美源伯根 (ABC) 2003 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the AmeriSourceBergen conference call.

At this time all participants are in listen only mode, later we will conduct a question and answer period.

Instructions will be given at that time.

If you should require assistance during today's conference call, please press zero followed by star.

As a reminder, today's conference call is being recorded.

I would now like to turn the conference over to your host, Mr. Michael Kilpatric (ph).

Please go ahead.

Michael Kilpatric Good morning, everybody and welcome to AmeriSourceBergen conference call covering fiscal 2003 results.

I'm Michael Kilpatric, Vice President of Corporate Investor Relations and joining me are David Yost AmeriSourceBergen's CEO, Kurt Hilzinger, President and Chief Operating Officer and Michael DiCandilo, Chief Financial Officer.

During the conference call today we'll make some forward-looking statements about our business prospects and financial expectation.

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

For discussion of some key risk factors, we refer to you to our SEC filings including our 10K report for fiscal 2002.

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

As in past quarters, on the AmeriSourceBergen web site under investor relations, you will find a short slide presentation covering some of the points we will discuss today.

And you're welcome to follow along.

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

And here is David Yost, AmeriSourceBergen's Chief Executive Officer, to begin our remarks.

Good morning.

And thank you for joining us.

As noted in our press release this morning, we reported another very strong quarter.

Our total operating revenues for the March quarter were up solidly and as was the case last quarter exceed $11 billion.

Operating income was up a strong 23 percent and EPS of $1.05 was up 21 percent both excluding special charges.

It is important to note that this strong performance is compared to a March quarter of 2002 that had EPS increase a whopping 53 percent quarter over quarter and follows the first full year of AmeriSourceBergen operating as the new combined company where EPS increased over 40 percent for the full fiscal year ended in September.

We continue to deliver solid performance on top of solid performance.

Both pharmaceutical distribution and PharMerica, our two report segments had strong quarters.

Operating revenues in the pharmaceutical distribution segment which includes our fast growing specialty distribution business were over $11 billion for the quarter up 13 percent which equates to an additional $1.3 billion of business we shipped this quarter versus last year.

Operating expenses were impact by the acquisitions we have made recently, but even with this, total operating expenses continued their downward trend year over year at the same time gross margins increased resulting in an expand operating margin of 17 basis points to just under 2 percent and operating profit increase of 23 percent for pharmaceutical distribution.

Operating revenues at PharMerica were almost $400 million, up ten percent from the previous year, operating expense decrease more than offset anticipated declines in gross margin also resulting in operating margin expansion at PharMerica to 6.1 percent, an historic high, and 23 percent increase in operating income.

For the total company, continued discipline in the use of working capital drove a robust return on capital at 23 percent at key company metric.

Good revenues, expanded operating margin, strong operating income and solid rock, lots to like about the quarter.

Before we discuss the specifics of the quarter, I'd like to comment on the industry from 50,000 feet.

First and most important, we do not see any fundamental changes to the robust industry in which we operate.

There seems to be some confusion regarding wholesaler revenues and prescription data, so I would like to address this.

The much publicized prescription data reflects the prescription trends at retail with some notable retailers excluded and records prescriptions, not dollars.

A starter prescription of 7 pills counts the same as a 90 day refill, though of course the dollars could be dramatically different.

Brand name and generic prescription are not differentiated.

Wholesaler revenues include institutional sales and institutional prescriptions are not included in the script data nor certain dispensing pharmacy benefit manage PBMs nor are some specialty prescriptions.

Wholesalers revenue could be impact by channel expansion.

For example, when warehouse business or dock to dock revenue is converted to whole sale or operating revenue.

Value added services wholesalers provide to customers totally independent of script data as are certain classes of merchandise.

Even within the retail channels the results of individual retail customers can have a big impact on individual wholesale results.

So the dead net is there is not a good correlation between absolute prescription data increases and wholesale revenue increases.

One statistic reflects orders at retail and one reflects dollars of a larger and different industry.

The whole sale drug industry continues to be robust, growing at double digits by almost everyone's estimate and continues to be very stable.

On our last quarterly call I went to great lengths to highlight that relative stability and avoid repeating myself simply again note there's not a lot of movement among accounts in this $200 billion industry.

The pricing environment for pharmaceuticals remains fundamentally unchanged and strong and as been noted previously, generics, are relatively small part of our business, less than 10 percent, do represent opportunities.

We expect industry price appreciation to continue to be strong for the year though individual quarterly activity difficult to predict.

We continue, of course, to strong balance sheet strength to seize upon any opportunities to make sense when we turn on committed capital on rock basis and in fact did so late in the quarter which resulted in month end snapshot inventory levels being higher than some analysts may have anticipated.

Inventory management agreements or IMAs continue to become somewhat standard operating procedures for the large brand name manufacturers in the industry, though it is important to note that all IMAs are different.

IMAs are probably best described as new opportunities for whole sailors to work closely with their suppliers and offer wholesalers new ways to make profit and efficiently manage capital.

IMAs are generally a year or two in length.

So there's opportunity for fine tuning as both parties work through them.

When properly constructed and implemented IMAs should assist in make the industry more efficient.

We have noted on the a number of occasions that since AmeriSourceBergen has traditionally operated with less inventory than our peers IMAs offer the best opportunity for AmeriSourceBergen.

Continuing in dealing with industry topic, I would point to an additional two.

Medicare prescription drug coverage and patient safety.

We continue to be convinced that Medicare prescription coverage will emerge as the leading topic in Washington as soon as war issues are less prominent and that increased pharmaceutical dispensing will be extremely positive for the industry at AmeriSourceBergen.

As we're upgrading our distribution network with new and remodeled distribution centers we're building capacity to handle the increased volume which in most cases will be incremental.

Patient safety is emerging as one of the key issues for hospital CEOs and administrators.

In part due to the recent bar coding initiatives of various government agencies and potential for human errors as all parties in the health care system are called upon to do more with less.

Pharmaceutical wholesalers have a great opportunity to capitalize on this market need and AmeriSourceBergen has a commanding position in this space.

Our bridge medical bed side scanning system in conjunction with our automation alternatives and our American health programs offer a compelling closed loop solution.

During the last quarter, I made several calls to health systems CEOs as the AmeriSourceBergen integrated solutions were presented and was very pleased with our reception.

You may call that were we merged the former AmeriSourceBergen and former Bergen Brunswick (ph) together, we predicted that we would use our new role to enhance our role in the pharmaceutical supply channel and our patient safety and automation solutions are great examples of that commitment.

The future of AmeriSourceBergen continues to be excellent.

We are now about 20 months into the integration of the former companies.

We are on schedule and on budget to capture the 150 million dollars worth of operating synergies that we originally forecast would be captured by the end of year three or September 2004 and some of that synergy capture has been recognized in our operating performance in the last six quarters.

Our synergy capture opportunities continue well past September 2004 as our new and remodeled distribution facilities become operational.

Kurt Hilzinger, our President and Chief Operating Officer will detail that progress as well as other operating highlights and Michael DiCandilo our Chief Financial Officer will detail the numbers for the quarter.

Kurt?.

Thanks, Dave.

Good morning, everybody.

In our market leading pharmaceutical distribution business which includes the drug company and specialty group, we again posted strong results driving solid top line and solid income operating performance.

Cost savings from our integration efforts were again evident with continuing leverage over operating expense driving operating expansion for the sixth consecutive quarter since the merger.

Our gross margin continued to accelerate from generic pharmaceuticals to higher gross profit contributions and the positive impact of our recent higher margin acquisition.

The (inaudible) side component of our gross margin met our internal expectation in the quarter as product inflation remains strong.

As always, we remain focused on capital management again driving return on committed capital up sequentially and well above year ago levels which Mike will detail.

Now let me turn to our integration activities.

As we indicated at the beginning of the year, with the integration of our key functional support areas complete, our integration efforts in 2003 would almost entirely be devoted to executing the work plan of our state future distribution network.

In the fall we closed the merger integration office and transitioned into a office in order to better execute the network plans.

We refer to our total distribution network plan as the optimized program which includes a $350 million multi year capital spend.

To the application of state-of-the-art information and automation technologies, many new to the U.S. pharmaceutical distribution industry the optimized program is designed with the specific intent of creating the highest quality, lowest cost distribution capability in the industry.

As a reminder, we expect to fund the entire capital program through increased working capital efficiency by eliminating redundant inventory investments.

During the quarter, we made some organizational changes in order to streamline coordination between the operations management office and field operations.

Terry Haas who spearheaded our integration effort and is now in charge of the Operations Management Office took on responsibility for the drug companies regional vice presidents with them day to day responsibility for drug company field operation.

Terry will continue to report directly to me.

We also aligned our regional structure from seven regions to six region reflecting the progress of our distribution center consolidation activities.

In the March quarter, our integration plans continued on schedule and on budget with synergy capture again ahead of our expectations.

During the quarter, we completed two distribution center consolidations, Joplin, Missouri and Lynchburg, Virginia.

The consolidations occurred on schedule, below budget and with no customer disruption.

Year-to-date, we have now completed three consolidations and a total of ten since the merger.

Three additional consolidations are planned for the remainder of the fiscal year.

One consolidation is scheduled for the June quarter and two consolidations are scheduled for the September quarter.

At the end of this fiscal year, we'll be operating 38 distribution centers, approximately half of those will be operating with annual revenues of $1 billion or greater, offering significant operating leverage in fiscal year 2004 and beyond.

Construction of our six Greenfield DCs remains on track with construction occurring at two locations and land purchases and plans being finalized for the remaining four.

Our facility remodeling plans remain on track as well with one expansion completed in the December quarter and another due for completion in the fourth quarter with plans actively under way for another two.

Our new warehouse management system installations are also proceeding well with a medium volume facility scheduled to go live next week and one of our largest facilities scheduled to go live mid-summer.

Our recent acquisitions are also progressing very well.

Automated technologies, pharmacy automation business we purchased last summer, recently referred an initial starting order of 50 automated dispensing units from a large retail chain as part of a much larger total installation plan.

A large number of other chains and food drug combination chains have begun technical reviews and test sites (inaudible) automated enjoys the backing of ABC.

Significant momentum is building in the hospital market place for automatic equipment in combination with bridge medical to address patient safety concerns.

As many of you know the FDA recently announced regulation of bar code labels on all pharmaceuticals sold in the U.S., which in our view, significantly enhance both auto meds and bridge medicals both near and growth term prospects.

Integration activities for U.S. bio-services and especially grew(inaudible) are proceeding smoothly.

Now let me turn to the specialty group.

During the quarter, Steve Kallis (ph) and his team continued to deliver excellent results.

Each of the business which make up the specialty group exceeded our internal expectations for the quarter on nearly every key measure.

The unit's overall focus remand on the distribution of pharmaceuticals two physicians around specific diseased state by providing an increasing array of services to pharmaceutical manufacturers.

As we indicated at the outset of the year, in fiscal year 2003, particular emphasis would be placed on leveraging the unique capabilities of these individual businesses into creating an integrated service model to assist biopharmaceutical manufacturers to bring new products to market.

An example of this service model was announced during the quarter in partnership with Biojen (ph) for the launch of MAV (ph), an injectable product for psoriasis.

AmeriSourceBergen specialty group designed and implemented a comprehensive drug launch service offering including directed physician distribution, reimbursement consulting and physician education services as well as information technology resources to support sales activities.

The specialty group is made up of a very attractive group of high growth high return on committee capital businesses growing substantially faster than our core pharmaceutical distribution business as we have continued to emphasize specialty group businesses taken as a whole provide a significant future revenue and earnings growth platform for AmeriSourceBergen.

Now let me turn to PharMerica.

The strong trend lines we saw last year in the first quarter continued in the second quarter with gains and revenue in operating income of up to 10 and 23 percent respectively.

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

During fiscal 2002 PharMerica added sales and marketing resources to accelerate revenue growth which have clearly benefited 2003 results.

Focus on asset management particularly in the area of credit and collections lowered our capital invested in the business again and dramatically improved PharMerica's return committee capitals over a year ago.

PharMerica continued to leverage its recently implemented common IT platform in the long-term care division driving further operating expense efficiencies to the consistent application of best practices at the pharmacy level and continued to place additional emphasis on leveraging the clinical expertise to resident in PharMerica, greater therapeutic interchange recommendations, increasing value proposition to customers and manufacturers alike.

During last quarters conference call we announced Chuck Carpenter's decision to retire as President of PharMerica and that we would work through the transition to a new senior management during the second quarter.

In early March we announced internally the promotion of Bill Shields (ph) to the President of the long-term care pharmacy division.

Bill had been servicing as Senior Vice President of Sales and Marketing of the Long Term Care Division.

We also announced the promotion of Dave Widener (ph) as President of the Workers Compensation Division .

Dave had been servicing as PharMerica's CFO.

Bill Shields who is a registered pharmacist has spent nearly his entire career in the long-term care pharmacy business and Dave Widener's prior experiences makes him uniquely qualified to manage the intensive process oriented nature of the worker's compensation business.

Both Bill and Dave report directly to me.

In addition, Janice Rethorski (ph) will take on new responsibilities of the Clinical Long-Term Care Division and seek out ways to leverage that expertise across the whole of AmeriSourceBergen.

We're very pleased with these changes and remain excited about the prospects of these businesses going forward.

Lastly, as Dave mentioned, we remain confident in our initial forecast of achieving annual synergies of $150 million by the end of fiscal year 2004 and additional incremental savings beyond 2004 as we complete our distribution network buildout plan.

Now I would like to turn the call over to Mike for review of the financials.

Thanks, Kurt.

Good morning, everyone.

AmeriSourceBergen's second fiscal quarter results include strong operating performance across business segments and disciplined capital usage resulting in significant operating margin expansion, interest expense control, strong return on committed capital and EPS growth at greater than 20 percent.

Allow me to begin by mentioning that my comments and year over year comparisons will exclude special items representing a net charge to the P&L of 2.4 million dollars for the current year quarter related to facilities consolidation and employee severance costs which are set out as a separate line in our operating statements.

Special charges in the prior year consisted of merger costs of $2.9 million net of tax.

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

First the consolidated results for AmeriSourceBergen.

Operating revenue for the consolidated -- group was $11.2 billion for the quarter, up 13 percent over the prior year with both operating segments achieving double digit growth once again.

Operating income was up a strong 23 percent in total and in both segments compared to last year's quarter resulting in consolidated operating margin expansion of 18 basis points.

Earnings per share for the quarter increased 21 percent to $1.05 per diluted share before special items compared to 87 cents per share report last year on the same basis.

The earnings growth for the quarter was positively impacted by ongoing merger synergies and continued low interest expense and was adversely impact by the 5.5 million dollar writedown of a technology investment during the quarter which is reflected in the equity and loss of unconsolidated affiliate and income line in the income statement.

Moving through the pharmaceutical distribution segment.

Operating revenue for the segment was $11.0 billion, up 13 percent compared to last year's quarter.

The customer mix in the quarter between institutional, which includes health systems, alternative site pharmacy, mail order pharmacies and our specialty group at 55 percent and retail which includes independents and chains at 45 percent changed slightly from the prior year as our institutional business grew 18 percent and our retail business grew 7 percent versus the prior year quarter.

The institutional growth was driven by strong growth in the mail order customer group as well as by continued above market growth in our specialty distribution business.

Our retail growth in the quarter was less than last quarter's growth consistent with market trends and the performance of certain of our large regional chain customers.

In the pharmaceutical distribution segment, gross profit margins increased 7 basis points compared to last year's quarter.

The increase is a result of the positive impact of our higher gross margin acquisitions which offsets the shift and mix to lower gross profit margin businesses such as mail order and continuing competitive environment in the quarter.

With regards to LIFO (ph) accounting we recorded a charge of $26.5 million this quarter compared to a charge of $36.3 million in the second quarter last year.

For the six months this year, our LIFO charge was $35.3 million compared to $41.2 million in the first six months of fiscal '02.

For the full year, we continued to expect drug price inflation to be in the same five to five-and-a-half percent range that it was in fiscal '02.

Operating expenses as a percentage of operating revenue of 2.15 percent improved by 8 basis points for the quarter compared to the same period last year.

In addition to customer mix, this improvement in the operating expense ratio reflects efficiencies of scale and the elimination of redundant costs resulting from the merger integration process which offset the adverse impact of the acquisitions previously mentioned.

As a result, operating income as a percentage of operating revenue expanded by 17 basis points over the prior year quarter.

Turning to PharMerica, PharMerica again had a very solid quarter, revenues increased 10 percent over last year's quarter to just under $4 million.

The gross margin declined 42.4 percent from 33.5 percent primarily due to the sales gains in the lower gross margins workers compensation business which continues to grow at a faster rate than the long-term care pharmacy business.

The change in sales mix as well as continued improvements in operating practices drove operating expenses down to 26.3 percent of revenue in the quarter, a reduction of over 180 basis points from the prior year period.

As a result, operating income for the quarter was up a strong 23 percent and the operating margin expand by 64 basis points to 6.07 percent for the quarter.

Importantly, this is the first quarter in which PharMerica has exceed the 6 percent operating margin hurdle.

We expect PharMerica's revenue growth for the remainder of the year to be in the low double digits and expect their EBIT (ph) growth to be in the mid to high teens with operating marches expanding to greater than 6 percent for the full year.

Looking again at the company as a whole.

Interest expense for the current quarter was $38.4 million compared to $38.8 million in the prior year as we continued to benefit from improved capital usage.

Net average borrowings in the section fiscal quarter of '03 were 2.4 billion dollars compared to 2.6 billion dollars in the prior year quarter.

The average amount fixed rate debt to total debt outstanding during the quarter increased versus the prior year resulting in an increase in average borrowing rates which offset some of the benefits from the reduced average borrowings during the quarter.

The effective income tax rate for the quarter was 39.5 percent compared to 39.7 percent in the prior year.

Turning to the balance sheet and close.

For the pharmaceutical distribution segment day sales outstanding were 17.3 days in the quarter compared to 16.2 days in last year's second quarter.

The increase was due to the strong growth in the specialty business, the businesses within the specialty group generally have a significantly higher receivable investment compared to our core distribution business.

At PharMerica, DSOs were down 40.3 compared to 42.3 days in the prior year quarter continuing their strong performance.

Inventory levels of 6.9 billion dollars at the end of March increased by approximately 500 million dollars from the end of December due to significant byside (ph) opportunities at the end of the quarter as well as a more drawn out quarter for price increases and duplicate inventories on hand at the end of the quarter related to the distribution center -- to the distribution centers which were consolidated during the period.

As a result, inventory turns in the quarter were 6.3 compared to 6.9 notice prior year quarter.

We would expect that inventory levels would return to the low $6 billion range over the remainder of the fiscal year.

Our networking capital investment as a percentage of revenue was 8.1 percent in the current year quarter compared to 7.9 percent in the prior year quarter.

Capital expenditures were 18.7 million in the quarter and we expect cap-ex to be 80 to 100 million for the year.

This is a reduction from our prior guidance of 100 to 130 million dollars as some of our '03 capital projects have come in under plan and some will carry over into fiscal '04.

Total debt to total capital at quarter end was 35.8 percent compared to 37.3 percent at the end of March last year, reflecting the efficient use of work capital over the last 12 months.

During the quarter we paid off the $150 million of senior notes which were due in January and immediately after quarter end, we paid off the $125 million of PharMerica bonds which became callable on April 1st, thus completing our $3 hundred million long-term bond refinancing started in November '02.

Note that next quarter's earnings will be adversely impacted by the $1.2 million one-time cost to retire the PharMerica bonds, the treatment of which is no longer considered extraordinary under accounting rules.

Cash generated from operations for the quarter was $54 million, compared to generation of $644 million in the prior year quarter.

We generated less cash in the current year quarter due to the inventory build mentioned previously resulting from buy side opportunities duplicate inventory from our DC consolidations and the timing of price increases during the quarter.

In the prior year, a larger than usual amount of price increases occurred earlier in the quarter resulting in above normal cash flow during last year's March quarter.

In the current year quarter trend reverted to a more normal distribution of increases throughout the quarter.

By the end of our current fiscal year, we continued to expect cash flow from operations will approximate $300 million.

Return on committed capital which you recall is one of our primary financial measures increased to 26.2 percent for the quarter well above our long-term goal of 20 percent, an improvement over the prior year quarter.

Each of our business units also exceed 20 percent.

All in all, another very solid quarter reflecting strong execution and attention to details.

For the year, we expect operating revenue to be approximately 13 percent, in line with our 11 to 14 percent guidance given at the beginning of the year which implies a growth rate of approximately 11 to 12 percent for the next six months.

We continue to expect 20 percent EPS growth before special charges and the cost of the PharMerica bond retirement for the next six months and as usual, we will give our fiscal '04 guidance at our year end earnings call after the completion of our detailed annual planning process.

I will now turn it back to Mike Kilpatric for a few additional comments and questions.

++q-and-a

Thank you, Mike.

We will now open the call to questions.

I would ask you to limit yourself to one question only all have had an opportunity.

Then if there's time you can ask additional questions.

Go ahead, Anna.

Ladies and gentlemen, at this time, if you would like to ask a question please press one on your phone.

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

You may remove yourself from queue at any time by pressing the pound key and if are on a speaker phone please pick up handset before pressing the number and if you pressed one prior to this announcement, please do so at this time.

Our first question comes from Ray Falci from Bear Stearns.

Please go ahead.

Good morning, guys.

How are you doing?

I have some comments around the optimized programming.

I heard you say, Kurt, about the application of many new technologies that are I guess being newly applied to the pharmaceutical distribution business.

I would love to hear you hear you expand on what those are, how these might be points of differentiation for you if at all going forward.

And then in that same context, these are helping you, you know, obviously pull out some of the synergies, given that you've been ahead of your schedule now for many quarter, I was wondering if there's any point you guys are reconsidering the timing of the 150 number maybe pulling it up a little?

Okay.

Fair enough.

Let me just spend a minute on optimize.

We had our investment meeting in New York in December and we got into a little bit more detail there, Ray, so I'll kind of just hit the highlights here.

We talk about bringing new technologies in that are new to our particular industry.

And I don't say that casually.

We did a very extensive review of technologies literally around the world of some of the best that are being used, and in a nutshell, I would put them into two different buckets, one is automated type picking equipment, A frames and other types of related equipment to that that we're sourcing from overseas, particularly from Europe as well as the PKAMS warehouse management system which you heard us talk about, this is a system which for AmeriSourceBergen had settled on right prior to the merger that will a make our warehouse paperless, everything will be bar code driven within the facilities.

So the net of the two technologies in combination to one another is really improved order picking accuracy therefore improved order fill rates.

Better efficiency of use of space within the four walls of the warehouse.

Clear improvement in terms of labor use and labor hours and what brings it all together is we'll be able to implement pay for performance systems with our warehouse workers will really drive new levels of productivity.

So the long and short of it is we think we're going to in effect deliver a better picked product for our customers, improve their operations by having a better fill rate and in effect be the lowest cost operator in the industry.

With regards to the 150, you know, we have debates about that.

We clearly are very pleased with our progress.

I don't think we're -- while we would love to did it, I don't think we would be inclined to move that date up for everybody, but I would tell you again, we feel very confident that the 150 is in track for the end of '04.

And as a reminder, you know, there are still a lot of synergies available in after that three year mark as we complete the builddown and some of these technologies really continue to take ground against costs.

Thank you.

Thanks.

Next question, please.

Our next question is from Lisa Gill with JP morning, please go ahead.

Good morning.

Congratulations on the quarter, guys.

Just wondering if you can give us some thoughts around the specialty pharmacy operations, maybe talk a little bit about the am MAV (ph) ramp and any other preferred relationships you expect to sign over the next year?

Thanks.

Lisa, it's Kurt again.

You know, the MAV ramp is going extremely well.

You know, I don't think we're in a position to release specific data around that in deference to Biojen, our partner there, but the rollout is going as we anticipated and planned for.

Steve Kallis and his team have just done a superb job.

I think Biojen is pleased with the performance of the new model and I think with a couple more months of good success here, I think there will be more opportunities made available to Steve and the team to service more Bio pharmaceutical manufacturers.

You know LASH (ph),which is the reimbursement consulting and physician education arm of the business is just a superb asset within the specialty group, you know, within U.S.

Bio services, there was a business like LASH called DOCUMEDICS, a West coast presence.

Those two together formed the largest reimbursement consulting firm in the country and their client is, you know, the very best of the pharma community and it really is a jewel within the specialty group.

What kind of growth rates are you seeing on the specialty side?

Is it high teens, low double digits?

What are your thoughts going forward?

I'm going defer to Michael DiCandilo.

We haven't broken that out specifically.

We continue to say the business is in a run rate in excess of $3 billion and it continues to grow well above the market growth rates.

It's been a real driver for us, but I don't think we want to break it down further than that.

One thing we would say, Lisa, the manufacturers services is growing very, very nicely there.

Kurt mentioned LASH there's some others, as we're getting some great traction there we're enjoying that.

Great.

Thanks very much.

Next question, please?

Our next question is from Glen Santangelo from Salomon Smith Barney.

Please go ahead.

Good morning, Glen.

Dave, just want to have a quick question on that specialty as a follow up.

In the April quarter or April press release last year, you said a business on a run rate north of $2 billion.

So it sounds like it's grown 50 percent in the last year even if I exclude U.S. bioservices, that's pretty healthy.

So if you can give us some indication of how much of that is organic versus market share gains and where that market share might be coming from that would be helpful.

And I'm guessing given the small size and some of the timing of your recent acquisition, is it fair to say that the specialty business is a having a pretty significant impact on your gross margins?

Well, specialties, clearing have some very impact, Glen.

We have had some good growth.

Those numbers that we're using when we talk about $2 billion, $3 billion or just relative guidance on how the total business is going, but it has grown very well.

We moved into some -- we think we're getting some very good traction, have some dominance and entire disease state categories, we've expanded the categories we're operating into, so we moved into some new product classifications.

That's one of the reasons we're getting some big growth there.

You know, the MAV is a good example where we've captured an additional array of services within individual products.

So it's growing well, Glen, and we are very, very happy to be in that space.

We think you know, this is a manufactured oriented service offering.

You know, we think it's the biotech products come down to the pipeline the wide array of services we have will be very, very attractive to the manufacturers.

Dave, if I can just ask you one quick follow-up question on IMEs, you said it might be more beneficial for AmeriSourceBergen because you traditionally have carried less inventory versus your peers, are you sort of making the statement that you traditionally have been less reliant on inventory profits versus your peers so IMAs are a better thing for you.

If you could just sort of flesh that out a bit?

And also it relates to IMAs, do you think that clients would be more likely to use a wholesaler or less likely to use a whole sailor because of the advent or evolution of these IMA agreements?

Well first, I to answer your first question is yes.

I mean we do think that AmeriSourceBergen is run with traditionally you know, lower inventory levels, some of our peers have had higher and what may eventually happen with the IMAs is that we meet somewhere in the middle.

So I think that's kind of how things are revolving and as I mentioned in my prepared comments, we think the IMAs you know will benefit AmeriSourceBergen in the long-term and I think it will also have a very positive impact on the industry.

In terms of individual customers I'm not sure the IMA's as have much of an impact, glen, except to the extent they make the entire industry more efficient.

And the industry, you know, has had a great history of passing those efficiencies on to customers as they've been achieved.

And so I think to the effect that the IMAs contributed to that, it will make the industry, you know, stronger and benefit our customers.

Thank you, Glen.

Okay.

Thanks.

Next question, please?

Next question is from Robert Willoughby with Banc of America.

Thank you.

Dave, you mentioned you might possibly come with an indication of new distribution business that you plan to implement in 2003.

Is there any reason that number is not available?.

You mean in terms of specific accounts and the like, Bob?

Just an aggregate number?

Yeah, we decided that, you know, we gave a lot of thought, Bob, and at the end of the day we decided we were probably best giving total industry or total revenue guidance for the balance of the year which is the 11 to 12 guidance that Mike gave for the ball lapse of our fiscal year, which of course ends in September, and as pointed out will be providing guidance for fiscal '04 toward the end of the this year.

Thank you.

You bet.

Next question, please?

Our next question is from Michael Fitzgibbons from Morgan Stanley, please go ahead.

Hi on the gross margin change.

Can you try to give us a sense, maybe say compared to last quarter when I think you had about a 10 or 11 basis points decline in gross margins, if you exclude acquisitions would you be in that ball park, maybe slightly higher or lower?

Can you just give us a general sense for whether that underlying number is consistent or has changed positively or negatively at all?

And then one other quick follow-up on that specialty space, are you getting any feedback from your customers since you got into the U.S. space on how they view your entry there and are you -- you know, how do you feel about that, their perspective?

Mike, this is Mike.

I'll answer the first part of your question and I'll hand the second part over to Kurt.

You know, as we said the acquisitions did have a beneficial impact on our gross margins.

As you mentioned, we were down 11 basis points last quarter in pharmaceutical distribution year to year, we would have done better than that without the acquisitions, but certainly we would have probably been down year to year exclusive of the impact of the acquisitions, you know.

As we've said, Auto Med (ph), U.S BIO (ph) and Bridge are all higher margin businesses than our base drug business and they've contributed greatly.

Remember, they've also added to the expense line.

And we expect them to increase our presence in the pharmaceutical supply channel and so far, we're very happy with their performance.

I'll turn it over to Kurt for the second half of you're question.

Yeah, Mike, the U.S. bio services business, first of all, it's performing extremely well since we, since we bought it.

You know, you know, I think it is something we're still very excited about.

The reason we made the acquisitions as a reminder for everybody, it allows us to provide a complete suite of offerings up the channel to our biopharmaceutical manufacturing partners, that's the reason we're in it.

Our intent it is not to compete with the channel at all.

The approach we've taken is we want to work collaboratively with them so the manufacturer's needs are met so we are actively working with a number of our customers about ways to work with them and take care of the direct patient distribution requirement some of the many biotech manufacturers are looking for.

So I think we're steady as she goes on that.

Thank you.

Next question, please?

Our next question is from Larry Marsh with Lehman Brothers, please go ahead.

Thanks.

Good morning, everyone.

I just want to maybe, Dave, your commentary about supply relationships and reflected on the opportunity for you guys have not had a significant inventory carry, some of your competitors not having a trading business, per se, that's been a user of capital.

Do you think of these relationships as being fairly healthy or should we look at that as some are good, some are not so good?

Are you willing to sign the IMAs that have been presented or you know, or are there some that you maybe are not as comfortable signing.

And how do we see the business of all I know, you know, obviously competitors talk about cash flow improving.

How do you think about it?

Is that going to show up in cash flow for you guys or is that not going to be that noticeable given your traditional inventory carry?

First of all, in terms of our supply relationships, relationship with our manufacturer suppliers, we think they're excellent.

We think they're improving.

One of the great things about the whole IMA process is that it provides an opportunity to sit down with our large brand name manufacturers and talk about the business relationship.

And that's what the IMAs are about.

And you know, we have not been confronted with a situation where you know a manufacturer comes forward and says hey, this is the IMA kind of take it or leave it kind of an issue.

This is a give and take on meetings needs of the, you know, the manufacturers which are unique to each individual manufacturers and then balance that, you know, with the needs that AmeriSourceBergen has.

And you know, the overall focus, you know, on the IMAs is to meet both people's needs and end up with a more efficient distribution network.

So you know, we're very optimistic that will happen in the long-term and you know, we've been very encouraged by the process that we've made you know with the IMAs that we have.

At the risk of piling on here Larry, I just want to chime in one other concept.

I think what we're seeing here is maybe a convergence of some of the business models here where the IMAs are forcing wholesalers who have been big into the capital game out of that game a little bit, but some of those profits in an effort for the manufacturers to create a level playing field are making those profit opportunities available to a wholesaler like ABC in a way they haven't been available before.

So I think you'll see the models being more consistent, you know, in the years ahead between the wholesalers.

Yeah and I think the point has been made by us on a number of occasions and others, but you know were we sit down with the IMAs to negotiate IMAs to talk about the relationship, we have yet to have a situation where the manufacturer says hey I think you're making too much money let's get down the table.

That's clearly not what we're about here.

What they're about and we're about is trying to develop a more efficient system.

Thank you, Larry.

Larry Marsh Okay, good.

Next question, please.

Our next question is from Christopher McFadden from Goldman Sachs.

Good morning.

Thanks for taking my question.

If I could, two points.

One, Kurt, you talked about synergy capture and reiterated your confidence in the FO 4 FO 5 timeline.

Could you give us a sense just compares FO 2 to FO 3 what you think the net synergy yield would look like in dollars to the P&L and could I gets you to just sort of expand on or reflect on the characterization of the growth you saw in the quarter in your independent chain business versus your institutional business, you know how much of that was the strength of the biological business that you've talked about here a couple of times in this call?

How much of that was from contract gains or losses and however of that was from the underlying trend of the pharmaceutical you're seeing?

Okay.

Chris, I'll take the first part, then Mike will take the second part.

Very much appreciate the question about the synergy capture.

I will tell you, I think we're going to be reluctant to give you a breakdown of what that dollar impact was in '02 or '03 compared to 0 '02.

I would just tell you that there has been a very steady positive trend line around the synergy capture, you know, to some you some qualitative comments around it, last year in '02, we were clearly benefited early by some of the synergies with the merger.

This year, we're benefiting more from operating expense savings through the DC consolidation efforts, it's two major buckets.

You know, in between there has been the rationalization of a lot of the administrative activities for the whole of ABC and that's been a fairly steady, you know, trend line during that 18 month period.

So you know, I think still the right way to think about this is kind of a straight line trend line of 150 to the end of '04, but that continuation of that trend line at a similar rate, if you will, into '05, '06, '07.

I mean we're seeing that kind of opportunity left in the merger and the network itself.

And so Kurt, just to follow on, how many facilities if you would just remind us, when you closed the Bergen transaction, how many facilities did you have open at that point and what is your current facility count?

And remind us when you complete the 60 facilities where you plan to be?

Just to provide that, we started with 51, Chris.

At the end of this fiscal year year we'll be down to 38 as I indicated in my comments.

We'll close 13.

At the end of the process the total network plan is a total of 30 including Hawaii and Puerto Rico. 28 in the Continental 48.

Now, you know, in there, you've got to add six new Greenfields.

So there will be another round, if you will of consolidations that will occur once the Greenfields come on stream.

So there's still a lot of cost takeout available in the network today.

Very good.

Thank you.

Just so there's no confusion.

The 30 includes the six new Greenfields, right.

Yes.

As far as the second half of your question, this is Mike.

I just reiterate that, you know, we think one of our strengths is our balanced customer portfolio being roughly half and half retail and institutional and the facts that we have, you know, no customer other than the federal government that's more than five percent of our operating revenue and we think with that mix it helps us you know parallel market growth and with certain customers exceed.

And certainly on the institutional side, we're doing that today with a real strong contribution from our large mail order pharmacies which, as you know, are growing significantly faster in the overall market.

We also, you know, in that group in the institutional include our specialty group, which we seed previously is growing significantly above market as well.

Health systems are also in there.

We have certain customers within that group that are also growing well.

So I think we've had strong contributions from each of the customers within our institutional segments.

As we mentioned, our retail growth was a little bit less than it was last quarter and I think that's reflective of where some of the chains have reported in the market place, we have a couple of customers that have struggled a little bit recently.

But we certainly expect them to turn around their businesses and provide a great contribution going forward.

Thank you.

Thanks for the detail.

Next question, please?

Our next question come from Kevin Berg from First Albany, please go ahead.

Yeah, a bit of follow-up on that last question.

In terms of retail change up 7 percent.

Is that based on same store sales?

I mean you obviously had some losses in business that search well aware of.

Can you put more detail around that.

And the second half of your revenue growth being on the first half of your revenue growth, can you give a little color why that's going to be?

I'll do the second part first.

We are seeing a modest temporary slowdown in the market due to generics ant lack of new product introductions and that's affecting our forecast for the balance of the year, that 11 to 12 percent for the balance of our fiscal year, so that is reflected there.

Though I hasten to add that we think the slowdown which is an industry issue is temporary and that as the R&D budget that are just staggering from the brand name manufacturers, they begin to bear fruit, new products are introduced that temporary phenomenon will be reversed.

Another thing that will have a big impact on the industry, of course, is the prescription, you know, coverage under Medicare.

So you know, those two issues can have the biggest impact offsetting the temporary slowdown.

Mike did you want to --.

Yes, the increase is not same store.

That's our increase in total from year to year.

And again, there is some mix of loss and gains of customer accounts in there as well as all other factors.

Would same store have been higher than the 7 percent number?

I guess that's my question.

I think we're reflective where the overall market is and the market in the retail sector has been in the single digits.

Okay.

Thank you very much.

You bet.

Thank you.

We're ready for the next call in.

Our next question is from John Ransom from Raymond James.

Please go ahead.

Hi.

Just a broader question, if I could.

Some of the big buyers, I suppose you would say, of pharmaceuticals have made some anecdotal comments recently that deals are coming more directly from manufacturers versus funneling through the wholesale channel.

And there was also some commentary yesterday about leakage of market share when you switch from branded to generic.

And I just want you to address this issue of disintermediation and market share and what you view the overall market share of the wholesale channel vis-a-vis total U.S. drug sales and if you think that's changed.

Thanks.

John, let me start by talking about this issue of generic leakage.

I would say - first point I'd want to make is the generics continue to be very, very profitable for us.

You know, both from a margin standpoint and from a return on committed capital.

And we have a good gross profit dollar contribution from generics, even with the leakage.

So I will say that there is some leakage, but I would put that in the historic perspective, John.

I would say, since I'm the oldest guy sitting around the table here, when I started in this business, the brand names, manufacturers sold direct.

You know, a lot of them sold direct.

There were only a few who dealt only through the wholesalers, and you competed against the brand names as you were trying to write orders.

And over time, what evolved was a situation where both the customers and the suppliers realized that the most cost-effective way to get product to the market was through the wholesalers.

And that's why the wholesalers exist today.

That's the reason we're here.

And I think the same thing is going to happen with generics over time.

I think they'll gravitate and go the same route that the brand name manufacturers have.

It's just a matter of time and that that leakage that's kind of going around the system will eventually come back through the system because we've built a very, very efficient distribution network and it makes a lot more sense to have it all come through one system.

Why do you suppose the behavior is different?

Do you think it's just a maturity cycle issue?

Yes, I think it clearly is, John.

And I think it will evolve the way of the brand name manufacturers for exactly the same reason.

And again, I literally witnessed this out in the field carrying a bag 25 years ago.

OK.

Thank you, John.

Thanks, John.

We have time for one more question, and Anna, if we could have the last one please?

Our last question is from John Susquehanna from SG Cowen.

Please go ahead.

Thank you, though.

Question on the distribution center network, and specifically, is it your belief, Kurt, that the modernization of the network and some of the technology that you're putting in these new DCs can lead to new business wins in either the institutional or the retail base, post the rollout or the build-out of the network?

John, I think that clearly is an opportunity for us.

I think that some large national firms in the past would not look at former AmeriSource or former Bergen as a viable service provider on a national basis to meet their needs, either because we didn't have the right capacity and the right locations, or the facilities weren't modern enough, et cetera, et cetera.

And so I think that as this gets completed and they see exactly what's being built here, my guess is they're going to want to know a lot more about what we've done and start to test our capabilities.

That's clearly our hope.

The success of the network clearly is not built in a way that requires that we lay in those types of accounts, but clearly they would be beneficial to us on an incremental basis if they were to choose to do business with us.

Yes, John.

I would just follow on and just say that when this network is done, we hope that those who are still doing some of their self distribution will come and look at our distribution network and they'll say "My goodness, you guys are doing it so much better than we can.

We'll turn that business over to you."

So we think it clearly is going to provide us some new opportunities as we get it developed.

It can be self-warehousing.

You're talking within the retail base, or institutional, or both?

All of the above.

Anybody who is handling product we think that we'll have a system that will allow us to do it better.

We think that we're there now, but we'll even improve upon that as we go forward.

Great.

Thank you.

Thank you, very much.

Thank you, everybody, who asked questions and participating.

I know there are some still in the queue we couldn't get to.

Sorry about that.

We're just contained by time.

I'd like to now turn it over to Dave for some final comments.

Again, we're sorry we didn't get to everyone's questions in the interest of time for those who are on the call.

We're going to break it off.

We've been over an hour.

We do want to thank you very much for joining us and giving us a chance to tell our story.

We continue to be very, very excited about the leadership role we have in the industry we operate in.

It's a very robust industry.

There's lots to like about this quarter.

Good revenues, expanded operating margins, strong operating income, good ((ROC)), good EPS, lots to like.

We continue to be excited about our long-term opportunities and we look forward to talking to you next quarter, if not before.

Thank you very much.

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