美源伯根 (ABC) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the ABC earnings conference call.

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

Later, we will conduct a question-and-answer session.

Instructions will be given at that time. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Mike Kilpatric, head of Investor Relations.

Please go ahead.

Good morning, everybody, and welcome to AmerisourceBergen's conference call covering fiscal 2006 second-quarter results.

I'm Mike Kilpatric, Vice President, Corporate and Investor Relations.

Joining me today are David Yost, AmerisourceBergen's CEO;

Kurt Hilzinger, President and Chief Operating Officer; and Mike DiCandilo, Executive Vice President and 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 2005.

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 remarks.

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 this morning, ABC had a strong quarter.

Operating revenues were up 15%, crossing the $14 billion mark for the first time in our history.

Operating margin in Pharmaceutical Distribution was about flat.

Interest expense was down significantly.

Diluted EPS from continuing operations was $0.61 on a GAAP basis, up 33% over last year, with $0.06 of benefits from special items.

We finished the quarter with $1.8 billion in cash and short-term investments with no net debt and the strongest balance sheet in our history.

We enter the second half of our fiscal year with great positive momentum in a great industry.

Our strong operating revenue performance of $14 billion, up $1.8 billion over last year, including 1% from acquisitions, was above our expectations.

AmerisourceBergen's Specialty Group had another very strong revenue quarter in a series of strong quarters, and is now at a run rate of over $8.5 billion.

AmerisourceBergen Drug Company continued to win new customers and have momentum in all segments, experiencing the strongest gains [against] the largest customers.

Though we expect to sustain the $14 billion run rate for the balance of the year, that translates to a growth rate of 8% to 10% for the next two quarters because of tougher comparisons in the June and September quarters, and a 10% to 12% growth rate for our full fiscal year.

We completed three acquisitions in the quarter.

In February, we closed on NMCR, Network for Medical Communications Research, for $87 million, adding certified medical education or CME capabilities and unique analytical research expertise to our oncology offering.

In March, we expanded our packaging capability into Europe with the $50 million acquisition of Brecon Pharmaceuticals, located in Wales, United Kingdom, and solidified our position in the Canadian Pharmaceutical Distribution market with the $18 million acquisition of Asenda, operating in western Canada.

Given our very strong balance sheet and cash position, I want to address the issue of acquisitions.

We have said on a number of occasions that we will continue to be very disciplined in acquisitions, and that the modest sized acquisition below $200 million is our sweet spot.

And we have said we would consider something larger if it made good strategic 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 -- well-run companies in the pharmaceutical supply channel, with operational and/or managerial synergies, with attractive growth prospects and good margins, or a strong pathway to that criteria.

But let me be more specific.

As we look ahead, our focus will be on brand-name and generic Pharmaceutical Distribution, specialty Pharmaceutical Distribution and related services, and pharmaceutical channel enhancements including packaging and other areas.

You can expect our acquisitions to be focused in these areas.

After spending very little money on acquisitions in fiscal '04 and '05, so far this year we have spent about a quarter of a billion dollars in a small number of acquisitions that were strictly in line with our focus.

We targeted Canada and made two acquisitions there that are strong in branded and generic distribution.

We are very happy with our experience to date in Canada, our first step in distribution outside the US.

We targeted European packaging and identified and ultimately acquired Brecon Pharmaceuticals.

We identified a need for continuing medical education certification, and acquired NMCR, building on the Imedex acquisition of two years ago that has proven very successful.

All very focused, all with operational and/or managerial synergies in the pharmaceutical supply channel, and all bought, we would add, at a reasonable price.

We will continue to review our dividend policy with our Board as we do every year.

We will continue to expect to repurchase approximately 400 to $450 million of ABC stock during our fiscal year.

You can expect us to continue to be very disciplined in the use of cash.

ABC continues its leadership role in the integrity and security of the US pharmaceutical supply channel.

ABC continues to be the only company among our peers that has announced publicly that all pharmaceutical product will be bought only directly from the original manufacturer.

We have expanded this program to include all products including over-the-counter medications and health and beauty aids.

As reports of counterfeit product continue to surface, we remain convinced that our policy is the only one that makes sense for the long run.

The transition to fee-for-service was a very hot topic a year ago.

Today, the transition has been completed, with more than 75% of our buy side branded pharmaceutical profits under some form of fee-for-service agreement.

We remain convinced that fee-for-service has been good for both suppliers and wholesalers.

We continue to work through the effects of the Medicare Modernization Act.

All dispensing pharmacists, including, of course, our customers and our long-term care associates in PharMerica, have experienced new and unprecedented challenges as they have executed the largest public health policy change in 40 years.

Pharmacists have truly emerged as the heroes of MMA.

It is still a little early to assess the impact of MMA on AmerisourceBergen.

Incremental revenue gains appear modest at this point.

We have had some pressure on receivables as our customers experienced some slowness in payment from the government.

We have no insights into whether the signup period will be extended; and if not, expect our customers will have to deal with a large number of signups in the next two weeks.

The effect of the so-called doughnut hole remains to be seen.

The Pharmaceutical Distribution segment, particular the Drug Company, continues to be clearly focused on operating margin enhancement.

The Optimiz Drug Company program of distribution center optimization is in its final stages.

The Transform program, specific action items to enhance Drug Company operating profit, is clearly gaining traction.

Generics continue to provide great promise for the industry in general and AmerisourceBergen in particular, because of our customer mix.

Our Specialty distribution and services companies continue to have strong revenue momentum, particularly in oncology.

PharMerica demonstrated some positive revenue momentum this quarter as it established itself as the clear number two player on the national scene.

Though our operating income was disappointing, we continue to develop a differentiated strategy based on technology and customer service.

Kurt will provide some color in his remarks.

Before I turn the floor over to Kurt and Mike, let me say I continue to be optimistic about the Pharmaceutical Distribution industry and the role ABC will play in it.

Our position in Specialty and Packaging, our operating margin opportunities in the Drug Company, the generic pipeline, coupled with our customer mix and strong balance sheet, all point to a bright future.

Here is Kurt.

Thanks, Dave, and good morning, everyone.

Today I will review the quarter's business unit performance, discuss our focus areas for the balance of 2006, and highlight some of our opportunities as we look to 2007.

We posted very strong performance in the Pharmaceutical Distribution segment, driven by a solid recovery in the Drug Company and continued strong performance by the Specialty Group.

Revenue growth was stronger than expected, largely due to the continued strong growth of our larger customers and new business wins.

We were also able to achieve a healthy sequential improvement in both gross and operating margins and continued strong cash generation, driving another improvement in our return on investment as the benefits from our fee-for-service model transition became more fully realized.

Price appreciation on inventory was not as great a factor this quarter, as most of those gains were credited to fees under the new fee-for-service model.

Again, we executed very successfully under these new fee arrangements, which yielded performance incentive payments equal to or greater than our internal expectations.

As we reported last quarter, we have now completed our contracting activity, and we expect these new agreements to yield additional benefits for the remainder of 2006 and into 2007.

We have a small handful of agreements due for renewal this year, and we expect these negotiations to be smoother than in the past, as manufacturers gain a greater appreciation of the benefits of this new model to their own business.

Generics were again an important factor in the quarter.

Our efforts under the Transform program continued to increase our penetration of generics through improved customer compliance.

This, in combination with improved sourcing, drove additional margin dollars versus year-ago levels.

Our outlook on generics remains bright for the remainder of 2006 and well into 2007, as a number of large branded products go generic and the demand for these types of products is further enhanced through Medicare Part D. We're working aggressively with selected generic manufacturers to create the right balance of price, quality, and availability, to ensure maximum market uptake as these new products are introduced.

Regarding Medicare Part D, ABC took a number of steps during this past quarter to support the needs of our independent and smaller retail chain pharmacy customers, including providing extra credit terms to help bridge cash flow needs due to the slower-than-expected reimbursement payments out of CMS.

We also provided education and support services through published updates and help desk services specifically set up to handle the Part D inquiries from ABC customers.

Our PPN network continued its contracting efforts with PDPs on behalf of our retail network of greater than 4,000 pharmacies.

Just briefly, regarding independent pharmacies, during the quarter we secured over 70% of the United group pharmacies and continued a prime vendor relationship with over 80%, a testament to the strengths of our Good Neighbor, Diabetes Shoppe, and other value-added programs.

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

The Optimiz program continued on schedule and on budget.

Our sixth and final greenfield in Bethlehem, Pennsylvania, remains on schedule to open in early June.

No consolidations were planned for or completed in the second quarter.

Three more consolidations remain on track to be completed before the end of the fiscal year bringing the total for the year to six.

All other aspects of the Optimiz program remain on track, including completing our network next year with a small number of additional consolidations for our final network in the mid 20s.

Integration activities related to our Canadian acquisitions proceeded smoothly during the quarter.

Operating expenses as a percent of revenue were down only slightly from prior-year levels, as additional investment spending in sales and marketing and IT infrastructure, all intended to drive better gross margin performance, offset near-term productivity gains.

So all in all we made some solid progress stabilizing our margins through fee-for-service and the Transform and Optimiz programs and are confident more improvements can be achieved in future periods.

The Packaging Group had another solid quarter with continued strengthening of its pipeline of new product launches at both American Health Packaging and Anderson Packaging.

Our acquisition of Brecon Pharmaceuticals is off to a very strong start; and we have already begun to realize synergies between Brecon and the rest of the Packaging Group through joint marketing and sharing of operational best practices.

We expect the Packaging Group to continue to make a solid contribution for the remainder of 2006, and its pipeline bodes well for 2007.

Now turning to PharMerica.

PharMerica had a significant downturn in operating performance versus year-ago levels, driven by a more difficult than expected transition to environment to Medicare Part D. Extra costs in the quarter directly related to the transition were roughly 2 to $3 million.

But clearly there were other indirect, more difficult to measure costs as well.

While these are specific to the transition, we expect some continued impact through the remainder of the year.

Manufacturer rebates were in line with the reduced expectations we shared last quarter.

Importantly, however, reimbursement rates driven by a favorable PDP mix were better than expected, but still not sufficient to offset the reduction in manufacturer rebates.

This gap will clearly be a key point in our upcoming PDP negotiations this summer.

As many of you know, in early April, CMS issued its final PDP call letter which provided disclosure guidelines on manufacturer rebates paid to providers such as PharMerica.

In essence, CMS stated that the rebates are legal and that long-term care pharmacies must disclose these rebates to the PDPs.

We support CMS's efforts here and will continue to work with them to help further clarify these guidelines and other Part D issues, such as the need for a uniform prior authorization process.

Behind these transitional issues, we continue to make some solid operational improvements.

Revenues grew for the seventh consecutive quarter through share gains against our largest competitor, smaller regional players who are having a difficult time with the Part D transition, and a concerted focus on reducing customer churn and improving patient acuity mix.

We continue to make prudent, targeted investments in the business.

In the quarter, additional investments were made in new customer-facing technologies to support our differentiation strategy and ease of doing business.

We continued our investment spending in pharmacy automation to reduce prescription processing costs.

Also during the quarter we opened a new pharmacy to take advantage of an attractive market opportunity.

So while this is clearly a difficult transition year, we are beginning to see signs for a little bit more optimism for the business going forward.

Lastly, turning to the Specialty Group, the group had another excellent quarter of strong sequential growth, driving revenues past an $8.5 billion annualized run rate and operating earnings ahead of our internal projections.

The top line was driven by an especially strong performance by our oncology platform, supported by an ever-growing pipeline of new products that continue to grow ahead of the broader drug market.

Just a quick note on the CAP vendor program.

Late last week CMS announced its vendor selection.

Our Specialty Group was selected as a vendor.

However, upon review of the composite bid and the CAP contract, we have chosen not to participate as a CAP vendor at this time.

As you know in late December, we filed with CMS to be a CAP vendor beginning July 1.

However, our application made some very specific recommendations on changes we felt needed to be made to make the program commercially viable.

Our surveys indicate that a small percentage of our physicians will elect to participate in CAP as it is currently constructed.

We of course recognize the hard work and effort by CMS and are thankful for their time in considering our concerns.

Importantly, the Group's other two distribution businesses, ASD and Besse Medical, both enjoyed strong top-line and bottom-line performance in the quarter, driven by favorable pricing dynamics for blood plasma products in the case of ASD, and excellent market penetration of certain key physician administered products at Besse Medical.

Our manufacturer services businesses, Lash Group, ICS, and Imedex, also had a solid quarter as a number of new programs were both awarded and launched to help manufacturers commercialize new products.

The group of businesses which now make up the Specialty Group provide us with the broadest set of capabilities in the marketplace and a very competitive position.

The acquisition of NMCR further strengthens our ability to provide a unique set of connected offerings from the manufacturer to the physician.

All in all, a solid quarter.

We clearly have more opportunity and more work to do to drive our Pharmaceutical Distribution operating margins closer to historical levels; and we have more work to do on our long-term care pharmacy business.

But by and large, the trends bode well for the remainder of the year.

Now here is Mike for a review of the financials.

Thanks, Kurt, and good morning, everyone.

I am very pleased to present our second-quarter results which reflect continued strong performance in our Pharmaceutical Distribution segment, including top-line growth and cash generation above our expectations.

Once again, we ended the quarter with an extremely strong balance sheet, leaving us well positioned for the second half of the year.

As usual, I will cover both our consolidated and segment results, comment on our strong cash flow and balance sheet trends, and finish with an update to our guidance.

We did have several special items that I will detail in my consolidated review.

Also remember that all prior-year share and per-share numbers reflect our two-for-one stock split in December 2005.

Now starting with our consolidated results for the quarter, operating revenue was up a higher than expected 15%, driven by both our Drug and Specialty units within Pharmaceutical Distribution.

Consolidated EBIT was up 10%, driven by our Pharmaceutical Distribution segment's 14% growth, offset in part by the significant drop in PharMerica's EBIT.

Included in our consolidated gross margin for the current quarter was a net benefit pretax of $9.4 million resulting from a litigation settlement relating to a manufacturer antitrust case.

Reflected in our consolidated operating expenses for the quarter were $3.6 million of facility consolidation, employee severance, and IT transition costs, which compares to $1.8 million of similar costs in the prior-year quarter.

The prior-year quarter's expenses also included a $5.3 million impairment charge.

Excluding the litigation gain and the special charges, consolidated EBIT increased by 3%.

Equity compensation expenses of $4 million were included in the March '06 results and were negligible in the prior year as a result of our current-year adoption of FAS 123(R).

Below the EBIT line, we had other income of $5.8 million resulting primarily from gains of $6.5 million related to the sale of an equity investment and proceeds from an eminent domain settlement.

Net interest expense was a low $7.3 million, down a significant 49% from the prior year, reflecting the financial leverage from our net debt reduction.

Our effective tax rate for the quarter was 34.5%, down significantly from last year's 38.4% rate, due to certain tax adjustments which provided a $5.5 million benefit or reduction in tax expense in the quarter.

Excluding these adjustments our effective tax rate for the quarter would have been 37.3%, still a reduction from last year due to a shift of our invested cash to more tax-free investments.

Our effective tax rate for the next six months should continue to be in the 37% to 38% range.

Diluted EPS from continuing operations of $0.61 was up a strong 33% from last year's $0.46, again driven by the strong growth of our Pharmaceutical Distribution segment and our outstanding financial leverage, evidenced by the year-over-year reductions in net interest expense, weighted average outstanding diluted shares, and our tax rate.

The net positive after-tax impact of the litigation gain, the investment sales, the facility consolidation costs, and the tax adjustment was $13.5 million or $0.06 per share compared to a charge of $4.4 million or $0.02 per share in the prior-year quarter.

Our average fully diluted shares outstanding for the quarter were 210.8 million, down nearly 10 million shares from last year as a result of our share repurchase program.

Moving to the Pharmaceutical Distribution segment, we had a top-line increase of 15%, aided 1% by our acquisitions, primarily our Canadian acquisitions.

This increase was obviously higher than we expected and was driven by continued strong growth of our large customers in the Drug Company, new business wins across all segments, and the continued strong growth in the Specialty Group.

The customer mix in the quarter was 59% institutional and 41% retail.

Our institutional business growth of 20% was once again driven by our Specialty Group and our large customers in the alternate site space.

Retail growth in the quarter was 9%, helped by the Canadian acquisitions.

Our Pharmaceutical Distribution gross margin of 3.16% was down 5 basis points in the quarter, due to the higher than average growth of our large customers, which offset strong performance in both the fee-for-service and generic areas.

We had an $8.5 million LIFO charge in the quarter, compared to a charge of $5.7 million in the prior year.

Operating expenses as a percentage of revenue were 189 basis points, a 4 basis point improvement from the prior year, as our productivity gains from Optimiz were offset in part by our investments in sales and marketing and IT infrastructures, as expected.

As a result, our Pharmaceutical Distribution EBIT margin for the quarter was essentially flat compared to the prior year, at 1.27%, and for the six months was 116 basis points -- importantly, up 12 basis points over the prior year.

We continue to expect margins in the 115 to 125 basis point range for the year, though likely towards the lower end if we grow our top line at the high end of our 10% to 12% growth range.

Now turning to PharMerica, revenues of $413 million were a record high, up 6% versus the prior year.

Our EBIT margin of 3.92% in the quarter was down significantly from the prior year, as the decline in supplier rebates net of increases in reimbursement drove gross profit margins in the quarter down 177 basis points from the prior year.

Expenses as a percentage of revenues were also up significantly in the quarter to 23.6% or a 249 basis point increase over the prior year; and was due to a $3.5 million increase in bad debt expenses and 2 to $3 million of MMA related expenses, as Kurt mentioned.

You may also remember that the prior year benefited from a $4 million reduction in sales tax liability that did not recur in the current-year quarter.

We continue to expect that PharMerica's operating margin will be in the 4% to 5% range for the year.

Now turning to cash flows on the balance sheet, cash generated from operations for the quarter was a strong $472 million, and for the six months was $703 million.

Obviously, this is ahead of our goal for the year of 5 to $600 million; and 2 to $300 million of this cash is a result of the timing of payments to manufacturers at the end of March and will reverse in the third fiscal quarter.

However, we were very comfortable in raising our operating cash flow guidance to a range of 6 to $700 million for the year, as cash generated from income in the next six months will offset this working capital reversal.

The cash generation in the quarter was driven by the $600 million-plus inventory reduction from December's peak level to a level of $4.4 billion at the end of March, in line with our guidance for the year, which is a range of 4 to $4.5 billion.

This was offset in part by our $300-plus million increase in receivables, which was directly related to our 15% sales increase, and a 23 business day month in March.

From a statistical standpoint, average inventory days on hand during the quarter dropped to 29 days from 36 days last March; and DSOs were up slightly to 16.7 days.

CapEx for the quarter was $32 million and for the six months was $60 million.

We continue to track towards our guidance for the year, which remains in a range of 125 to $150 million.

Our debt to capital ratio at the end of March was 19.5%, up slightly from last year.

With cash and short-term investment balances of $1.8 billion at the end of March, our net debt to capital ratio was less than zero once again.

Obviously, this provides us with continued flexibility and significant opportunity to deploy cash.

In addition to the $157 million we spent on our acquisitions this quarter, we repurchased $43 million worth of shares, leaving $618 million remaining under our share repurchase program.

We continue to expect to spend between 400 and $450 million on our repurchase program during the fiscal year.

Overall, another solid quarter driven by higher-than-expected top-line growth and strong execution, with more capital to be utilized as we move forward.

From a guidance standpoint, we're raising our fiscal 2006 EPS from continuing operations on a GAAP basis from our previous range of $1.98 to $2.13 per share to a range of $2.06 to $2.21 per share, reflecting the expected net benefit of $0.08 from special items including litigation gains, facility consolidation, severance, and IT transition costs, and the second-quarter tax adjustment and investment sales.

Net of the special items, which we previously expected to net to zero, our EPS guidance remains unchanged.

As mentioned previously, we expect operating revenues to continue to be in the $14 billion range for each of the next two quarters; and accordingly have raised our top-line growth guidance for the year to 10% to 12%.

Our Pharmaceutical Distribution operating margin guidance for the year remains unchanged at 115 to 125 basis points.

However, it is likely that the higher we are in our top-line growth range, the lower we will be in the operating margin range as a result of our customer mix.

Finally, as previously mentioned, our operating cash flow guidance for the fiscal year has been raised to 600 to $700 million.

With that, I will turn it over to Mike Kilpatric for a few additional comments, and then Q&A.

Thank you, Mike.

We will now move on to questions.

We ask you to limit yourself in your questions so as many people as possible will have that opportunity.

Go ahead, Stacey.

(OPERATOR INSTRUCTIONS) Larry Marsh with Lehman Brothers.

My question has to do with top line, which clearly has accelerated a lot for you guys over the last year.

I guess I am reflecting, why would you think your US revenues would drop sequentially Q2 to Q3 and Q4, as you're suggesting, given the better-than-expected Q2 here?

I guess as another point, I know, Kurt, you and Dave had talked about the importance of discipline in this industry, of needing to be happy to have organic growth rates in that sort of 5% to 10% growth range.

Is that still a fair characterization?

If so, would you be concerned that we might see some more reacceleration of aggressiveness by the industry over the next two years to capture some of this top line?

Larry, it's Dave.

Let me kind of start out by putting the revenues in perspective.

We expect the run rate to continue.

We are at about a $14 billion run rate for the quarter in operating revenues; and we expect that $14 billion to continue through the next two quarters.

The only reason that the percentage increase comes down is because we have a tougher comp.

So we are steady as she goes in terms of revenues.

You know, the revenue increase as I mentioned has been coming from -- we picked up 1% of it of course from Canada, which was all new.

We have gotten a lot of growth out of our Specialty business which continues to grow substantially faster than the rest of the market.

And we have had good growth in all of our segments, particularly in the largest customers.

Kurt, do you want to comment on the environment?

Yes, I think it is fairly stable.

We have been very selective; and that is part of what Transform is about, is choosing those customers that we think we can add a lot of value to; and then going out and getting the business.

That is based -- our approach is to do it based on our value-added offerings and services, not on price.

So I don't see a re-inflammation of the pricing wars that we had two or three years ago in the industry.

Things feel fairly stable to us.

I think we have done a particularly good job here in the last year, putting together our programs.

If you recall, we said we were moving, about a year ago, we were moving from business integration to capabilities integration within ABC.

I think you start to see some of that coming to the market and getting traction with customers, where we can add some real value.

So we are pleased with the top line.

Admittedly, we are slightly surprised by the growth, but I think we are being disciplined and smart about how we go to market.

Okay, thanks.

Lisa Gill with JPMorgan.

Just as a follow-up to that, I was wondering if maybe you could give a little bit more color on the new business wins.

You mentioned that you had some new business wins in Distribution.

Then also you talked about the fact that MMA really hasn't had much of an impact on volume.

But what are your expectations going forward if we have not started to see it already?

In the case of new business wins, Lisa, it has really been across all the segments.

First of all, we have had -- in terms of Specialty, we have had some good traction there.

But literally in every segment in the Drug Company we have had good wins.

Kurt talked about our emphasis on value selling.

It's been a great emphasis for our sales force.

They have gone through a pretty extensive training program, and I think we are starting to see some of the benefits of that.

MMA, we have not seen much benefit of it yet, Lisa.

I think it still remains to be seen.

We're thinking it is probably going to be an '07 event as we sit here today.

Can you quantify though at all these new business wins?

I mean you talked about 1% coming from Canada; and Specialty being as part of the growth rate.

But what are we seeing as far as this exceptional top-line growth?

What is coming from these new business wins?

Well, you know, the market according to IMS is growing in the 6 to 7 [million] percent range.

We have got another 1% coming from Canada.

So I guess you could make the case that the balance of that is coming from market gains.

But I think you have got to be a little careful with the Specialty, because Specialty is not counted sometimes in the IMS numbers.

So we're getting good traction there.

It is growing a lot faster than the basic pharmaceutical business, and that’s that $8.5 billion now that is having an impact on our top-line growth.

Then just lastly as a follow-on, are these competitive wins?

Are they coming from your two major competitors?

We are really kind of indiscriminate on how we take business, Lisa.

We're taking some from the regional guys.

We're taking some from our big competitors.

We are capturing some business that may be going through a different channel before.

So we are really getting broad-based coverage.

Lisa, I would just add, I think we are defending successfully as well.

This United thing was, as we said, was a little bit of a disappointment that we had to go through that.

But we shared our statistics on the United.

And again our programs and our services really have won the day there.

We have retained that business, albeit at some margin pressure.

There is no doubt about it, for that book of business.

But we have maintained the account, and that was important to us.

Great, thanks for the color.

Robert Willoughby with Banc of America Securities.

Dave or Kurt, just on PharMerica, can you possibly characterize some of the revenue surprise there?

How much you would think was from better Medicare reimbursement relative to Medicaid?

And maybe possibly what is an example of an indirect cost associated with the implementation?

Could those costs in the aggregate be more or less in line with the direct cost that you reported?

What component actually continues into the second quarter?

Yes, I would say that the indirect costs were at least as equal to the direct that we could measure.

Examples of that, we have just got extra executive time on these issues, where we don't have direct labor hours but we have got time and attention on those things.

We have got all types of other indirect costs that are like that.

It was really a diversion of efforts to get through this transition period.

There was clearly a price to be paid for that.

We took people off other assignments and put them into call centers and customer service support areas where we didn't add cost but clearly it took away some other things that we were focused on.

So it was at least what we -- at least a direct cost; and we would expect it, as we said, to continue, I think at a decreasing rate for the next two quarters.

But it will clearly be a part of the business as we get through the rest of the fiscal year.

Obviously we will continue to report on it, to give you all visibility to what we think it's going to be.

Bad debts is a piece of that too.

We're going to have some bad debt costs as we go through this, and that is part of our thinking as we continue to kind of maintain a 4% to 5% EBIT margin range for the business.

The top-line growth, I would say, the impact of MMA on the top line is really indiscernible at this point.

Most of the growth is really due to business wins.

Particularly against our largest competitor; there are some integration issues going on there, and therefore some opportunities for us.

Again, some of the smaller regional players, they clearly are struggling with the Med D environment.

So.

And the pipeline for us remains very strong as we look out at the remainder of the year for the business.

So again all encouraging signs.

Not enough for us to take guidance up on it.

But we see, I think, we have probably hit the nadir on the business and things are beginning to turn a little bit.

We feel good about that.

That's great.

Thank you.

Christopher McFadden with Goldman Sachs.

Kurt, in your prepared comments, you talked about I think the last of the distribution centers in Pennsylvania.

Can you just step back a second, talk about sort of where you stand relative to the distribution center blueprint that you laid out going all the way back to the Bergen merger?

Where you are in terms of the completion of the costs associated with that?

As you sort of take the opportunity to look back, what financial benefits do you think you're getting from the center and how you think those manifest to you as you look out over the next couple of quarters or into F’07?

Thanks.

Yes, well, there is a lot there.

I will see if I can top-line it for you.

Obviously, I think we have done a good job here, Chris.

It was a big effort.

The Drug Company operations team deserve just a huge amount of credit here.

We are about to open our sixth and final greenfield.

These are large, highly automated, very sophisticated distribution centers, each one costing 40 to $45 million to get up and operational.

They have come on line, on time, on budget all along the way.

If you recall, we started with a network of 51 back in the late summer of 2001.

We are down to -- by the end of this fiscal year we will be at 28, which is --.

The target we had kind of set out at the time of the merger, we said we would probably get down to the high 20s.

As we have gotten closer to it, we understand our customers and our delivery requirements, we think there is opportunity for a little bit more, which is why we signaled a handful more consolidations going into '07.

So we think the final network will be in the mid 20s.

So the benefits have been coming in all along here.

We reported that we got to that $150 million synergy target within three years.

We kept good accounting of that as we went along.

But the benefits continue to come with these consolidations this year and the handful next year.

But then there is a longer tail than that on this program, because we are putting in new warehousing systems, RFID systems.

Everything is wireless, barcode-enabled, paperless, and pay for performance systems are going in these distribution centers.

So from a labor efficiency standpoint, we are going to drive more costs out in the coming years.

That has been validated by the work we have done to date.

So we feel good about it.

It's been a heck of an effort by us, but I think we have got a network that will support the business for years to come.

Chris, if you go back and you look at our EPS growth since when we started; and you take this year and you consider that we're going to end up in the range that we said, we have had a compounded annual growth rate of our EPS 15% in the last five years finishing this year.

So I would say that would make the case pretty strongly that it's been a very, very successful program.

So just a quick follow-up.

You talked about the capital investment in each, Kurt.

I know you guys track returns very closely.

So would you venture a guess on what you think the return on invested capital has been on the investment that you have made in the X numbers of centers that you have opened?

Then if we think about either the P&L or the operating metrics that you often share with us, are there metrics that you think will continue to improve from call it the first half of F’06 that would reflect some of the additional productivity and efficiency benefits, that the centers that you are bringing online are going to bring to the Drug Company?

Thanks.

Yes, top line on the investment equation, I would just give you these numbers, Chris.

If you recall, we targeted $150 million of synergies for the merger.

We targeted about a $450 million capital program for Optimiz.

Probably about 150 to maybe $200 million of that capital program has been funded through reductions in redundant inventories as we have gone through the consolidation work.

So if you think of a net investment in a $250 million range, to get $150 million of benefits, you get some sense of the kind of returns we're getting from this; and hence the kind of EPS growth that Dave referenced.

On a DC by DC basis, or an automation piece of equipment by piece of equipment basis, these things all bench out very, very attractively.

Some of the equipment benches out better than other.

But generally these things are well above our hurdle requirements.

Part of what we're doing with the money, frankly, these are savings and efficiencies, beyond what we had sized at the beginning.

We're reinvesting some of that into the Transform process, and sales and marketing training, and those kinds of things.

So we can get more stickiness with the customers, add more value, and become more important in the success of our customers' operations.

That is, I think, how we are going to try to live and prosper in this environment going forward.

Thank you.

Barbara Ryan with Deutsche Bank.

Barbara, it's Dave.

I hope you have a question for Mike, because if you don't he is not going to want to come to these things anymore.

He's going along without having a question.

Nice to hear from you, Barbara.

Nice to hear from you too.

Okay.

A lot of them have been asked.

But one of the questions, just to go back to the revenues again, and maybe there is something I'm missing.

But I understand the issue of the customer mix and the margins.

But when you look at the customer mix, it seems to be that that relationship between institutional and retail looks to be the same certainly sequentially.

Obviously, I think in the last quarter, your Specialty business had a run rate of $8 billion and now -- I mean, sorry -- had a run rate of 8.5 (multiple speakers) this quarter.

So I'm just having difficulty understanding how the larger customers or lower margin piece of the business is outgrowing the smaller customer, unless there is some fall off in the independent pharmacy piece.

Maybe if you can just sort of characterize that a little bit more specifically; and maybe I have missed something in there.

Thanks.

Barbara, this is Mike.

I will make a couple points.

Our institutional growth as I mentioned in my comments is a lot more robust, including the Specialty Group growth at 20%, where the retail side is in the single digits.

That is where a lot of those larger customers reside that have the lower margins.

I think with the Specialty business, the important thing to remember is that most of the growth is coming from the distribution of products to physicians.

I think we have said in the past that in that part of their business the margins are very similar to our overall drug distribution margins.

So a lot of the benefit that we get from the Specialty Group really stands in those other businesses and those other services which we are continually looking to expand, like we did this quarter within NMCR.

But certainly, that has been the majority of the growth.

The large customers seem very early on to have benefited more than others from MMA at this point.

That is what is skewing our mix right now.

Thank you.

Eric Coldwell with Robert W. Baird & Co.

It's kind of a two-part question.

First, I'm just curious if Canada or what impact, if any, Canada had on your EBIT margin.

Historically, Canada was considered a lower margin business than the US distribution.

Then my segue there would be, Dave, during your prepared remarks you kind of opened the door on M&A and international growth.

I'm just curious, are there any geographies outside of the US or Canada that look interesting from the perspective of the core business.

And if you could give any insight on your thoughts there, that would be great.

I will start off with international, Eric, and just say that Canada was a very logical extension for us as we move north.

We dealt with currency fluctuations which we had not before, and quite frankly, language, since we've got the French influence in Canada, and we really like what we have seen there.

So we will continue to look to other areas, Eric.

We think that the model that we have built here and the relationships we have had with the manufacturers, what we are doing with generics in our value-added program and so forth that could have value as we move on.

So we are clearly looking other places.

Eric, as far as the overall margins in Canada, they're not materially different from our overall margins in our pharmaceutical distribution segment.

That's great, and if I could just have a quick follow-up.

You mentioned generic sourcing is a key theme in terms of your program there and also tied that into Transform and what you are doing with customers.

I'm just curious if you could give a little detail on how ABC is differentiating its generics program from that of the two largest competitors?

Thanks again, and I will jump out with that.

Eric, it's Kurt.

You know, I think we're differentiating ourselves in part on price.

We are a very, very large buyer of generics, and I think we consistently find ourselves with very attractive prices that we are able to negotiate with our manufacturing partners.

I think we have also been able to secure -- I think we have made some very nice choices in terms of the partners that we work with there to get the right products at the right price and the right quantities.

I think also, I think we are leading the way on this issue of channel integrity.

I think our customers know that when they buy a product from us that it's come directly from the manufacturer, the original manufacturer of that product, and that is meaningful in the marketplace today.

And we're not being at all shy about letting our customers know the important decision we made.

That is a little bit where some of the efficiency savings has gone as well.

We have gotten out of the secondary market.

There was margin there.

We have let that go, but we have done it for the right reasons over the long term for the safety of the supply chain.

And we have done it not only in branded, we have done it in generics and we have done it in OTC.

So we are buying everything direct from the manufacturer today, and that is important for us, and I think it is important for the industry.

Thanks.

Tom Gallucci with Merrill Lynch.

Most of my questions that I had were answered as well, but maybe just one or two follow-ups.

First on the PharMerica business, any update that you can offer on the Beverly business at this point?

It's Kurt again.

Beverly, we continue to have a strong business relationship with Beverly, and we have every confidence that that is going to be a customer of ours for a long time.

Okay, has it formally been renewed at this point, or that is still in discussion?

Still in discussions.

Okay, and then you mentioned that you also invested in a new pharmacy in PharMerica.

Does that relate to business wins that you have kind of got on the table already?

Or do you think there is more opportunity there from what you call the integration at your biggest competitor?

We actually went into a market where there was an opening, where there were two competitors, where there wound up being one.

So there was an opening for a second service provider in that marketplace.

So we assessed; we did some market surveys, assessed that there was real demand there that we could take advantage of, and we moved in and opened.

We are starting to win some business there.

So that is an example of how we're kind of taking advantage of the consolidation.

The final question, you mentioned I guess a few contracts up for renegotiation this year with manufacturers.

To the extent that you have started some of those talks, maybe from a high level, are you just discussing rates?

Or are there still kind of conceptual things that the manufacturers are coming back with?

Or is it just more of a renewal of rates?

Thank you very much.

Tom, it's Kurt again.

I will just chime in on this one.

It is actually both.

It is rates, of course, because that is important to us.

But it is also every time we enter into one of these discussions with a manufacturer, we like to engage in -- how can we improve the relationship?

What is important to the manufacturer?

What is important to us?

What other metrics and methodologies can we put in place to improve the transparency, improve the efficiency in how we operate together?

So we enter these things with very specific ideas in mind as to what we think would be helpful to the manufacturer; and then obviously, listen to what their needs are; and try to craft an agreement that really works to both parties' advantage here.

It has worked well for us to date.

Glen Santangelo with Credit Suisse First Boston.

Yes, thanks.

Dave, just two quick questions.

First, with respect to PharMerica, I think we talked last quarter about one of the primary issues being the ability to get rebates from the manufacturers; and the uncertainty or ambiguity of the rules at the time.

Now CMS has kind of come out, as you said earlier in your comments, and declared that rebates are legal.

What seems to be the hang-up on the margin side?

Because I would imagine that those rebates would start to increase and we would see some margin improvement.

So any type of additional color there would be helpful.

Yes, it's Kurt.

What has happened here is we have just got a disconnect from a timing standpoint.

If you recall, CMS did some -- what they thought was clarification work late at the end of the calendar year last year.

That really allowed some manufacturers to kind of step away from the table and not write rebate contracts for this upcoming '06 calendar year.

So we have got a hole, if you will, in earnings.

Now the PDP reimbursement rates, as I mentioned and Mike mentioned, are better than what we expected.

That is really good news.

But it does not completely fill the gap between -- for the manufacturer rebates that were kind of lost coming into '06.

Having said that, we kind of have two bites at the apple here.

One is with PDP negotiations this summer; and then the second time is when we reenter into rebate negotiations with manufacturers in the fall.

So both of those are opportunities to get the margin dollars back into the business.

But that is not going to be something that is in the next quarter or two, [with] some benefit as we kind of look to '07 for us.

Then maybe just one follow-up question on an unrelated issue for Mike.

There seems to be some controversy about the tax rate, Mike.

Maybe if you could comment on the Company's decision to move more into some tax-free investment; and just quantify the impact that it had on the tax rate.

Is the offset to that basically lower interest income for investing in those tax-free investments?

Then I will jump off.

Thanks.

No, I think you hit it.

Basically, we took more of our investments and we put them from taxable investments into tax-free investments.

You're absolutely right; that interest income is netted against our interest expense.

So we will see a little bit less of a benefit on the interest line; and we will see more of that benefit in the tax line, like we did this quarter.

That is what really drove our tax rate down from the mid 38% range down to the low 37% range.

As we go forward, we would expect that tax rate to be in that 37% to 38% range.

The other point I will make is we make those decisions, whether it's invest in tax-free or taxable, every day based upon the relative returns.

That mix can change as well, so that it is a dynamic amount.

But it's going to show up and benefit us in one of two spaces.

Either it is going to be in the interest expense, if it is more weighted towards the taxable; or it is going to be in the tax expense of it's more weighted towards tax-free.

This quarter we had more in tax-free.

Okay, thanks, guys.

Ricky Goldwasser with UBS.

A couple of follow-up questions.

First on PharMerica, just to clarify.

The margins in the quarter were below your guidance for the year.

So the question here is, was the quarter kind of in line with what you were budgeting, that is why you are not – you are maintaining the 4% to 5% margin guidance assumption?

Or are you just expecting -- or the quarter was (indiscernible) below kind of your initial expectations, but you're looking for some turnaround later in the year?

Secondly, on the operating expenses, it seems that with fee-for-service being now behind us, a key factor for margin expansion in the future kind of really the further reduction in the operating expenses.

So when will we start seeing the significant benefits from kind of all of the DC consolidation that you have gone through in the last three years?

How should we think about the level of operating expense margin a year from now?

Ricky, I will take the PharMerica question, which is the first one; and Mike will take the second one.

I think the way to think about this quarter's results for PharMerica is that we had transition expenses that were higher than our expectations.

Those transition expenses offset basically what we found to be a better reimbursement rate mix under our PDP arrangements.

So it came in very much in line with what we were expecting.

At the low end of the range for the full year, but not surprising.

It just came in differently than what we expected.

The good news is the reimbursement rates have an annuity to them.

The transition is fairly one-time in nature, which is one of the reasons we feel a little bit better about the outlook for the business.

But our guidance is still kind of 4% to 5% for the year.

From an operating expense standpoint, Ricky, I think as Kurt mentioned, we obviously have reinvested some of the benefits that we have gotten from our programs in our sales and marketing and IT infrastructures, as we had guided at the beginning of the year.

Certainly as we go forward beyond '06, we would be very disappointed if our operating expense growth was anywhere near our top-line revenue growth.

From a combination of just the inherent leverage we continue to have in this business, which is very strong, in combination with the investments we have made it in our automated DCs and all of the other Optimiz initiatives.

Certainly, given the same mix of business going forward, and that is a big determinant, we would expect those operating expense revenues in Pharmaceutical Distribution to come down fairly significantly in the future.

We head into '07 for the first time with all six of our large automated new greenfields up and running.

Certainly, we have had the investments in our numbers for the last two to three years.

[David Deal] with Morgan Stanley.

One last question, just in the interest of beating this thing absolutely to death.

There is a new sense in your risk statements from the forward-looking statements that talks about the risk of further declines in the amount of market share rebates to PharMerica.

How big is that risk, and what would drive that?

You know, it is just a precautionary statement.

There's nothing new there.

I think it's just an indication of kind of the environment we have been through here.

So we're just calling it out as a risk factor for our investors.

That is all.

Thank you.

Okay, we will take one more question.

John Ransom with Raymond James.

Just under the bell.

It counts no matter when it comes in, John.

I'm not going to proclaim to be the institutional pharmacy expert, because we don't cover Omnicare.

But we have heard that some of the competitors to PharMerica were successful in pushing on the PDPs more of a standard contract.

The impression we got from PharMerica was that now that the 90-day grace period is up they're going to be subject to all these kind of retail (indiscernible), therapies and hoops, etc. to get the drugs to the seniors.

So our impression was maybe because the costs go up a little bit in the second quarter, just in terms of running through all these hoops that you have.

So my question is, is that true?

Secondly, as you go through this renegotiation process with the PDPs, do you think you'll be able to successfully push onto them more of a uniform contract and get out of this kind of retail contracting mentality for an institutional benefit?

Then I have one follow-up.

Thanks.

John, it's Kurt.

I don't want to get really into a direct answer on that question because you're getting into some pretty competitive areas.

I think we feel good about where we came out on the PDPs.

We have been favorably benefited by the mix of the PDPs, that now make -- that cover the patients for our long-term care pharmacy business.

That is good news.

We're still kind of maintaining our guidance at that margin for the remainder of the year.

And I really cannot get into the puts and takes on a particular expense for that for the next quarter or after that.

What about the -- do the hurdles get higher, though, for you this quarter in terms of getting the drugs to the patient?

We are obviously doing a lot to -- there's a lot of extra labor going in and trying to get the reimbursements taken care of and covered.

So in that sense, there is extra labor right now.

But that started in January with the opening of the program; but it's gotten better as we have gone along.

I think we have got a very compelling case with the PDPs in this round of negotiations that we are a different class of pharmacy, that what we do is important to them, and that we do have a certain amount of margin that we need to sustain this business and do the job for them that they need us to do.

So the direct answer to your question is, we feel good about going into the negotiations, getting some of that money back into the system for us.

Thanks, John, very much, and thank you to everybody for participating today.

For those who wish to hear more about the AmerisourceBergen story, we will be attending two conferences next week, the Deutsche Bank healthcare conference May 3 in Boston, and at Morgan Stanley's global healthcare conference May 4.

Later in May we will be attending the Robert Baird growth conference in Chicago, May 9; and the Banc of America healthcare conference May 17.

Finally, on June the 14th we will be at the Goldman Sachs healthcare conference in Laguna Niguel.

Now here's Dave Yost for a few final comments.

I just want to thank you all for joining us and for your continued interest in AmerisourceBergen.

We continue to be very bullish on our industry and the role we will play in it.

We think our broad customer mix, our position in specialty pharmaceuticals and related businesses, the opportunities we have in generics, and our broad-based offering within the pharmaceutical channel, coupled with our strong balance sheet and cash position provide some great opportunities for revenue and operating margin enhancements as we go forward.

We look forward to seeing you at -- some of you at our upcoming conferences.

Thank you very much.

That ends the call, operator.

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