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Owens & Minor Inc. (NYSE:OMI)

Q3 2008 Earnings Call

October 28, 2008 9:00 am ET

Executives

Craig R. Smith – Chief Executive Officer, President

James L. Bierman – Chief Financial Officer and Sr. VP

Charles C. Colpo – Sr. VP of Operations

Grace R. den Hartog – General Counsel

Dick Bozard – Treasurer

Olwen Cape – Controller

Analysts

[Asha Heman] – JP Morgan

Larry Marsh – Barclay's Capital

Eric Coldwell – Robert W. Baird & Co

Joel Ray – Davenport & Company

Glen Santangelo – Credit Suisse

Robert Willoughby – Banc Of America Securities

Randall Stanicky – Goldman Sachs

Operator

Good morning ladies and gentlemen, and welcome to Owens & Minor’s third quarter 2008 conference call, (Operator Instructions) I would now like to turn the conversation over to your host for today’s call Mr. Craig Smith, President and Chief Executive Officer of Owens and Minor, Please proceed sir.

Craig Smith

Good morning every one and welcome to the Owens and Minor third quarter 2008 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 Financial Officer, Charlie Colpo, our Executive Vice President, Grace R. den Hartog, our General Counsel, Dick Bozard, our Treasurer and Olwen Cape our Controller,

Now before we begin [Trudy Allcott] our Director of Investor Media Relations will read the Safe Harbor statement, Trudy.

[Trudy Allcott]

Our comments today will be focused on the company’s results for the third quarter of 2008 which are included in our press release, The press release and our related presentation can be found on our we site,

In the course of our call 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, And finally this conference call will be archived on our website for the next three weeks, Thank you.

Craig Smith

Let me call on Jim to brief us on some great financial results, Jim?

Jim Bierman

We are very pleased with this quarter’s results, We are reporting record quarterly revenue and net income as well as strong improvement in our operating margin. Also, effective October 1st we completed the acquisition of the Burrows Company, while this acquisition did not have a material impact on third quarter results, I will provide some insight into how the acquisition will affect our fourth quarter results,

As we have said our goal continues to be, to position our company for profitable, sustainable growth, I will begin my remarks with an overview of the third quarter results,

Third quarter 2008 revenues of $1.81 billion were $124 million dollars greater than revenues reported in the third quarter last year, an increase of 7.3%, The primary driver of revenue growth was penetration of existing accounts, a continuing trend, We also had one additional sales day during this year’s third quarter when compared to the same period last year,

On a sequential basis, quarterly revenues increased by $15.6 million when compared to second quarter this year, in line with our guidance and our expectations, Year-to-date revenues were $5.36 billion, an increase of 6.1% when compared to revenues in the first nine months of 2007,

Based on our year-to-date results we remain within our target range for annual organic revenue growth, As we have said we are targeting the Burrows acquisition to contribute a minimum of $500 million in additional annual revenue,

For the third quarter gross margin was $194 million, an increase of $15.5 million when compared to the third quarter of 2007, As a percent of revenues gross margin was 10.70% for the third quarter, An improvement of 13 basis points when compared to last year’s results, The improvement from the prior year third quarter resulted primarily from greater manufacturer price increases, additional sales of value added programs and services and then approximately 30% increase in sales of our MediChoice private label products,

On a sequential basis third quarter gross margin increased by $3.5 million, that is a 10 basis point improvement as a percent of revenues, The improvement was primarily due to manufacture price increases and the recognition of certain supplier incentives, These incentives have an element of seasonality as we tend to achieve the annual performance thresholds in the third and fourth quarters of a year.

For the year to date period, gross margin was $571 million, improved $41 million when compared to the same period last year, As a percent of revenue, year-to-date gross margin was 10.66% an increase of 17 basis points compared to last year, The year-to-date increase resulted primarily from improvement in the acquired McKesson account, additional sales of value added programs and services, increased supplier incentives and manufacture price increases in the first and third quarters.

SG&A expense for the third quarter 2008 were $141 million an increase of $9.6 million from third quarter 2007, When comparing to a year ago, several factors affected SG&A including fuel costs that increase by approximately $1.1 million and incentive compensation expense including equity base compensation which was about $5.5 million greater.

However, even though the expense dollars were greater, SG&A expense as a percent of revenues held steady when compared to the third quarter 2007, When looking at SG&A results sequentially expenses were essentially in line with the second quarter of 2008.

Year-to-date SG&A expenses were $420 million an increase of $12 million compared to the first nine months of last year, The increase in SG&A expenses resulted primarily from the following factors, An increase in our incentive compensation expense reflecting approved achievement against certain performance based measures, higher fuel costs and an increase in the accounts receivable reserve for the DTC business.

These expense were somewhat offset by a decrease in selling costs so far this year, As a percent of revenues SG&A year-to-date was 7.83% an improvement of 24 basis points over the same period last year, When comparing our year-to-date SG&A results to last year, You’ll remember that during 2007 we experienced costs associated with the transition and integration of the acquired McKesson business, including approximately $7 million of transition fees paid to McKesson during the first quarter of 2007.

For the third quarter 2008, operating earnings were $46 million, increased $5.3 million from last year, As a percent of revenue operating earnings were 2.55% a 12 basis point improvement compared to third quarter last year,

For the first nine months of this year, operating earnings were $131 million, an improvement of $28.8 million when compared to the first nine months of 2007, As a percent of revenue year-to-date operating earnings were 2.45% improved 42 basis points from last year.

Net interest expense, which is a component of net income but not of operating earnings, increased approximately $900,000 in the third quarter 2008 when compared to a year ago, For the first nine months of this year net interest expense was $12.6 million a decrease from the $19.2 million during the same period last year, The decline in interest expense resulted from lower balances outstanding on our revolving credit facility and a more favorable interest rate environment.

The decline in the interest expense though was partially offset by interest expense recognized during the third quarter of 2008 on the interest rate swaps that were hedging our $200 million in fixed rate bonds.

These swaps were designated as fair value hedges until one of our counterparties, Lehman Brothers, declared bankruptcy, At that time we determined that the swaps were no longer expected to be effective and we discontinued accounting for the swaps as a fair value hedge.

We terminated the swaps on September 26th and recognize the loss of $3.1 million in the third quarter, representing the difference between the fair value of the swaps as of the discontinuation date which was $6.9 million and the proceeds received on termination of the swaps which was $3.8 million, The $6.9 million fair value adjustment will be amortized over the remaining life of the bonds as an offset to interest expense.

The effective income tax rate for the quarter was 36.7% and for year-to-date the rate is 38.3%, These lower rates were due to a decrease in tax accruals related to potential tax liabilities as outstanding tax issues were resolved during the quarter, For the year we are targeting an annual tax rate of approximately 38.8%,

Net income from the quarter was $25.3 million, improved $4 million compared to a year ago, For the third quarter, net income per diluted share was $0.61, improved 17% from last year, For the year-to-date period, net income was $73.1 million, an improvement of almost $23 million over the same period last year, For the first nine months of this year, net income per diluted share was $1.76, increased 43% from the same period last year,

Turning now to our asset liability management efforts, for the first nine months of this year we reported cash provided by operations of $124 million compared to $202 million in the same period of the prior year, You will recall that last year at this time we were recognizing cash flow benefits as we liquidated the inventory acquired in the McKesson acquisition, DSO as of the end of the quarter was 23.8 days improved from 23.7 days at the same time last year,

Inventory turnover was 10.3 in the third quarter compared to 9.8 for the third quarter last year, So far this year, cash used for capital expenditures was approximately $20 million, We had paid dividends of approximately $25 million and finally, we have used cash to reduce our borrowings under our revolving credit facility by $77 million,

Turning now to our directed consumer business, we reported revenues of $24 million for the third quarter of 2008 and $73 million year-to-date, That compares to revenues of $27 million and $81 million in the same period last year, DTC earnings were essentially breakeven for the quarter, There were approximately 182,000 DTC customers as of the end of the third quarter 2008 decreased from 187,000 customers in the prior year,

And finally, let me give you a brief overview of the financial aspects of the Burrows transaction, Effective October 1st, we completed the transaction acquiring certain assets and liabilities of the Burrows Company for cash of $23.7 million plus assumed debt of $56.1 million, We used approximately $80 million of our revolving credit facility to fund the transaction, In conjunction with the Burrows transaction, we entered into an agreement to purchase real estate used by the Burrows Company,

We continue to negotiate the terms and conditions for this transaction and hope to complete the purchase by year end, The purchase price is expected to be in the range of $20 million, We would plan to immediately offer the buildings up for sale, Now looking ahead to the fourth quarter, we believe that organic revenue growth will be in line with our previous guidance and that fourth quarter net income per diluted share will be similar to third quarter 2008 results, Thank you, Now I will turn it back over to Craig for his remarks.

Craig R. Smith

Thanks, Jim, and let me just open up by saying we are very pleased with our results this quarter, Our revenue and earnings set quarterly records for Owens & Minor, We saw improvement in operating margin as well as quarterly operating cash flow, Our teams in the field and at the home office are just doing a great job working with our customers and managing the steady growth of our business, And I’d just like to say we continue to hit our marks and I believe we are showing remarkable consistency especially in today’s’ volatile economy,

Every day we work toward maintaining a strong balance sheet and generating positive cash flows, At the same time, we are investing in our business, training our teammates and growing our position in healthcare, As for recent events, we are very excited about the Burrows acquisition, This acquisition gives us added strength in the Midwest and provides us just some outstanding new customers, and we are very encouraged by their initial response,

Our transition team is preparing to launch what I would call a phase conversion plan starting in November, We will be using the same teammates, the same techniques and procedures we used so successfully with the McKesson conversion, Now we expect to complete the customer conversion by the end of second quarter next year,

During the transition period we will incur the usual expenses related to integrating an acquisition of this size, Just for example, these expenses would include extra travel, overtime, inventory purchases, transportation, and of course training, We have many of the Burrows’ sales force in today, We’ve actually started training, temporary headcount and real estate costs,

Now, I’d like to say the Burrows’ teammates built their business by providing strong customer service and a high degree of operational excellence, and we believe the Burrow sales teammates are a good fit for Owens & Minor and we are pleased to have them on board, In fact, as I had said earlier, the OMU team has already begun training these teammates as we speak,

Now we also expect to achieve synergies with this acquisition, There is a significant overlap among our supplier base and we expect to realize the benefits of this added sales volume, Also, our distribution network overlaps with the Burrows’ locations so we will be consolidating the business over the next three quarters, And finally, these customers really have not had access to private label products or advanced supply chain management solutions, so we see a great opportunity to introduce them to our programs and services,

Now turning briefly to the overall healthcare market, I have been traveling quite a bit in the last three months and I am hearing consistent themes from our acute care customers, and I’m sure it comes to no surprise that hospitals in general are facing a tighter credit market, Now at Owens and Minor of course, we see this as an opportunity to work more closely with our customers, We are well positioned to provide supply chain solutions that we’ve been investing in since 1999; they can help hospitals lower the overall cost of providing healthcare and free capital for other uses,

We also see opportunity for growing our private label, Medichoice, as it offers healthcare providers what we would call a cost-effective alternative, As you know, we monitor hospital surgeries trends and they appear fairly consistent with recent years, Surgery volume is higher with slightly more growth flowing to outpatient procedures, This is, of course, a pattern we have been seeing for some time and as we’ve said, our business really correlates most closely to surgery trends,

As for how this economy is affecting Owens & Minor, we have been long viewed as conservative and in today’s market we believe that’s the right place for us to be, and as always, we continue to closely monitor the credit quality of our hospital customers,

In terms of asset management, we continue to effectively manage our inventory and accounts receivable and we have a proven ability to generate positive operating cash flow, We are a continual consistent dividend payer and we have the capacity to invest in our business for the future,

One last note, we want to invite all of you to our 2008 Investor Day which we are holding on December 10th in New York this year, We look forward to sharing more about our strategic direction and give you a sense of how 2009 is shaping up, and we will be announcing more details soon,

I’d like to finally just say this quarter we are again extremely pleased with our results, Revenues were strong again this quarter, our operating margin improved, we continue to leverage our business over growing sales, and we are well positioned operationally, financially and strategically as we look ahead, Thank you, and now we would be happy to take your questions,

Question-and-Answer Session

Operator

(Operator Instructions), And your first question will come from the line of Lisa Gill – J.P. Morgan.

[Asha Heman] – JP Morgan

Thanks, it’s [Asha Heman] for Lisa, Jim, you had mentioned that product sensation was a contributing factor to better growth margins in the quarter, could you perhaps quantify what that was and going forward do you continue to expect price increases which should benefit you and then have a second question related to the interest rate?

Jim Bierman

Sure, the component of the variance relating to product price increases is less than we’ve seen in certainly the first quarter and we would characterize pretty much as a follow on the changes we saw in the first quarter,

Primarily in sort of the July time frame and we think that’s basically run it’ course, So just speaking to your follow on question of what do we see going forward with it, We think in today’s environment that definitely is more than likely stabilized but certainly on a quarter-to-quarter basis just looking back over 2007 we’ve seen some pretty dramatic swings in the fundamentals of the raw materials that contribute to those products,

I mean you don’t have to look any further than changing gasoline prices to see what the impact within with in 2007 has been but going forward we’re not anticipating a similar environment that’s what we had in 2007,

[Asha Heman] – JP Morgan

And then would the interest rate for the swap would actually be terminated? It looks like you won’t have any floating rate exposure, could you give us perhaps what's your view on the ongoing interest expense given that the fair value of the debts bets being amortized, what that expense is going to be on a quarterly basis? I just don’t know what the remaining life is.

Jim Bierman

I think the remaining life is about eight years, That’s generally it, I don’t have in front of me the projections of what interest expense will be, That I could commit, that we would talk in some degree of specificity at our Investor Day as we look forward to 2009,

Operator

Your next question will come from the line of Larry Marsh with Barclay's Capital.

Larry Marsh – Barclay's Capital

Craig and Jim and everyone else, look forward to seeing in December, a couple of follow ups to Keith]'s question really on pricing, You had three million of a I guess, sort of onetime but unusual benefit in the first quarter with as you say, the unusual activity in commodity prices,

Today you are saying that the increase, it didn’t sound like it was as much as the first quarter, more typical to what you see in the third quarter, I just want to confirm that that is consistent and then just around that volatility, given the fairly substantial declines in pricing we’ve seen the last month how might that be reflected in pricing over the next year do you think and in just thinking back a very few times where I’ve actually seen prices get cut, but help me think through that potential possibility and then how you would react to it,

Jim Bierman

Let me take the first part real quick, Craig, and then you can answer the more forward looking statement, Yes, Larry your standing of the variances is correct, Let me just state it another way, The majority of the variance for the, in the third quarter, had more to do with the supplier incentive programs kicking in than the purchase price component and in just a little bit of color on that.

The quarter itself was very strong with over 7% revenue growth and correspondingly now that we’re nine months into the year and coming off of very strong quarter we triggered various incentive thresholds that enabled us to recognize some additional margin in that area, which isn’t unusual and we’ve spoken about that in the past but being seasonal and we would expect is to continue into the forth quarter along those lines,

Craig R. Smith

Larry, let me take the second part of the question and a couple of things, Of course we just signed our HPG deal October 1st and we’re in the sign up period so we have now locked that pricing in for roughly the next five years and then on the Premier deal we hope to have that probably done by the end of this year so as you remember, our deals, the distribution deals are separate really from the manufacturing price, I think we do see if you look at the numbers we’ve had about $3 million in additional expense in fuel and I think we hope we’re feeling like we’re leveling off a little bit so we see that as a potential opportunity at least for us next year.

I’m not sure we’re going to see dramatic drops on the price, I think you probably, again, see a leveling off on that, I’ve actually seen probably the GPOs push back on the increases and are looking to really probably level the playing field a little bit more for the playing field for next year, so I think, one, we’re going to see, we’re going to have almost all of our, well we will have all of our GPO business locked in by the end of this year,

We probably see maybe some upside, potential upside, on the fuel costs, internally for us, I think that takes a little pressure off the manufacturers too from inbound costs for them, shipping costs to us, so hopefully that’s going to take a little pressure off the supply chain for next year.

Larry Marsh – Barclay's Capital

And Craig, remind me just as we think about it how much of your business would you now define as being true activity-based and your costing?

Jim Bierman

It’s still around about 37%, net actually is, it may be a little high, it may be what the Burrows business coming on, you got to remember we brought the McKesson business on and the Burrows business on which is roughly billion and a half, billion six, and it’s still a pretty significant piece of our business; it’s still a very high priority for us.

The piece that we have been working on for the last probably six to nine months is to bring the manufacture piece on that, So we had kind of plateaued from the improvement on a process cost between the hospital and Owens and Minor and now what we’re doing is we actually have I believe in beta site, a couple of hospitals where we’re bringing the more efficient manufacturer which should overall reduce the hospital fees,

So I don’t know that we’ve actually done the numbers Larry, since we’ve brought the Burrows business in but it’s still for our larger hospital systems, it’s still a very significant pricing tool for us,

Larry Marsh – Barclay's Capital

Okay second question is just on the surgical volumes and again, I'll use [inaudible] tend to like, you still generally speaking surgical volumes were up, you said maybe 1 or 2% and it sounds like your feedback is at, maybe it's flat to up one or something just comparing with some of the public disclosures we’ve seen, even this quarter, we’re hearing down 2, down 3%, in some cases a little bit more and that’s a little bit worse than we saw in the June quarter, So how would you reconcile those two data points and are there some regions or areas where you could say that there is some more weakness, or not really?

Jim Bierman

Well, I’ll be honest the documents that we look at the research that we looked at and we don’t jump from research to research, pretty much still shows that we’re probably, it looks like it’s up about 1%, Now I think what I’ve heard anecdotally over the country is depending on where you are admissions are somewhat all over the board or down,

Now some of the larger systems are taking some market share but overall admissions which doesn’t really impact us as much as the surgeries, If you’re going to have surgery you’re going to have surgery, The admissions are down but we’re still showing through the information that we use that surgeries overall are up slightly back to your point maybe 1%, maybe something like that.

Larry Marsh – Barclay's Capital

And there is no geographic change or impact or difference that notice?

Jim Bierman

I think the data we use Larry is national data and so I don’t know that’ it’s granular down to the regions but I can tell you as I kind of travel all over the country, some areas might be down a little bit more than others in terms of admissions,

Obviously, emergency room visits are up pretty dramatically but the key, really the key financial indicator we look at are inpatient and outpatient surgeries.

Larry Marsh - Barclay's Capital

Finally, would you elaborate a little bit on what the real estate is you're buying from Burrows and also along with that maybe any anecdotes or feedback you're getting so far from some of their sales force as to how they might be able to work within your organization? What are some of the opportunities and some of your biggest concerns with this piece of business coming in this year?

Jim Bierman

Yes, real quickly, Larry, on the real estate, Burrow has nine distribution centers that we will be acquiring and subsequently hopefully selling and of the nine I think Charlie can speak to what the plans are going forward, I guess,

Charles C. Colpo

We would like after the transition is over and done we would look to be occupying one of those facilities, And as far as some anecdotal things about our sales force, we are thrilled with the sales force that has come over and the customers that they're bringing on, too, Burrows has been a company that maybe a little light on technology standpoint and a little light on programs and services and that's the story we hear from them is that they're very eager to get started with MediChoice,

In fact some of the DPs that are targeted late in the transition phase are asking how do they get access to MediChoice now so they can begin to sell, So I believe they're very excited about the programs and services they will begin selling to the customers and so far so good as far as that goes.

Operator

Your next question will come from Eric Coldwell – Robert Baird

Eric Coldwell – Robert W. Baird & Co

I think Larry had quite a few of my questions as well so just a couple of quick follow-ups, I think kind of playing off what Larry was asking in terms of the various product lines within your customer base, are you seeing any particular changes that are surprising or particular slowdown in terms of either DME or capital equipment or are there particular areas that you would care to identify?

Craig R. Smith

We're really seeing no variation in our product offering or sales of our products and most of our equipment is the small equipment type products like lockers and those types of things and they remain as strong a they've been in the past,

Eric Coldwell – Robert W. Baird & Co

Very helpful, thanks, Craig, I know you've been loath to share some of this data in the past but I guess I'll keep trying, Private label, great growth in MediChoice; I think you quoted 30%, I was hoping we could get the number of SKUs and I guess I'll keep trying on percent of sales and ultimately it might become material enough that you'll share it with us,

Craig R. Smith

I love a guy who keeps trying, I really do, You're my guy and I'll give you the SKUs, 1,700,

Eric Coldwell – Robert W. Baird & Co

1,700.

Craig R. Smith

Yes, and actually, Eric, I think, one, the core sales force continues to do a nice job on growing MediChoice and as we've said before and again, we deliver on what we say we're going to do, A lot of the growth really has come from the McKesson accounts and so we're seeing, one, McKesson accounts being open to private label and, two, the reps really coming over and embracing that and I'll just speak a little bit more maybe anecdotally to Charlie,

I think some of the guys, it's the old 80/20 theory; the 20% of the reps the Burrows reps that drive a lot of the business are really looking forward to MediChoice and the programs and services, So we have been very happy with private label, I will also say that we now can sell MediChoice to the HPG customers,

We've now been put on that contract and so this continues to open up for us as we talked two years ago GPOs were fighting us to some degree, We're almost on all the GPO contracts where we can sell MediChoice and I think that's where that success has come from in the end, We're now looking hopefully for some new launches coming up and so I'm looking forward to the day where we break that out too for you, But I think we're rolling on the private label,

Eric Coldwell – Robert W. Baird & Co

It sounds very good, A strategic question, I know that Mr. Bierman has quite a long history on M&A in the past in healthcare and that one of the things that I think he was targeted for when he joined the company was to contribute to your corporate development, It's clearly becoming more of a buyer's market I'd say in the current environment, so I'd like to get an update if you will in terms of what you're seeing in terms of potential interest in the market for smaller private companies to merge with OMI, And there's always been this belief that you're going to follow the patient home and move into some new verticals and also maybe on that front if you will,

Jim Bierman

As we sit back and look at the environment the obvious initial assessment is it's a challenging time but we certainly recognize that with a challenging time also comes some opportunities, and certainly I think although the timing of the Burrows transaction was a little ahead of the current market situation, I think the Burrows transaction is very illustrative of the opportunistic approach that the company takes,

We continue to look in the marketplace for opportunities, We are beginning to see a different level of activity being presented but I think it's premature to comment on any of that at this particular point in time, and I think also the context of looking at opportunities is important and I guess I would encourage everyone to listen to the Investor Day discussion where we can put our assessment of the market environment within a broader context in a little more time in a more meaningful fashion,

Operator

Your next question will come from Joel Ray – Davenport

Joel Ray – Davenport & Company

Congratulations on a good quarter, I was hoping we could clarify a couple of things that I see in the quarter, You had mentioned of course that interest expense net was up substantially in the quarter, This is a figure that has been running in the $3 million range and now we're at $6 odd million, is it fair to state that ex the Lehman swap reversal, that this would track back down by that same $3.1 million that we experienced in the current quarter from the Lehman debacle?

Jim Bierman

Yes, with one caveat which you maybe probably have already factored in and the caveat would be remember that effective October 1st, we took down another $80 million and with the closing of the real estate component as transaction in the aggregate it would look to be almost $100 million that would be additional borrowings, But as long as you factor that in everything you said was correct,

Joel Ray – Davenport & Company

I just wanted to make sure, and then secondly we discussed the fact that the tax rate had dipped down below 37% and could you elaborate a little bit about what was involved in the tax situation there?

Jim Bierman

Yes, sure. As everyone will recall the date for filing after extensions the 2007 tax return is September15, so in the third quarter you always tend to have two events occur, could have two events occur, One is the actual filing of the prior year's tax returns which can result in adjustments to the provision, and then secondly you have, if you're fortunate, the expiration of open tax years for the year that you filed three or so years ago and we had that, We had some contingencies set up and reserves accordingly that as the open tax years expired triggered the reversal of those adjustments,

Joel Ray – Davenport & Company

That makes perfect sense and that would imply that you had mentioned for the year a 38.8% which means that for the fourth quarter your tax rate bumps right back up to that 39.5 to 40% range.

Jim Bierman

Exactly, a little less than 40 but in the low 39 range, yes.

Joel Ray – Davenport & Company

Okay and it also sounds like when you were suggesting your earnings outlook for the fourth quarter is fairly comparable to the third quarter, you obviously aren’t looking for anything much in the way of dilution arising from the Burrows transaction at this point in time.

Jim Bierman

Well, I think a better way of probably saying it or a more accurate way might be that whatever the effect of dilution is would be mitigated through continued improved and in either margin or some cost reduction efforts, but fundamentally, yes.

Operator

Your next question will come from Glen Santangelo – Credit Suisse.

Glen Santangelo – Credit Suisse

Jim, I just want to follow up quickly on that last question, just so I understand kind of what you are expecting in the fourth quarter, You said earnings consistent with the third quarter, which I guess would be in the low 60s kind of range, $0.61?

Jim Bierman

We said it would be similar to the third quarter and the third quarter is $0.61.

Glen Santangelo – Credit Suisse

And that third quarter kind of included, roughly, a $0.05 impact from writing off those interest rate swaps, Is that fair?

Jim Bierman

True, I think you need to be careful because it also included, as Joel pointed out, an increase in the tax rates, So, I think as you look forward there is going to be some movement between interest and tax provision that more than likely would tend to offset if you look at the two quarters on a net basis.

Glen Santangelo – Credit Suisse

And maybe some incremental dilution from Burrows this quarter?

Jim Bierman

Yes, exactly.

Glen Santangelo – Credit Suisse

Okay and then just to kind of follow up on some comments you made earlier, If in fact, you're going to close eight of those nine distribution centers, would you do that rapidly? How should we think about the dilution over the next three quarters, will it be more front or will it be spread more evenly over the next three quarters?

Jim Bierman

We need to get everyone to Investor Day to go through that and just to touch more detail, but the quick sort of easy answer is yes, it’s being staged over a three quarter horizon based on, to a degree, the complexity associated with the different conversions and customer needs, So it is ratable, generally, over the three quarters, That being said, I would expect the fourth and first quarter to have more of an impact than the last quarter of the year, if nothing else because we will have honed the process even further during that time frame.

Glen Santangelo – Credit Suisse

Craig, maybe just one last question, based on your comments, you kind of talked about your still getting some benefit from private label pulling out through the customer base, As the deal is just about two years old now, do you still think there's further opportunities there or how should we think about that from a gross margin perspective heading into the next year?

Craig R. Smith

Well, again, I have been very pleased with this quarter and last quarter being the eternal and optimistic salesman, I think – but I do believe, we, Glen or – there is still some opportunity I think, with the new HPG deal, You know we have an opportunity to sell there now, in all of those accounts and I would say that’s probably a pretty good opportunity because there’s a lot of mid-sized hospitals that are looking for some opportunities and that,

I think the Burrows folks are really fired up so there is another big chunk of business and I don’t think we’re done with the McKesson acquisition in terms of adding private labels so I think we’ll continue to grow that, As I said, we have some launches coming up and this is – we’re pushing hard on this initiative across the company and so I do believe there is still some opportunity.

Operator

Your next question will come from Robert Willoughby – Banc Of America Securities.

Robert Willoughby – Banc Of America Securities

Craig or Jim, can you give us any sense of what the Burrows acquisition brings you from a working capital standpoint that you think you can cut over that three quarter timeframe and secondarily, Jim, I thought you mentioned an A/R reserve addition for the DTC business, it must have been small, but can you size that for us?

Craig R. Smith

Let me answer the last question first, I think in my comments the reserve we're talking about increasing in the DTC business explanation as to why performance and you're right, in the third quarter, there was not that type of an adjustment.

On the working capital coming out of the Burrows transaction, I think we would be more comfortable doing that in a greater detail, again, sort of in the December timeframe as we look forward to giving additional guidance into 2009, I’m a little reticent to just pick off a piece of 2009 activity and begin to pontificate on what that might look like without, again, looking at the entire context of the year.

Robert Willoughby – Banc Of America Securities

Could you possibly grade the Burrows management team in terms of stewards of capital here, were they efficient on the working capital line item or are there material opportunities, anecdotally, can you comment one way or the other?

Craig R. Smith

I’ll take that because Charlie works day to day with the Burrows folks and I can sit back and more editorialize on this, I think in the area of receivables management they were brilliant, They did an excellent job of managing the business, I think that there are great – that where there are opportunities, is going to be in the area of inventory management and I think some of our operational people that manage this area will have a good positive influence on their business and that’s where we're anticipating seeing the benefits come.

Operator

Your next question will come from Randall Stanicky – Goldman Sachs.

Randall Stanicky – Goldman Sachs

A follow-up; you mentioned, with respect to Burrows, I think you called it light on technology, Thinking about that and in conjunction with some of other spending on your core business, I think around the area of automation and some of the infrastructure spending, how do we think about some of that investment over the next few quarters through SG&A, and effectively, what are you looking to add there?

Craig R Smith

In terms of capital, I would say that the next three quarters you would see the increase and just the racking, the equipment that we would need to outfit the distribution centers, My comments about technology relate more to the technology of sales force, The use of technology that will provide training opportunities to us and then actually selling our technology to the customer base, too, is a program that Burrows did not have, But, in terms of the next three quarters, I would expect to see just a bit above normal infrastructure spent in capital.

Randall Stanicky – Goldman Sachs

And that would be pro forma for both companies SG&A?

Craig R. Smith

I think we will be able to give you a little more color on that December 10th on some investments we’ve made this year and then some investments that we will make next year, which should have some impact on warehouse productivity and we’ll give you an update on that December 10th.

Operator, we have time for one more question, if there’s any more.

Operator

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

Craig R. Smith

Before we wrap up today, I want to make a few final comments, We obviously continue to believe that the healthcare market represents a growing opportunity for us, We are very pleased with the third quarter results, We completed the Burrows acquisition and will begin the customer conversion in November so we’ve got a busy time ahead of us, We continue to focus on maintaining a strong balance sheet and generating positive cash flows, even as we invest in our business for the future and we work every day to reach operational, financial and strategic goals.

I want to thank all of our teammates for just an outstanding quarter on revenue and net income, It’s what you do for us every day and for our customers that make a difference, And, of course, we all look forward to seeing you December 10th at Investor Day in New York, Thank you for your participation and I hope you have a great day.

Operator

Thank you for participating in today’s conference, This concludes the call.

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