美源伯根 (ABC) 2005 Q4 法說會逐字稿

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

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

Later, we'll conduct a question-and-answer session, instructions will be given at that time. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded.

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

Please go ahead.

Good morning, everybody.

Welcome to AmeriSourceBergen's conference call covering fiscal 2005 year end and fourth quarter results.

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

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

We remind you that there are many risk factors that can 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 here is Dave Yost, AmeriSourceBergen's CEO to begin our remarks.

Good morning and thank you for joining us.

Our fourth quarter and our guidance for fiscal '06 reflect our hard work in a tough '05 transition year, and our confidence in a stable and improved 2006.

As noted in our press release this morning, we had record operating revenues in the September quarter of almost $13 billion, and had record operating revenues for the year of over $50 billion.

In the quarter, EPS from continuing operations was $0.95, excluding net special items.

We generated a record $1.5 billion of cash for our fiscal year ended in September.

AmeriSourceBergen has unprecedented financial leverage and flexibility, as we move forward.

Net of a large customer loss, which we annualized in August, our pharmaceutical distribution operating revenues in the fourth quarter were in high-single digits, with continuing strong contribution from our Specialty group.

We began our new fiscal year on October 1, with a lot of very positive momentum.

I would like to use my time this morning to address several industry issues, and then set the stage for '06, which will be the focus of our call today.

First, I would describe our industry, the $250 billion pharmaceutical distribution industry, as stable.

We have no multi-billion dollar contracts up for award, and there have been minimal customer changes within the industry.

It is important to note that ABC enjoys less customer concentration than our peers.

While buying group contracts have been in play of late, it is important to know that these contracts are not definitive, and usually represent a license to hunt.

The receivable and final relationship is with the individual account, and often there is a separate contract with the individual account.

The industry's response to Katrina was noteworthy.

Within days, ABC began delivering truckloads, and millions of dollars of supplies to those impacted.

In addition, our employees donated several hundred thousand dollars individually, matched dollar-for-dollar by the Company.

So that I was able to present a check of more than $700,000 to the American Red Cross, in addition to the product.

This was on top of our tsunami relief efforts.

The industry continues to provide the safest and most secure pharmaceutical delivery system in the world.

On October 1, ABC took a leadership position within the industry, in further securing the safety of the U.S. supply channel, when we announced that going forward, we will buy pharmaceutical products, branded and generic, only from the manufacturer.

Though less than 0.5% of our pharmaceutical purchases were coming from authorized distributors, and the rest from manufacturers, this additional step further ensures the security of the distribution system, and provides both our suppliers and dispensing customers additional comfort.

At the recent annual meeting of the Healthcare Distribution Management Association, our trade association, our manufactured trading partners were overwhelmingly supportive of our new policy.

That meeting was expertly chaired by Kurt in his role as Chairman of HDMA, and the industry has benefited greatly from Kurt's leadership in that role.

The final industry issue I will mention is, the Medicare Modernization Act, or MMA, due to take effect January 1, 2006.

We think that the effects will be felt over time for the bulk of our business, though we may have a near-term effect in our PharMerica long-term care business.

MMA will provide increased attention to the dispensing of generics, important for the industry, with a large number of patent expirations occurring in the latter part of fiscal '06, and a particular plus for ABC, due to our customer mix.

As you will recall, the cap program of MMA, Competitive Acquisition Program, dealing with oncology distribution and reimbursement, has been delayed to July 1, 2006.

CMS announced refinements to the CAP program yesterday, and though we have not had an opportunity to study the details, we're very encouraged that CMS seems to have addressed most of our original concerns.

Now some specifics about ABC.

First, we acquired a Canadian wholesaler, Trent, in early October.

Canada is a logical extension of our distribution network, and we could not be more excited about the Trent leadership and associates, their momentum, and customer relationships.

The initial reaction of our entry into the market has been extremely positive.

Trent is currently the third largest Canadian wholesaler with revenues of over US$500 million, and a strong relationship with independent retailers.

We're optimistic that our retail programs, supplier relationships, distribution expertise, and strong balance sheet will enhance their momentum.

We think we have a great opportunity to learn from each other.

Second, our fee-for-service relationships are about solidified, in accordance with the schedule we communicated over a year ago.

While we have a handful of contracts to finalize, by the end of this December, in FY '06, we expect more than 75% of the drug companies' brand name manufacturing gross margin, to no longer be contingent on price increases.

There will continue to be impacts from the timing and size of price increases, but decidedly less than in the past.

Significantly, many of our agreements are performance-based.

Our generic business continues to be robust, enhancing our operating margins, though pressuring our operating revenues.

Though the largest brand name to generic conversions will occur this summer toward the end of our fiscal year, our pro-gen program. and the growing use of generics provides us excellent positioning.

Our investment in our distribution network through our optimized program,, continues to gain traction and in '06 we'll continue to benefit from our efforts.

You may recall that four years ago, we laid out our optimized program of consolidation and efficiency improvements, and we're on-schedule and on-budget as Kurt will detail.

Regarding our use of cash.

AmeriSourceBergen has currently about $1.3 billion in cash on its balance sheet.

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

Our past performance should be a good predictor of future activity.

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

We have an active corporate development program, and continue to search for 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.

We all run companies in the pharmaceutical supply channel with operational and/or managerial synergies, with attractive growth prospects and good margins, were a strong pathway to that criteria.

We will continue to identify opportunities, such as Trent, and when available, we'll act quickly and decisively.

We will review our dividend policy in FY '06 with our Board as we do every year.

We continue to expect to repurchase approximately 400 to $450 million of ABC stock by the end of fiscal '06.

I can assure you we will continue to be very disciplined in our use of cash, as we are in our operations.

Before Mike and Kurt drill down on specifics, let me share with you my optimism for FY '06.

First, we operate in a stable and growing market.

We have good sales momentum, in both the drug companies and specialty distribution.

We have moved into a new market, Canada.

Our generic program is robust, and should gain traction throughout the year.

We have an excellent history of operational execution.

Our fee-for-service negotiations are essentially behind us.

PharMerica will continue to have some significant challenges, but we continue to be optimistic regarding customer opportunities, resulting from Omnicare's acquisition of NeighborCare.

For FY '06, we expect to grow our revenues in the 6 to 8% range, in-line with our expectation of market growth, and we see diluted EPS in the $3.95 to $4.25 range including the impact of expensing stock options.

Here's Kurt.

Thanks, Dave.

Good morning, everyone.

This morning, I'll provide a few highlights from the fourth quarter and discuss of some the key focus areas and goals we have, for each of our business groups in the upcoming year.

As be a overall theme, our results were led by an improved performance in our pharmaceutical distribution segment, with consolidated results at the high end of our internal expectations, despite a poor performance in our PharMerica business, which I'll address later in my comments.

Performance in our drug distribution business was driven largely by an improved gross margin, as the key initiatives we've been highlighting throughout the year, began to bear some fruit.

As Dave mentioned, we're in the final stages of our fee-for-service negotiations with our brand manufacture partners.

These efforts benefited the quarter, and will lead to greater earnings stability, and improved returns going forward.

Also, our other key initiatives under the Transform program, drove improved customer profitability, pricing discipline, and contract compliance, particularly in the area of generics.

Added to the quarter, and will be important foundational work for improved margin performance in 2006.

We also saw the return to solid top-line growth with the right customers.

Those that need and value our services most highly.

Early last week, we made an 8K filing regarding a decision by a group purchasing organization for a large number of independent pharmacies we serve, to do business with another distributor.

As we indicated in the filing, we expect to keep the substantial majority of these customers.

Many of the accounts are Good Neighbor Pharmacies, or use other ABC programs, such as Diabetes Shoppe and Performance Plus Network, our managed care adjudication solution.

Because of the strengths of these programs, most of the member pharmacies have already indicated they will stay with ABC.

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

The optimized programs continued on-schedule and on-budget.

During the fourth quarter, we consolidated three distribution centers.

Meeting our goal of six for the year, and setting the stage for solid efficiency gains in 2006.

Looking ahead, we will open the last two of our six new state-of-the-art Greenfield facilities in 2006.

Kansas City became fully operational in the month of October on-schedule and on-budget, and our sixth and final Greenfield in Bethlehem, Pennsylvania, remains on-track to be fully operational in the spring.

As these facilities come on-line, we will continue to consolidate our older, less efficient facilities, with six more consolidations scheduled for 2006.

At the end of fiscal 2005, the distribution center network for the U.S. operations of the drug company consisted of 32 facilities.

And is projected to be 28 by the end of fiscal year 2006. 32 plus the 2 Greenfields, less the 6 consolidations.

We anticipate getting to final state in 2007 with a small number of additional consolidations for a final network in the mid 20s, down from 51 at the time of the AmeriSourceBergen merger in late 2001.

The other components of the optimized program remain on-track as well.

With an accelerated roll-out of our new warehouse management system in 2006.

In addition, the outsourcing of our IT infrastructure and core business applications to IBM occurred smoothly in the September quarter.

This, in combination with completing our migration to one I.T. platform in the drug company early next calendar year, will allow us to reduce costs and invest in new capabilities, to improve the quality and availability of information to our customers and manufacturers alike.

So, putting this all together, we see a continued strengthening in the financial performance of the drug company in 2006, driven by more stable gross margins, and improved operational efficiencies driven to optimize, and the resumption of attractive top-line growth.

Now, let me turn to the Specialty Group.

The group had another excellent quarter of strong sequential growth in both revenues and operating earnings, exceeding our internal expectations, and finished the year with annualized operating revenue greater than $7 billion.

Standout performances occurred at the units oncology-related businesses and plasma business unit, as well as our manufactured services units, LASH, ICS, and iMedix.

Looking forward, we anticipate another solid year performance by the Specialty Group in 2006.

The Packaging Group enters 2006 with solid momentum at both American Health Packaging and Anderson Packaging.

The Packaging Group exceeded our internal expectations in the quarter, as well as for the year, as both operating companies increased -- with increasing share in higher margin business lines.

At Anderson Packaging, over 50% of the 15 programs launched for branded pharmaceutical manufacturers during fiscal 2005, were in compliance prompting designs, including two of the four launched during the fourth quarter.

At American Health Packaging, 17 new items were launched in the quarter, in support of their mission to supply products in packaging tailored to the specific needs of providers.

This helps satisfy the needs of pharmacies for increased internal efficiency, and improved patient outcomes, while allowing manufacturers to differentiate their products in the market place.

Finally, during the quarter, the group successfully tested RFID labeled products, and developed product serialization concepts to establish the base for future product authentication offerings, in support of product integrity and patient safety.

Now, turning to PharMerica, which had another difficult quarter, revenues were up slightly, due to better customer retention and new business wins, in both the long-term care and workers compensation business units.

However, operating income was down versus both year-ago levels and sequentially, primarily due to a gross margin decline from competitive and reimbursement pressures.

Most of the operating income shortfall occurred in our long-term care business unit.

As we have looked at 2006, we continue to believe that there is a clear role for an alternative national provider in the long-term car marketplace.

On the positive side, we're clearly seeing some new customer opportunities open up, and we plan to aggressively pursue those in the coming year.

However, to be successful over the long-term, our long-term care pharmacy business will need to develop a differentiated strategy from its largest competitor.

There is a need for a pharmacy services provider that places its nursing home patients first, and is committed to fast, customized responsiveness to the needs of the nursing home provider.

We see a clear opportunity for improved connectivity and transparency, from our pharmacies to the home, and are actively testing new solutions.

This is a marketplace devoid of many of the technology tools at work in other provider settings served by ABC.

In 2005, we introduced with great success, a handful of customer facing technologies from other parts of ABC.

These new interface technologies drove efficiencies in our operations, and in the nursing homes.

We'll continue to invest inside our pharmacies with new automated capabilities to further reduce our costs in 2006.

With regard to MMA, our long-term care business completed its negotiations with TDP contracting entities during the fourth quarter.

And we're now confident that our reimbursement for dispensing and related services will not be hurt by the change in part D.

As a result, these contracts are expected to have a neutral impact on the Company's revenues and gross margin in 2006.

Importantly, PharMerica's PDP contracting strategy has been customer-driven, meaning we have contracted broadly, so that we can serve all of our customers and patients without interruption.

This broad approach will allow PharMerica to offer its nursing home provider customers, the ability to provide continuity of care for their patients, by maintaining access to and the clinical efficacy of, a patient's existing drug regimen.

This is a distinctly different approach than that taken by our largest competitor.

Looking ahead, long-term care is now actively engaged in negotiations with pharmaceutical manufacturers, to secure rebate-driven contracts for products that offer both clinical and are cost containment advantages to their patients and payors.

Importantly, it is now clear that a Safe Harbor exists for manufacturers to provide rebates to long-term care pharmacies under part D, and long-term care can still influence patient care, through comprehensive drug regimen reviews, and therapeutic interchange programs.

However, the profit contribution from these activities will remain uncertain until two things occur.

First, negotiation with manufacturers are complete, and second the final mix of PDP entities serving Pharmerica's patient base is known.

Based on what we know now, we expect to have clarity on this issue by the end of the second fiscal quarter.

Let me close by saying that 2005 was clearly a challenging year as we both transitioned and continued to invest in our various businesses.

Importantly, we entered 2006 having made significant progress on our key management initiatives this past year, and remain confident in the attractive long-term growth dynamics of the markets we serve.

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

My discussion of the quarter will focus on results talk about our continued positive balance sheet and cash flow trends, including our recent refinancing, and provide some more color on our fiscal '06 guidance.

My discussion of the quarter will focus on our results from continuing operations, excluding the charge for our early retirement of debt which as expected, was $70.8 million, net of tax, or $0.68 per share.

And also before our facility consolidation and employee severance costs, which were $7.4 million net of tax, or $0.07 per share in the quarter.

Note that the majority of these facility costs were related to our I.T. outsourcing transition as expected, but were not offset as expected by the receipt of an antitrust litigation settlement from a manufacturer, which we actually received in the first week of October and accordingly, will record the benefit in the first quarter of fiscal 2006.

Now, starting with our consolidated results, operating revenue was a record $13 billion, up over $360 million sequentially.

And up 7% over the prior year quarter, driven by our pharmaceutical distribution segment.

Operating income was down 6% from the prior year as an increase in the pharmaceutical distribution segment EBIT was offset by a decline in PharMerica.

You may remember that in the prior year fourth quarter, PharMerica benefited by a $12 million reduction in their sales tax expense.

Consolidated EBIT was also adversely impacted by $6 million in the current quarter by Hurricanes Katrina and Rita, reflecting our cash and product donations, asset damage, and increases in receivable reserves for affected customers.

Net interest expense for the quarter was once again a record low at $9.4 million, down over 60% from last year's $23.5 million, reflecting the financial leverage from our net debt reduction over the last year, and for the second consecutive quarter our invested cash on average, was greater than our average borrowings.

Our GAAP effective tax rate in the quarter was 38.3%, and for the year was 37.7%.

Note that the tax rate applied to the early retirement of debt was 36.1% as those costs are not deductible in certain states.

Excluding our special items in the quarter, our effective tax rate bass 36.6% which benefited us by about $2 million, or $0.02 in the quarter.

We continue to expect the tax rate in the range of 38% going forward.

Diluted EPS from continuing operations before the debt retirement and facility consolidation costs of $0.95 increased by $0.11, or 13% from the prior year on a comparable basis, mainly due to the impact of our financial leverage.

This leverage is evidenced in both the significantly reduced interest expense, and the significant reduction in average diluted shares outstanding, which were down by over 12 million shares from the prior year to 104.8 million shares for the current quarter.

Our share count for the quarter was slightly higher than we expected, due to the impact of significant option exercises, and less than expected share repurchase activity, as we were effectively restricted from purchasing shares in the quarter, due to the refinancing transaction, and the Trent acquisition.

As of the end of September, we have 104.9 million common shares outstanding.

Moving to the Pharmaceutical Distribution segment, which continues to show positive momentum, resulting from a lot of hard work during a tough transition year, operating revenue for the segment was $12.8 billion for the quarter, an increase of 7% compared to the prior year. 9% adjusting for the impact of the Advanced PCS business, which we anniversaried in August.

The customer mix in the quarter was 59% institutional and 41% retail, with the majority of our growth in the quarter coming from the institutional side, driven by our Specialty group.

Importantly, Pharmaceutical Distribution gross margins increased 8 basis points compared to the prior year quarter, as solid progress continues to be made with our fee-for-service contracts as Kurt mentioned earlier, and we also felt the positive impact of our Transform and generic initiatives during the quarter.

We had a $15 million LIFO credit in the quarter, down from the $27 million credit in the prior year quarter, and for the year our LIFO credit was $4 million, primarily as a result of our reduced inventory levels.

Operating expenses as a percentage of revenue were 2.02%, up 9 basis points from the prior year, primarily due to a $10 million increase in bad debt expenses, at one of our Specialty group units.

Our operating margin in the quarter fell 2 basis points to 118 basis points, primarily as a result of the expense increase I just mentioned.

Turning to PharMerica.

As Kurt mentioned, revenues exceeded $400 million for the first time this year, and we were up 3% compared to last year.

We were disappointed with operating margins that were down significantly from the prior year, as gross margins continue to decline as a result of competitive and reimbursement pressures, and operating expenses were up significantly compared to last year, again primarily as a result of the prior year quarter's expenses, which were favorably impacted by a $12 million reduction in sales and use tax expense.

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

We continue to feel the benefits of the changing business model as cash generated from operations in the quarter was $276 million bringing total operating cash generation for the fiscal year to a robust $1.5 billion, which was above the high end of our range of 1.1 to $1.3 billion.

As inventories fell to the low end of our range at $4 billion as of the end of September.

During the quarter, we successfully tendered for and retired our $500 million 8.125% bonds and our $300 million 7.25% bonds, replacing them with the issuance of two new bonds, a $400 million 7-year bond at an effective rate of 5.71%, and a 10-year, $500 million bond with an effective rate of 5.94%.

These new bonds issued at historically low rates will provide us with both great interest savings, and increased financial flexibility going forward, and we couldn't be more pleased with our execution on these transactions.

In fact, during fiscal 2005, we either paid off, refinanced, or amended each debt instrument that we had, simplifying our capital structure, lowering our financing costs, and increasing our flexibility.

As a result of the debt refinancing, we were able to raise the remaining amounts authorized under our share repurchase program to $750 million, which is the amount available at the end of September.

Cap Ex for the quarter was $40 million, and for the year was $203 million, in-line with our guidance.

Our debt-to-capital ratio at the end of September was a low 18%.

Down from 25% last year, and with the cash balance at the end of the year of over $1.3 billion, our net debt-to-capital ratio was less than zero once again.

Obviously, this is below our target, 30 to 35%.

Debt-to-capital ratio providing us with continued flexibility, and significant opportunity to deploy capital.

The remaining capital will be available for internal investment, 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 32 days, down 11 days from a year ago, and down 18 days from two years ago, and DSOs continued to be very strong at 16.5 days.

Now, turning to our guidance for fiscal '06, as Dave mentioned, we expect operating revenue to be in the 6% to 8% range, and diluted EPS to be in the range of $3.95 to $4.25 per share.

Our revenue guidance, assumes a 1% benefit from our Trent acquisition, our EPS guidance includes the impact of equity compensation expenses, expected to be a charge of approximately $0.09 per share in fiscal '06.

Additionally, it assumes facility consolidation and employee severance costs, will be offset by anticipated litigation recoveries during '06.

Our EPS guidance also assumes that we will buy back approximately 400 to $450 million worth of our shares by the end of fiscal 2006.

Also, as you know, we do not give quarterly guidance, but we would expect our first fiscal quarter EPS, to be below the average quarter for fiscal '06.

From an operating margin perspective, in pharmaceutical distribution, we would expect a range of 115 to 125 basis points, which compares to the 108 basis points we had in fiscal '05.

In PharMerica, we would expect our operating margin to be in the mid 5% range.

While we do not give gross margin or operating expense guidance, I will note that in Pharmaceutical Distribution, more of the increase expected in EBIT margin between years, is gross margin-related than expense driven, as we continue to make investments for the future, particularly in our I.T. and sales and marketing infrastructures.

From a balance sheet and cash flow standpoint, we would expect to have cash flow from operations in the 500 to $600 million range, as inventories are expected to continue to be in the low to mid $4 billion range in fiscal '06.

Said another way, we do not expect in '06 to have a repeat of the significant reductions experienced over the last two years in inventory, as we have largely completed our move to the fee-for-service model, and would expect future operating cash flows to more closely track net income.

And finally, we expect CapEx to be in the range of 125 million to $150 million in '06.

As we look forward, we continue to be very excited about the industry and our prospects, and feel that we have great momentum, as we begin to realize the benefits of our labor over the last 12 months.

With that, I'll turn it over to Mike Kilpatric for a few additional comments.

Thank you, Mike.

We'll now open the call to questions.

I would ask you to limit yourself to one question, until we've had an opportunity for people to ask, and then we'll return to you.

Go ahead, Stacy.

Thank you [OPERATOR INSTRUCTIONS] First question, we'll go to the line of Larry Marsh, Lehman Brothers.

Please go ahead.

Okay, great, thanks.

Thanks for all of the detail.

My question is, to get you to drill down a little bit on PharMerica, Kurt.

Obviously you're guiding down a little bit on the margin this year, and you talked about you now have pretty good confidence about the margin and revenues, with your negotiations with the PDPs under Part D.

I think you also said that the profit contribution from your manufacturer rebates are still a little uncertain.

And you'll know more by the middle of next year.

Maybe reconcile those two statements, and is that some of that uncertainty why you're giving some guidance of down margins this year?

Your spot on Larry, that's exactly where we are.

We're just being cautious here, in terms of the performance for that business unit next year.

You know, we're in the early stages of these discussions with the manufacturers and we'll just to see the outcome.

We wanted to highlight for the investment community, it is an open item.

We didn't want to get expectations out ahead of what we thought made sense, and you know, it is in keeping with our style here as a management team.

Just a follow-up with that.

Are you communicating that you would like PharMerica to move in a new direction or do you feel like it is already differentiated versus its biggest competitor, and let me also address the obvious question of, you know, your biggest customer could be under different management, you know, where do you see that relationship going, if they were to change management?

Appreciate that.

I would say the model change I spoke about today has been in the works for about a year, year and a half.

We've been kind of headed in this direction.

I think what we've come to conclude now, is that we need to push a little harder with the group, and push for a little bit more change, and frankly we're hearing from the marketplace, that we want to have a different type of service provider made available to them in the marketplace.

So, we're bullish on the market prospects, and what we've got to do now is write the more definitive plans, to get that model in place more quickly.

That's what I'm working on the team for, which is really why we look at '06 as a transition year.

As it relates to the Beverly, you know, we've got what we consider to be a very solid relationship with that organization, it has been long-standing, as you know, and we've got every confidence that we'll continue to have that relationship, as part of our PharMerica business unit for a number of years to come.

So, we're looking forward to continuing to build our business model out with them.

They've been very interested and intrigued by of some our plans, and so we'll keep that relationship going.

Thank you.

Next question, please, Stacy.

We'll go to Tom Gallucci with Merrill Lynch.

Please go ahead.

Thank you.

Kurt, outlined a number of factors that you see driving margin expansion next year.

Whether it is D.C. consolidation or generics, the stabilization of the model relative to new fee-for-service type deals, et cetera.

It looks like you're looking for 10 to 20 basis points in round numbers of margin improvement, can you help us maybe size the buckets of opportunities in each of those area us that mentioned?

The relative magnitude to drive the consolidated improvement?

Appreciate that, Tom.

I'll let Mike field that one.

Yes, Tom, I don't think we're going to get into breaking down the benefit from each of the initiatives.

As we've talked about often, you know in '05, we embarked on a number of initiatives whether with our Transform program, our Optimiz program, our generic initiatives, and our fee-for-service initiatives.

And we think all of those initiatives have been hugely successful.

And you know, we expect to get the full benefit from those initiatives as we move forward, and some of that is reflected in '06 and I think some of that is going to continue in '07.

I go to an extreme and say that some of those initiatives have been so successful, we're going to continue to make investments in '06, to those initiatives which will help turn some of those project type initiatives into ongoing sustainable business processes as we go forward.

In terms of the fee for service deals, you're kind of implying that maybe some things get better in '07.

Do they also have escalators over time, or can you give more color on that aspect of it?

Tom, it is Kurt.

Yes, some of them in fact do have escalators over time, which gives us some confidence in the out years, '07 and '08.

Some of them, which was to our design and our liking, are performance based.

We have the opportunity to drive more income for us if we perform what we've committed to very, very well.

We're confident with our execution capabilities that we can drive more profitability for the company going forward.

Thank you, Tom.

Stacy, next question please.

We'll go to the line of Lisa Gill with J.P. Morgan.

Good morning.

I was wondering if we could just talk a little bit about generics, and the impact in the quarter, as well as the impact going into 2006.

Obviously you have a strong, independent base and generally speaking, we see better margins with the independents, and then secondly, I was wondering, Dave or Kurt, if maybe you want to talk about what you think is the long-term sustainable growth rate for a company like an AmeriSourceBergen?

Obviously you've had a couple of tough, challenging years, and 2006 looks like it is really going to be the turnaround year.

Where do you think things can go over '07, '08 not to get too specific on numbers, but maybe an overlying growth rate prospects?

Thanks.

Lisa, it is Dave.

I'll start off with our long-term goal is to grow our EPS at 15%, and grow our revenues with the market.

Now, as the market slows down, you know, over time in outlying years, that could impact that 15%.

We've not taken our eye off that goal.

In terms of generics, we continue to be very excited about the opportunities for generics.

They're really back-end loaded.

The really big products are coming off patents the latter part of our fiscal year, which is summer.

Which we think is going to give us good opportunities as we set up '07, to finish out the year.

So, it is really back-end loaded.

But also as I mentioned in my prepared comments, we think the Medicare Modernization Act is going to put a lot of emphasis on generics, which we think is great.

The customer base we have, which is largely skewed toward independents and regional chains who rely upon us for their generic decisions, we think will help us going forward.

So, kind of a concisely impact on our operating margin, but very attractive impact on our gross margins going forward.

That was one of the items that Mike mentioned.

Can you give us any kind of metric around that, Dave?

Is there a certain percentage that you can tell us, as far as who's buying their generics for you are all independents buying their generics from you?

Is it, 90% of them just so we have an idea?

Let me just tell you, it is a metric I track closely.

I mean, I'm not comfortable sharing with you.

It is one of the metrics that Kurt, Mike and I really look at on a daily basis.

What our generics are day by day.

We literally look at customer by customer.

Many of our customers have contracts that require them to order percentage of their total volume in generics.

So we watch it very, very closely.

It is an integral part of our pricing strategy to our customers.

Are you happy with that increase?

I guess just the last part of that -- ?

Yes, the answer Lisa is, yes we are.

I mean I think we shared with the group that we had a new PROGEN program in April 1st, and we've been very, very happy with the traction that we've gotten from that, and have actually picked up some new customers as a result of that.

Great, thanks for the comments.

You bet.

We have a question from Robert Willoughby with Banc of America.

The share repurchase guidance looks like it accounts for about 2/3 or more of the cash you think you'll generate this year, if I'm right.

That still leaves with you over a billion in cash on the balance sheet.

Can you give us a sense -- what is the base need for cash that you need to carry at any point in time on the balance sheet under the new world order?

Yes, Bob, this is Mike.

Typically, our needs from an ongoing perspective is in the couple hundred million dollar range, and I think anything above that is available for future capital deployment.

And I think you categorized it very accurately.

We had a billion three on our balance sheet at the end of the year.

We expect to generate free cash flow and that's 400 to $500 million range during '06, and we've targeted essentially that amount for share repurchase in '06, which still leaves us a great deal of flexibility, some of that we committed, a minor amount of that to the Trent acquisition.

But we continue to have great opportunities for financial leverage beyond what we've announced already.

It seems that maybe it is a huge unanswered question, kind of how that capital might be deployed.

I wonder if at some point you would be forced to give some clearer plans.

I mean you've been helpful to date, but that seems to be a big number that's unexplained.

It is a big number, Bob.

But you know, we want to continue to be, to maintain our flexibility, and be ready to seize upon any opportunities that might avail themselves to us.

So, you know, we don't feel any pressing need to spend that billion dollars down at this point.

And certainly, as short term interest rates rise, it is only a benefit to us in the short term.

So, as Dave said, we'll be disciplined in using that cash.

Thank you, Bob.

Next question, Stacy.

we'll go to the line of Jennifer Hills with Goldman Sachs.

Please go ahead.

Thank you.

Chris McFadden here and good morning, everyone.

I was wondering if you could give us a bit of a breakdown, in terms of the assumptions that lead into the 6 to 8% top line growth forecast, that you provided for the upcoming fiscal year.

You mentioned about 1% from the Canadian acquisition, but I'm wondering if you could detail of some the other assumptions that are embedded in that, including what type of retention rate for the United stores that you have put in the forecast?

Secondly, could you just talk about what is the assumption relative to LIFO adjustments on an F '06 basis?

I'll start out with the United, Chris, we don't like to talk about specific customers but everything we know about the market at this point is embedded in our forecast going forward.

As Kurt mentioned, we expect to keep a substantial majority of that business.

The big impact, you know, that we take into account, we have literally build our model from the ground up.

We visit with individual customers and the like and get a good sense of what's going on out there.

Generics have impacted it.

The other thing that's important to note is the impact of our Specialty business.

Which we mentioned is a $7 billion rate.

We're such a dominant factor in that market, that we're not sure we're going to be able to have that growth, the same sustained rates that it has in the past.

We think the brand name appreciation will be in a 4 to 5% range.

We think a little impact from MMA in the early part of the year.

As far as the LIFO assumption for '06, we would expect a modest charge in the $10 to $15 million range.

A quick follow-up.

Kurt or Dave, you highlighted in your prepared comments the CAP program coming out of CMS.

I know the new details came out late yesterday.

Not a fulsome explanation in terms of the adjustments, but as you think about the broad direction of the CAP program, can you just talk about operationally, some the planning you're doing within the Specialty business to be able to just handle and manage some of the unique requirements that that business will ask of you, compared to the traditional specialty business that you've operated in?

Thank you.

Well, you know, we expect to be integrally involved with the CAP program, Chris.

We were very encouraged by CMS's refinements.

Not to get too specific but you know, they grilled down on several concerns we had.

How new drugs came into the program, newly-approved drugs, what happens with unused drugs.

How the co-pays would be collected, arrangements for that under the physicians.

So, you know, we expect to be actively involved in that program, and we're very encouraged by the fact that the CMS has heard the concerns we had early on.

Thank you, Chris.

Next question, please, Stacy.

We'll go to the line of Andy Speller with A.G. Edwards.

Please go ahead.

What are the assumptions between the high and the low end of the guidance range?

For?

In terms of EPS.

Thank you.

Well, you know, first off, we've got a range for distribution margins.

And from the bottom to the top of that range for distribution margins, you know, certainly can impact that range of EPS, and certainly the timing and the amount of our share repurchase program, Andy, is another example of an item that can produce some variability in those results.

Just to drill down on that a little more in terms of the range on the distribution side, I guess you narrowed that a little bit from where it's been.

Between the high and the low, what are the key things you're looking at there?

Well, again, we've you know, between the high and the low is the benefits that we're going to get from some of the initiatives that we've talked about.

And you know, net of some of the investment that we're going to make as I mentioned to institutionalize of some those initiatives.

So, I think those things can impact.

I think you've got the normal customer mix issues, you know, obviously LIFO is something that can affect that range.

As I've just mentioned, we have a 10 to $15 million expectation within there, and certainly if there's any changes in our stock option, or equity comp program, that can have some effect as well, though I think that's pretty much will be what the range was that we gave for the year.

One last follow-up on the EPS range, you said the first quarter by not giving quarterly guidance would be below the average for I guess the range for the year.

Just trendwise, through the year, can you give us some idea where EPS is going to go on a quarterly basis?

Yes, I think you know, once you get beyond the first quarter, I think you'll have some more uniformity.

Certainly in the first quarter, if you go back to last year, we're anniversarying a quarter that was extremely low from a price appreciation standpoint and historically, has been a quarter that's been pretty low from that standpoint.

So, that's one of the reasons we've directed the guidance down slightly for that first quarter.

Also, as we mentioned, there's still a few fee-for-service agreements that are going to be in during the quarter, and the initiatives we've talked about with Transform, optimize, et cetera, certainly we'll gain more traction as we progress throughout the year.

I think that all of those lead us to think that the first quarter will be a little bit lighter than the average quarter.

Thank you.

Next question, Stacy.

We'll go the to line of Andy Weinberger with Bear Stearns.

Just wanted to follow up, on some the cash flow questions earlier.

With your targeted debt to cap ratio in the mid 30s, it looks like you have almost $3 billion of deployable capital, and you haven't been overly acquisitive over the last four years or so.

I guess, can you discuss any potential plans to increase the dividend.

It seems like you have about $12.50 in cash per share, and another $1.5 billion in borrowing capacity.

The borrowing capacity seems like it more than covers any potential capital deployment initiatives, along with operating cash flow.

As a brief follow-up to that, can you just kind of discuss whether we should expect fiscal '07 cash flow to grow over '06, or is there still a day or so of additional inventory coming out of the '06 number, before you get fully normalized as you fully transition to fee-for-service.

Andy, let me start out with the dividend, and just say we'll review that.

Our Board will review that during fiscal '06 as is reviewed every year.

In terms of acquisitions, what I would point out, Andy, is we have not made a lot of acquisitions, but it is not because we haven't been active in looking at acquisitions.

We've got a very active corporate development program and in many cases, we have seen properties that we were interested in that just got too pricy, really did not make much sense to us.

So, it is not that we're standing on the sidelines.

Because we're not looking at acquisitions.

It is because we're very, very disciplined in price.

When an opportunity like Trent comes along that we think is attractively-priced that meets our criteria, we'll act decisively, as we did on that occasion.

We don't feel any pressure to make acquisitions.

There is clearly none built into our numbers for '06.

As you pointed out, there's not a lot of contribution in previous years to that so that's kind of all upside for us.

Mike, you want to talk about '07?

As far as future cash flows beyond '06, I think our statement that we think cash flow is going to more closely track net income in the future going forward should be that guidance.

Do we see some room to bring inventories down even further.

I think the answer is yes.

But I think that's much more modest improvements than the dramatic change we've seen over the past couple of years.

And for example, we've outlined a number of consolidations that are going to occur, both in fiscal '06, and beyond fiscal '06.

And as we've often said, the fewer distribution centers, the more efficient working capital dynamics.

So, I think there's still some of that ahead of us.

If I could --

Thanks, Andy.

Stacy, next question.

Qe'll go to the line of Eric Coldwell with Baird.

Please go ahead.

Thanks, good morning.

Question relates to sell side pricing.

I know in the prepared comments, management made the comment that sell side profitability overall was up by efficiencies and compliance programs.

I'm hoping you can give us some sense of the actual effective sell side pricing, are sell side margins still coming down, if so, at what rate, and then market pricing overall, what the competitive dynamics are, in terms of sell side nominal distribution fees?

Thanks.

I guess I would say that, you know, we continue to be in a very competitive environment but as I tried to point out in my prepared comments, I think the market is stable.

It doesn't mean that we'll get pressure from time to time.

It doesn't mean that we don't have people looking for better prices, but I would say it is stable.

Pretty much steady as she goes right now.

Clearly our margins are affected by our mix, and we continue to do more and more business with our largest customers, who frequently not only command the best price, but they also have the best operating efficiencies for us.

So, I would see it be stable.

Kurt, anything else?

No.

I think you brought the mix home, that's an important piece of it.

I would agree.

Yes.

Thanks, Eric.

Next question, please, Stacy.

We'll go to the line of David Veal with Morgan Stanley.

One particular question, on the pricing front.

I wonder if you could talk about the competitive dynamic on the United contract.

Was it price that made that contract go away, or more service?

Based on your comments earlier, it sounds like there are other contracts that may still be up for grabs.

Is that accurate.

If so, when can we expect some resolution on that?

First of all, David, we're not very comfortable talking about specific contracts and why they are awarded or not awarded, the truth is sometimes we don't know why they're awarded or not awarded.

We put forward a very good total program, which includes price and programs and services, and you know, sometimes the account makes the decision to go our way, and sometimes they do not.

The truth of the matter is we're not totally sure on that.

I don't think that implies that there's any -- I don't think anything more should be implied from it from the marketplace from that standpoint.

And we didn't mean to imply that there's any other unusual things happening in the market, in terms of contracts.

In fact, as I tried to point out, we think the market is stable.

There are no multibillion dollar contracts up for bid, and the market is very, very stable.

I think it is important to put in perspective the fact that this is a $250 billion market.

So, when you talk about a billion or even a 2 or $3 billion account, while that's very large in absolute terms, as a percent of the total market, it really is not a very big percentage, and there's not big percentages of the market moving around here.

So, I would continue to characterize it as stable.

Thank you.

Stacy, next question, please.

We'll go to the line of John ransom with Raymond James.

Please go ahead.

Hi, this is more of a longer term conceptual question but clearly, we're in an environment where drug spend is mid single digit and script growth is about 1, and of course you got the branded scripts declining, the generic scripts growing.

You know, as you guys have been in this business a long time, you've kind of taken the big chunk of cost certainly out of the Bergen deal.

But how do you operate in a business like this longer term, and produce the kind of growth rates that you want to produce which would imply, you know, kind of ongoing leverage at the operating margin line?

Thanks.

Well, John, I'll start off.

One of the reasons that we built these large distribution centers is so that we continue to show increased efficiencies as we go forward.

So, that plays a key role in our future, and we're not done there.

Second thing is we'll target specific customers, those who have an appetite for the value-added services that we provide, and we expect to provide more service than simply moving product around.

We'll continue to focus on the elements of the market that we think have the greatest growth potential.

Which include the specialty business and the large number of oncology products and related specialty products coming down the pipe.

We continue to be optimistic about the growth rates of the industry long-term.

And you know, they have slowed down relatively in the last year or so.

But if you take it in an historic context, the pharmaceutical industry has had very robust growth rates and we think that is a good estimate for long-term.

That the consumption of pharmaceuticals is really part of the healthcare solution, not part of the problem.

And that will continue to occur at an increasing rate.

So, we're very bullish on the industry.

And you know, I've had the opportunity of viewing this with, over a 30 year perspective.

As I look out, I continue to be very bullish.

John, this is Craig, I can give you a little different perspective.

I think you're right to point out we've been successful in our driving efficiencies out of the Bergen merger, and we're coming to the next 18 months of getting that out.

But I would think of the channel differently, and that is that while we're efficient, the pharmaceutical supply channel in total, is very inefficient today.

And we bring a lot of capabilities and we'll continue to invest in capabilities that have allowed us to capture some of those inefficiencies, and make the channel more efficient in the years ahead.

So, you know, we have a saying around here, complexity is our friend, that this is a complex supply channel, very difficult for people to get into.

There is a lot of wastage going on in the supply channel, and there are a lot of opportunities for a company like AmeriSourceBergen, to make the entire supply chain more efficient.

That's what we're about.

We're bullish on the long-term as well.

I'll throw in, John, even at the reduced levels of cash flow from the incredible levels we've had in the past couple years, when you're talking free cash flow in the 400 to $500 million range, you're talking several percentage points of financial leverage which I think we'll continue to drive the bottom line faster than that top line growth.

I guess my follow on it is looking at PharMerica, and I'll confess to probably understanding this less than anybody in America, but from what I understand, there is some complexity on the institutional pharmacies to bill some of these PDPs, and have contracts with every PDP in every region that you have to go into, and you know, A, is that accurate?, and B, is the adjudication and contract management process, is that something that is overly high on your radar screen?

Well, you know, I comment a little bit on that, John in my comments.

PharMerica took a different approach than its major competitor here.

We've contracted with every PDP.

We were contracted with PDPs before they were named officially by CMS.

Once the official list was out, we went back and contracted with everybody that we had missed, that had been awarded a PDP status.

We're contracted very broadly.

We're doing that for the benefit of our nursing homes, and the benefit of patient care.

Because we want these patients to continue to get the drug regimens, and the products they've been used to having in the past.

The other piece of it, the adjudication, the administration, we're expert at that.

There's no substantial new investments required on that front.

And we will plug and play on that piece of the puzzle.

Okay, thanks a lot.

We'll take one more question, Stacy.

Thank you.

We'll go to the line of Ricky Goldwasser with UBS.

Yes, good morning and thank you for taking my question.

We've been hearing there is a move in the industry, to try and work directly with the institutional customers, broaden their GPO as a way to capture more of the generic upside.

Is that factored into your guidance, or do you assume status quo on that front, and then specific to United, do you think you'll be able to capture more of the generic profit under remaining business, now that the GPO is being basically out of the way, and lastly on gross margins, what percent of your gross margin assumption is kind of locked in under the fee-for-service agreement?

Thank you.

Dave?

First of all, I don't want imply we think United is out of the way.

Ricky, United is a group purchasing organization, and I don't feel confident of pining, or what they'll do or what they won't do.

We continue to be optimistic we'll capture the generic business of the customers that we deal with it. t It is one of the contract criteria that we deal with and it is one of the things that makes them attractive.

We'll continue to go after that.

I'm not sure I totally followed the issue on the institutional business with the generics, but I guess I would say, that everything we know about the market is reflected in our guidance, and you know, we have every intention of going forward to work closely with group purchasing organizations, as we have in the past.

And it is an integral part of our marketing strategy.

Just to repeat, I think something we said earlier from a gross margin standpoint with our brand manufacturers, we expect over 75% of that brand manufacturer gross profit to be non-contingent on price increases in fiscal '06.

Thanks, Ricky.

Thank you, everybody.

I want to remind and invite you all to our annual Investor Day, Thursday, December 1st, 2005 at the Grand Hyatt in New York City.

You can call my office, Mike Kilpatric, if you would like to attend, and have not received an invitation.

And now I would like to turn the call over to David to make a few final comments.

Just I would like to close by thanking you again for joining us.

Reiterating the fact that we're very enthusiastic, very optimistic about FY '06, we're operating in a stable growing market.

We've got good sales momentum.

We've entered a new market, Canada.

Fee-for-service negotiations are essentially behind us.

Our generic program is robust.

We have a solid track record of execution.

Strongest balance sheet we've ever had.

A great group of associates.

We think our future is very, very bright.

And we look forward to seeing you at our Investor Day.

Thank you very much.

Thank you very much, that concludes our call.

Thank you.

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