美源伯根 (ABC) 2005 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the AmerisourceBergen earnings conference call.

At this time, all of the participant lines are in a listen-only mode.

However, there will be an opportunity for questions.

Instructions will be given at that time.

If you need any assistance, please press star, and then zero and an operator will assist you on the line.

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

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

Please go ahead, sir.

Good morning, everybody.

And welcome to AmerisourceBergen's conference call covering fiscal 2005 1st quarter results.

I am Mike Kilpatrick, Vice President Corporate and Investor Relations and joining me today are David Yost, AmerisourceBergen 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 a discussion of some key risk factors, we refer you to our SEC filings, including our 10-K report for fiscal 2004.

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

As in past quarters, on the AmerisourceBergen website, under investigation, 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 remarks, and here is Dave Yost, AmerisourceBergen CEO, to begin our remarks.

Good morning, and thank you for joining us.

As noted in our press release, total operating revenues were just over 12 billion for the December quarter, about even with last year.

Total gross profit was off substantially.

Operating income was off about 35 percent.

Fully diluted EPS from continuing operations was $0.66 cents, off 31 percent from last year.

We generated $123 million of cash for the quarter, and delivered a return on committed capital of over 27 percent.

Our balance sheet is the strongest it has ever been.

The quarter was clearly below our expectations, so let me put some of the numbers in perspective and share with you the pathway to improvement.

First regarding revenues.

During the December quarter last year, we enjoyed $934 million worth of veteran's administration revenue, and $785 million of advanced PCS revenue.

That combined revenue of $1.7 billion equates to 14 percent of total operating revenue.

So taken in perspective, our revenue growth net of the two account losses was clearly ahead of market growth.

One of the factors that distinguishes AmerisourceBergen from its peers is our strong specialty business and that was in evidence this quarter with especially strong oncology sales.

Pharmerica's performance suffered from an extremely competitive market, state regulatory changes, and the unsettling impact of a prolonged potential merger between two of the largest participants in the long-term care provider space, all of which Kurt will address.

As we transition through this fiscal year, a word of caution regarding revenues going forward.

Uncertainty will continue to surround our oncology business until the physicians experience the full impact of their new reimbursement.

Though we have not experienced a dramatic change in oncology revenues in January, and are encouraged by what we have seen to date, it still may be early to assess the impact.

Second, it is important to note that in both our operating segments, we are moving aggressively to discontinue doing business with unprofitable accounts, particularly any non-prime vendor accounts remaining or those accounts with an unprofitable mix.

And last the Cox two category could ultimately affect our future revenue.

Mike and Kurt will detail the gross profit and operating income shortfall.

I would like to comment on price depreciation in general, fee for service, our ongoing focus on the concept of prime vendor and the competitive environment.

Clearly the two most asked questions we receive are around price appreciation and fee for service.

Regarding price appreciation, we have noted on frequent occasions that until we move further along the path to fee for service from inventory management agreements that the March quarter and the fiscal '05 financial performance will be heavily influenced by the size and number of price increases.

We have also stated that our fiscal year EPS guidance is predicated upon price increases being in the 5 percent range for the balance of the year.

Given where we are in the quarter, with January almost over, and given that one month doesn't make a quarter, we do not see anything at this point regarding price appreciation that changes our view of the year.

We continue to think price appreciation will be in the 5 percent range for the remainder of the year.

Our fee for service discussions continue with a high sense of urgency, and we are satisfied with both our strategy and progress.

We will not publicize any fee for service contract completions just as we do not publicize customer contract awards for the following reasons.

First, publicity tends to encourage signing deals prematurely.

That is agreeing to a so-so deal now versus a good deal later.

We would rather wait 60 days and get a better deal.

Second, where do you draw the line on the size of manufacturing you announce?

Do you announce a supplier who is number 20 in size, but not number 25?

Third, the account hybrids who are only pure fee per service contracts, and is our hybrid the same as one of our competitors?

The key issue here is that this is not about numbers of contracts, but rather an evolution in the way we do business with our suppliers, and the evolution is proceeding in an orderly fashion as we anticipated.

The the way we do business with our provider or dispensing customers also bears repeating, which is primarily on a prime vendor basis.

That is handling substantially all of our provider customer's business versus one or two lines or products or fill-in business.

There are two good reasons why we have remained committed to the prime vendor approach.

One, economic, and one strategic.

Economically, the efficiencies in the channel only work with the servicing of a full line of products.

Just take delivery costs for example, only one component of our costs that run in the range of 15 to $25 per stop, and are essentially independent of the amount of merchandise delivered.

In a less than prime vendor situation, delivery costs alone could easily run 10 percent to 20 percent of the cost of merchandise.

Totally inefficient and unacceptable to all parties.

Strategically, the best way for ABC to demonstrate its total capabilities to our customers is run their business better and expose them to our wide array of value-added services is for us to have all of the business in a prime vendor environment.

The prime vendor relationship keeps us close to the healthcare provider, and increases the efficiencies in the supply channel.

The prime vendor relationship is driven by both economics and strategy.

Last, let me comment on the competitive environment.

I mentioned Pharmerica's long term care business previously.

Assessment of a pharmaceutical distribution business is somewhat anecdotal since no large contracts have been awarded of late, and even when they are, the unsuccessful bidder is never really sure of the price and terms and conditions of the winner.

So let let me make this observation.

In spite of a very competitive market, as it has been in my 30 years in the industry, the pharmaceutical distribution market is very stable with not a lot of movement among accounts from wholesaler to wholesaler.

Since industry contracts tend to be two to three years, theoretically one-third of your business comes up for bid annually, but with very little of it switching.

The market is well over $200 billion, and there are very few accounts over $1billion, none of which has changed distributors lately, except the VA, and little movement among the accounts in the hundreds of millions of dollar size.

It is important to note that our gross profit in both of our operating segments is affected by mix in business concentration with our larger customer getting our best price reflecting their cost of business to us.

Before I turn the floor over to Kurt for some granular detail, let me assure you that we are clearly on the path to return ABC to levels of profitability you have come to expect.

The March quarter will be the last full quarter where we feel the full effects of the VA revenue loss.

Our new buildings, which will drive down our operating costs, are on schedule and on budget.

The initiatives in our drug company to improve revenue and gross profit and decrease costs are gaining traction.

Our specialty group continues to perform extremely well in a very robust market.

Some of the Pharmerica market issues will be resolved with the resolution of the proposed acquisition.

The Medicare Modernization Act, now less than a year from implementation will provide new incremental volume and an added emphasis on generics, positively impacting the industry at AmerisourceBergan. '06 will be a strong year for new generic introductions.

The new CMS regulations for institutional pharmacies appear to be positive for AmerisourceBergen in total.

The fundamentals of this industry continue to be excellent.

The industry growth continues to be very strong, and the value provided by distributors to both manufacturers and healthcare providers is being better understood every day.

The future looks very, very bright.

Here is Kurt.

Thanks, Dave, and good morning, everyone.

Let me start by echoing Dave's disappointment with the quarter, but that we continue to be optimistic looking forward.

As you are well aware, we're in a state of transition in our drug distribution business and a number of our other businesses are in challenging environments as well.

We have been clear that 2005 would be a tough transition year, and we are aggressively responding to the changes in the markets we serve, and that's what I'll spend my time on this morning.

Our overall shortfall in the quarter was largely driven by lower than expected performance on the buy side margin of our drug distribution business.

This short fall was principally due to lower inventory appreciation profits driven by lower inventory levels, and fewer than expected price increases up through the presidential election.

This dynamic underscores our need to remove this exposure from our business model by moving to compensation arrangements with our suppliers that are not contingent on price increase events.

As important, however, a this is a point we continue to stress with our manufacturer partners, a performance based approach with shared incentives, in combination with demand transparency can substantially reduce cost at the manufacturer level of the supply channel.

An approach which says simply that distributors buy and sell products on their own accounts misses the significant benefits available to an integrated supply channel approach enjoyed by many other U.S. industries.

Those manufacturers who have take the time to understand this approach and study our data recognize that this is a powerful economic argument, and have engaged us -- and have engaged with us because of the substantial benefit they see for their own shareholders.

We expect to be substantially completed with our efforts here by the end of calendar 2005.

Importantly, we are taking a significant number of other steps, as well, to improve our gross margin.

We have a number of initiatives underway to improve our customer compliance through existing contracts, including generics, and other programs.

We are also firmly enforcing minimum purchase requirements and the elimination of any backup wholesaler activities, reflecting our commitment to the prime vender model.

We have identified unprofitable and low profit customer accounts and are either improving them or eliminating them, and substantial work is underway to improve the market contribution from our HBAOTC product offerings.

Lastly, we remain committed to maintaining pricing discipline with our customers, focusing on profit, rather than revenue growth.

Below the gross margin line, we have a number of key initiatives underway as well.

The optimized program.

Our distribution center network modernization and efficiency program continues to be on schedule and on budget.

The second of our six new Greenfield distribution centers in Columbus, Ohio began operations during the December quarter.

This large, highly automated facility came on-line on time and on budget with no major customer issues.

Two additional Greenfields, Dallas and Chicago will go live in fiscal 2005, and we remain on-track to have five of the six in operational by the end of calendar year 2005.

As we've highlighted in past calls, as these facilities come on-line, we will consolidate our older, less efficient facilities driving further efficiency gains in 2005 and beyond.

We started with 51 distribution centers and today with are at 34.

We are an on track to complete six consolidations in fiscal 2005, and expect to have less than 30 in our final configuration in early 2007.

The other major components of the optimized program remain on track as well with the continued rollout of our new warehouse management system in six of our largest facilities in 2005.

Documented productivity and quality improvements from these system investments continue to exceed our internal expectations.

Under an internal program we began last summer, which we've branded as transform, substantial work is underway to further align our sales and marketing activities to target our most valuable customer segments and to create differentiated solutions using offerings from our specialty, technology and packaging groups.

There is a significant opportunity here to improve our value proposition to our provider customers and be paid accordingly.

So having said all of this, we remain optimistic that these key initiatives, conversion to fee for service compensation model, being disciplined on customer pricing and compliance, driving additional operating efficiencies through optimize, and creating unique solutions through cross selling will strengthen the operating margin of our drug distribution business in future periods.

Now let me turn to the specialty group.

Although the group was negatively impacted by markets flu vaccine suspension, in total, the group had another excellent quarter of strong sequential growth, especially in its oncology-related businesses, again driving revenues and operating earnings ahead of our internal expectations.

However, we continue to remain cautious here.

New reimbursement pricing went into effect in early January, but we do not believe the changes have yet cycled through the marketplace, so it's too early to assess the full impact on our oncology businesses.

Until more is known, we've chosen to take a conservative view on this outcome in terms of our guidance.

In response to shortage of flu vaccine, in December we negotiated a 10-year supply agreement with IB Biomedical, the largest producer of flu vaccine for the Canadian market.

The contract will secure better product availability for our provider customers and improve our overall profitability on this class of product growing forward.

If approved by the FDA on an accelerated basis, the product could be available for the 2005-2006 flu season.

Momentum remained strong at our packaging group during the 1st quarter with results better than our internal expectations in both revenue and operating income performance.

A few of our highlights.

At Anderson Packaging, a total of five new manufacturers programs were launched during the quarter, three which included new manufacturer customers.

In addition, Anderson was awarded a record amount of new business during the quarter, including on large physician sampling program behalf of a top U.S. manufacturer.

Anticipating a heavy launch schedule in the 2nd half of fiscal 2005, Anderson completed the validation process of its new production facility by both it customers and the FDA during the 1st quarter.

American Health Packaging continued to evolve as an innovator in provider oriented packaging solutions, further building out its unit dose product line during the quarter and launching an innovative compliant profit package on behalf of a major U.S. retailer.

Importantly, the packaging group also remained active in both setting standards and testing various forms of electronic track and trace technologies to help combat the risk of counterfeit pharmaceuticals.

The group also continued to be an advocate for safety and therapeutic benefits of compliance profiting packaging.

In fact, efforts are underway to obtain reimbursement coverage for compliance profiting packaging under the medication therapy management program provisions of the MMA.

Getting recognition from CMS for reimbursement for this time of packaging would be extremely beneficial to our packaging companies.

Now let me turn to Pharmerica which had a disappointing quarter with revenues and operating income below our expectations.

The worker's compensation business unit continued to drive a significant return on committed capital, and has begun to enjoy a resurgence in new business wins.

Our long-term care pharmacy business continued to face a difficult competitive environment with intensified competitive pricing pressure, driven in part by the possible industry merger and continued pressure on state Medicaid reimbursement levels.

Importantly, however, the group executed on a number of the cost reduction issues we outlined last quarter, contributing to an over 200 basis point reduction in operating expenses in the quarter and will continue to have a substantial positive impact over the longer term.

During the quarter, significant progress was made in the consolidation of a number of pharmacy level administrative activities into a handful of efficient regional service centers.

Additional work was completed to deploy automated prescription fulfillment equipment from AmerisourceBergen technology group to drive down its cost of operations at the pharmacy level.

Pharmerica also deployed a number of customer facing technologies proven elsewhere in AmerisourceBergen, including an advanced hand-held customer order entry system, as well as a number of powerful on-line customer reporting tools, and early customer adoption rates have been excellent.

Now let me switch gears.

Last Friday, as most of you know, CMS released the final rules for the application of the Medicare Modernization Act to long-term care pharmacies.

We are clearly doing a detailed assessment of the new rules, but much of the impact on long-term care pharmacies will have to await subregulatory guidelines, which we expect to come out during the year.

So while it's too early to know the impact on our business, our initial interpretation of the new rules is that they clearly show appreciation for the various service attributes delivered by long- term care pharmacies versus other pharmacy settings.

They will establish unique practice standards for long-term care pharmacies.

The rules respect the historical one pharmacy and one skilled nursing facility relationship.

Further, they reconfigure rebase and formularies, such as if they reside at the prescription drug plant or PDP level.

And to lastly, the new rules value our in-facility consulting services, although they have yet to say how they will be paid.

At this point, it is important to remember that it is still early in the process, and we expect to actively participate as the rules are refined in the coming months.

Let me close by saying as we indicated last quarter we expect 2005 to be a challenging year, as we both transition and invest in our various businesses.

We, however, remain confident in the attractive long-term growth dynamics of the markets we serve, and look forward to return to our historical growth rates in late 2005 and beyond.

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

Thanks, Kurt, and good morning, everyone.

In the next few minutes, I'm going to provide some more insight on our 1st quarter earnings shortfall, detail our positive financing transactions during the quarter, and lastly review some of the drivers behind our guidance for the rest of the year.

My discussion of the 1st quarter results will focus on income from continuing operations, the loss from discontinued operations of $0.06 per share in the quarter relates to our sale of our noncore Rita Ann cosmetics business.

Prior year numbers have been adjusted slightly as well to reflect earnings from continuing operations without Rita Ann.

Now starting with our consolidated results.

Operating revenue was essentially flat as expected, while operating income was down a significant 35 percent from the prior year, as pharmaceutical distribution EBIT fell 46 percent due to the buy side shortfalls and Pharmerica EBIT fell 17 percent.

The current year quarter was benefited by $18.8 million pretax in favorable litigation settlements from two manufacturer antitrust cases, while the prior year quarter was benefited by a similar amount relating to a bad debt recovery last December.

Facility consolidation and an employees severance costs increased to $5.1 million this year versus $1.6 million in the prior year, reflecting increased consolidation activity.

Interest expense for the current year quarter was a record low, 22.1 million, compared to $31.5 million last year, a significant decrease of 30 percent reflecting the financial leverage from our greater than one half billion dollar debt reduction over the past nine months.

Net average borrowings during the quarter declined to $767 million, compared to 1.5 billion in the prior year quarter.

A pretax charge of 1 million related to the early retirement of our term loan is shown as a separate line item within the income statement.

The effective income tax rate for the quarter of 38.4 percent is consistent with fiscal '04's full year effective rate.

Diluted EPS from continuing operations of $0.66 was down 31 percent from the prior year, primarily due to the reduction in buy side gross profit in the drug company.

The net positive after tax impact in the quarter from the litigation settlements facility consolidations, and early debt retirement was $7.8 million, or $0.07 per share.

Moving to the pharmaceutical distribution segment.

Operating revenue for the segment was $12 billion for the quarter, and is expected -- was flat compared to the prior year quarter.

As Dave mentioned, the VA and advanced PCS accounted for 14 percent of sales in the prior year quarter, above market growth in our specialty business, ahead of the January 1st reimbursement change, and market growth in our traditional drug distribution business exclusive of the two customer losses offset this lost revenue.

The customer mix in the quarter was 55 percent institutional, and 45 percent retail.

Our retail business grew a strong 13 percent, continuing its strong momentum noted the last few quarters, and our institutional business was down 9 percent compared to the prior year quarter.

Obviously, the institutional business growth was impacted by the prior year customer losses without which it would have grown in the mid-teens.

Pharmaceutical distribution gross margins were down 54 basis points compared to the prior year quarter, with the majority of the shortfall on the buy side, including a decline in inventory appreciation profits.

A number of factors contributed to the decline in the inventory appreciation profits, including lower levels of inventory on hand during the current year quarter, price increases on our top items at a rate closer to 4 percent than our 5 percent assumption, and the continuation of fewer than expected price increases up through the election date.

In addition, alternate source and deal opportunities, which were expected to be fewer than in the prior year, were significantly less than our reduced expectations, most likely due to the modest number of price increases prior to the election.

While our expectations for deals and secondary source profits continued to decline throughout the year, we would expect an increase in contribution from price appreciation, including the impact of an increasing number of fee for service type agreements.

Operating expenses as a percentage of revenue were once again less than 2 percent coming in at 1.95 percent.

The increase as a percentage of revenue compared to the prior year is a result of the bad debt recovery in the prior year that I previously mentioned.

The operating margin in the quarter fell 70 basis points to 83 basis points, primarily as a result of the gross profit decline.

Turning to Pharmerica.

As Kurt mentioned, Pharmerica had a soft quarter at both the top and bottom line due to the competitive long-term care marketplace resulting from merger overhang, forthcoming reimbursement uncertainty, and increasing cuts in Medicaid reimbursement, which offset the positive impact of increased customer acceptance of our new customer facing technology products, and significant cost-cutting programs.

Additionally, increased competitive pressures affected the workers' compensation business.

Segment revenues declined by 4 percent to $386 million in the quarter, and gross margin reduction of over 300 basis points was well in excess of improvements in operating expense margins of greater than 200 basis points leading to a reduction in our EBIT margin of 98 basis points to 6.1 percent.

As a result of the market conditions in the segment, we are now expecting its revenue growth to be flat for the year, with operating margins in the 6 percent range.

Now, turning to the balance sheet and cash flows where the news is much more positive.

We had a very busy quarter from a financing perspective, with a number of significant transactions completed.

As we mentioned last quarter, the changing business model, in combination with strong operating results over the last two years has helped us generate significant cash from operations. $1.4 billion in the last 12 months alone, and we have put that cash to good use.

We generated $123 million of cash from operations in the quarter, compared to using 454 million in the prior year quarter, again primarily as a result of reduced inventory levels.

In this quarter, we replaced our $1 billion secured revolving credit facility with a new $700 million unsecured revolving credit facility that has limited restrictions and better pricing.

Additionally, we have redeemed the $180 million remaining on our term loan facility.

We also amended our receivable securitization financing to extend its term, lower its pricing, and to increase our availability under the facility.

In addition, we repurchased $253 million in stock during the quarter, bringing the total repurchase under our 500 million program to nearly $400 million.

We would expect to repurchase the additional $100 million during the '05 fiscal year.

In addition, 33 million of our $300 million 5 percent convertible notes converted to equity by December 31st, with the remaining 267 million converting to equity in early January.

As we mentioned in our press release earlier this month, we would expect to get board approval to repurchase the shares recently issued from this redemption.

CapEx for the quarter was 79 million and we continue to expect it to be in the $175 to $200 million range for the year and as a result of our financing, debt to capital was a record low of 22.5 percent for the quarter, down from 30 percent last year and on a and on a pro forma basis for the January redemption of the remaining convertible debt was 18 percent, well below our 30 to 35 percent target ratio providing us with continued financial flexibility.

Inventory dollars declined to $5.2 billion in the quarter from $5.7 billion in December of last year from a statistical standpoint, inventory days on hand dropped to 41 days from -- down 5 days from a year ago, and down 14 days from two years ago.

DSOs continue to be strong at 16 days.

Turning to our fiscal year '05 guidance, which is consistent with our press release in early January, we expect consolidated operating revenue to be flat for the remainer of the year.

Please note that our initial press release this morning incorrectly stated that we expect operating revenue and operating income to be flat for the remainder of the year.

We issued a subsequent press release correcting the statement to be that we expect operating revenue to be flat for the remainder of the year.

We expect operating income to be slightly less than in the next nine months than in the prior year, and we apologize for the inconvenience.

In addition, our guidance is for diluted EPS from continuing operations to be in the range of $4 to $4.10 per share, and operating cash flow to be in the 375 to $475 million range.

This guidance assumes low double digit market growth, 5 percent manufacturer price increases for the remainder of the year, specialty business growth with the overall market, completion of our $500 million share repurchase program, and the expectation, again, that the board will approve an additional $300 million share repurchase program to buy back the shares recently issued from the convertible debt redemption.

With the softness in our December quarter we have received a number of questions concerning our full year guidance and how we expect to achieve it.

I would like to remind everywhere of what we believe will be the four drivers of EPS for the remainder of the year.

First, the numerous drug company initiatives Kurt mentioned, including the optimize program, generic opportunities, and increased customer contractual compliance.

Second, increased buy side profits.

As most of you know, the March quarter has historically been the most significant quarter for price appreciation, and we expect that to be the case once again.

In addition, we expect our new manufacturer agreements to add profitability throughout the year.

Third, we expect increasing contributions from our recent acquisitions and value-added programs, and finally, we expect significant financial leverage, both in the form of reduced interest expense and reduced shares outstanding.

We continue to be very excited about the industry and our prospects, and despite a tough transition, we are working very hard to return to the type of financial performance you expect from us.

I will now turn it back over to Mike Kilpatrick 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 until everyone has had a chance or an opportunity.

Then at this time, you can ask additional questions.

Go ahead, Jacques.

Thank you.

And ladies and gentlemen if you would like to ask a question, please press the star, then 1 on your touch-tone phone.

You'll hear a tone indicating you've been place in queue.

To remove yourself from the queue at any time, please press the pound key.

Once again, if you do have a question, please press star, 1, and first we'll go to the line of Robert Willoughby with Banc of America Securities.

Please go ahead.

Thank you.

Dave, is it possible that you can provide any update on the kind of the normal acquisition rhetoric that you have, what kinds of assets look attractive to you, and how has your philosophy changed with the business model conversion kind of hitting the earnings but boosting the cash?

Good question, Bob.

Obviously we have strong cash flow, and a very, very strong balance sheet.

Our philosophy really hasn't changed.

We would have an interest in moderate-sized opportunities.

The $100 million to $200 million range or so would be our sweet spot.

Clearly focused on the pharmaceutical distribution channel either enhancing our value up or down the channel, clearly the an opportunity to expand our margins and get a good return on committed capital.

There was an indication you might use stock in the 10-K.

Is that a change in your thinking?

I think we have to look at that as we go along, Bob, but we've got an awfully strong cash position right now, and our stock is somewhat depressed from historic levels, so that would all go into our thinking.

Thank you.

Next question, please.

And that's from the line of Tom Gallucci with Merrill Lynch.

Please go ahead.

Good morning.

Thank you.

I was wondering in Pharmerica you listed some of the pressure on the top line.

Was there actually any customer losses of late?

And you mentioned customer wins.

Any quantification that you can offer there, and I was hoping Kurt could clarify his statement regarding the MMA recent rules.

You talked about rebates in formularies more residing at the PDP level.

Could you explore that a little bit more for us?

Okay, Tom.

Yea, it's Kurt.

In regards to the top line at Pharmerica, there were no significant customer losses.

The book of business remains relatively stable.

We have had -- I did reference briefly some of the new technologies we're introducing, and those are filling the queue, if you will, in terms of the sales pipeline, so we are excited about that, but I would -- I don't want to raise expectations too high here.

There's no large contracts that we're in the hunt for right now, but, you know, so the revenue line is -- it's fairly stable.

With regards to -- with regards to the rebates.

I mean, obviously, this is something we're still studying.

The rules just came out Friday, so our team is going deep on this stuff, but it is clear to us the rebates in the formularies are intended by CMS to move out of our business and reside at the PDP level.

And I think the basic observation here is that CMS is interested in getting those types of dollars separated from where the point of dispense occurs.

Now, having said that, what is also clear in the regulations is that CMS is interested in finding other ways to compensate our business for the value that it provides, specifically through dispensing fees, and there will be a lot of discussions with them about what those dispensing fee rates ought to be going forward, given some of the unique services and packaging that goes on for that business, but there is also clearly a place holder in the regulations regarding being paid for our consultative or clinical capabilities, which today is a real value add by our long- term care pharmacy So we need -- the rebates are being separated from the point of dispense, but we don't view that as a real threat because we think there are other income opportunities for the business over the long-term than I think will continue to sustain the business model.

Next question, please?

And that's from Larry Marsh with Lehman Brothers.

Please go ahead.

Thanks.

Let me get back to one of the comments that Kurt made about, I guess, the idea you can reduce manufacturing costs with better demand transparencies.

You hear occasionally from manufacturers around this whole negotiation process that there's maybe historically not enough transparency from some of the wholesalers about pockets of how they generate profits.

Are you saying that you are going to be maybe more willing to, say, open up your books as an industry to the manufacturers?

Do you feel like that open book policy will be -- is in process, and, you know, how long of a process do you think that's going to take?

If you could elaborate on that a little bit, that would be great.

Yeah, Larry, we are taking an open book policy here.

I think it's important for our manufacturing partners to understand how we've paid and made our money in years past.

And you've heard us say it a number of times.

In many respects, we're so good at what we do that a lot of the manufacturers really lost track of the real value we provide in the channel today.

So there is an open book policy.

That's the position we're taking.

I assume that our peers are, as well, as we begin to re-educate our manufacturers about how we make money in this business.

And, you know, part of the value here, of course, for the manufacturing partners, is this demand transparency.

There is an enormous amount of inefficiency that occurs at the manufacturing level because they are flying those businesses without a lot of visibility to what the real demand is in the marketplace.

So there's a lot of production runs that occur that miss the mark, in terms of the true pull-through and uptake for particular products in the marketplace today.

So what we're stressing with our manufacturing partners, if you look at other industries around the United States, this type of transformation has already occurred.

It makes perfect sense here, as well, and the case studies can be applied to the pharmaceutical supply channel as they have succeeded in other industry verticals in the U.S.

So we're still on it, we're still educating, and we're optimistic again that we'll have this wrapped up by the end of the calendar year.

Thanks, Larry.

Thank you.

Our next question is from Lisa Gill with J.P. Morgan.

Please go ahead.

Good morning.

Dave, at the beginning, you made a comment about Cox 2 inhibitors impacting potential sales in 2005.

I was wondering, could you talk about, Is that already in your guidance that you have out there today?

And, if so, can you talk about what you expect the overall impact to be?

And then secondly, I know in the past you have talked about renegotiation of contracts around generics being in April of 2005.

Is that with your customers, or is that with the manufacturers?

And can you just speak to us about the number of customers today that use you for buying of generics?

Thanks.

I'll start the first part and let Kurt talk about the second part.

I want to put the whole issue of Cox 2s in perspective.

Lisa, I appreciate you bringing up because it has been in the news of late.

You look at the total class of Cox 2s, and if there are shifts among products within that, it does not have a big impact on us, and that's one of the advantages of course you get in dealing with a distributor, and participating in the total market.

If the entire class of Cox 2 were somehow eliminated or discontinued, that could have impact on our revenues in the neighborhood of three quarters of 1 percent, or 1 percent, something like that, you know, in the low 1 percent range.

So I just kind of want to have that in perspective, but I brought it up as something to keep in mind in looking -- looking at us going forward.

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

Well, Lisa, we are in the process of renegotiating our generic formulary, which we brand as pro generics here at our company and this is a program you know is kind of an industry standard, and we use it to aggregate demand, and most of our smaller customers, particularly on the retail side, in fact some of our larger retail customers also use the program, but we goring through that negotiation process.

We did this about three years ago, and those contract terms are coming up, and so we expect to finish that process this April, and have a new set of products available for the marketplace here starting early summer.

Would you expect that you'll pick up some additional customers based on this new product offering, or it will remain the same?

Is there any opportunity around this?

I think there is an opportunity for us to -- to gain some new business with a reenergized formulary program, so our sales force is excited about the opportunity to take that to market starting in early summer.

Great, thank you.

You're welcome.

Next question, please?

And that's from the line of Andy Weinberger with Bear Stearns.

Please go ahead.

Hi.

One brief clarification the a question on -- the clarification of guidance, I mean, is it fair to assume the slightly down operating income that you expect year-over-year for the remainder of the year is primarily attribute to be the Pharmerica unit, and on the pharma distribution side for the next three quarters, it's probably essentially flat?

And then I had one follow-up.

Certainly, Andy, it's a decline in total.

The pharma distribution, we be obviously expect to recover from where they were there in the December quarter and show improvement, and they should be, again, slightly below, but very close to last year, and, you know, Pharmerica as we said, being at 6 percent, that is a decrease from the prior year.

Okay, great.

And then my question is with regard to the scalability of the pharmaceutical distribution unit.

I know you're going up a against a tough comp on the SG&A line from the recovery of bad debt but I think also last year in the December quarter you mentioned that there were some other sort of negative impacts which represent about $8 million or so.

So I guess if you back all of that out, it looks like SG&A as a percentage of revenue in the distribution business is up somewhere in the mid to high single digit basis point, which is the first time that business has kind of been up over the last five years or so in terms of SG&A as a percentage of revenue.

Is that due to primarily the loss of the two big contracts which inhibit scalability?

Or is that more based on the strong growth in the specialty business?

I think it's a combination of a couple of things.

You know, first, the mix in our business, obviously, has changed a little bit, and I think you hit it right on.

The specialty group is growing at a faster rate than the core drug distribution business and the operating expense ratio is higher there, particularly in the service businesses, which we added a physician education business during last year, and it adds to that expense line, as well.

And certainly you have some start-up costs.

We brought on a new Greenfield distribution center in the quarter, and we now have two up and running, still in the very early stages, and the cost of opening those DCs have also been reflected in the December numbers.

Thanks, Andy.

Great, thanks.

Next person?

And that's from the line of Eric Coldwell with Robert W. Baird.

Please go ahead.

Thanks very much.

The first question relates to cash flow, given the strong performance in the first quarter, you're practically a third of the way to your full year target.

I'm curious if there's any change in your outlook on cash flow, if that number could perhaps edge forward, especially with inventory opportunities, and than if I may, a quick follow-up.

I'm just curious how much of the existing guidance of 4 to 4.10 is really driven by one-time items such as the litigation recoveries in that, if you don't mind.

Thanks.

Yeah, Eric.

First, we have no changed our operating cash flow guidance of $3.75 to $4.75 for the year.

Obviously with the changing business model, you can probably expect a different pattern than we have had in our past years, and obviously last year we had -- last two years, we had big cash usage in the 1st quarter as we were building up our inventories, and with the inventories more consistent, you're not going to see that type of volatility in our cash flow during the year, so you'll see a more -- a more steady state, but, remember, again, one day of activity is $150 million, so there's a lot of volatility in those quarterly numbers.

So no big change towards the $3.75 to $4.75, as far as, you know, one time items in our guidance, you know, obviously, this quarter, as we mentioned, we had the impact of $0.07 I think, as we look out the rest of the year, there may be some modest impact.

I don't think anything significant.

There are still a couple of antitrust case cases that are out in the marketplace, and if they settle, it could be a positive impact, but certainly we're going to continue to have charges related to our distribution center network, and those -- those charges are expected to pretty much offset any positive we would expect from litigation over the remainder of the year.

Great.

And I don't know if I missed this, but did you give the LIFO creditor charge for the quarter?

The LIFO charge was $2 million for the quarter.

It was $6 million the prior year.

Thanks, Eric.

Next question, please?

And that's from Glen Santangelo with Jefferies and Company.

Please go ahead.

Yea, David.

Just a quick question.

You talked early in your comments about your commitment to your prime vendor strategy, and along those lines some of your competitors, they talk more aggressively about potentially waking away from manufacturer relationships if they cannot generate an appropriate return.

And I'm just sort curious about your thoughts.

Hypothetically speaking, what if one of your competitors did in fact sever a relationship with a top five manufacturer with tens of billions in revenues.

Would a development of that magnitude prompt you to rethink your committment to a prime vendor strategy?

How should we think about that?

Talking about hypotheticals, granted it is a lets risky, but I tell you the two key factors we talked about were strategic intent, but also the economics, and the problem is that the economics just don't work with when you're making multiple deliveries to multiple accounts.

So the economics are a very, very powerful force.

You know, the second one, as I mentioned, is this whole issue of strategic intent, and that is if me want to be totally involved with our customers, and totally involved with running their business better, and it's hard to do that when you're only taking a few items or few lines.

I don't want to say never say never, but I will tell you we spent a lot of time developing and enhancing the economics and the strategies around prime vendor, and I will tell you, I don't see anything on the horizon right now, Glen, that would change that.

Thanks.

Our next question is from Andy Speller with A.G. Edwards.

Please go ahead.

Yea, hi.

I've got a clarification on the guidance.

I assume you're giving GAAP guidance, is that correct?

That is correct.

Okay.

Can you give us a sense for what sort of facility consolidation charges might be in the balance of the nine months?

Is it going to be similar to we saw last year?

Yeah, think you may see them a little bit higher than last year based upon where we were in the 1st quarter.

We were at $5 million bucks in the 1st quarter, and we have a number of closings to happen during this year, so we would expect to have a higher charge this year than last year, with, you know, our goal of closing six centers for the year.

And then if I could just follow up on SG&A.

As I recall, when you lost the VA contract, there was some talk about expense dollars being able to come out of that.

I'm a bit surprised that the -- on an absolute basis we haven't seen expense dollars come down.

Is that more a function of I guess maybe speeding up the optimized program?

Well, we targeted -- Andy, it's Kurt.

We, at the time we targeted taking 1 percent out related to the volume on that account, and we carefully calculated that, and we achieved that goal on the timeline we had expected to.

I think the dynamic maybe what you're seeing is the change in the mix, in the customer base.

So, the segments that we continue to serve are higher cost to serve than what the VA was.

So we're confident we took the costs out that we felt we needed to take out, and the rest is a pretty efficient expense line for the book of business that we're running today.

You also have to remember that the impact of the specialty business as it flows through there, as well, and we've taken on new businesses which are higher margin, but are also higher cost, so that's had an impact there.

We continue -- we're very happy with the cost structure we've developed and our ability to take costs out.

Then we wouldn't anticipate seeing absolute expense dollars be down on a go-forward sequential basis?

Yeah, I think you'll see the dollars the rest of the year fairly comparable to the run rate we were in the 1st quarter.

The other thing you've just got to remember, we're bringing up two additional buildings, and as you do that, you have duplicate costs.

So at the time the buildings come up, you actually hit -- it hurts you on your expense line, but ultimately those buildings are very, very efficient, and hit helps you long-term.

Next question, please?

And that's from the line of Ricky Goldwasser with UBS.

Please go ahead.

Yes, good morning.

One follow-up question on Pharmerica.

You said that going forward you expect growth to be flat and operating margins at a 6 percent level.

Before you got into revenue in high single digits, and I think similar level of operating margin.

Given that EPS guidance really didn't change since your December update, are you being more optimistic on other sides of the business?

Then an additional question is on the specialty business.

Obviously, your normalized top line is growing very impressively ahead of market growth.

Can you just comment on whether in the December quarter the specialty business grew at a higher rate than the blended normalized growth rate for normalized operating revenue?

Yeah let me talk about Pharmerica first, then I'll turn it over to Kurt for the specialty discussion.

But the guidance we had previously given on Pharmerica was high single digit revenue growth, but EBIT less than what it was last year.

So where we've made a moderation at the top line, saying the top line guidance or top line revenue would be flat, we've quantified what the reduction was this time in the EBIT margin down to the 6 percent level, but that is not a significant change from our original guidance.

You know, with regards to specialty, you know, they did have a very strong 1st quarter.

They grew well ahead of the growth rate that we experienced in our traditional drug distribution business, and so we were very pleased to see that.

Again, I would just highlight the point we raised during our commentary, and that is that we did have a reimbursement change occur on January 1, and still are cautious about what kind of impact that's going to have on that business unit going forward.

You know, there is a risk here that some of those prescriptions that are being dispensed by the physician move to other care settings, and could impact the top line on that particular unit, but we'll just have to wait and see as we go through the rest of this quarter as to what the impact is for the remainder of the year.

Thanks, Ricky.

Thanks.

Next question, please?

And that's from from the line of Steve Halper with Thomas Weisel Partners.

Please go ahead.

Hi, good morning.

As you're going through your discussions with manufacturers for fee for service, you do get any sense that manufacturers are looking at alternate distribution vehicles?

I will tell you, we really do not, Steve.

I will tell you, I think we continue to have very positive discussions and the value we provide, is clearly being recognized so it just does not make much sense from an economics perspective, and I don't see that.

Kurt, what's your perspective?

I would take a little different -- I think, Steve, there are some manufacturers that have clearly done the numbers, and they've looked at it, but think the good news is they have concluded that the model that we presented them in the marketplace today is the most cost efficient and the lowest cost to serve for their product lines, so I think that's really behind us.

I think a lot of those calculations were being kind of being done last year, and we're now in active negotiations now to try to figure this thing out for the benefit of the total industry.

Great, thanks.

You're welcome.

Next question?

That's from Kevin Berg with CSFB.

Please go ahead.

Yes, in terms of your buy side margin, how much of your margin today is really on price inflation, and how do you foresee that changing?

As we I think Kurt you said most of these fees for service should be done by the end of the year, so as we look out a year from now, how will that be changing?

Just trying to understand that impact there.

Yeah, I think as Dave said in his comments, currently, a good part of our buy side profit is still very sensitive to price increases, both the amount and the timing of those price increases, and will continue to be very volatile, throughout the rest of this fiscal year.

As we transition to more fee for service type agreements and more hybrid agreements as we you throughout the year, and as we said, we expect to have most of those in place by the end of the year, that certainly is going to reduce the impact of price increases on our business, but certainly not eliminate it.

As a number of those agreements as we've said, will have hybrid elements, both fee for service, and some of the features of the IMA.

So we will have some reliance on price appreciation as we get into next year, but obviously our goal is to continue to diminish that as we continue to cycle through these agreements.

Thank you very much.

Next question, please?

That's from David Veal with Morgan Stanley.

Please go ahead.

Hello, this is Sylvia calling in for David Veal.

I had a question on Medicaid reimbursement.

Could you guys quantify your expectations for Medicaid reimbursement in the Pharmerica segment for 2005?

Quantify on what metric?

Is it down?

Do you expect it to be down 50 percent, or could you kind of give us some quantification for what it is this year versus last year.

Mike, that's a guidance question.

I'm defer here.

I mean, we're clearly under pressure at the state level here, and I think we have maintained that under an MMA environment with the federal government stepping in here, that we think we get some stability back in the payer system here a little bit, but Mike I'll let you take it from there.

I think definitely our guidance this year, which was for EBIT margins less than last year reflected some of that impact from declining state reimbursements.

You know, one of the things we expected was that with the Medicare rules on the horizon, maybe you wouldn't see an acceleration of some of that pressure, but certainly we have seen some pressure most recently.

A good example is in Kentucky, which reduced reimbursement rates fairly significantly, and we're fighting those changes as we always do.

I think it's in that business.

I think that's the consistent risk that we face, and certainly it was in great evidence this last quarter.

Okay.

And, I also had a question about sales lease back transactions during the quarter.

Could you provide a little bit more clarification as to what was involved in those transactions?

Yeah, our sales lease backs relates to the equipment in some of the Greenfields that we have opened.

We have chosen to lease that -- sell that equipment and lease it back.

It gives us a better overall leasing or financing rate, and that's purely why we did it.

It's it's just a cost-effective way to finance adding equipment to the Greenfields.

Thank you.

Next question, please?

And that's John Ransom from Raymond James.

Please go ahead.

Hi, just made it in under the bell.

We may be just missing the mark on our modeling, but the gross margin came in a little bit lower than what we were looking for.

I noticed your comment earlier that your retail sales are were up double digits, which was certainly higher than we were looking for.

I wonder if you might offer a comment to see if those two things are related, i.e, in response to the loss of some of your larger contracts, or retail, is incremental retail business still being priced still very aggressively out there in the market?

Well, I think this is a -- has been and always will be a very competitive marketplace, John, but I think the driver continues to be the buy side this quarter.

You know, that's where we saw the softness and that's where we think, you know, we'll recover as we get into the March quarter.

Obviously, the initiatives Kurt went over with the drug company will certainly help us on the seller side, but I don't think the increase in the retail business was the real driver for the decline in the gross profit.

And as a follow on, I mean some people are out there saying that the new Medicare bill is going to make it harder for manufacturers to raise their prices after '06.

I mean number one, do you buy that thesis, and number two, is the shift to more of a fee for service going to be enough, and the increased volume going to be enough to offset maybe a downtick in drug inflation?

Well, the first one, John, I'm I'm not sure we're qualified to answer that question.

Quite frankly, I'm not sure everyone in is qualified to answer that question.

And if there are rebates that go back from the manufacturers to the government what form they take remains to be seen and so forth.

I would say the big takeaway we have for the Medicare Modernization Act is A), we think it's going to increase, obviously increase the amounts of prescriptions that are dispensed, anything that increases the amount of prescriptions that are dispensed is going to be helpful to us.

We think that the customer base we focus on, which is a retail customers, particularly the smaller chains, regional chains, and the independents are going to fare very, very well here, and that's these going to be a very strong generic component.

So we think that the MMA as we look out in '06 is a big positive for us.

How it interfaces with the manufacturers, John, is really not an area that we feel comfortable opinioning on.

And again, the fee for service is designed to mitigate the impact if that does happens.

We have time for one more question.

And that will be Sandy Draper with Draper Research.

Please go ahead.

Thanks.

Most of my questions have been asked.

I just have one follow-up.

On the share repurchase.

You mentioned $253 million in the quarter.

Could you give me either the average share price or the number of shares?

I think in total, our average share price is in the $52.50 range for the entire program, 400 million to date

Okay.

Thanks.

Thanks very much.

Thank you all very much for joining us today.

And now David would like to make a few final remarks.

I just want to thank you again for joining us and again point out that the fundamentals of the industry continue to be excellent.

We're very, very happy with the industry that we're in, with the growth prospects of that industry, the role we play in that industry, and we look forward to delivering a little bit of more positive news on our next several quarters.

Thank you very much for joining us.

Ladies and gentlemen, this conference is available for replay.

It starts today, January 25th at 2:30 p.m. eastern.

Will last until February 1st at midnight.

You can access the replay at any time by dialing 320-365-3844, the access code is 765507.

That number again 320-365-3844, the access code 765507.

That does conclude your conference for today.

Thank you for your participation, and you may now disconnect.