentary about being a little more cautious in your internal modeling for the overall economic situation and hospitals' financing pressures and some commentary about increasing your bad debt reserves; yet in Q1 that debt reserves were actually down just fractionally versus Q1 of '07. Can you give us some color what's going on there and what we should be looking at for bad debt reserves for the remainder of the year?

Yeah, and again, the first quarter 2007 provision for losses on accounts receivable was 6.2 million, and in the first quarter of 2008 it was 5.8 million. Reserve actually increased year-on-year, but the provision is down marginally. I would say that tends to be normal fluctuation that we would see within a book of business and appears pretty reasonable and within expectations, at least as we are here today. Remember, the provision for losses on those accounts includes a component for the DTC business as well as the core distribution business.

Right. So I guess on a quarterly basis should we be looking at about this trend - continuing, this magnitude of reserve continuing for the remainder of the year?

Yeah, I am not sure I am comfortable going that much further. I think within the totality of the SG&A guidance that we've given, we certainly have factored in our expectations regarding the provision for bad debts, and I would say that the first quarter is definitely within those expectations that serve the basis for the overall conclusion, if that helps in another way.

Great. Thanks much. Good job on the quarter.

Thank you very much.

All right. In closing let me just make a couple of comments here. We are making very good progress in leveraging the McKesson acquisition. We've managed our SG&A effectively despite rising fuel costs. Asset management has been outstanding. We felt we had a great quarter, and we look forward to giving you our results at the end of the second quarter. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.