美源伯根 (ABC) 2002 Q3 法說會逐字稿

Thank you for standing by and welcome to the AmerisourceBergen Fiscal 2002 Third quarter earnings call.

At this time all participants are in a listen only mode.

Later we will conduct a question and answer session and instructions will be given at that time.

However, if you should require assistance during the call, please depress "0" then star.

As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Head of Investor Relations, Mister Michael Kilpatrick.

Please go ahead.

Good morning, everybody.

And welcome to AmerisourceBergen's conference call covering [physical] 2002 Third Quarter results.

I'm Mike Kilpatrick, Vice President, Corporate and Investor Relations, and joining me today are David Yost, AmerisourceBergen President and CEO, Kurt Hilzinger, Chief Operating Officer, and Mike DiCandilo, Chief Financial Officer.

During the conference call today, we will make some forward looking statements about our business prospects and financial expectations.

We remind you that there are many risks factors that could cause our actual results to differ materially from our current expectations.

For discussion of some key risk factors, we refer you to our SEC filings including the definitive proxy statement prospectus for Amerisource and Bergen merger, as filed on August 1, 2001, our 10-K report for fiscal 2001, and our 10-Q reports for fiscal 2002 to date.

Also AmerisourceBergen assumes no obligation to update the matters discussed in this conference call, and this call cannot be taped without the express permission of the company.

As in past quarters, on the AmerisourceBergen website under Investor Relations, you will find a short slide presentation, covering some of the points we will discuss today, and you are welcome to follow along.

As always, those connected by telephone will have an opportunity to ask questions after our opening comments.

And here is Dave Yost, AmerisourceBergen's President and CEO, to begin our remarks.

Good morning, and thank you for joining us.

This is our third full quarter as AmerisourceBergen, and we continue to be very excited about our results, the industry we operate in, and our leadership position in that industry.

On the financial front, consolidated operating revenues were up 14% this quarter to 10.3 billion.

Pharmaceutical distribution revenues were up 14%, crossing the $10 billion mark to 10.1 billion, excluding bulk shipments to customer warehouses, which were up 12%.

PharMerica was up 11%, to 373 million.

On a pro forma basis, total operating costs reached their lowest level ever, as a percent of revenues, to 3.1% for the total company, and 2.15% for the drug distribution company, as our synergy capture continue to gain traction.

Total operating income was up 16%; 14% in pharma distribution, and 28% in Pharmerica.

Net working capital investment, as percent of operating revenue, was 6.7% in the quarter, compared to 8.1% on our pro forma basis last year, demonstrating our emphasis on working capital, and our attention to every detail in this critical area, throughout the organization.

The term committed capital was again very strong at 24.6, demonstrating our continuing financial discipline.

EPS was up 48% to 86 cents per diluted share before special charges.

Lots to like about this quarter and lots to like about this industry.

Let me hit a few issues on the industry from 50,000 feet.

There are no changes to the fundamentals of this industry, and the fundamentals of this industry remain strong.

Industry growth continues to be very positive as we look forward, in the 13-14% range, impacted the brand to generic switch, and temporary slowdown of blockbuster drug introductions.

The fundamental drivers of the growth of this industry will not change.

Favorable demographics, new products, increased utilization of product, and new uses for over-products.

The multi-billion dollar research budgets of the big pharma companies will undoubtedly result in new products that will move through our network.

A medicare drug benefit will probably not occur in the immediate future, but when it does, it will provide strong revenue opportunities for the industry and for us, which have not been included in any industry forecast.

As you are probably well aware, the Senate has rejected three drug proposals of late, but there is some speculation, that a fourth or fifth proposal could make it through, which would raise the level of discussion on this topic as the November election frenzy begins, and perhaps precipitate actions sooner than originally forecast.

We see price appreciation continuing at an annual run rate of 5% or so, stronger in the first half of the calendar year, than in the September quarter, as has been typical over the last few years of continuing at a very strong rate.

We see no indications of change in this area.

The opportunities to work closely with our manufacture suppliers have also seen no fundamental change.

As the market leader, we work closely to meet the unique needs of each supplier.

Generics continue to be a great opportunity for the industry in general, and AmerisourceBergen.

Since we have much stronger influence over the supply change in generics than brand name products and are the largest purchaser of generics in the country, we can command a higher gross profit in this category while delivering very strong value to our customers.

Our new generic program, Pro-Generics, is being very well received by our customers.

Generics have a moderating effect on the top line, but as part of our upcoming planning process, we have recently completed a detailed study of generics, and confirm our expectation that gross profit percentage, gross profit dollars, and return on committed capital, are all stronger in our generic portfolio than in our brand name portfolio.

The fundamentals of our industry are strong, and have not changed.

Let me change gears and spend a minute on corporate governance.

We endorse the new SEC certification of financials by the CEO and CFO, and as noted in the press release, will conform to the new standard.

In fact, in addition to our principal financial officers, Kurt and I have been certifying the numbers to our Board of Directors for years.

I have reviewed the New York Stock Exchange recommendations concerning corporate governance, and am supportive of them, as is our Board.

As a matter of policy, our outside auditors perform no internal audit functions, and no consulting work for the company, and that includes our integration work, when we contracted with [Deloit] and Mercer for assistance.

We have no off-balance sheet financing, and our audit and compensation committees of the Board of Directors are composed only of independent directors.

Let's turn our attention to the specifics of AmeriSourceBergen.

During the quarter, we announced, and have now closed, the acquisition of AutoMed for $120 million in cash.

AutoMed is more than just another automation company.

AutoMed has the broadest pharmacy automation offerings in the industry, with over twenty unique product offerings for both the retail and institutional market.

What makes AutoMed unique is that it's products are scalable, so that value can be delivered to a single small independent drugstore or a large mail order facility.

Scalability is why AutoMed is the best solutions company for our diverse customer base.

AutoMed equipment is the backbone of our central filled joint venture with Long's, and AutoMed provides automation equipment and service to the VA's consolidated mail out-patient pharmacy or CMOPP.

AutoMed has a patented process for putting caps on prescription containers and very sophisticated proprietary programs for evaluating productivity and will become an important part of our full service offering.

Reducing the cost of dispensing prescriptions, improving dispensing accuracy, and relieving staffing pressures, are among the greatest challenges our customers face, and Automed provides a key part of the solution to these challenges.

As noted previously, we expect AutoMed to be slightly accretive to earnings.

AutoMed was a big hit at our healthcare conference and trade show, held mid-July in Las Vegas.

We had over 4,000 independent and small chain operators at the show, and in addition several sizable regional chains, make it the largest such industry event in history.

It provides us a great opportunity to showcase our programs and services.

We has our entire retail sales forces on site, and used the opportunity to provide two days of intensive sales training.

In all, we had over 6,000 people in attendance.

We continue to do a good job of executing the basics and our merger synergies are clearly gaining traction.

Let me turn the mike over to Kurt Hilzinger our Chief Operating officer to provide some color.

Thanks, Dave.

Good morning, everyone.

Today I'd like to focus my comments on the operating highlights of our business units, and again provide a progress report on our merger integration activities.

In our market leading Pharmaceutical distribution business, which includes AmeriSourceBergen [Drug] Company, and AmeriSourceBergen Specialty Group, we stayed focused, continued to make customer service, expense control, and effective capital management top priorities.

While at the same time, moving aggressively ahead with our integration work.

Pharmaceutical distribution reported top line growth for the quarter, in line with our expectations.

Again, the group reported extremely strong operating expense performance, up only 3% over the prior year to a record 2.15% of revenues, reflecting disciplined management at all levels of the organization, as well as the capture of cost synergies to out integration activities.

While I will comment more on our integration work in a few minutes, our integration momentum remains strong in the third quarter.

Again driving synergy capture savings ahead of our internal expectations.

The group's buy side margin contribution was again better than our expectations this quarter which was due in part to the improved scale and now combined procurement expertise of ABC.

We remain disciplined in our use of capital.

Require any returns on committed capital of greater than 20 percent from our investment buying activities.

Keeping mindful of the fact that we want disciplined customer pricing in combination with expense and capital control to be the primary driver of our earnings long term.

Requiring returns on committed capital of greater than 20 percent will continue to be the primary metric by which we evaluate new customer opportunities.

The fundamental strength of our drug company lies in its customer diversity not weighted too heavily toward any one customer group.

We enjoy number one market positions in the hospital systems acute care market, alternate site market, which includes mail order, the regional chain arena and with independent community pharmacies.

These customer segments offer us a broad range of growth opportunities where our higher service capability and offerings are recognized and rewarded.

As Dave mentioned, at our trade show we held two days of extensive sales training around the combined offerings of ABC.

Our entire sales force is now equipped to sell the value added programs which were uniquely offered by each former company.

As a reminder we field the largest sales force in the industry.

AmeriSource Specialty Group continued its rapid growth and development in the quarter by focusing on the distribution of pharmaceuticals around specific disease states, and by providing an increasing array of services to pharmaceutical manufacturers.

Each of the businesses which make up the specialty group exceeded our internal expectations on every key measure.

Revenue growth, operating income, and return on committed capital.

The group is now operating annualized revenue in excess of 2.5 billion.

This is a very attractive group of high growth high return on committed capital businesses growing substantially faster than our core pharmaceutical distribution business.

In terms of a few specific highlights for the quarter, oncology supply again set record levels for revenues and operating income and may now be the largest oncology supplier in the country.

ASD, the group's blood products distribution business was awarded an exclusive service contract with AmeriNet, a hospital buying group and continued to gain new accounts in the quarter.

Both contracts are excellent examples of taking advantage of cross-selling opportunities between specialty and drug.

At ICS, the group's third party logistics provider assisted a number of pharmaceutical manufacturers launch five new products in the quarter.

PharMerica, our institutional pharmacy business, continued to make substantial gains, growing revenues 11 percent in operating income, 28 percent in the quarter.

The company's increase in revenues and operating earnings were driven by the continued strong performance of the company's workers' compensation division and accelerated revenue growth at the company's long term care pharmacy division.

The recently implemented common IP platform in the long term care division drove improved expense efficiencies through more consistent application of best practices at the pharmacy level.

For example, the company has implemented bar code scanning in 60 pharmacies as of June 30th, versus zero a year ago, improving accuracy and eliminating rework and labor.

Continued focus on asset management, particularly in the area of credit and collections, has significantly reduced gross day sales outstanding, lowering our capital invested in the business, and dramatically improving PharMerica's return on committed capital over year ago levels.

Now I'd like to turn to our integration efforts.

We continue to make solid progress.

During the third quarter, we continued to meet our integration timetables, executing the detailed integration plans we wrote last summer and early fall.

We remain ahead of our internal expectations on synergy capture, and importantly, below our estimates in terms of cost of capture.

With regards to specific milestones during the month of July, we completed on schedule consolidation of the Portland, Oregon distribution center former AmeriSource in the Seattle center of former Bergen with no customer interruption.

Three additional distribution centers are scheduled for consolidation in the fourth quarter, bringing the total number of consolidations in the fiscal year to seven in line with the goal we set at the beginning of the year.

In terms of other milestones, during the quarter, we completed the staffing and slotting of our entire sales and marketing organization.

In fact, we have completed associate staffing decisions through the Vice President, director and manager levels in every functional area.

During the June quarter, we rolled out a new combined health and welfare benefit program across the entire company and migrated all associates to a common payroll system.

Both the benefits and payroll conversions occurred ahead of our original timetables.

In addition, by the end of the -- by the end of September, all of our procurement activities will be migrated to a single procurement system which will allow us to drive service level improvements and additional working capital efficiencies in fiscal 2003.

With the integration of the administrative and other support functions nearing completion, the integration management office structure will change over the next six months as many of the integration dedicated resources go back to day-to-day activities.

The integration management office will transition into an operations management office in order to better execute the work plans of our future state distribution network.

We are now actively adding a number of highly skilled staff positions, project manager, engineers, and systems specialists from inside and outside the organization to be a part of the operations management office.

As I mentioned in our last call, our future state distribution network plan calls for the construction of six new distribution centers.

These will be large, highly automated distribution centers located across the United States.

In addition, the plan calls for the expansion of 7 existing distribution centers and a total of 28 distribution center consolidations.

The time frame necessary to complete all this work is four to five years.

We remain confident in our initial forecast of achieving annual costs synergies of 150 million by the end of fiscal year 2004.

However, as we mentioned last quarter, we envision additional savings beyond 2004 as we continue work to complete our distribution network buildout plan.

Savings beyond 2004 will be driven by distribution center consolidations which will occur upon completion of the six new builds which will begin coming online in late 2004.

It takes approximately two years to build, equip and bring online these larger facilities.

Our plans are actively under way.

In the June quarter, we began buying land parcels to support these new facilities and have broken ground on one location.

And began two of the seven planned facility expansions.

We believe we're headed toward building the highest quality, lowest-cost distribution center network in the industry.

Finally, while we are very busy with the work of integration, the organization remained focused on our customers' needs.

Customer service and local market responsiveness will continue to be a hallmark of the AmeriSourceBergen franchise.

Now I'll turn the call over to Mike for a review of the financials.

Thanks, Kurt.

Good morning, everybody.

AmeriSourceBergen's third fiscal quarter includes strong operating results across business segments and disciplined capital usage resulting in operating margin expansion, interest expense control, and strong return on committed capital.

The outlook continues to look very good and I'll talk more about that at the end of my comments.

Before I get to the numbers, I'm very pleased to welcome two new top-notch finance professionals to the AmeriSourceBergen team.

As detailed in our press release last night, we have named Jack Quinn, Vice President, and Corporate Treasurer, and Tim Gutman Vice President and Corporate Controller.

Jack comes to us from Icon Office Solutions where he served as Treasurer and Tim joins us from Syncorp where he served as Vice President of Finance.

Both Jack and Tim bring a wealth of experience to us and we expect them to make significant contributions to ABC.

Now to the numbers.

Let me start by mentioning that my comments in year-over-year comparisons will exclude special items totaling $4.9 million for the quarter and $12.3 million for the nine months.

Net of tax, related to merger integration costs which are set out as a separate line item on our operating statements.

As you are aware, the combination is accounted for as a purchase of Bergen by AmeriSource.

Accordingly, the current year financial statements include the results of both companies and prior year financial statements include only the results of the former AmeriSource.

In our earnings release this morning, we again provided combined pro forma financial information for each quarter last year on a combined basis and for each business segment.

This pro forma information not only combines the operating results for both former companies but also eliminates the amortization of goodwill consistent with the new accounting this year.

Most of my remarks this morning will refer to the pro forma information.

My comments will include the financial highlights for the consolidated company as well as the two separate operating segments.

Pharmaceutical distribution, which includes the AmeriSource Bergen drug company and the AmeriSourceBergen special group and our other segment PharMerica.

First the consolidated results for AmeriSourceBergen.

Operating revenue for the consolidated group was 10.3 billion for the quarter up 14 percent on pro forma basis.

Operating income was up a strong 16 percent on a pro forma basis compared to last year's quarter.

Resulting in operating margin expansion of 3 basis points.

Earnings per share for the quarter increased a very strong 48 percent to 86 cents per diluted share, compared to 58 cents per share reported last year before merger costs and EPS was up 46 percent on the same basis for the nine-month period.

Turning to the pharmaceutical distribution segment, operating revenue for the segment was $10.1 billion, up 14 percent on a pro forma basis compared to last year's quarter.

The customer mix in the quarter between institutional, which includes health systems and alternate site, at 52 percent in retail which includes independents and chains at 48 percent, was was unchanged when compared to the combined businesses last year into the first two quarters of fiscal 2002.

Our institutional and retail customer groups both grew by 14 percent.

Institutional revenue grew to strong customer growth in our mail order and specialty group business, the specialty group which is included in this customer segment has grown to an annualized run rate in excess of $2 1/2 billion, while improving operating margins.

Retail revenue grew primarily due to strong performance from our regional chains and food drug combos.

In the pharmaceutical segment gross profit declined on a pro forma basis by 23 basis points compared to last year's quarter in line with our expectations.

The reduction is a result of our larger customers growing faster, the shift to lower gross profit margin businesses such as mail order, and the competitive environment.

The third quarter continues to provide us with strong buy side margins, however the impact of LIFO accounting somewhat mitigated the impact of those buy side opportunities in the third quarter.

The LIFO charts this quarter was $20 million compared to 10 pear 2 million for the separate companies combined last year and the increase is directly related to the increase in manufacturer price increases realized during the third quarter of fiscal '02 as compared to the prior year quarter.

The company's quarter LIFO provision is based on our estimate of our full year LIFO provision.

The calculation of the full year provision will occur in the fourth quarter.

We expect our full-year LIFO provision to be in the 65 to $75 million range, versus a LIFO credit of $6.7 million in the prior year.

Moving on to operating expenses, operating expenses as a percentage of revenue decreased 24 basis points compared to the combined companies last year.

In addition to customer mix, this decrease in the operating expense ratio reflects efficiencies of scale in the elimination of redundant costs resulting from the merger integration process.

As a result, operating income increased by 14 percent over the prior year quarter on a pro forma basis.

Turning to PharMerica, PharMerica continued to show improvement in all of the important financial aspects of its business.

On a pro forma basis, revenues increased 11 percent over last year's quarter to $374 million.

The gross profit margin declined to 33.1 percent from 34.8 percent primarily the result of sales gains in a lower gross margin workers' compensation business which grew at a much faster rate than the long-term care business.

However, the operating margins and the return on committed capital for the workmen's compensation division continue to be superior to the core long term care business.

The change in mix as well as the consolidation of IT operating platforms and continued improvements in billing and collection practices drove operating expenses down to 27.3 percent of revenue in the quarter.

A reduction of nearly 250 basis points from the prior year.

As a result, operating income for the quarter was up a strong 28 percent and operating margins expanded by 79 basis points to 5.82 percent.

PharMerica expects to continue to produce strong results in the fourth quarter of fiscal 2002, as well.

Moving below the EBIT line, interest expense including the pre-tax distributions on the trust preferred securities for the current quarter was $33.3 million.

As we continue to benefit from lower interest rates in disciplined use of working capital.

Average borrowings outstanding in the third fiscal quarter were $1.9 billion, compared to $2.4 billion on a pro forma basis in the prior year.

Reflecting very strong disciplined asset management.

As a result of higher anticipated borrowing levels in our fourth quarter, partially due to the financing requirements related to the AutoMed acquisition in July, interest expense including pre-tax distributions on the preferred securities is expected to be in the 35 to $37 million range for the fourth quarter of fiscal 2002.

The effective income tax rate for the quarter was 39.7 percent.

We continued to anticipate that the tax rate for AmeriSourceBergen will be between 39 and 40 percent for the fiscal year.

Now I will comment on our balance sheet and cash flows.

For the pharmaceutical distributions segment, days of sales outstanding for receivables were significantly reduced to 16.3 days in the quarter compared to 17.6 days last year.

The improvement was driven by customer mix and attention to asset management at the local level.

At PharMerica, net DSOs were down to 44 days from 52 days in the prior year quarter, a decrease of 8 days.

For long-term care, bad debt expense as a percentage of sales was less than 2 percent because of these improvements.

As expected, inventory levels of $5.2 billion decreased by approximately $120 million from March 31.

Inventory turns in the quarter were 7.3 compared to 7.1 last year.

And days payable outstanding were up slightly to 39.6 days.

Our networking capital investment as a percentage of sales was 6.7 percent in the current quarter compared to 8.1 percent on the pro forma basis last year.

A significant improvement.

Capital expenditures were $18.4 million during the quarter, and primarily related to technology investments.

In the previous quarter we had lowered our Cap Ex expectations for the year to 60 to 70 million from 90 million and we continue to be comfortable with that range for the fiscal year.

Total debt including the preferred securities to total capital at quarter end was 36 percent compared to 40 percent at September 30th, 2001.

Reflecting again the efficient use of working capital.

Net debt to capital was 31 percent versus 36 percent in September 30th.

Cash used in operations for the quarter was $104 million compared to usage in 235 million on a combined pro forma basis in the prior year quarter.

For the nine months ended June 30th, 2002, cash provided by operations was $127 million.

We continue to expect to produce positive cash flow from operations in excess of $100 million for fiscal year 2002.

In fiscal 2003, we continue to anticipate cash flow from operations to exceed $$200 million and we'll refine that number when we complete our '03 plan.

Return on committed capital or ROC which is one of our primary financial measures and which we define as operating income excluding amortization divided by fixed assets plus inventory and receivables less payables on a rolling 12-month basis was 24.6 percent for the quarter.

Well above our long term goal of 20 percent.

This continues to reflect a disciplined use of capital and good asset management.

Before we get into guidance for the fourth quarter we would like to emphasize that we are in the middle of our detailed bottoms up planning process for fiscal '03 the first such process as a combined company.

As a result, we will not provide detailed guidance for fiscal '03 at this time other than other than to confirm that we expect to grow revenues in line with market growth which IMS expects to be in the 13 to 14 percent range for fiscal '03 and expect to continue to grow EPS at 20 percent or greater with a ROCC in excess of 20 percent.

More detailed guidance for fiscal '03 will be provided when we report our September quarter.

For the fourth quarter of fiscal '02, we expect top line growth to be comparable to the June quarter.

We expect inventory appreciation profit dollars to be sequentially less than the very high levels in the March and June quarters while remaining very strong.

We also expect interest expense to be higher in the September quarter than in the June quarter as we previously discussed.

We would also expect diluted outstanding shares to increase to 114 million in the September quarter.

As a result, we expect diluted EPS before merger costs to be between 83 and 85 cents for the fourth quarter which would result in diluted EPS for the year of between $3.24 and $3.26, an increase of over 40 percent from the prior year.

Excellent performance by any measure.

I will now turn it back to Dave for a few additional comments.

Before we go to Q & A, I just want to add a comment and that is at the risk of piling on, I want to reiterate our comfort with the range of our EPS guidance for the September quarter of 83 to 85 cents and our discomfort with any numbers higher than the top end of the range for the reasons expressed by Mike.

With this quarter's results, we have raised our FY '02 EPS guidance 3 times with the good-faith effort to provide accurate guidance to our investors.

We want to be sure that the short-term history that AmeriSourceBergen has established in the last three quarters by beating consensus estimate does not establish an expectation of like performance in upcoming quarters.

With that, I'll turn it over to Mike.

Thank you, Dave.

We will now open the call to questions.

I would ask you to limit yourself to one question only until you have had an opportunity and then if there is time, you can ask additional questions.

Go ahead, Amber.

Thank you.

Ladies and gentlemen, if you wish to ask a question, please depress the 1 on your touch-tone phone.

You will hear a tone indicating that you have been placed in queue.

You may remove yourself from queue at any time by depressing the pound key.

If you are using a speaker phone, please pick up your handset before pressing the numbers.

And our first question comes from the line of David Risinger with Merrill Lynch.

Please go ahead.

Thanks very much.

Congratulations on the very strong financial performance.

Thanks, David.

Couple of questions.

Well, first of all, with respect to the recent initiatives and I guess I'll limit it to one here, could you just talk about the most recent inflections in costs?

You've obviously done some sales force rationalization, if you could talk about that, and when we will see that in the full quarter's numbers.

And also, the employee benefits plan and when the full benefit of that will be reflected in the numbers, just so that we understand the inflections that have been occurring recently with respect to your cost structure.

Yeah.

David, it's Kurt.

I would -- I think I would approach it this way.

The sales force rationalization was not about head count reductions or efficiencies.

It was about getting the very best talent we had at AmeriSourceBergen properly redeployed against the opportunities in the marketplace.

So while there was some head count reduction, that was not really the intent of that particular exercise.

So I would not count on there being an awful lot of cost savings that you could kind of metric into your model going forward as a result of that.

And I would probably give you the same guidance on the benefit program rollout, as well.

There are some cost savings there but we use some of those cost savings to actually increase the total offerings that we could make available to our associate base by using the combined purchasing power of the total associate pool at ABC.

So there were important steps for us in terms of the integration, but they weren't meaningful steps in terms of cost reduction going forward.

Thanks very much.

Thank you.

Thank you.

And now from the line of Ray Falci with Bear Stearns.

Please go ahead.

Thanks.

Dave or maybe Kurt you commented on some nice synergies.

It sounded like more top-line synergies between the specialty business and the novation relationship, which obviously the former AmeriSource was pretty strong there.

I was wondering if you could give us color on what you're really looking at there and what the opportunities are there for maybe synergies in both directions to get more novation core business or specialty business with existing novation clients.

I think this has been a terrific opportunity for ASD, which is the blood plasma distribution business of the former Bergen company.

You know, Steve Collis and Neil Herson and the team have done a terrific job taking advantage of the institutional relationships that we had on the former AmeriSource side.

I cited two of them.

There are two or three other examples like that where they have recently signed contracts with some hospital GPOs.

The AmeriNet one I cited specifically because that's an exclusive.

The others are licensed to hunt.

But I think their service capability will allow them to pick up some of the business there, as well.

They have had a terrific success with Novation.

We're estimating that we're starting from almost zero at the outset of the merger.

We think we're close to a third of the market share within Novation for the blood plasma business at this point.

Great, thank you.

Thank you.

Thank you.

Now from the line of Chris McFadden, Goldman Sachs, please go ahead.

Thank you.

Good morning, everyone.

Hi, Chris.

A couple of questions if I could.

Firstly, can you talk about the generics program that you have just rolled out?

You highlighted it as one of the contributing factors to performance in the quarter.

Have we seen the full impact of that in the June quarter?

I seem to recall it launched in the April time frame.

Should we expect more impact in the fiscal fourth quarter?

And I guess, how would you expect that to impact the numbers looking out to fiscal '03?

And then, a follow-up, if I might.

Could you talk about your new acquisitions specifically on the Opti-Fill automated line.

Where do you see marketing synergies between that product offering and your core drug distribution services?

Thanks.

Chris, it's Dave.

I'll jump in just so you know I'm still here.

I would say that in terms of the generic program, you have not seen the full impact on that.

Number one, it's continuing to gain traction.

At our trade show or our healthcare conference that we had in Las Vegas with literally thousands of customers there, we got a really good response on that.

So we will continue to make strides in our generic offering so we're very, very excited about that.

Full impact is not hit.

In terms of the automated, I would say there's lots of synergies.

Number one, I think in the case of Automed being tied now or being owned by someone who is very financially sound has definitely helped them in the marketplace in that there was some question going forward on their long-term, you know, viability or who would own them.

So now when customers step forward, there's absolutely no question that they will be a player in the long term.

And we have been able to already begin to bring our customers to Automed that for one reason or another they did not have access to before.

I will tell you that at our conference, they were literally five to six deep on occasion trying to get in to see the AutoMed technology and we literally booked orders for equipment at the show.

So we are very, very excited about the AutoMed acquisition.

I was just out at their facility last week and their sales team and their employee base is very, very excited about this relationship.

Thank you.

Thank you, Chris.

Now we have a question from the line of Robert Willoughby with CSFB.

This is Sean Harrington in for Robert Willoughby.

What in your opinion drove the up side in the current quarter relative to your previous guidance?

What took you by surprise?

Well, I think there were -- this is Mike, Sean.

I think there were a couple of things.

I think we had good performance at the operating line, particularly in PharMerica, which had very strong performance for us and we had very good balanced growth on the drug distribution side.

In addition, our interest expense performance was excellent below the guidance.

I think we had given of 75 to 80 for the last six months.

We came in at 33.3, which was really driven by our improvements in our working performance.

Our average borrowings were driven down substantially as I talked about earlier.

And that working capital management really freed up cash, really was the driver behind that reduction in interest expense in the quarter.

I think about half of the increase over consensus was probably due to that interest effect and the other half by the strong performance of the distribution company and PharMerica and the synergies that we realized in the distribution company.

That's very helpful.

Thanks.

Thank you, John.

Now from the line of Eric Caldwell.

With Prudential Securities.

Please go ahead.

In light of the target performance of PharMerica as well as the recent competitive bidding situation among a couple of your peers, could you give us an updated thought process on PharMerica as both internally in terms of commitment from ABC and, you know, sort of the long-term perspective for that division as part of the company?

I'm happy to comment.

This is Kurt, Eric.

We're obviously very pleased with what Chuck Carpenter and the team have been able to produce down PharMerica.

I think it's worthwhile for this audience to know that the gains we're seeing in PharMerica, you know, were put in place, you know, well before the beginning of this fiscal year.

And Chuck and the team have been working on that but I think they have been clearly, they have been coming through at a faster rate than I think what they had planned on, as well.

So we're very pleased with that.

You know, we've said from the beginning of the merger that we were really not going to, you know, consider any strategic decision around PharMerica for at least a year.

We are going to operate the business, get to know the group a little bit, get to know what the prospects were.

Clearly, those things have brightened.

We're very pleased.

We think we're creating shareholder value with PharMerica today.

So we don't have any decision or any thought process around a disposal of that business, if that's what you're getting at.

It is a scale business.

The merger that was announced in the industry will probably get that done will benefit those two entities to come together and perhaps benefit the industry in general.

Dave, I don't know if you have anything you wanted to add to that.

No, I would just -- so there is no doubt, Eric, you know, we are very, very happy with the performance of PharMerica.

They are doing all the fundamentals well.

They are driving their operating costs down.

They are doing a great job with the receivables.

They have benefited from our new generics program.

You know, they are doing the basics very, very well and we like what we see there.

Yeah, that's very helpful.

That's a good quarter there.

You bet, thank you.

Thank you.

And now from the line of Larry Marsh with Lehman Brothers.

Please go ahead.

Okay.

Good morning.

Everyone.

Well, you probably can predict my question.

Which is around the LIFO charge.

It looks like another boost to the LIFO reserve in the quarter, so best I can tell it's like you're 60 million through nine months.

It seems like you're taking up your LIFO charge guidance a little bit from what you said on the last call.

The question is, is that right?

And does that mean we should expect another 5 to $15 million LIFO charge in the fourth quarter?

And is there any sort of comment as to why you might be seeing such a significant increase in LIFO charge compared to your competitors?

Larry, this is Mike.

I'll take that.

First off, again, we did have a significant charge in the quarter of 20 million, as you mentioned.

And that charge is directly related to the strong results we had on the LIFO side from manufacturer price increases as we had in the second quarter.

I think our, you know, one reason I think our LIFO has been higher this year than what we expected initially and what you have expected is that the FIFO profits from increases have been higher.

The manufacturer price increases have been in the five to six percent range well above where we expected them to be at the beginning of the year and as you know, ABC has invested more heavily in spec inventory this year than either the combined companies did in the past because we have the financial resources to do such.

So I think all of that has impacted our LIFO charge, our expectation for inflation for the year.

Obviously, we're going to true that calculation up in the September quarter.

Our approach has been to be, you know, somewhat conservative during the year to avoid any sort of negative surprise in the fourth quarter from doing that calculation.

You are right that we would expect that a charge somewhat less than a charges we have had in the second and third quarter in the fourth quarter actually a lot less than we experienced in those quarters.

Why are we so different than McKesson and Cardinal?

I really can't comment on that because I don't know how they do their LIFO calculation.

I say we may be a little bit different, one, because we've changed our investment buying habits this year in that we have invested more than we did in the past.

And we've done that at a time when price increases were very high.

So our -- I think our mix is probably a little bit different than our mix has been in the past.

We may have a different mix of products in our inventory when we're taking our calculations.

Again, I don't know their mix.

And again, I think our approach all along has been to avoid any surprise.

You know, we did have a situation last year where AmeriSource, which was the acquiring company, had $2 billion in inventory acquiring $3 billion of new inventory at the end of last year, which comes in without any prior LIFO reserve on it due to purchase accounting.

So it's a big jump in our inventory.

And a whole different mix for us.

And we think we have been, you know, dealing with it in the most prudent way.

Appreciate all the detail.

And then along with that, the reductions -- sequential reduction your payables at the end of the quarter was that strictly timing or was there a sort of opportunities from, you know, suppliers that allowed you to trade terms with lower payables?

I think any change in payables between periods was timing.

I think I mentioned that our average days outstanding actually went up a little bit.

But that's not due to any fundamental change in how we are doing business with our suppliers.

Great.

Okay, thanks.

Thank you, Larry.

Next question, please.

Thank you.

And now from the line of Kevin Berg with First Albany.

Please go ahead.

Yeah.

In terms of the gross margin pressure, you mentioned some of your large customers growing faster than other customers and a competitive pricing environment.

Can you give a little more color on that environment?

Has it become more competitive or is this the same level of competition we have seen since there's three large entities out there?

You know, I'll take that.

I have been in the industry probably three decades or so and that's always been a competitive industry.

I would say that, you know, the problem with dealing with it is it just ends up being somewhat anecdotal on the last account you called on.

But I would make this observation.

You know, Kevin, about the industry.

I think it's very -- it's a very stable industry.

When you look at how big this industry is, probably $190 billion or so, and the relative few number of accounts that change hands on a yearly basis, I think it really speaks to the stability.

What we're seeing more and more is that customers negotiate when their contracts are up as opposed to putting it out for bid.

If we were visiting this morning, I think since the first of this calendar year, the three of us couldn't remember a single announcement that's been made in the industry of more than $250 million on an annual basis so when you but the that in the context of how big the three of us are in terms of our revenues and how big the industry is, I think it speaks to the fact that it's a very stable market.

So I would say, you know, not much change there, Kevin, you know, continues to be a competitive landscape.

But no change.

Okay.

Thank you.

Thanks, Kevin.

Next question, please?

Yes, sir.

And now from the line of Mr. Andy Speller at AG Edwards.

Please go ahead.

I just wanted to follow up on the gross margin questions about pharmaceutical distribution business.

I think your comment in your prepared remarks talked about fourth quarter inventory, I guess it was the investment buying side subsiding into the September quarter.

I'm also wondering, shouldn't we have cycled also the customer mix issue in terms of the mail order, large mail order customer that came on and just going forward, should we still see the same rates of decline in terms of gross margin as we move into next year?

Well, first of all, let me talk a little bit about the mix, Andy, because we have anniversaried the advanced PCS which we made very public but when you look at our total, you know, customer base and you look at our mail order and some of our other very large customers, we find that they are growing faster than the market as a whole and faster than the rest of our business.

So you continue to have some impact from those -- from those large customers going forward.

But that impact shouldn't be as great as what we had seen when those customers were coming online.

I mean, even if they are growing faster and they're not growing, you know, 50, 70 percent faster than the overall market.

That's right.

The comment, Andy, regarding the fourth quarter which I think referring to the inventory was the price increases which we expect to be lower in our fourth quarter, September quarter, than has been in the first part the year.

And just to give a little bit more color to that, Andy, as you know, January and February were just extraordinary months.

A lot of that product has been sold through in our second fiscal quarter and our third fiscal quarter, we have continued to have good price increases, but certainly not to the levels that we had in Q2 and Q3.

So we expect again a strong environment price increases still in the 5 percent or greater range, just slightly less than the very high levels in the second and third quarter.

Okay.

So I mean, I guess so that comment in terms of the pricing, the gross margin decline should be more than what we saw this quarter?

Is that kind of what you are getting at?

No, I think we'll be in line with our expectations.

We said 20 to 30 basis points gross profit decline for the year, with that being higher in the first half than the second half.

I think we'll continue to be in that range.

We'll have a little bit of impact again from the price increases.

Some of that will be mitigated by LIFO because if the price increases do go down significantly, our LIFO will also go down in the fourth quarter so there is some balance to that.

Okay.

Thank you.

Thank you, Andy.

Thank you.

And now from the line of John Ransom at Raymond James.

Please go ahead.

Good morning.

Given that inflation has been higher than we all thought, does that imply, then, given the overall slowdown that prescription unit volume has declined maybe from 10 percent at the peak to something like 5 to 6 percent?

And secondly, I just wondered if you might give us your take on where you think generics are impacting the market from an overall top line growth perspective.

Let me take an issue or take a crack at the whole prescription issue, John.

I think one of the things you have to be a little careful about when you are tracking prescriptions is tracking absolute number of prescriptions and not pharmaceutical dollars dispensed.

One of the issues is that as prescriptions move to mail order they may go from a 30-day prescription or in the worst-case scenario you could have a trial prescription that goes from a 10-day supply of product to a 90-day supply of product that in that circumstance the number of prescriptions would not have increased at all and would just be one versus one.

But the dollars dispensed would be up dramatically.

So you know, as a result of that, we try to keep a handle on the dollars flowing through the system not necessarily prescriptions being dispensed.

In terms of the generic impact, we are in the process of building some pretty detailed models on that as we go forward.

But we're looking in the range of, you know, 1.5%, perhaps 2 percent impact, you know, going forward.

Some of that is impacted by the timing of, one, some key products, you know, come off patent.

But I don't think there's any question that it's having a mitigation effect on the top line.

And David, just a follow-up on that, I mean, looking at the dramatic break in the price point, for example with Prozak, I mean, does the assumption still hold that generic drugs are higher dollar gross profit for folks in the channel like yourself and drugstores?

It seems hard to see that just given the dramatic price point.

Are we entering kind of a new era where maybe that doesn't hold like it used to??

I would say John that we want to be very careful about talking about an individual product and how that works.

But what -- you know, one of the points I was trying to make in my opening comments was that when we look at that portfolio, we have done some very detailed analysis on the portfolio of -- generics, portfolio of brand names.

And when we look at that portfolio of generics, we're very comfortable with the fact that we are making more gross profit percentage, more gross profit dollars, more return on committed capital.

And in addition, so it's very, very good for us financially.

In addition to that, you know, it provides us two other opportunities and that -- one of them is to provide our customer a great value in the marketplace and a value that they cannot get because they don't have the same scale that we have.

And it will also allow to us differentiate our offer because the generic offering that we have is not exactly the same as that offered by our peers.

So you know, overall, we consider generics to be a great opportunity for us going forward and is a key focus for our sales and marketing team.

Thank you very much.

You bet.

Thank you.

And now from the line of Paul Lee, a question from Bethlehem Pension.

Please go ahead.

I have a question about the founding costs.

There is a tremendous need for, you know, for the debt funding and the bank debt funding.

And currently your debt rating is in the Single B range.

Are you talking to the rating agency for a possible upgrade so that in the future, if you can move up to Triple B, I mean, I would imagine your funding costs will be greatly reduced and that should have pretty significant impact on the bottom lines?

Are you talking to the debt agencies, or are you also thinking of taking advantage of the current low interest rate environment to maybe issue some more debt and lock into the low rates?

Yeah, Paul, this is Mike.

I mean, we have ongoing discussions with the rating agencies.

I think our senior notes that are out there today that we placed at the end of August were are rated in a double B Minus range.

We are certainly, you know, hoping for an upgrade over time.

I think from the rating agency's perspective, what they would like to see is a couple of more quarters of strong performance like I think we just showed in the third quarter today.

We're still very new as a combined company and when you look at our balance sheet today at the end of June, we're pretty much where we were at the end of March where we had a billion-dollar revolver that was unused.

We've got two receivable securitization facilities that were unused at the end of June and we just have very, very good liquidity.

Our incremental borrowing rates on those variable facilities are -- on the receivable securitization are in the low 2 percent range.

So, you know, I think we have got some very good financing right now available to us and obviously, we'll continue to study that situation as we go forward.

Okay.

We'll take two more questions.

Can I ask a follow-up question, please?

Okay.

Yes.

With regard to your shares outstanding, in the past two quarters, we have seen pretty big, you know, increase in the shares outstanding.

Are you forecasting -- I mean, in the next year, year 2003, are you seeing the same magnitude or same level of increase in terms of shares outstanding?

Our shares have really gone up for two reasons this year.

You know, one is we have had a number of employees exercise stock options during the year due to the price rise that's occurred during the year.

And secondly, that price rise has affected our calculation of the diluted shares outstanding using the treasury share method.

The higher the stock price, the more dilution attributed to the outstanding unexercised options.

So they are the two factors that have driven the shares upward this year it's hard to say what that behavior would be going forward as we get into a more normalized pattern following the merger.

But I would expect to add about a million shares outstanding a year.

I'm trying -- what I'm trying to get at is there any -- due to the merger, is there any one-time sort of shares grant or option grant due to the, you know, the new -- your new incented program and after the merger.

Well, I tell what you.

In the interests of time, if we could take it off line, we would appreciate it just because we have some other people in the queue.

We'll be happy to talk to you about that we'll give you --

I'll give you a call.

Okay, thanks.

All right.

Could we have the next question?

Because we're running at 12 so we'll take a couple more questions here

Thank you, sir.

And a question from the line of Lisa Gill at J.P. Morgan.

Thank you very much.

Making it under the wire here.

Kurt, I was wondering if you could talk about the specialty distribution business and you said it's at about a run rate of 2.5 billion today.

What do you view as the overall size of the market there and what do you view as the future opportunities as far as disease states go?

Gosh, Lisa, that's probably more than I can answer in this moment because we're really dealing with the market definition, question in a market that's really defining itself as we go.

You know, the way we think about the specialty distribution business today is that there is an enormous opportunity because of the pipeline that kind of supports ultimately the growth potential of that business.

A lot of the new products that are coming down the pipeline as you know, require special handling and special administration and that's what we are gearing ourselves up for.

So I'm just not in a position today to kind of give you where we are relative to a market definition.

The business is growing very, very nicely.

And we're just -- we couldn't be more pleased with it and as we said, it will continue to be a larger and larger part of abc in the years to come.

Can you give us an idea of how fast it's growing?

Is it growing in line with the pharmaceutical distribution component, or is it twice as fast?

It's -- it's -- it's growing much more rapidly than the pharmaceutical distribution business.

And, you know, two times would be -- would probably be a working number to go with.

Okay, great.

Thanks.

Thank you, Lisa.

And the last question is from?

Thank you, sir.

The last question comes from Glen Santangelo with Salomon Smith Barney.

Go ahead, please.

Yes.

Thanks.

Glen, we got your name right!

Got your name right that time that was great.

You're getting better, Dave.

My question is regarding PharMerica.

Obviously you had some strong results but I just wanted to get your comments.

There's obviously the House Bill which I think is going to be published in the Federal Register today which is going to talk about or make some changes in nursing home reimbursement.

We are starting the 60 day comment period today and I think the new rates will become effective with the government's new fiscal year in October 1st and they are calling for a reduction in Medicare reimbursement and so I don't know if you guys have done any sort of analysis on what you think the sensitivity might be for PharMerica if there is a change in the [rug rates for sniffs]?

One of the things I will tell you Glen is that we're actively involved in that process.

There is a coalition of key and nursing home providers.

Chuck Carpenter is very actively, you know, participating in that.

They are meeting in Washington, you know, on a number of occasions.

They have got some professional, you know, lobbyists helping them work through it.

So we're very optimistic that the rates will not change detrimentally and we have as good a, you know, feeling about the process right now as we ever have.

But, you know, I just want to you know that we're very much involved with that process.

Chuck Carpenter has taken a leadership role not only within our company but within the industry to stay on top of that.

Okay.

Thank you.

Well, thanks for your comments and congrats on the quarter.

Thank you very much.

That concludes our Q & A period.

For those of you interested in hearing more about AmeriSourceBergen and our story, we'll be presenting at the Bear Stearns Healthcare Conference on September 18th in New York.

And in addition, we'll continue to be on the road meeting with investors over the next few months.

And now, Dave Yost would like to make a few final comments.

I guess we would just like to close by reiterating our enthusiasm and optimism for our industry and the leadership position we have in that industry.

We have been approaching -- we are approaching the first year anniversary of the merger that created AmeriSourceBergen and we are ahead of schedule in capturing the operating synergies and the working capital efficiencies that we identified early on as we began.

We have an extremely seasoned and motivated associate base, a diverse customer base, an outstanding suppliers in an industry with very attractive organic growth rates and we are very, very excited about our future.

We look forward to seeing you for our Q4 results.

Thank you very much.

Thank you.

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