美源伯根 (ABC) 2003 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

And welcome to the AmeriSourceBergen third quarter earnings conference call.

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

Later we will conduct a question and answer session.

Instructions will be given at that time.

If you should require any assistance during the call today please press star then zero.

As a reminder, the call is being recorded.

I would now like to turn the conference over to our host, Mr. Michael Kilpatric.

Good morning, everybody, welcome to AmeriSourceBergen’s conference call covering fiscal 2003 third quarter results.

I'm Mike Kilpatric, Vice President Corporate and Investor Relations and joining me today are David Yost, AmeriSourceBergen’s CEO, Kurt Hilzinger, President and 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 risk factors that could cause our actual results to differ materially from our current expectations.

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

Also, AmeriSourceBergen assumes no obligation to update the matters discussed in this 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'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 Dave Yost, AmeriSourceBergen's Chief Executive Officer to begin our remarks.

Good morning and thank you for joining us.

As set forth in the press release this morning, AmeriSourceBergen reported another strong quarter with operating revenues up 11.7% to $11.5 billion for the total company, our largest quarter ever.

Pharmaceutical distributions operating revenue was up 11.8% to $11.3 billion, and PharMerica's revenues were up $400 million, up 7%.

Operating margin continues to expand in both reported segments.

Up 16 basis points for the company in the quarter.

Operating margin again crossed the 2% threshold before special items.

Return on committed capital remains strong at over 25% for the company and diluted earnings per share before special items grew 20% to $1.03.

Next month we will celebrate the two-year anniversary of the merger that created AmeriSourceBergen.

During the first full year of ABC's existence we grew diluted EPS over 40% and to follow that performance with now three additional quarters of diluted EPS growth of 20% or more.

Rock solid performance.

Our big news for the quarter is the closing of our Anderson Packaging acquisition in late June.

With the expansion plans that are under way at Anderson, we will soon have almost 1 million square feet and 1,000 people dedicated to packaging, one of the top operators in this space.

With over $85 million in revenue, Anderson is one of the largest and a premier provider of complete packaging services to some of the most prestigious manufacturers in the pharmaceutical, over the counter, and health and beauty aid industry.

Though the name Anderson does not appear on the package, many of the products in your medicine cabinet, like Crest White Strips and Dramamine, were packaged by Anderson.

Anderson not only allows us to expand our relationships with our key manufacturing partners in the design, planning, and packaging of physician samples and trade packs but also to participate at a different level within the industry.

For example, if products move from brand name to OTC, Anderson has the opportunity to participate in the packaging of the product as we are currently doing.

Anderson has the most experienced management team in the industry and provides total turn key service from the design of the package to the product testing in our on-site laboratory facilities.

Anderson is a great company and a great addition to AmeriSourceBergen.

When we completed the merger, we said we would use our new scale to enhance our role in the pharmaceutical supply channel, and we are delivering on that pledge.

With the completion of the Anderson transaction, AmeriSourceBergen has now closed a handful of transactions in the last two years in the areas of automation, patient safety, specialty pharmaceutical services for manufacturing, and physician management and consulting, and education services for manufacturers, in addition to packaging.

These businesses will not only continue to enhance our operating margins as we move forward but enhance our service offering up and down the pharmaceutical supply channel.

Let me hit a few industry issues from 50,000 feet before we drill down on our quarter.

Two legislative issues bear mentioning.

Prescription coverage for Medicare and drug importation, or re-importation as it is sometimes called.

First Medicare.

We continue to think that a prescription drug benefit will be passed by this Congress and implemented in the 2006 time frame.

Though the details are, of course, the key issue, anything that increases the number of prescriptions that are dispensed in this country should be good for our business because of our diverse customer base.

One of the details within the proposed Medicare legislation is the issue of AWP and oncology reimbursement.

As you know, we do a large oncology business with physicians.

Physicians have historically been reimbursed for the product they administer at a discount off AWP, or average wholesale price.

AWP is a price set by the manufacturer much like the sticker price on a new car.

It is important to note that we do not sell to the physician utilizing AWP, but rather sell off our actual cost.

If the discounts off AWP paid to physicians are increased, as has been discussed, there will probably also be an increase in the fee paid to the physician for the patient's office visit.

At any rate, since we do not set AWP, bill off of AWP, or get reimbursed at AWP, any impact to AmeriSourceBergen from changes in AWP utilization would only affect us indirectly through the effect on our customers, the physicians.

In the event the changes in reimbursement would affect how or where a product is dispensed, we think our diverse customer base and leadership position in the industry would ensure that we participate in the distribution of the product wherever the prescription goes.

Regarding drug re-importation.

Drug importation or re-importation is a terrible idea because of the safety risk it carries with it.

AmeriSourceBergen clearly has the ability to package pharmaceuticals received in both from abroad and, of course, the ability to provide national distribution of products received from any source.

However, when we agree with FDA Commissioner McQuellen (ph) and think it would be nearly impossible to prevent counterfeit and adulterated product from entering the supply channel through this source and think the re-importation risks do not justify the limited financial short-term benefits if any.

Anyone who is serious about the risks and dangers of counterfeit products cannot seriously endorse re-importation legislation.

The $200 billion pharmaceutical supply channel where we operate continues to be very stable.

Throughout the industry, no significant customers announce distribution supplier relationship changes during the quarter and a very small number throughout the last couple of years.

The switch from brand name to generic and to OTC is clearly having an impact on our top line in the short run, but it is our estimate that our industry continues to expand in the low double digits, off the pace to the mid to high teens experienced in the recent past, but good growth by almost any standards.

In our pharmaceutical distribution business, specialty business, and long-term care business, we see no fundamental changes.

We see price appreciation continuing in the 5% to 5.5% range for the year, maybe down a bit to this point, and spread a bit over the year, but not much different than last year.

Before I turn the floor over to Kurt, I want to hit one company-specific item and that is our Healthcare Conference and Exposition, our trade show that we held last weekend in Las Vegas.

We think it was the largest gathering of independent and regional chain pharmacies ever assembled, giving us an unprecedented opportunity to showcase our very strong value-added service offerings.

We had 6,000 people in attendance, including 2,100 customer accounts, 720 more than last year, all of whom paid to attend.

We sold several million dollars AutoMed pharmacy automation technology systems, and signed up family pharmacy and diabetes shop accounts, added hundreds of accounts to our third party network and rebate programs, just to name a few.

Many of the 400 or so suppliers in attendance reported they had never been to a more successful show and had never sold so much merchandise at an industry event in a single weekend.

The event was not only fun and profitable but provided great motivation to our retail sales force, the industry's largest, and demonstrated to them as well as our customers ABC's commitment to retail pharmacy and the benefits of the scale of ABC.

We created great momentum to carry us into our new fiscal year.

Now, here's Kurt Hilzinger to talk to us about some of the specifics of the quarter.

Thanks, Dave.

And good morning, everyone.

Today I will touch on the performance of each of our key business units in our integration activities.

I will take a few extra minutes during the course of the discussion to highlight a few initiatives as we continue our evolution toward becoming a solutions-oriented provider of services, which we believe will enhance our ability to drive shareholder returns over the long term.

In our market leading pharmaceutical distribution business, which includes the drug company in the specialty group we again posted strong results, driving both solid top line up 11.8% and solid operating income performance up 21%.

Cost savings from our integration activities were again evident with continued leverage over operating expenses, driving operating margin expansion for the seventh consecutive quarter since the merger.

Our gross profit margin benefited from the positive impact of our recent higher margin acquisitions and the continued benefit from the accelerated growth of generic pharmaceuticals to higher gross profit contributions.

As always we remain focused on capital management, again, driving return on committed capital well above our 20% minimum threshold, which Mike will detail.

During the quarter, we successfully converted $500 million of MedCo health business from bulk deliveries to operating revenues.

We view this as a positive, since it allows us to more completely integrate with this important customer while at the same time placing us in a position to handle more product and thereby increase our influence with manufacturers.

We are working with MedCo health on a variety of other integrations and service initiatives and as another example of our industry's ability to use its scale and capabilities to add value to large and sophisticated customers, such as MedCo health.

Let me now turn to our integration activity it is.

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

We refer to this plan as the optimized program.

A $350 million multi-year capital program.

Through 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 a specific intent of creating the highest quality, lowest cost distribution capability in the industry.

As we’ve mentioned in the past, we expect to fund the entire capital program through increased working capital efficiencies by eliminating redundant inventory investments.

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

During the quarter we completed one distribution center consolidation, Springfield Massachusetts.

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

Year to date we have completed 4 consolidations and a total of 11 since the merger.

Two additional consolidations are planned for the September quarter, bringing our total to 6 for the year and in line with our plans at the year's outset.

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 2004 and beyond.

Construction of our 6 green field distribution centers remain on track.

Construction is proceeding smoothly at our two previously announced locations, Sacramento, California, and Columbus, Ohio.

During the 2 quarter we broke down on a third facility located near Dallas, Texas.

Plant purchases and plans remain on track for the remaining 3 locations.

Our facility remodeling plans remain on track as well, with one expansion completed earlier this year and another 2 facilities due for completion in September, slightly faster than our previously announced timetable.

Our new warehouse management installations are also proceeding well, with the successful implementation at a medium volume facility during the June quarter and one of our largest facilities scheduled to go live next month.

Before moving into a discussion of our specialty group in PharMerica, I'm going to digress for just a minute and highlight a couple of instances where our scale and expertise in the pharmaceutical supply channel are being focused on developing solutions which make us an essential business partner to pharmacy.

First, in the area of pharmacy automation and technology and specifically AutoMed’s pharmacy automated offerings, at last week’s trade show in Las Vegas, as Dave mentioned, equipment orders were several million dollars and well ahead of our expectations.

The acute shortage of skilled labor in the form of both pharmacists and technicians, in combination with increased utilization script volumes is driving automation and other productivity enhancement tools at ever increasing rates.

In addition to improving productivity in a retail-type setting, AutoMed's offerings improve service quality by reducing the incidence of medication errors while freeing up the pharmacist's name for patient counseling and improving overall customer satisfaction.

Our acquisition of AutoMed appears to be very well timed.

In another area, obtaining access to restricted third party paid programs is

problematic for independent and regional chain pharmacies.

Today, 85% of all prescriptions are covered by third-party paid programs.

To assist in this area, AmeriSourceBergen recently launched performance plus network, the third largest managed care network of retail pharmacies in the U.S., slightly smaller than two large national chains.

With nearly 3,500 member stores, this network helps serve and secure participation by retail pharmacy in an ever-increasing third party paying environment.

AmeriSourceBergen is developing other solutions as well, for example, in the arena of patient care, AmeriSourceBergen manages the most comprehensive diabetes program available to retail pharmacies, Diabetes shop.

Think of it as a specialty store within a retail setting.

Nearing epidemic proportions, approximately 17 million Americans suffer from diabetes in the U.S.

And in 2002, $7.3 billion was spent on prescription medicines to treat diabetes.

Diabetes shop is now the largest program of its type, having grown to over 1,000 stores today from slightly over 400 stores three years ago.

Nearly 50 stores alone were added to the program last week in Las Vegas.

Programs of this type allow pharmacists to do what they're trained to do, patient care.

And we have similar program in development.

Those last three examples dealt principally with retail pharmacy settings.

The joint offering of AutoMed equipment with Bridge has proven to be a powerful combination in the hospital setting as a solution of choice to address patient safety concerns.

We have won a number of new large hospital contracts during the June quarter due to the effectiveness of these solutions.

And we are now broadening our thought process and looking for ways to improve the efficiency as well as the integrity of the entire medication management process in institutional settings.

In a broader context, these customer-oriented acquisitions and program launches further underscore AmeriSourceBergen's longer term drive toward becoming a solutions oriented provider of services dedicated to the pharmaceutical supply chain.

On our manufacturer oriented acquisitions, Dave carved our Anderson packaging acquisition.

I would only add that the integration activities for Anderson and American Health Packaging are proceeding smoothly.

Likewise, integration activities for US Bio Services and it’s specialty group are also proceeding smoothly.

Let me turn to our specialty group.

During the quarter the specialty group continued to deliver excellent results.

Each of the businesses which make up the specialty group continue to exceed our internal expectations for the quarter on nearly every key measure.

The unit's overall focus remained on the distribution of pharmaceuticals to physicians around specific disease states, and by providing an increasing array of services and solutions to pharmaceutical manufacturers.

During the quarter the group continued to place particular emphasis on leveraging the unique capabilities of these individual businesses into creating an integrated drug commercialization service model to assist bio pharmaceutical manufacturers to bring new products to market.

Oncology supply, the largest business within the specialty group continued its rapid growth in the quarter.

Further extending its leadership position with physicians and manufacturers alike.

As we look at the pipeline of new products scheduled to enter the market over the next five years, many of those products being oncology related, oncology supply is an extremely attractive growth platform for ABC, as is a whole of this group, a collection of high growth, high return on capital businesses substantially faster than our core pharmaceutical distribution business.

Let me turn to PharMerica.

PharMerica continued to demonstrate solid performance in the third quarter with gains and revenues and operating income up, 7% and 26% respectively.

Operating revenue came in somewhat less than our expectations due do a moderation in the historically rapid growth rate of the workers' compensation fulfillment business.

In the long-term care division, PharMerica continued to drive operating expense efficiencies through the consistent application of best practices at the pharmacy level and continued emphasis on leveraging the clinical expertise resident at PharMerica through greater therapeutic interchange recommendations.

Looking back over the last seven quarters, operating margins at PharMerica have expanded over 140 basis points.

Focus on asset management, particularly in the area of credit and collections, again lowered our capital invested in the business.

Dramatically improving PharMerica's return on committed capital from a year ago levels.

PharMerica has clearly improved its expense and asset utilization efficiency over the last two years, making the business increasingly attractive to the whole of ABC.

Lastly, we remain confident in our initial forecast of achieving annual merger synergy cost savings of $150 million by the end of 2004, and additional incremental savings beyond 2004 as we complete our distribution network build-out plan.

I'll turn over the call to Mike to review the financials.

Thanks, Kurt.

Good morning, everyone.

AmeriSourceBergen's third fiscal quarter results include solid operating performance across business segments, highlighted by strong expense control, resulting in significant operating margin expansion, strong return on committed capital and EPS growth of 20%.

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

In addition, my comments will exclude the effects of the $2.6 million net of tax cost of retiring the PharMerica bonds which was completed in early April.

Special charges in the prior year quarter consisted of merger costs of $4.9 million, net of tax.

My comments will include the financial highlights for the consolidated company as well as the two operating segments, pharmaceutical distribution and PharMerica.

First the consolidated results for AmeriSourceBergen.

Operating revenue for the consolidated group was $11.5 billion for the quarter, up 11.7% over the prior year.

As Kurt mentioned, both delivery revenue was down approximately $400 million as the company was able to successfully convert a portion of the MedCo health business from a bulk delivery basis to being serviced through our warehouses during the quarter.

Operating income was up a strong 22% in total compared to last year's quarter, with good performance in both segments resulting in consolidated operating margin expansion of 16 basis points.

Earnings per share for the quarter increased 20% to $1.03 per diluted share before special items and the cost of retiring the PharMerica bonds.

This compares to the 86 cents per share reported last year on the same basis.

The earnings growth for the quarter was positively impacted by ongoing merger synergies and continued low interest rates.

Moving to the pharmaceutical distribution segment.

Operating revenue for the segment was $11.3 billion, up 11.8% compared to last year's quarter.

The customer mix in the quarter between institutional, which includes health systems, alternate site pharmacies, mail order pharmacies and our specialty group at 57% and retail, which includes independents and chains, at 43%.

Chains from the prior year as our institutional business grew a strong 23% while all retail business was flat compared to the prior year quarter.

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

The conversion of the MedCo bulk business contributed over $500 million or 5% to the operating revenue growth during the quarter.

Our retail growth in the quarter was effected by the full impact of the previously announced loss of a large food and drug combo account, continued slow market growth in the retail sector reflecting brand to generic and OTC conversion and a performance of certain of our large regional chain customers.

In the pharmaceutical distribution segment, gross profit margins were essentially flat, down one basis point as compared to last year's quarter.

The shift in mix to lower gross profit margin business such as mail order and continuing competitive environment in the quarter were offset almost entirely by the positive impact of our higher-gross margin acquisitions.

With regards to [lipo] accounting, we recorded a charge of $11.8 million this quarter, compared to a charge of $20 million in the third fiscal quarter last year.

For the first nine months of fiscal '03, our lipo charge was $47 million as compared to $61 million in the first 9 months of fiscal '02.

For the full year, we continue to expect the drug price inflation to be in the 5% to 5.5% range.

As we do every year, we'll shore up our estimate in the fourth quarter when we compute our actual life to reserve calculations.

Operating expenses as a percentage of operating revenue of 2.01%, improved by 14 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 expense impact of the acquisitions previously mentioned.

As a result, operating income as a percentage of operating revenue expanded by 13 basis points over the prior year quarter.

Turning to PharMerica.

They again had a very strong quarter despite revenues below expectations.

Revenues increased 7% over last year's quarter to just under $400 million.

The 7% was less than last quarter's 10% growth due to the moderation of growth in the workers' compensation business.

This moderation is expected to continue in Q4, resulting in mid single digit growth for that quarter for PharMerica.

The gross profit margins declined slightly to 32.3% from 33.1% while continued improvements in operating practices drove the expense ratio down to 25.4% in the quarter, a reduction of 185 basis points from the prior year period.

As a result, operating income for the quarter was up a strong 26% and the operating margin expanded by over 100 basis points to 6.83% for the quarter.

In spite of the reduced revenue growth expected for Q4, we expect PharMerica's EBIT growth to be in the mid to high teens with operating margins continuing to exceed 6%.

Looking again at the company as a whole.

Interest expense for the current quarter was $37.2 million compared to $33.3 million in the prior year.

An increase of 12%.

Net average borrowings in the third fiscal quarter of '03 increased significantly to $2.7 billion compared to $1.8 billion outstanding in the prior year quarter due to higher levels of inventory outstanding during the current year.

The increase in average borrowings was offset in part by lower market interest rates and rate reductions due to the company's long-term debt refinancing.

The effective income tax rate was 39.2%, lower than the 39.7% in the prior year, as expected and reflects the impact of some of the tax planning strategies we implemented after the merger.

Turning to the balance sheet and cash flows.

For the pharmaceutical distribution segment, day sales outstanding for receivables were 17.2 days in the quarter compared to 16.3 day in last year's third quarter.

The increase similar to last quarter 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 fell under 40 days for the first time, dropping to 39.3 days from 43.6 days in the prior year quarter, continuing their strong performance in this area.

Inventory levels of $6.7 billion at the end of June decreased by approximately $170 million from the end of March, but were higher than normal for this time of the year due to significant buy side opportunities at the end of the quarter and duplicate inventories on hand related to our DC consolidation program.

As a result, inventory turns in the quarter were 6.4, compared to 7.3 in the prior year quarter.

We expect that inventory levels will return to the low $6 billion range by the end of the fiscal year.

DPOs were flat year to year.

CapEx was $16 million during the quarter and we expect it to be in the $80 to $100 million range for the year as we stated last quarter.

This implies an increase in expenditures for Q4 versus Q3 due to the timing of the build out of our distribution center network.

Total debt to total capital at quarter end was 37% compared to 36% at June 30th of last year.

During the quarter, our company and debt ratings were upgraded by S&P and we continue our progress towards investment grade status.

As I mentioned, during the quarter we paid off the $124 million of PharMerica bonds which became callable on April 1st, thus completing our $300 million long-term bond financing started in November of '02.

In addition, we were very happy to complete our new $1.05 billion securitization program in July for the company's trade receivables.

This new program provides $550 million under a three year revolving agreement and $500 million on a 364 day basis.

It replaces two separate securitization programs which the company inherited from it’s two previous companies at the time of the merger.

Cash used from operations for the quarter was $165 million compared to usage of $109 million in the prior year quarter.

We used more cash in the current year quarter due to the inventory build mentioned previously, resulting from buy side opportunities in our DC consolidation program.

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

Return on committed capital or rock which you recall is one of our primary financial measures and is defined as EBITDA, before special charges divided by receivables plus inventory plus PP&E less payables on a 12-month rolling basis was 25.1% for the quarter, well above our long-term goal of 20% with each of our business units also exceeding 20%.

All in all, another very solid quarter reflecting strong execution and operating expense control.

We expect operating revenue growth for the year to be approximately 13% in line with our 11% to 14% guidance given at the beginning of the year.

This implies low double digit growth in Q4.

We continue to expect 20% EPS growth for the year, before special charges, and as usual, we'll give 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.

Thank you, Mike.

We will now open the call to questions.

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

If there's time, we can ask additional questions.

Go ahead, Mary.

Thank you.

Ladies and gentlemen, if you wish to ask a question, please press star then one on your touch tone phone.

You will hear a tone indicating you've been placed in queue and you may remove yourself from the queue at any time by pressing the pound key.

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

Once again, ladies and gentlemen if you do have a question, please press star 1 at this time.

And our first question is from the line of Lisa Gill with J.P. Morgan.

Go ahead.

I was wondering if you could talk a little bit more about your trade show and the opportunities that you saw in the AutoMed side.

You said millions of dollars.

I was wondering what you were seeing on the pipeline side there.

Secondly, my understanding is that there's an individual sales force that's selling AutoMed today.

Wondering how the conversion is going as far as your overall sales force selling that.

And then just as an add on to that, as you're signing agreements were hostile for AutoMed and bridge, are you also picking up or having conversations about getting the business component of the business?

Thanks.

Lisa.

That's three in one, but we'll take it on since it's all AutoMed related.

We indicated that we had multimillion dollars worth of equipment sold on the trade show.

I think what we were most surprised about was Duane Shoey, who you know has been running that business, has never really had the experience of actually making sales of equipment on trade show floors in the past.

So I think he was -- we were very surprised to be writing contracts of that magnitude as people walked into his booth.

Importantly, there were a number of leads that we took away from the trade show.

You know, 200 plus what we consider to be very well-qualified leads for other ABC customers that are seriously considering the equipment in the future, so we were very pleased with that.

Clearly, we had the opportunity with our sales force to -- they had hands-on experience with the equipment and they saw their customers eyes light up by looking at it and so they're getting more and more knowledgeable about the equipment every day.

Lisa, on the hospital and bridge, you know, what we found with Bridge is that it really gives us access to the CEOs of the hospitals, since patient safety is such a key issue these days and we absolutely do tie in that.

We try to point out to the various highest levels of the management within hospitals that not only do we have a great pharmaceutical distribution network but we have automation, we have patient safety, we're building new things to help them going forward.

Kurt and I both made calls, you know, linking these systems up and it's been very well received.

Any success to date, Dave?

We have, actually.

We don't like to report to specific customers but, yes, we have several.

Great.

Thanks for the comments.

Thank you.

Thank you, Lisa.

Thank you.

Our next question is from the line of Ray Sulchi with Bear Stearns, please go ahead.

Good morning, guys.

Question on the MedCo business.

You were doing the dot to dot for them for a while and an opportunity you've been pursuing them.

I was wondering you could tell us what you think drove them to start running more business through you this quarter, whether or not magnitude-wise you've gotten as much as you think you can get or if there's more there.

And then for the quarter specifically, I think you just told us the quarter was $ 500 million of incremental revenue, is that what you had contemplated coming into the quarter?

This is Kurt.

We've been in discussions with MedCo about expanding our relationship with them for some time.

You know, they went through on RFP process last fall.

This was part of those discussions.

You know, I think that they -- you know , it take as little bit of hassle out of their business model by leaning on us a little bit more on what our core capabilities are and that's really handling this product and acting as a more proactive interface for them with manufacturers on logistics-type issues.

So, you know, I think it is an indication of a strengthening in the relationship.

I think you'll see probably more of this business convert overtime.

That's our intent.

That's MedCo's intent.

It's hard to get a clear line of sight of how it's going to come to us, but I think both parties are desirous of making that happen.

When we looked at the quarter, you know, we did anticipate about this magnitude coming into this quarter and so there was really no surprise there as it relates to our previous guidance.

Great.

To be clear, this incremental business that you pulled through this quarter, you expect it to continue to receive that in future quarters?

We do.

Great.

Thanks.

Thank you.

Our next question is from Tom Gallucci, with Merrill Lynch.

Go ahead.

Good morning, everyone.

As a follow up to Ray’s question just wondering, if you say you're broadening the relationship with MedCo.

Are there other services outside just core drug distribution that maybe you're talking to MedCo about, as a follow up to Ray?

And then turning to the PharMerica business, you talked about workers' comp being a little bit slower.

I think on the last call you talked about expanding the sales force at PharMerica.

Could you just give a little bit more color on some of the issues that you're looking at there?

I'll take the first part, Tom and let Kurt talk a little bit about PharMerica.

I think one of the things we want to be careful is not to get too specific on one customer.

You know, regarding MedCo health.

What I will tell you we're working hard to fully integrate all of the service offerings that we have for our customers.

One of the things we said over time, one of the reasons why the industry is so stable is because of this forward integration, you know, that occurs.

You look at our company, and a large company like MedCo health, not only are we bringing them distribution services, we've got the issue of automation, which all the large customers and even mid-size customers are interested in.

We have the patient safety issues.

We have specialty expertise that we're able to bring them through our specialty company.

So there are a wide array of issues.

We're also finding that even some of our large customers are very interested in some of the third-party pay programs and the network we're building.

So we really have a broad array of offerings and we're clearly trying to integrate them.

As Kurt talked about, present a solution selling approach instead of just individual product.

Kurt, do you want to talk a little bit about PharMerica?

Yeah, a little bit more color on, you know, the workers' comp top line because, you know, as we've indicated in the past, that business has been on a very very rapid growth pace.

We did see that moderate this quarter.

And it was kind of an unusual set of circumstances.

We, in fact, lost a fairly meaningful account but what's interesting is we didn't lose it to a competitor, we had some employees that had been working at this customer that basically formed their own business.

So they create a competitor and the client decided to out source its service.

We're not sure whether this competitor is going to be successful or not.

We clearly have got ourselves focused down there on this event.

And I think we'll continue to see this business grow attractively in the quarters ahead but probably at a little bit more moderated pace than what we've seen in the last year or so.

As it relates to the long-term care side of the business, you know, Bill Shields and the team have been investing in additional sales talent down there and we're going through the planning process with them later this summer.

I think we're going to see some nice growth rates with them on the long-term care side.

Is there any particular other customers that you view as being particularly at risk because of the way this new company was formed or did they take their primary relationships with them and you expect to move on from here?

I think it's the latter.

I think it's a one-off circumstance.

Thank you.

Our next question is from Robert Willoby with Bank of America Securities.

Please go ahead.

Looking at the working capital you're running higher than where we thought you would be.

You did give some guidance of the inventories and the explanation behind it.

Could you hazard a guess on accounts receivable and accounts payable, where they’ll wind up at the end of the fiscal year?

Bob, this is Mike.

We would expect our DSOs in the fourth quarter to be similar to where they were in the third quarter, which would lead to, you know, a measurable comparison to Q3.

As far as payables, I mean, we expect our DPOs to be pretty consistent as well.

I think most of the impact that you'll see on working capital in Q4 will be inventories being reduced.

As I mentioned, we expect them to be in the low $6 billion range, and that will drive most of the cash flow in the fourth quarter.

That's great.

Thank you.

Thanks, Bob.

Thank you.

Our next question is from the line of Christopher McFadden with Goldman Sachs.

Go ahead.

Thank you.

Good morning.

Dave, picking up on your comments on re-importation and implications for security and the pharmaceutical supply chain, could I get you to comment on implementation of pedigree requirements in the state of Florida, talk about operationally what AmeriSourceBergen is doing to comply with that?

And, I guess, if you could touch on the FDA task force dealing with the issue on a more national basis and how you think that will affect your business, if at all.

And then if I could ask one clarifying follow-up, which is, Mike, could you clarify the lipo numbers you gave?

Were those for the quarter or for the nine months?

Thank you.

Do you want to do life to?

Sure.

Chris, I think the lipo numbers we gave were $11.8 charge in the quarter versus a $20 million charge in the prior year quarter.

And for the nine months, I believe it was $47 million versus $61 million last year for the nine months.

Thank you.

Chris, this whole issue of pedigree and what Florida has done, we do not think that that is the answer to solving the counterfeit problem.

Very simply, it's because, you know, someone who's going to counterfeit product is going to counterfeit the pedigree.

You don't really solve anything that way.

We think part of the answer is a lot more stringent oversight of wholesalers, you know, in Florida there are well over 1,000 wholesalers in spite of the fact that 90% of all of the pharmaceutical distribution is done through three wholesalers.

So we don't think the pedigree is the right approach.

We think it's got to be a lot more intensive than that.

We are working very closely with FDA and other federal agencies to see if we can come up with a better system, you know, to make sure the flow of product continues to be pristine.

It's important to note that the United States is unique in that counterfeit product is not a problem here and the rest of the world, it clearly is.

We want to make sure that we don't allow the system to degenerate from where it is now.

As far as Florida goes, the individual specifics, that has no impact, you know, on our business long term.

But again, we don't think that's the answer.

You know, we think it's got to be, you know a more concerted effort than that.

Great, thanks, Dave.

Thank you, Chris.

Our next question is from the line of Larry Marsh from Lehman Brothers.

Go ahead.

Thanks.

You mentioned this quarter that your retail segment was flat, institutional up over 20%.

Mike, you mentioned one of the reasons for that, your loss of customer retail trends and then some of your chain customers.

I guess apart from the loss of the customer, have you seen any change in trend from, kind of, the thought you had last quarter when I think you commented about the market being up about 7% in retail.

And what was sort of the data points or hot topics from your customers at the trade show last week from a competitive stand point from the retail market standpoint?

I'll take is a shot at it.

Kurt, you know, talked to as many customers as I did, Larry.

But in general, you know, I find the customer retailers that I talked to, and I talked to a lot of them.

You know, probably 100 or so.

Typically, they were very upbeat on their business, very excited about going forward and so forth.

No question, though, they're feeling the impact of generics, you know, or the brand name moving to generics and OTC.

You know, having an impact on their business.

I will tell you there's a lot of talk on the floor which surprised me a little bit about this whole issue of re-importation from Canada.

And what, you know, impact that would have long term and the fact that they were concerned about that.

But the mood on the show floor was clearly up.

I would say the biggest single issue that the retailers that I talked to were concerned about is their ability to handle the increased number of prescriptions that are coming their way.

And, you know, it was a national firm from our AutoMed Technology but whether they were doing a couple hundred prescriptions a day or 500 or 600 were concerned about how they were going to handle these increased prescriptions that are coming right now, you know, well before we even talk about Medicare prescription coverage.

So, you know, our AutoMed offering was spot on and we literally had to expand the hours that we offered the AutoMed because we couldn't get all of our customers in there.

I would just say, Larry, I just pile on by saying I think we were encouraged.

We just felt a lot of buy singles from retail pharmacy, whether it was for longer-term investments, like AutoMed, or endorsing programs that required some elbow grease to implement but are good for the business long term, all the way down to procuring product on show specials.

We just saw a lot of buying going on and I think to Dave’s point, retailers, despite having been through kind of a soft slower spot here, I think are seeing things pick up in the months and the year or two ahead.

So it would be fair to say that your overall view of the retail market is comparable to what it was when you talked about it in the March quarter, Dave?

I will tell you, I'm more bullish on the retail market, you know, Larry, than I was a week ago.

After having been to our trade show.

You have to be a little careful that you don't get over-influenced by a few customers who are your best customers.

But the group was clearly upbeat.

I will tell you it's first time that I can remember with retailers getting me aside, talking about wanting to open up new stores, you know, talking about buying other stores.

There used to be we would go to these events and the hot topic was how many of the warehouse national chains were gobbling them up.

I will tell you, I did not hear that comment a single time with any of the customers we interfaced with.

Thanks.

Thank you.

Thank you.

Our next question is from Eric Coldwell with Robert Baird.

Go ahead.

Thank you.

My question relates to the lipo charge and price inflation.

A technical question here.

You're discussing 5 to 5.5% inflation in your lipo charge model but all signs have been higher inflation than that, some numbers suggesting 7 to 8% in some cases.

I'm just curious, when we get to the fourth quarter are there going to be any lipo charges that you're considering now or will these be offset by some of the OTC conversions possibly helping you out?

Yes, Eric, the 7 to 8% is not what we have seen.

We've seen more moderate than that.

Again, mostly in the 5 to 5.5.

If anything, I think maybe you know, this quarter may have been slightly less than the quarter last year.

So, you know, I think it depends upon what statistics you're looking at and to focusing on and there’s a lot of them out there.

But we can only go from our own experience.

And, you know, that slight moderation is why we had a slightly lesser charge in the quarter this year versus last year.

You know, as I've said in the past, our lipo charges is a reflection of the experience on the lipo side.

As we look to the fourth quarter our expectations would be to a charge in the fourth quarter, you know, however as I've said in the past, we go through our true up in the fourth quarter.

However, as I’ve said in the past, we go through our true up in the fourth quarter and inflation during the quarter and brand and generic switches are two of the factors that can have an impact on that as it's a very dynamic process.

Very good.

Thanks for the clarification.

Thanks, Eric.

Thank you.

Our next question is from the line of John Souter with Susquehanna Financial.

Please go ahead.

Easy for her to say, huh, John?

That's right.

Thanks.

These are questions on gross margins in pharmaceutical distributions.

They were a little bit better than I had modeled.

Can you give a little bit of color on the drivers here and perhaps specifically address if we're finally at the point where generics are large enough that they are having the positive impact that we've all talked about for a while.

John, this is Mike.

Margins in the quarter had a number of things impacting them, obviously a positive impact from our acquisitions.

You know, we estimate that the impact from the acquisitions was in the, you know, mid to high teens as far as basis points.

Benefiting our gross margins at the same time, the mix of business, the shift towards more institutional and mail order, you know, had an adverse impact on the margins.

But all in all it balanced out so that we were down one basis point.

You know, generics continue to be a strong influence on margins but, you know, again, I think you've got to keep the generics in perspective, still well below 10% of our business in dollars, so where they did have a significant impact, it was a little bit less than the benefit or a lot less than the benefit that we got from the acquisitions during the quarter.

The margin, if we continue to focus on it John, is the operating margin.

We continue to see that increase as Kurt pointed out, our seventh consecutive quarter.

We're very encouraged by what we're seeing on that front and how we're adapting to it with the way we're running the business.

Great.

Thanks, guys.

Thanks.

We have time for one more question, operator.

Thank you.

We'll go to the line of Kevin Bird with Credit Suisse First Boston.

It's actually Noah Yosha sitting in for Kevin.

First, I guess, does the MedCo incremental book continue the generic business and then related to that, I guess, what percent of your largest customers generics, I guess, go through the channel?

With regards to MedCo, that did not include the generic piece at this time.

We would love to support them on that piece of the business with our existing program.

Okay.

In terms of, you know in terms of capturing that generic business for our largest customer, that's one of the key issues we work on.

You know, our intent is to handle all of the pharmaceuticals that any of our customers have.

So, you know, one of the key issues that our salespeople work on is to capture all of their business, including the generic business.

You know, we're the largest purchaser of generics in the United States.

We could be a little dramatic and say in the entire world.

So we think we have a great opportunity to bring value to our customers in terms of generics.

We made a big point of it at our trade show.

Not only did we bring our customers the value, we also give them the ability to differentiate their generic offering to their patients, provide, you know, continuity of size, color, and shape of the pill and the like.

Generics are a big issue for us and we look to capture all of that business from all of our customers.

All right.

Thanks, guys.

Thank you.

Thank you, to everybody for joining us today on the call.

And I'd like to turn the call over to Dave Yost, CEO of AmeriSourceBergen for some final comments.

I would just like to close by telling you that we appreciate very much you joining us.

We continue to be very enthusiastic about the space that we operate in and we continue to be very enthusiastic about the leadership role that we have in that space.

We think the pharmaceutical channel is a great space to operate in, great fundamental drivers and we look forward to seeing you next quarter, which will be our fiscal year end.

Thanks very much.

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