Owens & Minor Inc (OMI) 2009 Q1 法說會逐字稿

Good morning, ladies and gentlemen. (Operator Insturctions)

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 and Minor. Please proceed, sir.

Thank you, Janika. Good morning, everyone. Welcome to the Owens and Minor first quarter 2009 conference call. We will review our results and take your questions in a moment.

But first, let me introduce my colleagues that are on the call with me today. Jim Bierman, our Chief Financial Officer; Charlie Colpo, Executive Vice President; Grace den Hartog, General Counsel; Dick Bozard, Treasurer; and Olwen Cape, Controller. Trudi Allcott will read our Director of Investor and Media Relations, will read a Safe Harbor statement. Trudi.

Our comments today will be focused on company results for the 2009 first quarter which are included in our press release. The press release as well as the related presentation can be found on our Web site. In the course of our call today we may 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 SEC filings for a full discussion of these risk factors. Finally this conference call will be archived on our Web site. Thank you, Craig?

Thank you, Trudi. Now let me call on Jim to brief us on financial result, Jim?

Thank you, Craig. And Good morning, everyone. The first quarter, 2009, was characterized by a number of strong positives and encouraging trends. While not all of our metrics improved, we view revenue growth, expense control and debt reduction as all very positive for the quarter. What is more significant, we achieved these results in the context of a sharp downturn in our economy that has pressured just about every market sector. I will present an overview of the first quarter results, and Craig will then provide comments on our business, the healthcare market, and progress on our strategic initiatives during the quarter..

As a reminder we completed the sale of certain assets of our direct-to-consumer diabetes supply business, on January 2, 2009. And thus, it is shown as discontinued operations, in our consolidated financial statements. All prior periods have been reclassified, consistent with the current period presentation..

First quarter 2009 revenues were $1.95 billion. An increase of $221 million, or 12.8%, when compared to first quarter 2008. Approximately 70% of the increase in revenue resulted from the positive impact of net new business, including the Burroughs Company acquisition. The remaining 30% of revenue growth resulted from penetration of existing accounts.

Gross margin for the first quarter, 2009, was $184 million. An increase of $14 million when compared to the first quarter of the prior year. However, as a percentage of revenues, gross margin and the first quarter of 2009, was 9.42%. A decrease of 43 basis points from the procedure year. The decline in the first quarter gross margin as a percentage of revenues resulted from the combination of two factors.

First, we experienced larger than anticipated supplier price increases during the quarter. Some 60% greater than increases in 2008, which if you will recall, were also greater than historical experience. A portion of these increases can be attributed to one large manufacturer that had not raised prices in more than three years. Because we use the LIFO method for valuing inventory we increased our LIFO provision by $6 million to $16.4 million in the first quarter, to account for the press increases. As we have said repeatedly, we believe that suppliers would represent a variability factor this year, and although we can not speak for our suppliers, we know that some have publicly stated they are selectively increasing prices as they look to improve certain product line profitability.

We experienced a similar phenomenon on a smaller scale last year at this time as suppliers raised prices and provided us with corresponding rebates. This year we received additional rebates from suppliers but one of our suppliers who had not raised prices in recent years implemented a significant price increase - a portion of which was not eligible for rebate. As a result, combined with the increase in the LIFO provision of $6 million, we experienced a $4.5 million reduction in gross margin, when compared to the comparable components of the first quarter, 2008. We anticipate that much of this loss will be offset, by other supplier initiatives as the year progresses.. As we look to the rest of 2009, we are not targeting a recurrence of such significant increases in the remaining three quarters of the year.

The second factor contributing to the decline in quarterly gross margin as a percentage of revenue resulted from the timing of the recognition of revenue of certain new contracts. As you may recall, late in the fourth quarter, 2008, we signed significant new business, including a large integrated service center project with a new customer. This contract and a few others contained features that require us to defer revenues, until we achieve certain performance targets, relating to services we are to perform over the remaining term of the contracts. For the quarter, approximately $4.4 million in revenue from these new contracts was deemed to be contingent revenue for accounting purposes. In other words, we will recognize the deferred revenue for a certain project when the contingent aspect is satisfied. The net effect was a reduction in gross margin related to these contingencies. In our view this is not an issue of whether the revenue will be recognized, but rather, when it will be recognized. We believe we will recognize the majority of this deferred revenue in late 2009. Finally, also impacting gross margin comparability is the conversion and integration of the Burroughs business which has a lower margin profile than our existing business.

Turning now to SG&A - first quarter 2009, SG&A expenses were $139 million. An increase of $16 million from first quarter 2008. As a percentage of revenues, first quarter SG&A expense increased only three basis points to 7.15% when compared to the same period last year. The increase in expenses resulted primarily from the integration of the acquired Burroughs business including increases in labor costs, distribution center leases, freight costs and transition-related expenses. Additionally, SG&A expenses increased due to employee benefits, and technology outsourcing fees, partially offset by decreases in management incentive expense, and fuel costs.

Sequentially the SG&A percentage declined five basis points from the fourth quarter, even as we were continuing the Burroughs transition activities. As we have said previously, we tend to experience a slight seasonal increase in SG&A results in the first quarter.

First quarter 2009, operating earnings were $40 million compared to $43 million a year ago. Operating earnings as a percent of revenues was 2.05% compared to 2.49% in the prior year quarter. The quarter over quarter decline in operating earnings, resulted from activities associated with the transition of the Burroughs accounts.

Interest expense, a component of net income but not of operating earnings was $3.3 million - essentially in line with last year's first quarter. In the first three months of 2009, our effective interest rate was 5.9% on average borrowings of $228 million, compared to 6.8%, on average borrowings of $214 million in the first quarter of 2008. The effective income tax rate for the quarter was 38.8%, essentially in line with last year's first quarter tax rate of 39%. The tax rate was lower primarily as a result of less interest-related to potential tax liabilities. Overall, we are targeting the annual effective tax rate for 2009, to be in the range of 39.5%, consistent with the previous guidance and the prior years effective rate. As we expected, income from continuing operations for the first quarter 2009 declined slightly by $1.6 million, to $22.4 million, when compared to the first quarter of 2008. The decrease was due to an increase in SG&A expense of $16 million, which was partially offset, by an increase in gross margin of $13 million, and a decline in income tax expense.

On a per share basis, quarterly income from continuing operations was $0.54 compared to $0.58 per share last year. Net income per diluted share was $0.34, compared to $0.59 per share one year ago. The decrease resulted from the effect of the discontinued operations.

Now let's turn to the status of the wind down of our discontinued operations. We recorded a loss of $8.4 million in the first quarter, or $0.20 per diluted share. The loss resulted from charges associated with exiting the DTC business, including a provision for uncollectible accounts receivable, losses on the disposal of assets, expenses for personnel and termination of contracts and leases. These were partially offset by a $3.2 million gain on the sale of the DTC business. Looking ahead, we believe that the disposition in exit costs are nearing completion.

As for asset liability management for the quarter, we reported, operating cash flow, of $83 million for the first three months compared with operating cash flow of $114 million for the first three months of 2008. Cash flow for the quarter was positively affected by the timing of payments for inventory, and collections of accounts receivable, but negatively affected by increases in inventory. Inventory turns in the first quarter, were 10.3, compared to turns of 10.6 a year ago. Inventory has increased in connection with the number of distribution center conversions completed in the first quarter of 2009. We were pleased with our DSO result which was 23.6 days as of the end of the quarter -- an improvement compared to year-end and in line with DSO of 22.6 we reported at March 31, 2008.

Cash used for capital expenditures was approximately $8 million, while cash dividends paid were $9.5 million. Cash provided by discontinued operations was $77 million, including the $63 million we received from the January sale of our DTC business. When you combine that with our $83 million of cash from continuing operations, was used to reduce our long-term debt by $147 million. As a result, our long-term debt as of the end of the quarter was $213 million, our total borrowing capacity under our revolving credit facility is $306 million, and as of the end of the quarter, we had approximately $291 million available to us.

Finally, a word about the Burroughs transition. As for the conversion activities, they are proceeding according to plan. We're on track to conclude the activity is about the second quarter of this year. To date we have closed seven of the facilities and continue to market the properties for sale. We expect the costs associated with this transition will continue into the second quarter of 2009, as planned. How does all this factor in to our guidance for 2009? We remain optimistic about the year. We also are aware of the continuing lack of visibility into the economy as a whole. Particularly in the second half of this year.

However, we are off to a good start this year, with very solid revenue, expense control, and asset management trends . As we said last quarter, we continue to target revenue growth in the range of 8% to 12%. And we are targeting income from continuing operations per diluted share, for 2009, to be in the range of $2.55 to $2.70. Now I will turn it over to Craig, for his

Thank you, Jim. And looking back, we performed well this quarter, and exceeded internal expectations on key measures, in our business. And I would say overall we're pleased with our quarterly progress, and believe we're well positioned for the year ahead. During the quarter, revenues grew at a strong pace, including contributions from the Burroughs acquisition and the new business that we talked about signed in late 2008. And to put our growth in context, quarterly revenues were greater than revenues for the entire year in 1993, just 15 years ago. We firmly believe our ability to bring about real supply-chain improvement is a plus in this market, where customers are seeking every avenue to improve and reduce costs. Our focus on process improvement is exactly the idea behind some of the agreements we have signed recently with larger healthcare systems. We are partnering with them to create real efficiencies.

Now the good thing about these contracts are, they are long-term in nature, and are based on both parties achieving performance targets. We believe our ability to offer these advance services to select customers, represents a competitive advantage. And while these contracts will sometimes involve deferring revenue until performance targets are met, we believe they are an excellent addition to our portfolio. New customers along with the Burroughs transition made for a very busy quarter - one of the busiest ones we have had as long as I have been here. Consequently we're very pleased with our success in controlling expenses during the quarter. We also continued to invest in our strategic initiatives and made positive steps in moving these projects forward.

Strong asset management and the resulting debt reduction was a big story for us during the quarter. As a result, we have paid back what we borrowed to fund the 2008 Burroughs acquisition. The transition of the Burroughs business to our systems is proceeding according to schedule, and while we have completed a great deal of the work, some of the more complex customer conversions remain. However, we still plan to conclude the transition by the end of the second quarter. As we work on growing our business, we're also allocating time, money, and talent, to our strategic initiatives as an investment for our future. One of these initiatives is investing to improve operations. To that end we're in the process of implements voicepick technologies in our facilities. This technology will improve speed and accuracy in our warehouses. We estimate that voice pick could enable us to achieve a 10% improvement in the picking process, and today we are very good at doing that, and we still believe there is a 10% opportunity to improve in the picking process. Now I have seen the technology firsthand and I have to tell you, I am very impressed by its potential.

In another strategic area, we continue to build out our OM health care logistics business. We have designated distribution space for the effort and we are in the final stages of deploying software and systems. I am also very pleased to report that the team has signed a new customer, and we will begin providing services this summer. We are also investing in our clinical supply solutions efforts, which targets the clinical areas of the hospital where we believe there is a strong potential to improve inventory management. We are now engaged in training our sales teammates around the country, on how to sell in clinical departments. So to sum up the quarter, we managed through a great deal of activity, we remain on schedule with the Burroughs transition keeping the costs in line. We brought on competitive business. We completed the sale of the major assets of our DTC business and we began implementing voice pick technology in our warehouse and we stayed focused on our strategic initiatives.

Turning to the year ahead we expect that we will continue to face a somewhat choppy economy. What does that mean for Owens and Minor? I want to tell you a story anecdotally. I had a chance, and many of you know I go see a lot of CEOs, CFOs, and COOs across the country in hospitals that are customers and noncustomers. I had a chance to meet with one of our bigger hospital CEOs and of course, usually the first topic is something about the economy, and when we think it is going to get back on track, and what is going on across the country. And he had a very many poignant remark. He said, you know, weak companies probably won't survive. But strong ones will emerge even stronger. He said the best thing to do is to focus on daily blocking and tackling, and to execute with precision every single day. And that really reminded me -- that is what we do at Owens and Minor, day in, and day out.

Since we're a pennies business, our strong suit has always been the daily attention to efficiency and productivity, and that is true today. Therefore, we remain comfortable with the ranges of our annual guidance, and as we have said, since December, and at the fourth quarter call, we're looking at a stronger second half in 2009. Looking ahead, we will rely on our core values and that means, growing our business, delivering excellent customer service, achieving operational excellence, using sound business practices, maintaining a strong balance sheet, and investing in our future. In closing, we are pleased with the strength and steadiness in key areas of our business. We continue to believe that we're well positioned operationally, financially, and strategically for the year ahead. I want to thank you, and now we would be happy to take your questions.

Your first question comes from the line of Larry Marsh, Barclays Capital.

Thanks. Good morning, everyone.

Good morning, Larry.

I can relate to the advice from one of your hospital CEOs except most days I feel like I'm the one getting blocked and tackled so [ laughter ] Anyway. Just a couple quick things. First on pricing. I'm not used to see this kind of LIFO charge in your business, obviously a big uptick in the first quarter. Two things here. One, what do you think your full LIFO charge will be for the year? And then two, how are you thinking about this environment, when you talk about a supplier who is raising prices without triggering any rebates - is that good for you, or do you think pricing could be going in an extreme here that could come back and hurt some suppliers.

Larry, let me take the first one on the LIFO charge for a year. Because you hit upon the essence of the accounting issue. Which is, in a sense, the accounting for LIFO provision is similar in concept to the accounting for income taxes where one needs to have an estimate or review as to what the amount would be for the course of the year. Our provision in the first quarter of $16.4 million, compares to last year's of $10.4, so you're absolutely right - It is a significant increase for the course of the year.

If you consider the variables that one would take into consideration in determining the LIFO provision for the year, certainly inventory levels come into play and the expectation as to both the quantity and type of inventory that you would have, as well as the critical variables of what the expectation for inflation and price increases would be over the course of the year. What we have historically seen, and if we don't look any farther back than last year to this year, what we saw was a significant amount of supplier price increases in the first quarter, followed by two more quarters, second and third, where very little activity, and then in the fourth quarter, we saw a small amount of price increases. We're taking that expectation as we move forward, into the remainder of this year.

And fundamentally saying that the experience pattern that we saw in 2008, more than seems reasonable as an amount to target to occur in 2009. So that is how we have looked at it and that is how we're considering it. Obviously we have little to no control over many of the price increase factor. And we're somewhat at the mercy of the suppliers. But as we sit here today that's our best estimate as to what the future may look like. Let me defer the second question, aspect of your question, to Charlie, to give his view on the supplier side of this.

Yes, sure. Good morning, Larry. Jim mentioned the comment that we had a supplier who had a price increase that they had not taken in a number of years and in my almost 28 years at Owens and Minor, this was the most significant and broad-based price increase that I recall. So, it really came down to the fact that the supplier was unwilling to give us an unlimited rebate or funding to this price increase, and we look at this more as a one-time event, than a trend that will happen in the future.

Okay. All right. Fair enough. I can follow-up. Second really question is around the $4.4 million deferred revenues, Craig, I know you talked about it part of a contract that is creating a competitive advantage. Around this, was this deferral at all a surprise to you in this quarter and are you in a position to elaborate on what sort of performance targets you need to meet to hit this contingency?

One, I think we're very comfortable that we're going to hit our performance targets and you, especially, many others have followed us for a long period of time. This is really not something new to the company. We have been doing guaranteed savings on PANDAC for 35 years. With the onset of OM solutions over the last five years, we have a pretty good track record in terms of gain shares.

Now I think part of the challenge was, as we signed three of these in one quarter and, these are six month negotiations deals. One year negotiation deals, where there is a lot of back and forth in terms of setting targets. So it was probably that all three closed in one quarter might have been a little bit of a surprise because they are usually stretched out over a period of time. But let me be very clear that we are very comfortable that all that revenue, will be coming back, the majority of it, in 2009. And historically, we have proven time and time again, that the savings that we set up with individual customers, or IDNs, we're able to hit those benchmarks. So I think the one piece was, we closed the three pretty quickly. One was one that I had talked about in terms of new competitive business, which was pretty big, and we are very comfortable that the targets reset are very achievable.

Now the second part of your answer is that could be around asset management. It could be around labor reduction. It could be around transportation costs reduction. It could be a number of probably 10 to 12 different financial metrics that what we feel we have been investing in the company since 1999 starting with YO and our whole drive towards technology, that we have the right tools and that is why we're comfortable that we're going to be able to get this revenue back over the period a year.

Fair enough. Just to clarify. None of this was a surprise to you in terms of the trigger on the contingency in the quarter, it was just the magnitude was higher given there were three all at once so in some ways I know you don't guide to the quarter but I guess none of us, at least I didn't anticipate any of this, from a timing standpoint.

I think, Larry, just sort of stepping back and putting the quarter in the context of expectations, I think there are always pluses and minuses in any given quarter that ends up coming down to what the results are. I think generally in this quarter, we were pleased and saw revenue come in probably a little more than we were originally targeting. And expense control came in better than we were originally targeting and gross margin came in a little below where we were targeting such that we ended up within the general range of what we were targeting for the first quarter. Last point we would make is, we have said consistently, since December, in large part because of the timing of the Burroughs transition that 2009 was a back half of the year story. And so we remain confident with the guidance we have given for 2009.

Great. And the final question, following up on Craig -- your comments about solutions, we're certainly hearing more and more customers asking ways to save money. Ways to think about pricing, your solutions has gotten some good feedback that we have heard in the management place. Can you remind us who is running that business now and how you think about growing this and the opportunity set for '09 and '10?

That is a gentleman by the name of Jeff Marlett who took Solutions over probably about two years ago. He came from the consulting side of McKesson and he has done an outstanding job for us. One of the key parts he, did Larry, was he really honed the focus down in that organization, in terms of three initiatives. I think we were trying to be all things to all people, which when you're starting a business, sometimes you try to do that to gain some market share. But we're primarily focused today in the operating room, the cath lab and nuclear radiology or interventional radiology. And he's really keying that whole drive in terms of queue site and Wisdom Gold logistics inventory reduction, and he's doing a yeoman's job for us. We're also doing a lot of logistics engagements in terms of inventory optimization overall for an IDN, reduction in warehouse space, transportation, so it is really primarily driven on a technology piece, the OR and logistics. And he's done a nice job of getting that organization really focused and I would say he's also done a good job on expense control and really ramping up appropriately as the engagements become full blown.

Very good. I will stop there thanks.

Alright, thank you, Larry.

Your next question comes from the line of Glen Santangelo of Credit Suisse.

I just want to follow-up with you on the LIFO reserve question again. I thought if I heard you correctly, I thought you said in your prepared remarks, that you thought this loss would be offset by other supplier initiatives. Could you maybe just elaborate on that point a little bit?

I will let Charlie address that. Because over the course of the year, when you see manufactured price increases like this, there is a knock on effect where we get some settlement of elements recovered by Charlie can be more specific.

Sure. Glen, we supply close to 2,000 suppliers and we have relationships with a good many of them. And certainly all the top ones. And a lot of these are performance-based, based on growth incentives and things of that nature. And so we continue to negotiate with these suppliers. We're beginning to move more toward operational efficiency programs with them. And we believe those will offset A good bit of the reserve that we saw in the first quarter.

And is it fair to say, Jim, just to kind of follow-up, you don't think you will have to take any additional LIFO reserves later in the year? You feel like you have taken a pretty conservative swipe at the reserve?

I think I would stop short of making that blanket statement, Glen. I think, again, I would point everyone to the 2008 experience where we saw about 80% of the provision for the year being recorded in the first quarter, and then another adjustment at year-end as we saw another flurry on a much smaller scale of supplier price increases. My point would be, if we see a similar amount of flurry in price increases towards the back half of the year we would see a similar kind of an event.. I'm sorry, you have a question there?

It kind of sounds like a lot of price increases that surprised you were concentrated in primarily one supplier. Would you say that is true? And I am trying to understand did these price increases come at the beginning of the quarter, middle of the quarter, or late in the quarter? And the reason I ask is because I understand, you sort of commented that there would be some variability to the earnings depending upon manufacturer price increases. I am trying to figure out if on February 5 when you reported your fourth quarter and you gave your guidance for 2009, I am guessing you didn't anticipate taking this level of a LIFO reserve this early in the year?

That is correct. At that point in time, and over the course of the quarter, as the negotiations continued with suppliers, and we began to see additional suppliers raise prices, we began to get greater clarity as to what the quarter was going to look like.

And then, just one follow-up question on the deferred revenue piece, I am kind of curious just from a principal standpoint, if there are performance metrics you have to meet and certain contingencies here why would you get paid this up front if you didn't qualify for it at this point? Why is the customer willing to pay you up front for potentially revenues you haven't even earned yet.

I mean, obviously the timing of cash payments in a contractual negotiation, or in a contract is negotiated. And so if we are expending effort, on behalf of a customer, even if there is a contingent component that exists out to the future through negotiations, we're compensated for the activity that we are spending on behalf of the customer. And at some future date, certain milestone date, there is a settlement function, to see did we do what we had committed to do, and did the customer do what they had committed to do. At that point there is a settlement type of a feature. And I think that is really what we're speaking of within the notion of the deferred revenue.

That is correct. There is always low-hanging fruit, too, so I think you're talking about every customer is different in terms of what they are looking for and what they are trying to accomplish. So, you really can't put a box around five customers or ten customers or twenty customers. The other thing I would say is, we're going to selectively pick where we do this. And what we're trying to do is pick back to my story about winners and losers, clearly we're trying to align with some of these bigger organizations and lock them in for 7 to 10 years. I think you can't have a cookie cutter on this in terms of every deal is going to be the same because the opportunities are all different. Some are long term, some are short term. So it is a little bit of a challenge to try to put this into a cookie cutter form, but I think long-term, what we have to think about is, one, the revenue will be captured this year. Two, we're very comfortable with that we are going to capture that, and three, we're pretty experienced at what we do and I think that as these deals got a little bit bigger and you did three in one quarter, this kind of jumped up out of the blue a little bit.

And Craig, when you do kind of capture those revenues, if you're successful in 2009, there is no incremental expenses, that should be element pure gross profit, is that is a fair comment ?

Most of the investment, Glen, goes in in the first 30 to 60 days where we're putting people on site, things are being identified, the fees for technology are being built. And then it is on a short-term and long-term basis, we recognize the savings with the customer and then that is captured 'so a lot of the expense to your point is start-up costs.

Okay, thanks for the comments.

Your next question comes from the line of Lisa Gill of JP Morgan.

I'm wondering if I can ask more kind of general questions of what you're seeing in the hospital right now. Craig are you seeing any changes to inventory levels that hospitals are willing to carry? Just given that the broader economic outlook, number one. And then number two, the range remains pretty wide from a revenue perspective going forward 8% to 12%. Could you maybe talk about is there some opportunity for to you gain some additional contracts? You ever been really good at winning business over the last couple of years. That is part of the expectation at the upper end of the range.

Yes, I think going back to where we were earlier, Lisa, we were probably being somewhat conservatively cautious in the second half. We originally said 10 to 12. Then we came back at the end of the first quarter to say 8 to 12. Based on Jim's remarks what he was talking about, it is still somewhat vague the second half of the year. But as you can see our numbers were very strong in the first quarter, and we brought on a lot of business, in the fourth quarter along with the Burroughs business. So I think prior to the year, in the fourth quarter and in the first quarter, we feel very strong about the revenue, and I think because of some of these tools that we have, we continue to take business and have the opportunity to be at a higher percentage. I will speak to the first part of your question, a little anecdotally. I think we saw maybe a little bit of a -- I wouldn't call it a drop off -- but I think we saw a little bit of slowing in January, late December, maybe early February, but it looks like things are revving up.

And even as I talk to people, maybe it is more Richmond, it just seems like business is seeming to pick up, to some degree, perhaps even in some other businesses, small businesses here around town. But I would say overall, we broke out our existing business and our new business, and we're still growing obviously the existing business. It did slow down a little bit in January and early February. But it looks like it was picking back up. Has picked back up here in March and April.

Okay great,. What about on the inventory level side. What are you seeing hospitals doing at this point?

Well, I think that is where we saw the dip a little bit in January and early February, and it seems like it picking back up again, in terms of tracking our top 50 and then we track our top 200. It isn't dynamic but we certainly see it starting to pick up here in March and April.

Is this an opportunity for distributors, so that they use the distributor more than to buy the product directly because obviously if they are buying the product directly they are going to get it shipped when the manufacturer wants to ship it. They could probably have a better relationship with you as far as carrying that inventory for them. That is an opportunity in this environment?

Well, that is what we have been obviously we've been working pretty hard on the direct sales piece for the last two years of traditional manufacturers. I think the one thing, Lisa, you've followed us a long time. I think probably two years ago, three years ago we really went after the provider side pretty hard. And I think our numbers have shown where we are. But we're working the supplier side even through this 3PL healthcare logistics model. We're working both end of the supply chain. We think there is an opportunity for some nontraditional suppliers, who are trying to cut costs or trying to get a competitive edge to take a look at, and I think I will speak for us, looking at Owens and Minor, maybe to pick up more of the work load or get them exposure to some customers that traditionally, they haven't been able to crack into, and they see with our name and reputation, an opportunity maybe to pick up some market share.

Just so I understand this correctly, though, that is not in your expectation of that 8% to 12% revenue growth, right? That is a future opportunity but not in your current expectations?

That is a future opportunity.

Okay, great. Thank you.

Yes, thank you.

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

You have mentioned all or part of this but it looks you reference a portion of the sales for the quarters were not subject to rebates. Is that a manufacturer decision? How do we look at that as being something that is temporary?

Robert, it is Charlie Colpo. This was negotiation with the supplier. The way that they fund these price increases as we claim the rebates on the sale of that product. So this was very much discussed and negotiated over a fairly long period of time. On how this would play out.

Again, I just stress the uniqueness of this price increase, it is our first in a number of years and then was just significant and then really broad-based. Robert, just to clarify, if you look at the first quarter of 2008 and compare the rebate component, this aspect of the rebate component, in 2008, to what we received and recognized in 2009, we recognize $1.5 million more in 2009 than we did in 2008.. But on a relative basis, to the LIFO provision, it caused there to be a net decrease. But in absolute dollars, it was $1.5 million greater.

Okay. And the conclusion here, inventories do trend down going forward, correct? Even if you see some revenue growth comparable to what you reported here in the first quarter. We should see a lower inventory balance as you work through that Burroughs conversion inventory?

That's an excellent observation. We have built inventory in the last two quarters, in anticipation of the significant number of customer conversions and distribution center conversions associated with the Burroughs transaction. And so as we transition that, towards the completion of the transition activities, towards the end of the second quarter, we are anticipating that the inventory levels should start to trend downward.

Okay. And just lastly, are there any instances among your customer base, are there hospitals you have shut off for not paying as the economic environment, so punishing for some of the smaller guys, or is that just not a phenomena you're seeing?

We're very carefully and aggressively pursuing the issue of credit risk with our hospital customers. And we can do that in an array of ideally positive manners where we -- we mitigate the financial risks. You are correct that on an isolated handful of customers, we can get to a point where there is no other solution, to protect ourselves financially, other than to choose to resign from the customer and the account. But there are an array of other vehicles we use or propose in advance of that, to mitigate the financial risk. And we aggressively pursue those opportunities.

How do I see that, then, those other opportunities? Is it a lower revenue growth rate off an existing customer? How do I think about a change in the customer dynamic as it relates to the economy?

I think Robert, this is Craig. If you look back to the McKesson deal, I know people thought we were pretty conservative in terms of our estimates, but there was some business there that we jettisoned that we knew probably could become problematic over a period of time. I think Jack and the finance team and our AR is somewhat decentralized. We meet on a regular basis on credit risk. So I think, one, we're very careful who we give credit to. And secondly we monitor it pretty carefully. You never say never but I think we have been fortunate. But I think it is also because of our business practices that we haven't seen a lot of closures of hospitals that we serve.

And I don't know that it necessarily slows down when a customer has credit. I think what happens is, if you put the clamps to them then they leave and go to somebody else who is more than willing to give a credit. So this is something that we have been dealing with, prior to the economy, and we have regular conversations with all of our customers in terms of where they are and credit. So I think this is probably one of the strong parts of our portfolio and our business in terms of how we manage credit, and how we manage our customer sales. So you want to make sure that when a customer's sales start to go up rapidly that they are not moving over to us just to make sure that somebody is either going to cut them off or stop giving them credit. So I think it actually is part of an Art. It is partly history, it is partly the technology. I think we have a very good understanding of our customer base and the history and the areas, and our AR people are very aggressive in the markets we serve. So, you never say never but I think we do a very good job of managing our credit portfolio.

It sounds like just to sum up then, Craig, year-to-date can you count on one hand the number of hospitals where you just had to say, no thank you, we're kind of done with you?

It has been very small. We have been able in some other situations that they want a continuous flow of goods. They don't want to get in a situation where they take on a lot of expense moving over to another distributor so may they look at an alternative such as providing cash up front with deposits or they may wish to issue a letter of credit in our favor. There are a number of tools along those lines that we have found very helpful over the years and allowed us to maintain the business.

Okay. All right. Thank you.

Thank you, Robert.

Your next question is from the line of Richard Close of Jefferies and Company.

Jim, just to clarify, on the comments with your expectations in the quarter, I think you said first quarter was in line with internal expectations on the bottom line. So when you talk about back-end loaded, you don't feel that the annual guidance that you previously set is any more of a stretch now that we are done with the first quarter? You feel are pretty confident on your ability to get there?

Yes, I think -- know as Craig said and -- that we all believe that we're off to a good start. And if you look at really the key metrics that could potentially upset a year in general sense, revenue is always a critical one and expense control is sort of the second. I think in both those instances, we're pleased with how we're positioned accordingly. That being said, second quarter is pretty critical, that we complete the Burroughs transition and we get those costs out of the organization and that is an execution issue but it is within our control to execute.

Okay. Then with respect to the one supplier that had the broad-based increase. Can you think the fact that rebates were not eligible, is a function of that supplier, it being the first time they have increased prices in several years? I think you said three years?

Absolutely. I think it is the magnitude of the increase which is in large part due to the fact that it is not and hasn't been an annual occurrence for them. And they have gotten around to it, over a three-year period.

And then would you have any other major suppliers that fall into that same bucket?

We're not aware of any.

Okay. And then, I guess on the deferred revenue, on just a point of clarification there, how should we think in those contracts? And I apologize if you mentioned this earlier. Are they one-year contracts so you recognize that deferred revenue as you annualize the signing of the contract?

The component where the contingency is related is about a three-year period but the effort is front-end loaded, so the motivation and objective is to identify the savings earlier than later in those contracts. And if you think about it, you know that makes sense from the counter party's perspective, too. If we have potential savings, ideas, or activities, for our customers, that the sooner they can get those identified, and implemented, the sooner they can begin to realize the benefits. And so the contracts are structured in a way to try to get that to occur.

I guess I am trying to understand whether we will look at this on an annual basis, if they are a three-year contract do you identify new targets at the end of this year, or end of the fir year of the contract and then, we have a similar deferred revenue situation in the coming year?

Yes, Richard. Actually the agreement, the savings part usually runs three years. The distribution part runs seven to ten years. So at the end of three years, we could sit down with that customer and say okay here's another set of savings opportunities. I think the one thing you want to remember in this is we had three big ones signed in one quarter. Ordinarily it takes six months to a year to set the targets. And I think maybe the economy, there is a sense of urgency from some of these folks, so they sped things up a little bit. We're going to selectively pick where we do these so I don't think you're going to see us do ten of these in a year. Maybe one or two big ones a year.

But the one thing you also want to remember is we're going to tweak this model a little bit so that it is not quite as lumpy as it was this first quarter. So we will work on making sure that these going forward aren't as lumpy as they were in this quarter of this year. But again, we're very comfortable capturing the revenue. I think you can see this as a one-time deal where we had three in one quarter and ordinarily, we might sign maybe one in a quarter, one every six months so it doesn't have the impact that maybe these three did for this first quarter. Again it is a timing issue. It is not a matter of if, it's a matter of when.

And I guess just one clarification on Lisa's question. You had addressed it with respect to the suppliers, and I am just curious in terms of the current economic environment. We have heard that people -- the providers, hospitals, maybe adhering to their GPO contracts a little more. Do you see this as an opportunity where the hospitals do adhere to those GPO contracts more, rather than going outside it, also use yourselves more, and this current economy actually provides you guys an opportunity from additional business from the providers that maybe was leaking out in better times?

Well, let me tell that you culturally and historically that our relationship has always been with the individual hospital. So whether a hospital chooses more than one GPO really does not impact us. Our relationship is with an ALANA hospital or UCLA or Stanford. Whom they choose to do business with from a GPO standpoint is really up to them. So our goal has always been to penetrate the existing customer, with or without a GPO, as best to our potential as possible. So where a traditional distributor might be at 35% penetration, we shoot for 40%, 45% or 50% penetration. So our goal has always been to continue to find new product categories to find new business, in existing customers while we're out going after competitive business. To give you a long-winded answer yes, we see this as an opportunity for us but we always see it as an opportunity for any hospital that we do business with, is to continue to penetrate and grow our sales and the long term goal for us is really to have these bigger customers tied in for seven to ten years and not worry about a GPO contract that gets renegotiated every three or years. So many of these larger systems we have a separate distribution agreement with and the relationship is between the hospital and us, and then they go out and decide which GPO -- we never try to influence on that. Our relationship is always with the individual hospital and allow them to pick the GPO that they want to participate with.

Okay. And -- Jim, real quick, on cash flow, from operations for the year. Are you still I believe your target was $100 to $150. Is that still the number out there?

I am not sure we actually gave a dollar target of what cash flow from operations, I think what we have done as of investor day and subsequently was talk in terms of what would be reasonable given a book of business that we were describing. I think within general ranges, yes, we remain very comfortable and sort of that dollar range. If you look at the components, the opportunity to increase cash flow from operations, is squarely in the area of inventory. I think it is going to be difficult to improve the metrics in receivables. And so the key is going to be how we do inventory.

Okay. Great, thank you.

Operator we have time for one more question.

Your final question comes from the line of Jess Jonas, GAMCO Investors.

I wondered if there were any inventory step up charger in the first quarter from the Burroughs acquisition and if that gross margin line is something that should improve as the year goes on.

Jess, could you define step-up charges?

From the acquisition, and from stepping up the inventory to fair value.

This is Olwen. Essentially when we would value the inventory at the date of acquisition, which was the beginning of fourth quarter last year, and we were valuing our inventories about the same as Burroughs was so there was no step up at that time and there is no impact in first quarter.

But we would expect the margin for Burroughs-related accounts to improve over the course of 2009. And much as we saw in the McKesson situation where we were successful at an array of different programs at increasing the margin on those specific accounts. You're absolutely right on that.

Okay. And as that integration starts to complete and given your strong cash flow do you start to think about taking advantage of any acquisition opportunities that might be out there?

We were pleased we were able to use cash this quarter to reduce our debt outstanding. We realize that this is potentially an attractive time in the market place, to be looking at expansion opportunities. And I think on a selective basis, we continue to look for acquisition targets and we will continue to do so. It is part of our overall strategy for expanding the complement and depth of our services.

Okay, thanks a lot, guys.

Thank you.

This concludes the allotted time for questions and answers. I will now turn the call back over to Mr. Smith for his closing remarks.

Well, thank you everyone for joining us this morning. Thank you for your questions, and we look forward to seeing you and reporting out our progress over the next three quarters. Thank you and have a great day.