Owens & Minor Inc (OMI) 2012 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Owens & Minor first-quarter 2012 earnings conference call. My name is Ben, 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 call. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like in the presentation over to your host for today's call, Mr. Craig Smith, President and Chief Executive Officer of Owens & Minor. Please proceed, sir.

Thank you, Ben, and good morning, everyone. I want to welcome you to the Owens & Minor first-quarter 2012 conference call. We will 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 Operating Officer; Drew Edwards, our Interim Chief Financial Officer; and Grace den Hartog, our General Counsel. Now, before we begin, Trudi Allcott from our Investor Relations team will read a Safe Harbor Statement. Trudi?

Thank you, Craig. Our comments today will be focused on financial results for the first quarter of 2012, which are included in our press release. The press release, as well as a supplemental slide presentation can be found on our website at Owens-Minor.com, where we will also archive the webcast of today's call. In the course of our discussion today, we may make forward-looking statements. These statements are subject to risk and uncertainties that could cause actual results to differ materially from those projected. Please see our press release and our SEC filings for a full discussion of these risk factors. As to our Investor calendar, upcoming events are outlined in our press release, and we look forward to seeing you on the road in the weeks to come. Thank you. Craig?

Thank you, Trudi. I'd like to call on Drew Edwards, our Interim Chief Financial Officer, to review the numbers with us, then I'm going to ask Jim to provide an operational overview. So, let's start with Drew.

Thank you, Craig, and good morning everyone. I am pleased to have the opportunity to provide you with some insight into our quarterly financial results. Net revenues increased 4.4% for the first quarter of 2012, when compared to the same quarter last year. Net revenue growth resulted from an increase in sales to existing customers of approximately $56 million, contributing 2.6% of the total increase. An increase in sales to net new customers of approximately $33 million, or a 1.6% contribution to the total increase in revenues, and finally, fee for service revenues added about $5 million, 4.2% to the increase in revenues.

Gross margin dollars increased 1.7 %, primarily as a result of increased fee for service revenues. As a percentage of revenues, gross margin was 9.66%, representing a decline of 26 basis points, when compared to the first quarter of 2011. The decline in gross margin percentage in the first quarter of this year compared to the first quarter of last year resulted from changes in customer mix, including lower margin on new contracts with large, integrated healthcare networks, as we have discussed previously, and continued competitive pressures. On a sequential basis, versus the fourth quarter of 2011, the gross margin percentage declined by 9 basis points, due to lower revenues from our consulting services that tend to fluctuate from quarter to quarter.

The LIFO provision declined by $6 million compared to the first quarter of last year, which seemingly benefited the current-quarter gross margin. There are more numerous components to gross margin in inventory valuation, which change from quarter to quarter, and the impact of changes on in these other components offset the impact of the decline in the LIFO for the quarter.

I'd like to now turn to SG&A expenses, which improved by 10 basis points to 7.01%, versus the same period last year. On a dollar basis for this period, SG&A increased by 3%, or $4.6 million, driven primarily by higher expenses for fee-for-service operations of $3.6 million, reflecting the presence this year of a large 3PL customer that was not part of the mix at the same time last year. On a sequential basis, versus the fourth quarter of 2011, SG&A as a percentage of revenues increased by 15 basis points, due to seasonal expenses from payroll taxes and certain compensation benefits.

Depreciation and amortization expense was $8.6 million for the first quarter of 2012, down from $8.8 million in the first quarter of last year, largely from the expiration of certain non-compete agreements related to acquisitions conducted over the last six years. Looking ahead to the rest of this year, you may recall that we are investing $20 million to $25 million for the first phase of a multi-year information technology project, which well likely increase depreciation and amortization in 2012 above the 2011 level. For the quarter, other operating income net increased $1.7 million versus the same time last year, due to $500,000 of income in 2012, related to a class-action settlement and transaction-related costs last year that were not repeated this year.

Now turning to operating earnings. Operating earnings for the quarter were nearly $52 million, representing an increase of 1.7% over the first quarter of last year. The improvement was driven primarily by a $3.6 million increase in gross margin, efficiencies from our exit and realignment efforts that took place in the fourth quarter, and a $1.7 million increase in other operating income, offset by additional SG&A to serve 3PL business growth. As a percentage of revenues, operating earnings was 2.34%, a decline of 6 basis points from the prior year's first quarter.

Net interest expense for the first quarter was $3.4 million, a slight decrease compared to the first quarter of last year. The effective interest rate was 6.43%, a comparative decrease of 72 basis points, largely due to amortization of gains on interest rate swaps terminated in the third quarter of 2011. Average borrowings for the quarter were $214 million.

Our effective income tax rate was 39.4% for the first quarter of 2012, which is our current projection for the year. Our effective tax rate in 2011 was 39.3%. Net income for the first quarter of 2012 improved slightly when compared to the same period last year, resulting in earnings per diluted common share for the quarter of $0.46, up $0.01 over the first quarter of last year.

As for our asset liability management, cash and cash equivalents increased by approximately $78 million to $214 million as of the end of the first quarter. Cash from operations was approximately $102 million, driven by decreases in inventories, which had been increased to accommodate large customer conversions in 2011. This activity brought inventory turns to a more normalized level of 10.5 when compared to turns of 10 at the end of 2011.

Operating cash also benefited from an improvement in DSO of 0.8 days, partially offset by a decrease in accounts payable. For the first quarter of 2012, DSO was 19.9 days, an improvement from 20.7 days at the end of 2011. Cash used for capital expenditures was approximately $8 million, up about $1 million over the first quarter of last year, and related primarily to strategic and operational efficiency initiatives, especially information technology improvement. Thank you. Now, I will turn it over to Jim for his remarks.

Thank you, Drew, and good morning, everyone. I'd like to take this opportunity to provide a bit of an operational overview, especially in areas where we are seeing the impact of larger trends. Analysis of our revenue results shows that sales to existing customers continued on a strong pace, while sales to new customers, including the large new IDNs, were positively impactful in the first quarter.

You will recall that Craig has challenged the team to grow revenues by more than 100 basis points over market growth. We are pleased to note a 160 basis point growth in net new business for the quarter. In addition, revenue growth attributed to existing customers also grew in excess of the market, due in large part to our customers' expansion of their systems by acquisitions. Gross margin as a percentage of revenue for our traditional distribution business decreased 42 basis points from the prior year, related primarily to changes in customer mix. Partially offsetting this decrease was a 20 basis point contribution from our fee-for-service businesses in the first quarter.

For some time, we've been talking about the impact of the large new enterprise customers in the market. Last year, we signed a significant amount of this business, and we have commented on the leverage that these customers have in the marketplace. However, we see these large health systems and provider groups as the winners in healthcare, and we consider ourselves very fortunate to be aligned with them.

Looking at SG&A results for the quarter, we see the increase in expenses relating to the OM HealthCare Logistics new business. When comparing this year's first quarter to last year's, you may recall that we on-boarded OM HealthCare Logistics' largest customer in the second quarter of last year. We continue to see improvement in operating metrics as the OM HCL team works on day-to-day efficiencies. The team have made great strides in the last six months, and we continue to target achieving a breakeven run rate in 2012.

Offsetting the increased 3PL expenses were decreases in incentive compensation, consulting fees, selling expenses, and occupancy costs. Improvement in SG&A, excluding third-party logistics expenses, was also aided by the exit and realignment activities that took place in the fourth quarter of last year. From an operations perspective, our teams are doing a good job in managing our expenses, even as we grow our business and pursue new markets.

As for operating earnings this quarter, we see many of the trends we've been discussing reflected in the impact of these enterprise customers. Because the customer contracts are highly complex and involve many facilities across wide regions, it will take time for both parties to reach targeted financial performance. Several of our distribution centers took on a significant amount of this new business in a short period of time, which resulted in reduced operating efficiencies in these units. These teams are working diligently to align their resources with targeted amounts, but it will take some time as we balance our resources with the service needs of our customers.

Also, keep in mind that while the new pricing on distribution services takes effect on day one of these contracts, achieving synergies and optimizing performance on the accounts could take as much as a 12 months to 18 months. As we work with these enterprise customers to achieve targeted financial and operating goals, we are also pursuing a deeper analytical understanding of the financial profiles of our individual customers and suppliers. With this intelligence, we can more fully realize gain from the operating margin initiatives that Craig and I discussed at Investor Day.

Our teams in the field and at home office also did an exceptional job in the first quarter, in bringing down levels of inventory that have been built to serve the large customer conversions at the end of the year. This improvement in asset management helped us to generate $100 million in operating cash flow. This achievement illustrates that our teams are able to work with new customers and new contracts to achieve targeted financial and operational improvements.

We are also pleased to report that we have just signed a new contract with Novation, which will take effect on September 1 of this year. This new five-year contract has two additional one-year renewal options. With this negotiation behind us, we will be concentrating on the sign-up period with the individual providers over the course of this summer. We have been an authorized Novation distribution agent since 1985, and we look forward to serving the Novation members for years to come.

An important part of our culture is to create long-term value for our shareholders. We take this very seriously, as we achieve our strategic initiatives, expand into new markets, and grow our business, we will continue to work towards creating value. I am pleased to report that during the first quarter, we returned nearly $18 million in cash to our shareholders from a combination of $14 million in dividends and nearly $4 million from our Board-approved share repurchase program.

As we've said in the past, one quarter does not a year make. As is our normal and customary practice, with only one quarter of data, we believe it would be premature for us to adjust our annual guidance for early in the year. Consequently, we have reaffirmed our guidance for 2012. As we look ahead to the rest of the year, we continue to target revenue growth in the range of 3% to 5%. We are targeting net income per diluted share to increase 5% to 10% when compared to 2011 excluding the fourth quarter 2011 exit and realignment costs. Now, I'll turn it over to Craig for his remarks.

Thank you, Jim. I'm going to make a couple of observations of morning and then well open it up for questions. We're often asked about the current healthcare environment, and at this point, we would hesitate really to point any significant change in utilization over the last few months. Trends among our mix of customers are in line with what we have previously seen. Now as you know, I'm out on the road a lot, and I have been out on the road quite a bit the last three months. I'd like to share some observations with you, observations that I really have been seeing for a period now.

The large enterprise customers that we have identified really continue as significant players in the market. These large systems are working to create efficiencies and drive costs out of the supply-chain as they anticipate a lower reimbursement environment in the future, and I get told that all the time, really almost every week. In turn, these large enterprise customers are also the most active in consolidating, acquiring customers, and building new services for their patients. In fact, both of the two systems we brought on last year have either acquired or affiliated with new hospitals since joining us.

Now, just a few weeks ago -- and I'd like to give you some examples of when I'm out on the road and when I'm talking to with our larger customers and non-customers. One of our customers told me that they had just added four affiliates to the group and asked if we could move these hospitals on to their platform. Like many of our customers, this IDN wants to help with data collection, data cleansing, analysis logistics, supply-chain services, and integration of the new facilities.

Other healthcare providers are asking us for help introducing supply-chain costs as they work to meet lower reimbursement. In fact, I had two customers about two weeks ago recently told me they are trying to take roughly 30% out of their operating costs. Now, the advanced supply chain management solutions that we offer are tailor-made for these opportunities. We are convinced that these large IDNs will be the winners in a consolidating industry, putting up in a good position for the future.

In the year ahead, we will continue to focus on our four strategic initiatives, which includes modernizing our core infrastructure, and as you all know, we have been making investments in the core infrastructure for some time now. Under this initiative, we're launching a multi-year IT transformation project that will really improve our ability to pursue and serve new markets. I see it as an opportunity to gain greater flexibility, speed, and ease-of-use among our core business systems and for our customers.

As for our second strategic initiative, we will continue to enhance sourcing and product management efforts. So far, we are very pleased with our sourcing joint venture in China, Mira MEDSource, which is just one element of our sourcing strategy. In fact, several members of the Management team and I attended grand opening ceremonies in Shanghai in March, where we also met with several suppliers. We are very impressed with our Mira teammates, who bring enthusiasm, energy, expertise, and experience to the table.

With our third initiative, we will focus on the success of OM HealthCare Logistics, where we continue to see, as Jim said, day-to-day improvement in operating metrics. Now, we believe we are well on the way to the breakeven point with this service, and we are focused on adding new customers to this platform. Finally, we continue to explore expansion of our programs and services into the non-acute care markets, where our hospitals are continuing to migrate, especially as our large IDN customers extend their reach into physician practices.

Now, our annual shareholders meeting is scheduled for this Friday, and we have a full calendar of Investor Events this quarter. We look forward to seeing you on the road in the weeks to come. Thank you, and we would be happy to take your questions. Ben, you may open the line for questions now, please.

(Operator Instructions) Our first question today comes from the line of Glen Santangelo, from Credit Suisse. Your line is open. Please go ahead.

I just want to follow-up with you, Craig and Jim, on the margin issue. I have been getting a lot of questions on that, and if I look at your gross margins in the first quarter, you put up 9.66%. Jim, you obviously talked about the impact from the IDNs and the repricings and the customer mix. So I'm curious. Was that in line with your expectations, a little bit better, a little bit worse?

Sure, Glen. When we talked at our Investor Day, and we chatted about what the target range for gross margin on an annualized basis may look like, we talked in terms of a range of 10% to 10.25%. Obviously, the 9.66% is below that. We've also commented in the past, and as late as the last conference call, for the last quarter, that the major variable associated with that is the fee-for-service performance. So, as we think about the first quarter, that we have just completed, we came in with less fee-for-service business than we were originally targeting. Now, that, as Drew said, ties primarily to the consultancy business and work that we do. That does tend to fluctuate over time, and with the timing of individual contracts, but for the quarter, it was a bit less than what we had originally targeted.

So Jim, maybe if I can follow up on the logistics issue, it's encouraging that you believe the business can be breakeven this year. But I'm guessing it was not breakeven in 1Q, and implied in that statement that you expect it to be breakeven for the full year. Do you need to win additional revenues, or can you get there with what you have currently?

Just to not parse words, but just to restate, I think at Investor Day and what we said on numerous occasions since then, is that we would reach a breakeven run rate in 2012. But that being said, we have seen improvements to date in the financial performance of OM HealthCare Logistics. The improvements to date have primarily been in the area of expense reduction and greater efficiencies that have been brought to the front by Brian Shotto and his team, and their expertise in managing the third-party logistics business. So that's been very positive.

We do have capacity to do what we would characterize as a tuck-in addition to our customer base without increasing the infrastructure. As you well know, in that a situation, that incremental revenue would have a very significant impact on bottom-line performance. The sales efforts are underway for that initiative, and we're pleased with how things are progressing. We are very pleased with the market receptivity that we've seen with the Management team that we have in place.

Craig, maybe if I could ask you one last question and then I promise, I will jump off. Your revenue growth continues to be very strong, up almost 3% with existing customers. Is that coming more from price increases or are you seeing anything in terms of volumes or has it been status quo in that regard?

I think, Glen, I'd refer back to the last two or three quarters that we've been talking about these large IDNs, is that the growth really is coming from the larger systems that are either adding services or combining with other hospital systems. That trend continues. If you heard my comments, just as I go across the country, these systems are just consolidating. Really, the one example I gave you was four new customers for an existing customer we had that will start to move over. So I think we're going to continue to see that for some period of time.

Okay. Thank you very much.

Thank you. Our next question comes from the line of Larry Marsh of Barclays. Your line is open. Please go ahead.

Just a couple of questions. First, reflecting to February, Craig, then you announced the promotion of Jim to Chief Operating Officer, highlighting the need to drive margins in your business with all this incremental volume with key customers. So, I guess around that, maybe for Jim, are there any initial takeaways you have being in the role now for seven weeks that are different than what you've already talked about?

Then just a clarification, you mentioned your biggest variable here is fee-for-service performance. Are you referring that both to 3PL and consulting? When you say 20 basis points of contribution, how does that compare to last year and where do you think that can go?

Larry, you have a bunch of questions there. (Laughter) I'll do my best to pick them off. I think in terms of the more philosophical broader question you posed on directionally, what's the focus of operations initially. I think it would be silly for me not to acknowledge my technical training and background from a financial perspective, and not bring that to the forefront of these new responsibilities.

So I alluded to earlier in the comments that there is an increased focus on looking at the profitability of different subsets of the organization, and that profitability could be on a customer basis, a provider customer basis, it could be looking at the profitability of our supplier relationships on a specific supplier basis. It can be as much on a category or a line of products, and it most certainly, as you saw in the fourth quarter, focuses on our geographical alignment, and where we have resources allocated throughout the United States. So, I think we are looking at empirical data to validate positions and tactics that we will take in all of those given areas going forward.

Enough on the philosophy. I can drive into more of the details of the question you raised. The 20 basis point on fee-for-service business was for this quarter primarily driven by OM HealthCare Logistics. But keep in mind, as I know you well know, that we had a very low comp in the first quarter of last year in that business, and we had the CareFusion business running through. Though by definition, it would expected that we would get a benefit in that area.

The piece that came in below the prior year and below what we were targeting or thinking about, had more to do with our OMSolutions consultancy work. Some one-off work that the core distribution business does on a fee-for-service basis for selected customers. So that's really the variance that we saw for the quarter.

Got it. Okay. Thanks. It seems like the message you're sending, Craig and Jim, is with the changes, these gross margins are not really acceptable. In fact, I don't think I've ever seen them quite this low. I've covered you guys for a number of years, so I think that's what you're communicating. I just want to say that.

So the second question, and I'll maybe ask you, it [corners] really on the JV for the private label. It seems like that's a great opportunity for you guys to help offset some of the issues associated with bigger customers asking to do more. Craig, you said you're pleased with where that sits. I think I'm assuming that's going to be several cents accretive to your business this year. I'd still love to get you to reflect on where you feel like you are and where you think you can get to in terms of percentage of business, in terms of capacity? How quickly we can get there as you think about the next two years?

We've been at this for about five years, Larry, and again, you've followed us for a long time. I feel much more confident and comfortable, and again, I think we all have a tendency to stray back to the private label piece. There's really a bigger picture to this, and I think Jim, in answering your question about his first seven weeks here -- and I'm next door to him. So, he's a busy guy. He's got them lined up outside the door seeing him. But I think you have to look at the whole sourcing strategy [intoto].

I'm very pleased I got to go to Shanghai. We've got some great people there. The challenge I always saw us having is, do we have one person in China running around talking to manufacturers? I think we have the appropriate infrastructure now to address in a product category. When we want to do private label, we can either choose to go through China or a branded manufacturer can still approach us in private label for us.

We also have, we believe, an opportunity, with some of our larger suppliers to work with these large IDNs. This would be the whole hour discussion, but we're benchmarking all of our manufacturers. We're now starting to share that operationally with some of these larger IDNs who want us to be as successful as they are. So when we talk about -- I'm feeling much better intoto about our supplier strategy. Clearly, private label will be a fairly big component of that.

I almost feel like we're just starting again. But we're starting with the right people in place and the right direction. Some focus and discipline that Jim has brought through sourcing is now starting to pay off. I think we've publicly said that we would like roughly 10% of our business to be private label over a period of years. So we're going to stay at that. But we also have an opportunity with our branded manufacturers to improve profitability, to improve efficiency, and to improve productivity. That's what a lot of these larger IDNs are looking for.

Right. So it sounds like, and I'll jump off, it sounds, Craig, you're saying you're as comfortable that this is going to be a good contributor this year and next year regardless of how it comes in. You don't feel like there's any concern as we think about a year from now, you would come to us and say, you're a bit behind plan on the overall sourcing initiative?

As of this date right now, I'm feeling very -- a lot of things can happen in nine months, Larry. You know that probably as well as anybody in the market. But as to date, everything that I've seen, everything that I've experienced, everything that I've talked to and everybody I've talked to in the organization and talking with customers, I feel like this was the right investment and the right strategy is to really work on our supplier portfolio and make sure that we have the appropriate suppliers that our customers want. I think it's a win-win for us, the suppliers, and the providers.

Right. Okay. I'll stop there. Thanks.

Thank you. Our next question comes from the line of Robert Willoughby, from Bank of America-Merrill Lynch. Your line is open. Please go ahead.

Thank you. Craig or Jim, cash flow with the eye-opener for us. Maybe a three-part question. Can inventories come down more in the future, or are we at a steady state level needed to support the current revenue trend? Then maybe if you can comment on the M&A prospects that you may see. Does your cash balance suggest you might be more open to transactions possibly in the future? Lastly, just remind us when the last time you raised your dividend was?

Sure Robert. Let's address the last one first. We raised the dividend as of the last quarter, February. So it was effective as of the last earnings call. As we consider M&A activity, as we've said for some period of time, we have grown historically by being an acquisitive Company. We have looked at opportunities over the last several years and been disappointed in the pricing that was in the marketplace. But we are constantly on the lookout for significant opportunities that align with our strategic initiatives.

We've talked in the past that we would look in areas such as regional distributors, we're a great exit strategy for these family-run businesses. We would look in areas potentially to expand our third-party logistics capabilities. We would look for partnering opportunities with large IDNs. A handful of technology-based really enabling technologies for the services we provide. Those are the four major areas that we would consider.

As you look at the cash that we generated from operations for the quarter of about $100 million, I would tend to say -- and this is just my own editorial comment. That as one thinks about the performance in days sales outstanding, and therefore our receivables position, that there we pretty much have achieved about as good as it's going to get at 19.9 days. There would be some ebb and flow around that number in an ideal situation. In the inventory area, and believe me, getting from 10 last quarter to 10.5 this quarter was no small accomplishment, but we believe that there is still some opportunity that exists there. Craig has challenged the team to do more and do better.

I would point out one thing, though, that is maybe more nuanced and more detailed than the investor community really needs. But as these large IDN systems that Craig referred to grow through either affiliation or acquisition, there is, at times, they're adding new hospitals to their systems, and a conversion to us as a distributor, the need to build up inventory to support those conversions. So even though it's not a new business coming in to us, a new contract coming in to us, it is a bolus of the new business that we need to service.

So we may find times when we have these spikes in increasing inventory, that are aligned with serving the growth of these new large systems. But with that as a caveat, yes, I think there's an opportunity to continue to improve on the inventory side.

Just quickly on the valuation expectations, you said they had been high. Are they more reasonable now that we're more likely to see something over the next 12 months?

Well, you never want a handicap, but we're we are in the market all the time. We're looking aggressively at opportunities that we think can generate a return to our shareholders, that are consistent with our strategic initiatives.

That's helpful. Thank you.

Thank you, our next question comes from the line of Lisa Gill from JPMorgan. Your line is open, please go ahead.

Thanks very much, and good morning. I just had a couple of follow-up questions. Craig, you talked about these IDN relationships, and I was just curious. As you think about the optimal margins on these new larger contracts over time, do you anticipate that overall the operating margin will be better than your core book of business? Or I think you characterized the fact that they had a lot of purchasing power, that maybe they will be worse. How should we think about that over the next several years? And secondly, I know Drew, you said that it's still early on, but are you still comfortable with that target range of 10% to 10.25% on the gross margin side for this year?

Let me take the first part of the question, Lisa. I think that actually that is an excellent question, because you can look at these relationships short-term or you can look at them long-term. I think you move from a vendor-customer relationship to a partner-customer relationship and you have different discussion around logistics. You have, in one instance, we took one of these systems out of three warehouses. So, it's not necessarily always about price. And obviously, they are big and so they're expecting to be competitive in the marketplace. But that is really only a small component of that.

So, I would say over a period of time, the goal really is -- and one of the questions that was not asked today is we realigned in our larger systems how we sell. So, we don't have 20 people running around talking to 100 customers. We have a team with the senior leader executive, with three or four resources working corporately, corporate-to-corporate to come up with goals and objectives to help them drive their costs down.

So, in the old days historically, it would almost be like a medical device company where you have a lot of people out selling. This is really more of a centralized sell. So it might take a little bit longer than ordinarily 20 people running around and getting some hit and miss success among 100 hospitals. So we might, back to Jim's point, 12 months to 18 months, you're talking about for instance, as you're very familiar with, PANDAC, wound suture inventory management. You're talking about doing all 100 hospitals, or a region of 100 hospitals, versus trying to go out and individually sell to 100 hospitals. So we believe long-term that this will enhance profitability.

Also, they are more than willing to talk about which suppliers are most efficient and most productive for us. Now, there are existing contracts with suppliers that they have, and in some instances, we're going to have to let those contracts play out and expire. Then as opportunities come up, we're going to be sitting down these customers and trying to determine in a product category what is the best supplier for both the provider and for us. So we made a conscious decision on these larger IDNs to make an investment up front.

Jim talked about the inventory. I think that's a tremendous example of how the inventory is coming down, the operations are stabilizing, and now, we are going to work on margin and profitability.

Lisa, this is Drew. As Jim mentioned earlier, I think the key to achieving our 10% to 10.25% gross margin growth, one is meeting our goals for the fee-for-service business. Two, the other thing as Jim touched on in his script, is optimizing our business with our large enterprise customers. Those are really the two key areas to us achieving that goal for the year.

Great. If I could just sneak one last one in, I know you talked about the new Novation relationship. Are there any major changes to that relationship that we should be aware about?

No, don't think as we think about it, that there's anything particularly unique or different, as we said, at this point in time.

Great. Thank you for the comments.

Thank you. Our next question comes from the line of Eric Coldwell, from Robert W Baird. Your line is open, please go ahead.

Thanks. Just a quick follow-up on the last one from Lisa on the Novation deal. Jim, you said you didn't think there is was anything dramatically unique about the renewal. At the same time, my impression was that the last time OMI renewed with Novation, Novation wound up using many more distributors that had been originally expected, which was a disappointment. I was curious if you were able to convince them to narrow their distribution list and perhaps provide more volume to OMI.

Unfortunately, Eric, I'm not privy to that information. Maybe someone within our organization is, but I'm not aware of that. I think that's probably a question better directed to the folks at Novation.

Okay. Let me shift gears. We talked a lot about the asset management, the DSO, and inventory turns. Another component is days payable, which has declined I think for the third consecutive quarter, and was down at two days sequentially. Which is a historic low on the DPOs. Is there something about your manufacturer relationships that is changing? Is it simply a timing issue? Where do you see days payable going in the near-term and in the longer-term?

This is Drew. Most of that change and that decrease is due to timing. We would expect that as inventories move up and down, you would see the payables move up and down in tandem over a period of time. But most of that change is due to timing.

Okay. Then on supplier incentives and rebates, really just your focus on key suppliers. Last year, despite the strong revenue growth, you had lower profitability on that side of the equation. I'm curious, what's the status with supplier renewals this year and relationships? Do you see similar lower or higher opportunities on the rebates and incentives as you move forward?

I think going back to the earlier comment I made, Eric. We're looking at the financial contribution of all major components of our business. So therefore, we certainly look at the provider side and the financial contribution that we receive from providers. But just as equally, we look at the financial contribution we receive from suppliers. As you would expect, in instances when we are not achieving what we feel is a fair return, then we begin to have conversations. Both with the supplier obviously, the manufacturer, but with our hospital customers, to let them know why we are engaging in these kinds of conversations with the manufacturers.

My last question is related to the 3PL business. The major customer, CareFusion that came on in a big way in April of last year is now annualizing. It does not appear, from what we can model, that the revenue stream there has increased dramatically. In fact, your fee-for-service revenues have declined sequentially since the third quarter of last year. I'm curious. Are their additional tranches with that big customer to bring on board at this point or is that status quo business? Therefore, 3PL revenue, for that to increase you need to on-board new accounts? Or are their additional opportunities with the existing anchor client?

Sure, Eric. I think, and we've been pretty candid about this -- Craig, going back to the middle of last year, said look, CareFusion is an important client to us. It's the largest of the third-party logistics clients that we have. We need to get the service model right for it, and so we've been focused on that.

Sure, there's more opportunity with CareFusion, in that we don't have their entire book of business. We are always keen and interested in expanding the strategic relationship that we have with important customers, and CareFusion is certainly an important customer. But I think more importantly, is the fact that we need to get what we're doing right first. We're feeling really good about how we're progressing along those lines.

Okay. Thank you.

Thank you. Our next question comes from the line of Robert Jones, from Goldman Sachs. Your line is open, please go ahead.

I recall last quarter, I think in response to the changes you are seeing amongst your customers, you did discuss adjusting the sales force a bit. I was wondering, Jim, if you could give us an update on where you are in that process, if there's any sustained benefit we should expect from any of the changes there?

Sure. Yes, I think the changes we made in the fourth quarter, the benefits have definitely been recognized as we move into the first quarter of this year. We would expect to continue on during the course of the entire year. As Craig said, the model is changing. The service model, the selling model, is changing. You never want to say never, as to what the future may hold, but I think in the normal course of things, there's fine-tuning that needs to occur. We'll do that over time, as is needed. But we have seen the expected benefit as we look at the first quarter.

Great. That's helpful. Craig, I know you mentioned these larger IDNs actually approaching you more now, as it relates to servicing some of the non-hospital, non-acute care sites. I guess is there any sense you can give us of what percent of sales today may become from the non-hospital or the ambulatory setting? Maybe how does that compare to, say, a year ago, and where do you think that number can go to?

Well, what I would like to try to do, Robert, is guide us back again -- not trying to dodge your question here. Clearly the physician piece is going to play a more important role for us in the integrated delivery networks. If you remember, a lot of the ambulatory surgery centers today are either owned or managed by the provider systems. So we have that broken out. We are in the physician business. We are in the ambulatory surgery center business. What were trying to do is do a different model than what we've done currently in the past.

But I would guide back to the fact that most of these hospitals are moving from an acute care setting to a non-acute care setting, whether it's rehab services or clinics or surgery centers. So how we capture that is, we still look at the integrated delivery network intoto, in terms of ship-to-points that they have within that organization. So we're clearly focused on not going out and doing the one and two doctors on the corner, but more around the 100 or the 200 doctors that are owned or managed or affiliated with the hospital system.

Those numbers, we see, probably will improve this year only from the standpoint that we have been, I would say, doing some beta testing and really looking at that market. I think we're starting to execute with some of our larger IDNs. I'll probably have a little better picture for you at the end of the year, as we start to ramp up with some of these systems.

Got it. That's helpful. Just one last one, I wanted to circle back on the GPOs, and the good news on Novation. I was wondering if I could ask the same question a different way. Just any sense you could give us around repricing there. I believe you have two other large GPO contract coming up for renewal over the next year. I was just wondering how impactful the repricing of those contracts should be. Anything out of the ordinary or should this be similar to historical renewals that we have seen? Thanks.

Let me take that. I was fairly involved in the Novation re-signing. Actually, we have one more coming up which is Premier late of this year. I think what we did, is in Investor Day, tried to in our guidance take any impact that Novation, and obviously Premier, would have little or no impact on us at all this year because it's so late in the year. I believe Novation starts September 1. So there's probably a little bit of an impact in the fourth quarter. But we've actually really put that into our guidance for the year. We feel we're right where we need to be with Novation, and we are now working on the Premier contract.

Thank you. Our next question comes from the line of David Larsen, from Leerink Swann. Your line is open. Please go ahead.

Hi. Have you guys sized the total revenue contribution from these large IDN contracts at all, or can you give us a sense for their total size, if possible?

I don't think we've shared that previously. I think what I would point you to, David, is that Craig has spoken in the past that over the last 18 months or so, there was several billion dollars of business that was either signed or re-signed in conjunction with all of this. So it's a substantial portion of our revenue base. But I'm not sure at this point -- I don't have the numbers in front of me, and I'm not sure at this point we would look to share those specifics.

Okay. So in terms of the new contracts that are in place with these IDNs, where there appears to be a performance piece to them that you will probably realize in 12 months to 18 months. Is it correct to think about that whole portion that you mentioned subject to those new contract terms or just part of them?

I think its fair to think in terms of a relatively large component of our book of business has these, I guess as you put it, contract terms associated with them. These are large, complex customers, where we believe the opportunity lies in changing the model, adapting the model, to a different service level. Therefore improving truly SG&A performance, in order to achieve targeted operating earnings performance. I think that's a better way of saying it.

Okay, great. Thanks. My last question, in terms of the technology infrastructure, overall that you're implementing. Can you give us a sense as to how far you along you are in that, and what percentage of your distribution centers are being converted to the new platform. If so, what percent have been converted so far, and is that system live? Thanks.

Remember we went through what was called lift and shift about two years ago, which was with Microsoft, where we basically took all of the operating pieces of the business off the mainframe. So that allows us the flexibility to pick and choose a best-of-class, whether it's around financials or sales reporting or something like that. So really, the platform has been in place for a while, and we're now making enhancements to the systems. Primarily around making it more flexible and easier for our customer to do business with us, improving the interaction with the customer, making it easier for our customer service to be more proactive versus reactive. So, there's a number of initiatives that we've invested in, or are investing in, that are not necessarily going to go through a whole transformation or ERP system upgrade like you would do with SAP or somebody like that.

So we're about three months into it, four months into it. It's going very well so far, very smoothly. We think there's an opportunity around reporting structure and how we report internally in the organization. I'm actually very excited about that. But I would say we are on track. I assume that we will be on track through the three years. We've got a great team working on that, and we got a lot of operational people working with the IT folks to make this a world-class system and an upgrade for us.

Great. Thanks so much. Congratulations on the very strong [comp] line growth.

Thank you. Operator, we have one time for one more question, Ben.

Thank you. Our final question today comes from the line of Steven Valiquette from UBS. Your line is open. Please go ahead.

Thanks. Good morning, guys. I'm just looking for a bit more color here, on what did drive the lower LIFO charge in the quarter. Just to confirm, was there a notable step-up in rebates and discounts for manufacturers in the quarter? Or did you maybe just dip into some older LIFO layers with this big step down in inventory that you had in the quarter? I was trying to get more color around that. Thanks.

Stephen, the reduction in the LIFO charge was due to lower list price increases for the first quarter of this year compared to the first quarter of last year. It's that simple, really.

So, what do you think really is driving lower price inflation in the industry right now?

Well, I think we've been pretty open about the fact that it's a pretty competitive market out there right now. I think the customers -- it's a buyers' market, and actually we've been seeing this for that period of time. So I would just say the competitiveness in the marketplace going back to this taking 30% out of operating costs. Everybody is working very hard across the board to take pricing -- not pricing, but really to take costs out of the system. I think you're also seeing that the provider is looking at more and more of the market as a commoditization of the market and opportunities to perhaps look at products that are more commoditized. I think you're seeing probably categories, that were once before seen as maybe not necessarily high in clinical, but semi-clinical -- there's also pricing pressure on that with the manufacturers.

Okay. Maybe just a quick follow-up here quickly on the operating cash flow. It does bounce around, like for any distributor with changes in working capital. But I was just curious. Do you have a rule of thumb for your normal relationship between your adjusted net income and operating cash flow? Some years, it's lower, some years, it's higher. I think the average over the last five years or so, it's roughly a 1 to 1 ratio. Should we see something along those lines going forward? Or could that improve further on the cash flow versus net income? Just any broad picture color on that relationship would be helpful. Thanks.

This is Drew, Steven. I think longer-term, your metric there of operating cash flow, net income plus depreciation and amortization is probably a good metric for normalized operating cash flow. If you want to get to, what I'll call free cash flow before dividends, you would subtract out a level of capital expenditures from that number.

Okay. So pretty status quo them on all those inner workings. Got it. Thanks.

With no further questions, I will now turn the call back over to Mr. Smith for his closing remarks.

Thank you, everyone, for listening into the call. As Trudi said, we're going to be a very active out in the marketplace over the next quarter. So we look forward to seeing you at one of many conferences, and look forward to seeing you soon. Thank you.