美源伯根 (ABC) 2005 Q3 法說會逐字稿

Ladies and Gentlemen, thank you for standing by and welcome to the ABC third quarter earnings call. [OPERATOR INSTRUCTIONS] Starting off today's call we have Barbara Brungess.

Please go ahead, ma'am.

Good morning and welcome to AmerisourceBergen's conference call covering our June quarter results.

I am Barbara Brungess, manager of corporate and investor relations, filling in for Mike Kilpatric who is under the weather.

Joining me today are David Yost, Bergen'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 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 always, those connected by telephone will have an opportunity to ask questions after our opening comments.

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

Good morning, and thank you for joining us.

As noted in our press release total operating revenues were 12.6 billion for the June quarter, our largest quarter ever, up 4% over last year.

Fully diluted EPS from continuing operations was $0.96 on a GAAP basis.

We delivered a return on committed capital of over 26%.

Our balance sheet continues to be very strong, with almost $1 billion in cash at the end of June.

We had a solid quarter by most standards.

I would like to put some of the numbers in perspective and deal with some industry issues.

First, regarding revenues.

During the June quarter last year, we enjoyed $1 billion of combined VA and advanced PCS business, both of which we no longer serve.

That revenue equates to over 8% of total operating revenue in last year's June quarter.

Adjusting for the two large account losses, our total operating revenue growth was clearly ahead of the market growth.

One of the factors that distinguishes ABC from its peers is our strong specialty business, and that was in evidence this quarter with especially strong oncology and plasma sales, as was true last quarter.

PharMerica revenues were slightly above last year, and continue to be impact by 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.

That has been brought to conclusion.

As we transition through this fiscal year, a continuing word of caution regarding revenues is in order.

Uncertainty may continue to surround our oncology business as future physicians reimbursement is finalized.

Second, it is important to note that in both our operating segments we are moving aggressively to discontinue doing business with accounts that do not meet our profitability standards.

Though we did not discuss individual contract gains and losses, I do want to share with you the enthusiasm we have for the non-warehousing sector of the retail business, best characterized as independent drugstores and regional chains.

Just last week, we had our annual Healthcare Conference and Exposition for this segment in Las Vegas and the response was incredible.

We had nearly 7,500 people in attendance and the customer enthusiasm for our programs was exhilarating.

We now have almost 3,600 pharmacies in our third-party payer network called Performance Plus Network, making it the third largest in the country behind only the two largest warehousing chains.

Our Good Neighbor Pharmacy franchise-like program featuring advertising, merchandising, private label, and so on now has over 2,000 pharmacies and we expect to have 3,000 by this time next year.

Our Diabetes Shoppe store-within-a-store now has more than 1,300 stores.

As one data point, from the Exposition, we offer over 22,000 hours of continuing education credits.

That is 11 years of CE on a 40-hour-per-week basis.

Our Exposition has truly become an industry event.

Now, I would like to comment on some industry issues and reconfirm our confidence in the balance of the year and the year ahead.

First, we are frequently asked about the competitive environment of both of the segments we report and I would characterize each of them as stable.

The pharmaceutical distribution market in the U.S. was roughly $235 billion last year, and there are very few, very large accounts and relatively little movement among accounts.

In addition, the recent acquisition in each segment, D&K in the pharmaceutical distribution segment and Neighbor Care in long-term care will add to the market stability since it was our opinion that each of the acquired companies had been moving aggressively to capture market share, perhaps in anticipation of their purchase.

The (first) service will also contribute to the stability of the market since it will decrease the amount of quarterly fluctuation due to price increases and help make the buy side of gross profit more predictable.

Our fee-for-service discussions continue to be a high priority issue, and we are pleased with our strategy and progress.

We expect to have our fee-for-service contracts substantially completed by calendar year end as we have consistently maintained over long time.

Price appreciation for the quarter was in the 5% range, and we expect appreciation for the balance of the year to be at a similar level -- again, very stable environment.

A hot topic with many of our customers, and the subject of several continuing education classes at our Exposition, is the expected impact of the Medicare Modernization Act that takes effect January 1 of '06.

It is still too early to tell what the impact will be but at this point we remain very optimistic.

In a very general sense, anything that increases the number of prescriptions dispensed should be good for our business.

We are actively engaged at many levels in Washington to be sure the interest of the pharmacists are adequately and appropriately represented, pharmacists in both the community and long-term care setting.

Also we are very engaged in the dialogue around CMS' Competitive Acquisition Program, or CAP that could impact reimbursement for our oncologist's customers.

We may have better insight into CAP this fall when final bids for CAP providers are received and evaluated at CMS.

Let me briefly comment on our use of cash going forward.

AmerisourceBergen currently has about $1 billion in cash on its balance sheets after our additional share repurchase program and further reduction of debt in the quarter.

In the past, we have used our generated cash to pay down debt, buy back stock, invest in our business and make modest acquisitions.

In the past 12 months, we have retired nearly $600 million of long-term debt, repurchased well over $900 million of stock, invested over $200 million on our infrastructure and made a small acquisition.

In May, our Board authorized an additional $450 million of share repurchase of which 356 million remains.

We have said the 100 to $200 million acquisitions is our sweet spot, but have said that we would consider something larger if it made good sense.

We have an active corporate development program and continue to search for acquisition opportunities that meet our stringent acquisition criteria and provide a better risk-adjusted return to our shareholders than purchasing our own stock.

Our acquisition criteria is straightforward.

Well run companies in the pharmaceutical supply channel with operational and/or managerial synergies with attractive growth prospects, good margins and good return on committed capital are a strong pathway to that criteria.

Frankly, the opportunities we have looked at recently seemed to be too highly priced and didn't make sense for our shareholders.

Regarding our cash usage going forward, our past performance should be a good predictor of future activity.

We currently pay a very modest dividend and will review our dividend policy in FY '06 with our board as we do every year.

We will continue to be very disciplined in our use of cash as we are in our operations.

Before I turn the floor over to Kurt and Mike for granular detail, let me assure you that we continue on the pathway to return ABC to operating margins in pharmaceutical distribution to the 100 to 110 basis-point range for FY '05 with improvement in operating margins as we move into FY '06.

Our FY '06, which begins October 1, is shaping up to be a solid year.

Our very disciplined annual planning process is in full swing, and we will provide updated guidance for our fiscal '06 when we report our fiscal year end results in early November.

The fundamentals of this industry, and our role in it, continue to be excellent.

Our future is bright.

Here is Kurt.

Thanks Dave, and good morning everyone.

We have been consistent in our message that 2005 will be a challenging transition year and that we were going to aggressively respond to the changes in the markets we serve.

I will address each of our business groups separately but, as an overall theme, I am pleased to report that we are making excellent progress on the key management initiatives we laid out at the beginning of the year as well as with two additional initiatives that I will highlight this morning.

In our drug distribution business, we continue to make solid progress on our fee-for-service negotiations, as Dave highlighted.

While this has clearly been a challenge for us in 2005, as we look forward into 2006 and beyond we see increased stability and predictability of our P&L and improved returns on committed capital.

In addition to our work on fee-for-service during the quarter, we continue to take action on a significant number of other initiatives to improve our gross margin including driving improved customer compliance to existing contracts, improving or eliminating low-profit customer accounts and product categories, and maintaining pricing discipline with our customers focusing on profit rather than revenue growth.

And, we began to see the benefits of these actions during the June quarter.

Below the gross margin line, we made solid progress on a number of other key initiatives underway as well.

The Optimize Program, our $450 million distribution network modernization program, continued on schedule and on budget.

The fourth of our six new, large, highly-automated distribution centers began operations in Chicago at the end of the June quarter.

Looking ahead, our fifth (greenfield) in Kansas City will go live in the fourth quarter and we remain on track to have all six operational by the spring of next year.

As these facilities come online, we will consolidate our older, less efficient facilities to eliminate cost redundancies and drive further efficiency.

Year-to-date we have consolidated three of these older facilities, and we are on track to consolidate three more facilities by the end of fiscal 2005, bringing our total network to 32 and setting the stage for solid efficiency gains in 2006.

Substantial progress continued on our Transform Program, as we have worked to align our sales and marketing resources toward our most valuable customer segments and create differentiated solutions using our offerings from our specialty, technology and packaging groups.

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

So we remain optimistic that these 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 leveraging our capabilities will continue to strengthen our operating margin of our drug distribution business in 2006 and beyond.

Changing gears for a minute.

During the quarter, we finalized our decision to outsource our IT infrastructure and core business application needs to IBM in order to strengthen our IT offerings while focusing on our core business.

As many of you know, we have been executing an IT integration plan since our merger four years ago.

With our successful transition to one platform expected next spring, the time is now right to move from an IT-integration approach to an IT-development approach.

Effective July ,1 this decision allow us to draw on IBM's experience and expertise to help us deliver more service innovations faster through strengthened IT systems that will support our operations, our customers, and our suppliers alike.

IBM will be strengthened through the full-time hiring of more than 30% of our IT associates.

We will have access to our long-time associates as well as IBM business, hardware and software expertise while realizing savings in our IT budget that will allow us to increase our investments in the future.

AmerisourceBergen constantly evaluates and takes actions to build value through operational excellence.

This collaboration takes our technology capabilities to a higher level in terms of speed, effectiveness, accuracy and availability.

And, by improving our information flow, both internally and externally, we will further distinguish our capabilities in the marketplace.

On a different note, earlier this fiscal year we undertook an assessment of our technology group of companies as a means of exploring how to better leverage those capabilities within the group itself as well as with our drug distribution business.

As a result of this assessment, we made a number of key business decisions during the third quarter.

We reorganized the group and made the decision to sell our Bridge Medical assets to Cerner while continuing to make available Bridge products as part of our broad suite of patient-safety solutions.

Our reorganization included placing our pharmacy consulting business, Pharmacy Healthcare Solutions and our technology companies together to create better solution sets for our customers and drive faster market penetration.

Increasingly our provider customers are looking not only for the tools to solve their pharmacy and (critical) challenges but also the implementation expertise and know-how.

We also simplified our automation product offerings to create greater focus and, as a result, we incurred some charges this quarterly which Mike will detail.

We remain dedicated to building out the business capability within ABC as it represents both an attractive growth platform as well as an important competitive differentiator of our offerings to the provider marketplace.

I won't comment in detail this morning on the packaging group, except to say that the momentum remains strong during the third quarter, with results better than our internal expectations.

And, with a solid backlog of new projects, the group is poised for solid performance in 2006.

Now, turning to PharMerica which had a difficult quarter, with revenues up slightly but operating income down versus year-ago levels and sequentially.

On the revenue side our workers compensation business continued enjoying new business wins, building on the momentum we began to see earlier this year and setting the stage for a stronger 2006.

But, as has been the case for the last several quarters, our long-term care pharmacy business continued to face a difficult competitive environment with intensified competitive pricing pressure and continued reimbursement pressure from state Medicaid programs.

We will be pleased to see the final resolution of the long-pending industry merger.

We believe this presents a significant market opportunity for our long-term care business as we head into 2006, and may provide some relief to the very competitive pricing environment we have experienced this year.

We have continued to invest in order to drive efficiencies and improve our overall service quality.

And, we are confident that there is a clear role for an alternative national provider in the marketplace.

With regard to MMA, throughout the June quarter our long-term care business was in active negotiations with potential pharmaceutical drug plan, or PDP, contracting entities.

Time was also spent with numerous manufacturers and educating customers.

While we are pleased with our progress to date, much more work remains to be done.

Importantly, we remain very confidently in the unique value proposition of our long-term care pharmacy business and it will continue to be recognized in the marketplace.

In the coming months, we will remain very active further building out our service offerings around medication therapy management to meet the additional opportunities that we expect to become available under the regulations.

Lastly, turning to the Specialty Group, the group had another excellent quarter of strong sequential growth, driving revenues past $6.5 billion annual run rate and operating earnings ahead of our internal expectations.

As you know, we entered 2005 with a relatively cautious stance given the January 1 reimbursement rule changes for oncologists by CMS.

To date, we have not experienced a detrimental impact from physicians moving patients to other care settings.

The performance of our oncology-related businesses remained strong in the June quarter giving us a more optimistic view for the remainder of calendar year 2005.

The group's distribution results were also aided by strong performances in plasma and nephrology.

In addition, the commercialization business as a specialty group had another very solid quarter, with ICS, the third-party logistics provider and iMedix, the group's physician education business, setting record quarters.

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

We are making solid progress on our key management initiatives and remain confident in the attractive long-term growth dynamics of the markets we serve.

Now, I will turn the call over to Mike for review of the financials.

Thanks Kurt, and good morning everyone.

In the next few minutes I am going to provide some more detail on our solid third quarter results versus expectations, talk about the continued positive balance sheet and cash flow trends, and update you on our fiscal '05 guidance.

My discussion of the quarter will focus on our results from continuing operations consistent with our press release issued in June.

The 5.1 million, or $0.05 per share, loss from discontinued operations in the quarter relates to the sale of the assets of Bridge Medical.

Prior year numbers have been adjusted slightly to reflect earnings from continuing operations without Bridge or Rita Ann which you may remember was sold in our first fiscal quarter.

Now, starting with the consolidated results.

Operating revenue was a record $12.6 billion, up over $360 million sequentially and 4% over the prior-year quarter driven by our pharmaceutical distribution segment.

Operating income was down 33% from the prior year reflecting declines in both segments.

Gross profit was benefited during the quarter by $7.8 million, reflecting the net effect of three unusual items.

The first item was a benefit of $21.3 million relating to the receipt of favorable settlements from manufacturer antitrust cases and was partially offset by the second item, a $6.6 million charge related to losses from a generic manufacturer bankruptcy and a third item, a $6.9 million charge related to the product line rationalization in the technology group.

Again, the net pretax impact of these three items of $7.8 million is reflected in cost of goods sold and contributed $0.05 to our earnings in the quarter.

In the prior year June quarter you may remember that we received a $38 million favorable antitrust settlement which contributed $0.20 to last year's earnings.

On the expense side, facility consolidation and employee severance costs increased to $3.7 million, or $0.02 per share, in the quarter from $1.6 million, or $0.01 per share in the prior year as we began to recognize the transition costs from our IT outsourcing initiative.

Net interest expense for the quarter was once again a record low at $11.3 million, down almost 60% from last year's 26.8 million reflecting the financial leverage from the net debt reduction over the last year and, for the first time, our invested cash on average during the quarter was greater than our average borrowings and our average net borrowings were down by $865 million from last year's quarter.

Again, note that in the prior year quarter we had a loss on the early retirement of debt of $23.6 million which decreased prior year EPS by $0.12.

In the prior year we also received a liquidating dividend from a technology venture of $4.9 million which contributed $0.03 to the prior quarter earnings.

Our tax rate in the quarter declined to 36.4% from 38.5% in the prior year, reflecting the resolution of federal and state income tax issues during the quarter related to the closeout of certain past tax years.

We would expect our effective tax rate to return to the 38% range in the future.

This quarter's reduced rate contributed $0.03 to earnings in the quarter.

Diluted EPS from continuing operations of $0.96 was down 13% from the prior year, mainly due to the impact of the EBIT decline partially offset by the financial leverage evidenced in both the significantly reduced interest expense and the significant reduction in average diluted shares outstanding which were reduced the 13.7 million shares from the prior year to 104.4 million for the current quarter.

As of the end of June, we have 103.4 million common shares outstanding.

Again, before moving on to our segment results, the net impact of the three unusual gross profit items, the facility consolidations and employee severance item and the effective tax rate change was to increase EPS from continuing operations by $0.06 in the current quarter.

Now, moving to the pharmaceutical distribution segment.

Operating revenue for the segment was $12.4 billion for the quarter, an increase of 4% compared to the prior year.

The customer mix in the quarter was 58% institutional and 42% retail.

Our retail business grew 5% and our institutional business was up 4% percent and continued to be impacted by the prior-year customer losses without which it would have grown in the high teens reflecting the strong growth of our specialty business.

Pharmaceutical distribution gross margins were down 53 basis points compared to the prior year quarter with the majority of the shortfall on the buy side.

Note that the adverse impact of the generic manufacturer bankruptcy and the technology product rationalization totaling $14 million is reflected here and contributed to 11 of the 53 basis point decline.

Solid progress continues to be made with our fee-for-service contracts as Kurt mentioned earlier and we felt the positive impact of our generic initiatives during the quarter.

Operating expenses as a percentage of revenue were 1.91%, down 3 basis points from the prior year.

Our operating margin in the quarter fell 50 basis points to 105 basis points primarily as a result of the gross profit decline and, again, was adversely impacted by 11 basis points due to the generic bankruptcy and technology issues I just mentioned.

Turning to PharMerica.

As Kurt mentioned, revenues of $393 million were up 1% compared to last year and up sequentially from the March quarter.

Operating margins were down significantly from the prior year as gross margins continue to decline as a result of competitive and reimbursement pressures but, unlike the two previous quarters, was not offset by expense margin reductions as unfavorable health benefits experienced in the current year quarter adversely impacted expenses by $2.6 million compared to the prior-year quarter where expenses were favorably impacted by a $4.6 million bad debt recovery.

We continue to expect PharMerica revenues to be flat for the year with EBIT margins in the 6 to 7% range.

Now, turning to the balance sheet and cash flows where the news continues to be positive.

As we mentioned last quarter, the changing business model in combination with operating results over the last two years has helped us generate significant cash.

While cash generated from operations in the quarter was $58 million compared to over 600 million in the prior-year quarter, our earlier than expected working capital reduction in the March quarter has resulted in cash generated from operations for the fiscal year-to-date period to be $1.25 billion versus $661 million generated in the prior-year nine-month period.

As a result, we have increased our cash generation from operations guidance for the year from the 900 million to $1 billion range to a range of 1.1 billion to $1.3 billion.

Inventory is expected to be in the low- to mid-$4 billion range at the end of September.

During the quarter, we announced a new $450 million share repurchase program and we repurchased 1.4 million shares under this program for $94 million during the quarter, leaving approximately $356 million remaining at June 30th.

We would expect to complete the program by the end of fiscal '06.

Cap Ex for the quarter was 40 million and for the nine months was 164 million, and we continue to expect it to be in the 175 million to $200 million range for the year, most likely at the higher end.

During the quarter, as expected, we repaid our $100 million of 7.25% notes which were due in June and, as a result, our debt-to-capital ratio was a record low 17% for the quarter, down from 25% last year and, with a cash balance of just under $1 billion, our net debt-to-capital ratio was less than zero once again.

Obviously this is below our target 30 to 35% ratio, providing us with continued financial flexibility and significant opportunity to deploy capital.

The remaining capital will be available for capital expenditures, acquisitions, and returns to shareholders as Dave discussed in some detail.

Finally, from a statistical standpoint, average inventory days on hand during the quarter dropped to 35 days, down nine days from a year ago and down 22 days from two years ago and DSOs continue to be very strong at 15.6 days, down a day from a year ago.

Now, turning to our guidance for the remainder of fiscal '05.

We expect diluted EPS from continuing operations before the cumulative effect of the accounting change to be in the $3.30 to $3.50 range on a GAAP basis with pharmaceutical distribution operating margins in the 100 to 110 basis point range.

The increase in the midpoint of our EPS range reflects our strong third quarter results.

Additionally, we are raising our operating revenue guidance to 1 to 2% growth for the year.

Note that our fourth quarter, '05 guidance includes the net impact of our IT outsourcing transition costs including severance which are expected to be 10 to $13 million in the quarter and the expected receipt of another manufacturer antitrust litigation settlement which should offset the IT charge.

Our early look at fiscal '06 is unchanged, with diluted EPS expected to be in the $3.60 to $4.40 range with the bottom of the range assuming no improvement in EBIT margins compared to fiscal '05 and the top of the range reflecting an improvement of 30 basis points in the pharmaceutical distribution EBIT margin to 130 to 140 basis points, again reflecting the benefits from our current year initiatives with Optimized, Transform, our enhanced generic opportunities and our new fee-for-service contracts.

The guidance for fiscal '06 also reflects the full year benefit of our fiscal '05 capital deployment initiatives.

Obviously, we will update this guidance next quarter when we complete our planning currently in process.

We continue to be very excited about the industry and our prospects and we feel that we have great momentum as we enter the late innings of our fee-for-service transition and anniversary our customer losses which have been a drag on earnings for the last 12 months.

With that, 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.

Then, if there is time, you can ask additional questions.

Go ahead, operator.

[OPERATOR INSTRUCTIONS] We do have a question from Robert Willoughby, Banc of America.

Please go ahead.

Thank you.

Good morning.

Jon Wood in for Bob.

Mike, can you discuss the balance sheet effects of the decision to outsource the IT function?

And then, does it affect your capital spending plans as we move forward?

Thanks.

John, really no balance sheet effects.

The assets we have we continue to carry and will be utilized in the short run by IBM.

We may have some transition as we go forward.

Certainly one of the advantages of the IT outsourcing for us is that some of the savings that we will realize over time from the contract will be reinvested in technology and the in development of new technologies that are going to help us internally and help our customers.

Thanks.

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

Please go ahead.

Thanks and good morning, everyone.

I was wondering if perhaps you could just talk a little bit about the distribution center closings in 2006 and the impact that will have to your overall operating margin.

Obviously, fee-for-service is important in stabilizing that but I would anticipate that as you close these distribution centers with the six now all being fully operational at all six -- shouldn't that help to improve the operating margins?

And Mike, I think you talked about the guidance being -- things remaining between '05 and '06 at the bottom end of the range.

I am just wondering if you can comment on that.

And then also, around fee-for-service, when you say you expect the majority of contracts to be under some type of fee-for-service at the end of calendar 2005, can you define that a little bit better?

Is it better than 50%, better than 80%?

If you could just give us a number, that would be very helpful.

Thanks.

Lisa, it is Kurt.

Maybe, I will take a shot at this and lean on Mike a little bit for numbers guidance here.

Just with regards to '06, I think your observations are spot-on.

We will have, clearly, benefits from '06 from the consolidations that we are getting in at the tail end here of '05.

But also, there will be more that we will be accomplishing in '06 as we bring these two new Greenfields on, both Kansas City and then Bethlehem, Pennsylvania kind of midpoint next year.

So, we have more consolidations.

We have not publicly released how many more facilities we will be closing in '06 but it is a handful.

And we will be very specific with our guidance and our goals as we turn the corner here on the fiscal year and we set up the numbers for next year.

And I would say that I would give you that same guidance with regards to fee-for-service.We have tried to give some conveyance in morning that we feel pretty good about where we are coming out.

But, I think we are going to save ourselves to early November when we have kind of got a wrap on this thing to give you some specifics about percent that is contingent or non-contingent on price increases.

We will be fairly specific with the investment community at that point in time, but we kind of need to finish the process here and then we will move forward.

Mike, I don't know what else you want to try to add to that.

Certainly Lisa, the excess over expectations has been reflected in the revised fiscal '05 guidance.

Some of that excess, again, is one-time items and we didn't think it was appropriate to bump up fiscal '06 based upon those one-time items.

Certainly, we are going to go through our planning process.

We are going through it right now, and we will be able to give good updates on the guidance on our next call in November.

Can you just give us any idea, though, at this point where -- I know you probably have signed a number of the fee-for-service agreements.

Can you give us any idea as far as how far along you are or what you would expect as a percentage or do you just not have an idea?

I mean, we clearly have an idea.

We know exactly where we are right now.

You just don't want to tell me.

I just don't want to tell you, Lisa, and it is not personal.

It is just that we really want to complete the process so we don't have a lot of second guessing at this point.

We are pleased with where we have come out.

As we have said, this is a very healthy change for our business, it is a very healthy change for the industry.

And, look, we always think we justify more economics from our manufacturing partners but just getting this thing to a non-contingent environment is a big step forward for us and we will happy to share in November and we will get pretty specific with you that the point.

Great, I look forward to November.

Thanks.

Thanks, Lisa.

Our next question is from Tom Gallucci, Merrill Lynch.

Please go ahead.

Thank you.

Mike, you have mentioned the higher cash expectations so I was just wondering what your expectations are for inventory trends over the next two quarters and then even the next three years as where we are going to see that mature.

And then, as a follow-up to that, on generic market I was just wondering if you could comment on how fast that growth was in the quarter and what the impact of that really is on your business at the end of the day in terms of either margins or profit dollars or, obviously, lower working capital as part of that -- maybe that is part of the cash flow too.

I am not sure.

Tom just to address inventory first.

Our inventory at the end of June was in the mid-4 billion range -- $4.5 billion -- and as we set our expectation for the end of this year is to be in the lower- to mid-$4 billion range.

As we look at the next year, certainly we still see additional opportunities to bring the inventory down even further.

And really, both internally through the execution of our Optimize program as we get the Greenfields up and running and live and we finish our consolidations and, certainly, as more and more of our-fee-for service contracts become non-contingent on price increases as Kurt just said, the incentive to hold inventory is going continue to go down from where it is today.

Certainly directionally, as I mentioned, we are in the mid-35s today and I can certainly foresee over the next couple of years that we would go down towards the 30 day range.

As far as generics, Dave, I didn't know if you wanted to talk about the generics.

Talk about generics a little bit.

Tom, first of all, we continue to be excited about our generic program.

This is the first full quarter we have had it.

And, we an opportunity to literally interface on a personal basis -- Mike, Kurt, and I -- with literally hundreds of customers at our Exposition.

We got very, very strong feedback on the generics.

Just to kind of put it in perspective.

Our generics program is -- we don't think our volume with generics is probably not dissimilar from the total market perspective adjusted for our mix.

That is, for our retail customers probably less than 10% of our total dollars -- in the mid 40s and popping up toward close to 50% in terms of units sold.

It is important to keep in mind, though, Tom, that with our strong specialty business you have to adjust the generics for that.

In the specialty business, we do not have the same kind of a strong presentation but we continue to be very, very enthusiastic about our generic program and getting a lot of traction out of it with our customers.

But, is anything growing faster than, let's say, the traditional business if you exclude specialty or can you talk about just the dynamics there?

Thank you.

A lot of moving parts there, Tom, of course because you have your brand name products continuing going up in price and you have got your generics not having that same kind of price appreciation and you have got a lot of products jumping off patent and the like.

But, we are very happy with our generic program and think it is growing better than the market.

Thanks.

Our next question is from Larry Marsh, Lehman Brothers.

Please go ahead.

Good morning.

First of all, Mike, congratulations on your recent promotion -- well deserved.

Wanted to ask a question about topline, really, in pricing.

It looks like you are suggesting your topline for this year will be sort of up 1 to 2%, a little bit better than you had been suggesting.

Is that a function of better success in customer wins, improved market conditions or a combination thereof?

And, I guess, the same thing on the inflation side.

Looks like you are suggesting 5% inflation versus about 4 in the March quarter.

Are you confirming that the pricing environment has gotten a little bit better here of late?

First, Larry, on the issue of revenues.

Our mix plays a key role in that.

We continue to have good traction in our specialty businesses, as Kurt mentioned.

And, our run rate of $6.5 billion there.

The specialty pharmaceutical market is growing probably twice what the regular market is growing.

So, that is clearly having an impact.

We also think we are having some good success in the independents and regional chains, primarily as a result of the programs and the value-added services that we have had which got great play at our recent Exposition.

So, I think those are the big issues.

Okay.

And, do you think that you could pick up any incremental business going into next year with the recently announced acquisition in the industry?

We think both of the acquisitions provide us some opportunities, Larry.

The first one, in terms of D&K, I mean those customers have had the opportunity to do business with in the past and have elected not to for some reason, real or imagined.

But, we think with the recent changes they are going to have more opportunities to do business with us, and that the programs and the like that we have will present added opportunities.

So, absolutely, we think that there is some opportunities for us in the pharmaceutical distribution business.

In the long-term care business, we think there is clearly a role for two national players and we are one of those two.

So, we think that represents some opportunities and again the same issue applies.

All those customers had an opportunity to do business with the acquire for reasons and -- they did not for reasons, real or imagined, and we think that represents some opportunities for us.

So, at this point, we think both of those do represent good opportunities for us.

Thanks.

Very good, thanks.

Next question is from Glen Santangelo, CSFB.

Please go ahead.

Dave, I just wanted to ask a follow-up question on generics.

We have seen what we think to be pretty high profile examples of some generics where the price erosion in their post-branded life has been a lot steeper than what we have historically.

And I think, to some extent, even if you look at drugs like Prozac that have been generic for quite some time you continue to see erosion within the pricing of those types of drugs as well.

And so, as we look to next year at this generics opportunity that you had suggested might be a pretty sizeable opportunity for the company, are you at all concerned that the pricing in generics could erode to the point where maybe you will not be able to achieve, at some point, the gross-profit dollars that you maybe would have while these drugs still had patent protection?

We hear your point, Glenn and I understand the observation.

I would say as we look out to '06, one of the things you have got to keep in mind for '06, in terms of the big products coming off patent, it is a summer event.

When you look at the "Zees" - it is kind of Zocor, Zoloft, Zithromax that are the really big products for next year.

They are in the May/June timeframe.

So, those products are not going to have a really big impact on us in our fiscal year next year.

It is really a calendar '06 event rather than a fiscal '06 event.

That is the first issue.

The second thing is as we continue to get momentum in our generic program we are confident that we are going to be able to maintain that margin going forward.

That is one of the things that we look at very carefully when we set the price and so we think that generics will continue to be a big opportunity for us.

I will tell you, I think generics are going to get added emphasis from the Medicare Modernization Act.

When that goes into effect January 1, I think the whole issue of generics is going be in a lot higher profile with the public.

We continue to be bullish on generics.

Dave, can I just squeeze in one follow-up question.

One thing that you said in the call was that the company is potentially interested in looking at more sizeable acquisition opportunities.

I never heard you talk about that before.

Could you tell me maybe what businesses you would view as being, sort of, complementary to your business or are you potentially willing to move in an entirely new direction?

Well actually, Glenn, I tried to make that an exact duplication of what I have said previously and that is that we would consider something larger if made good sense.

The only thing I was trying to convey there is that we don't limit ourselves to 100 million or $200 million acquisitions ,and if a sizeable opportunity presented itself we don't feel constrained by that.

I certainly wasn't trying to telegraph anything more or anything less from that, Glenn.

And, it is not different than our position has been in the past.

Thank you so much.

You bet.

The next question is from Barbara Ryan of Deutsche Banc.

Go ahead.

Good morning, and thanks for taking my question.

I was wondering -- in the signing of the new fee-for-service arrangements, particularly with the larger companies that you have been recently doing -- can you give us some sense of what the changes are in terms of the amount of inventory on hand in those?

And, I recognize that obviously they are a blend and each one of them may have individual items that vary from contract to contract.

But, I know Pfizer has said that their levels are now at about 2.2 weeks which is, at least, they are saying what they have been for quite sometime.

The Merck-Schering joint venture this morning stated that they had made some changes due to new agreements where they took down inventory.

And, I was just wondering if perhaps you could give a sense of perhaps a year ago where sort of average inventory levels were and where they may be now in terms of inventory on hand in the trade.

Thanks.

Barbara, this is Mike.

Hi, Mike.

Some of these agreements are -- obviously does differ from manufacturer to manufacturer so it is tough to make generalizations.

A lot of the inventory movement happened as we had gone from the buy and hold to the IMAs.

A typical IMA might have been four or five weeks of inventory on hand, 30 days or so.

Certainly, that range is not -- is something that we were incented to maximize under the IMA model because we were going continue to get paid for price increases.

As we move to the fee-for-service model and the compensation becomes more non-contingent, I think even where there are agreements that allow us to have 30 days or so of inventory, we are more incented to lower those levels to a level where we think we can serve our customers and meet our service level requirements which we think is well less than that 30 day for a lot of the large branded manufacturers.

So, in some of these agreements again you may see three weeks on hand.

You may see less than that with a particular one, and you may see more.

A lot of it also is based on what the manufacturer wants to be out in the marketplace.

And, some are more adverse to risk than others and like to have a larger amount out there than we necessarily would think we would need on a daily basis to serve the customer.

I think Barbara, it is not unreasonable to expect that over time as we get fully into the fee-for-service that our inventories will click down and, as Mike talked about, we are laying at 45 days or so now.

Over the next year or two, it is not unreasonable to expect that to go down by several days.

Okay, thanks.

You bet.

The next question is from Chris McFadden,Goldman Sachs.

Please go ahead.

Thank you and good morning.

You have mentioned a couple of times on this call and on previous calls that you are going through a process of identifying profitability by account with the idea of enhancing the profitability of those accounts or those customers that are underperforming to your new margin environment.

Two related questions.

Could you give us an estimate of what sales volume of your customer base you don't think is presently meeting some of the margin targets you would like to see for those customers?

And, could you comment as to whether or not your think your larger mail-order PBM customer is meeting those margin targets?

Thanks.

Chris, it's Kurt.

I will step into this a little bit and maybe Mike and Dave can chime in here.

I think we are reluctant to give you a dollar estimate in terms of where we are here.

But, what is clear just in terms of the transition we are going through is that for many, many years every customer tended to be a good customer because he gave you an excuse to buy an inflating asset and enjoy price appreciation.

Obviously, that has changed pretty dramatically in a fee-for-service world.

And so, we have got visibility to that model change and we are trying to anticipate how the existing customer contract is going to function in the fee-for-service world and get ahead of the changes.

And we have some customers that, when you put it through that lens, aren't profitable.

We have some that don't meet minimum profitability requirements and those are the ones we are targeting pretty aggressively here in '05.

One of the things I think we are pleased about when we look at the revenue performance for the company this quarter is that that is despite the fact that we have -- in fact, have called a fair amount of accounts out of system and that has been additive to our gross margin for the business while we continue to grow the business at a pretty healthy rate.

We are pretty happy about that.

The only thing I would say about our large mail order customers -- they are a very valuable customer to us.

We very much enjoy our relationship with them and we are very honored that they would like to do business with us and we are going to do everything we can to keep them pleased and happy by being serviced by ABC.

We clearly would be uncomfortable talking about the specific profit contribution of any customer.

The other thing I would just add to Kurt's comment is that our first objective with unprofitable customers is try to make them profitable.

So it is not kind of like our way or the highway.

We try to work with them to bring them up to profitability and there's sometimes you just can't get it there.

And as Kurt said, at that point we have the discipline to walk away from it and we have begun doing that.

Thanks.

The next question is from Andrew Speller,A.G.

Edwards.

Please go ahead.

Thanks, good morning.

I want to follow-up on one of Lisa's questions that she asked about -- I am going ask this kind of a different way.

Your operating margin expectation of 0 to 30 basis points for '06 --can you give me a sense of how much of that is going be increase in gross profit versus what I think -- we are all kind of thinking here -- that your operating expense dollars are going to get a fair amount of leverage from the Optimize program.

Can you just give me a sense of -- either at the low end or high end -- where that breakout is going come in terms of improvement?

Andy, I don't think we want to get into the detail between the gross profit and expense elements.

The key to us is that there is really a four-prong program here.

As Kurt talked about, transform affecting or addressing the customer profitability issues -- Optimize again, which is going to be very active again next year and is going to provide us some of those expense-leverage opportunities that you have talked about as well as our continued success with our generic opportunities and, finally, our fee-for-service.

Obviously, three of the four of those things are gross-profit related.

You know, one is expense-related.

And I think, at this point, it would be hard to detail out certainly as we give our guidance next quarter.

Again, we may be able to refine that somewhat.

Okay.

Then okay.

And then, your comments with share repurchase, it seems -- looks like you are pushing that out a little farther than what you had stated previously.

Or, with the stock price up here, are you guys still looking to complete half of the 450 by the end of this fiscal year?

No, I don't think we have pushed it out.

I think, when we announced it, we said we would complete it by the end of fiscal '06 with approximately half done expected to be at fiscal '05.

And, I don't think those expectations have changed at all.

Thanks.

You bet.

The next question is from Andrew Weinberger, Bear Stearns.

Please go ahead.

Two quick questions.

One on PharMerica.

Just going back, probably, two years ago I think you guys were pretty insistent that the way to really drive value in that business is adding scale.

And, it doesn't seem like there is a lot of entities there.

I know you are investing a lot there, but does PharMerica really have to remain a part of ABC?

As sort of a long-term growth rate it looks like it is going to continue to be below the core business.

And then, a quick follow-up after that.

Maybe I'll deal with the scale issue Andrew, it is Kurt, and then Dave can deal with whether it belongs as part of the portfolio of ABC.

I think your observation is a good one in that it is a scale business.

It is not unlike drug distribution.

The name of the game is getting as many scripts in this case through that network of pharmacies as we possibly can.

But that is not the only way to compete in that business.

What we do have in front of us right now is a situation where we have got a competitor that is five times our size and so catching up from a scale standpoint is going to be difficult.

So we are going to need to compete on quality.

We are going to need to compete on service excellence.

We are going to need to compete on innovation and providing more tools to our nursing home customers so they can do their jobs better.

All of this, I think, is going to be augmented by the new world of MMA.

We think there are lot of opportunities there.

And just lastly, we think we have got a unique opportunity here in the next year or two to win some share as being the alternative national provider in the marketplace.

So, we are investing anticipating bluer skies here in the coming year or two and are kind of optimistic about the business.

Dave, I don't --

I would say, Andy, we remain unchanged where we think PharMerica fits into our business.

We like the long-term care business.

It is a logical extension of our distribution business.

It gives us real traction on our generic program and on the automation programs and some of the other value-added programs.

It enhances our relationship with the brand name manufacturers.

We think it is a good space to be in and, as Kurt pointed out, we think our opportunities right now are as good as they have been in that business for the last several years.

Great, thanks.

And, a quick follow-up.

As you contemplate potentially raising the dividend, it seems like you have a pretty good understanding as to what the normalized cash flow of the business is.

Can you help us understand how we should think about that -- exiting this business model transition with the working capital coming out of the business -- where the normalized level of cash flow is in '06 and if that sort of reappears in '06?

Just on the dividend, Andy, let me just say that is something that we review with our board every year -- on a very regular basis.

We will do that again in '06 and take a look at our dividend versus our peers versus expectations and the like.

In terms of cash flow, Mike, do you want to --

I think, Andy, over the past couple of years we started out by giving cash flow guidance in the 350 to 450 or 375 to 475 range which we feel approximates the normalized level of cash flow that this business is going to generate which is a little bit of net income plus the non-cash items adjusted slightly for the working capital requirements of the new business.

Certainly, that has been augmented these past two years by the business model transition and, as we look to '06, again I think as we have signaled we think there is a little bit more inventory to come out of this system and therefore our expectation is for the next couple of years that we certainly won't be below where our net income expectations are as far as cash flow.

In deference to everyone's time how about if we take one more question here.

Our next question is from Eric Coldwell, Robert W. Baird.

Please go ahead.

Thanks very much.

Specialty group's clearly having a blowout year -- ahead of expectations and it is exciting to see that At the same time, on June 30 the GAO report came out suggesting that Centers for Medicare Services is considering, or should be considering, reimbursement to outpatient hospitals at much lower levels given oncology and IV/IG drugs in some cases being reimbursed at greater than five times average acquisition cost.

I guess the question is -- with another round of reimbursement policy changes in January, I just want to make sure that we are not getting lulled to sleep with fiscal '05 results as we move into fiscal '06 and if you could add any more color on what you see on the reimbursement horizon.

Thanks.

Well, Eric, number one we are not getting lulled into a false sense of security here and your point is a good one.

We have got to really keep our eye on this whole oncology reimbursement and we have tried to note that in the comments that we have.

I would say that you may recall we entered '05 on a very cautionary note because we weren't exactly sure with the change in reimbursements that occurred in January '05 -- how that would shake out.

At this point, halfway through the year, it has not resulted in any dramatic shifts in the dispensing of product.

But, you are absolutely right -- changes again January the 1st.

We are -- the only thing I can tell you, Erik, is we are watching closely.

We are clearly involved with the dialogues at all levels in Washington and we are putting in a considerable amount of time and effort not only to understand the enhanced or the new reimbursement but also to make sure that the pharmacists' and physicians' position is well presented and well understood with the policymakers.

The only thing I can tell you is that it will be one of the issues as we shape our '06 that will take place and it is one of the reasons why we are reluctant to get too far out ahead of our estimates in '06 because that is one of the things we want to get more clarity on when we look at it '06.

That is great.

I just wanted to ask a follow-up.

Obviously, you guts were very conservative in your approach to fiscal '05 guidance in that regard -- related to that business when you first provided it.

With the initial guidance that you have given for fiscal '06, can we assume that you have also been fairly conservative in your specialty group assumptions given those uncertainties?

I think that is fair, Eric.

The truth of the matter is we are conservative group, and that is fair.

Thanks a lot.

Thanks very much for joining us.

In the interests of time, I think we will shut it off.

We want to tell you that we continue to appreciate your continued interest in AmerisourceBergen.

We continue to remain enthusiastic about our industry, very enthusiastic about the role we play into it.

We look forward to sharing with you our results for the fiscal year the late part of November and at that time we will update you with our guidance for '06.

Thank you very much.

Ladies and gentlemen, that does conclude your conference.

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