美源伯根 (ABC) 2006 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the AmerisourceBergen earnings call.

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

Later, we will open up the lines for questions-and-answers. [OPERATOR INSTRUCTIONS].

And as a reminder, today's conference is being recorded.

At this time, I would like to turn the conference over to your host, Mr. Mike Kilpatric.

Please go ahead.

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

I am Mike Kilpatric, Vice President, Corporate and Investor Relations; and joining me today are David Yost, AmerisourceBergen's CEO;

Kurt Hilzinger, President and Chief Operating Officer; and Mike Dicandilo, Executive Vice President and Chief Financial Officer.

During the 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 of the key risk factors, we refer to you 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 phone 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.

AmerisourceBergen posted a strong third quarter, as noted in our press release this morning.

Quarterly operating revenues were up year-over-year 15% and $1.8 billion to a record $14.4 billion, reflecting a 15% increase in Pharmaceutical Distribution and 8% in PharMerica.

Operating margin expanded in both segments and in Pharmaceutical Distribution, it is up 10 basis points nine months year-to-date.

The diluted EPS from continuing ops were $0.58 on a GAAP basis, up 21%.

We generated $178 million of cash in the quarter and have over $1.6 billion on our balance sheet.

Lots to like in our third quarter.

Next month will mark the five-year anniversary of the merger that created AmerisourceBergen.

In our last quarter, we crossed two milestones that I think symbolically mark the official end of the ABC transition.

In June, we opened our sixth and final drug company Greenfield distribution center in Bethlehem, Pennsylvania, on time and schedule, as has been true for the previous five, and we sold the former Bergen Brunswig headquarters building in Orange County, California.

As we celebrate our five-year anniversary within the Company in August, we will note that in those five years; we exceeded our initial synergy target of $150 million, combined two management teams, integrated two sales teams, migrated to one IT platform, completed a dozen or so acquisitions and using FY '01 as a base in the midpoint of our FY '06 guidance, grew our EPS at a compounded growth rate of 15%.

I think the ABC associates should be very proud of that track record.

We will continue to reap the benefits of the integration efforts as we move forward.

Turning to industry issues, I would highlight three; recent generic activity, the issue of average manufacturing price or AMP-based reimbursement and the Florida Pedigree Legislation.

On Friday, June 23rd, Simvastatin was introduced, which symbolically launched the generation of generics that has been much anticipated in our industry.

While we avoid talking about results and impacts of individual products or manufacturers, the launch of Simvastatin provides a good example of the role played by ABC in the generic channel.

By Saturday June 24th, one day after launch, virtually all ABC customers who are on our automatic shipment program and could receive Saturday delivery, had Simvastatin in their pharmacies, ready to respond to dispensing market demands as they materialized.

Generics provide ABC good opportunities for our bottom line and balance sheet and program differentiation.

On the AMP front, we are monitoring the situation closely.

To refresh your memory, publishing of AMP for generic drugs has been postponed until at least January 1 of 2007.

Transparency is not an issue for us or our customers as long as AMP is calculated correctly and it's published prices are not new in our industry.

The definition of AMP is a salient issue for our customers and it is essential that the AMP published price be calculated correctly, reflecting prices generally available in the market to that class of trade since this is the price that will determine the maximum reimbursement to the retailer.

It is essential that the AMP does not disadvantage any of our customer groups and therefore, we are working very hard on the issue of definition with CMS.

Last on industry issues is the Pedigree Legislation in Florida.

In June, Governor Bush signed legislation that requires wholesalers to pass pedigree only to customers that will be engaged in wholesale activity and only when the manufacturer -- the merchandise has not been purchased directly from the manufacturer or their authorized agent.

As we have noted on a number of occasions, ABC took a leadership role within the U.S. last year in securing the safety and integrity of the distribution channel when we publicly stated we would purchase all merchandise only from the manufacturer.

In Florida, some thought a pedigree should be passed with the sale of all merchandise, including to pharmacies, which would have dramatically increased the complexity and cost of our operations with no increase in safety.

In our opinion, Florida sets a precedented for other states to follow.

Florida was a big win and a strong endorsement of the distributor-established channel integrity.

Our management team returned last week from our National Healthcare Conference and Exposition in Las Vegas for community pharmacies.

It is by far the largest such event in the industry and clearly becoming a must-attend event for this customer segment.

Over 7,500 people were in attendance and over 25,000 hours of certified continuing education were provided, the largest offering in the U.S.

A wide array of merchandise, programs and margin enhancement ideas were presented during the three-day event to help our customers run their businesses.

PPN, our provider network of almost 5,000 stores, our PRO Gen generics program, our Good Neighbor Pharmacy program, and our diabetes shop were front and center.

I was taken by the optimism of our customers regarding their businesses in the future and the creativity many have demonstrated in responding to the challenges of Medicare Part D.

Our revenues were very strong this quarter, particularly in our Specialty Group, which is now at $9 billion for the last 12 months.

In the drug company, all segments demonstrated good year-over-year growth.

Though hard to quantify, Medicare Part D was a contributing factor in the quarter.

In light of our 15% revenue increase this quarter, I would like to focus on revenue expectations for the future in the Pharmaceutical Distribution segment.

Revenue shifts often take place in the industry because company acquire customers and move the business to their distributor.

This competitive phenomenon has helped our revenue in the March and June quarters but will pressure revenue in the September quarter, as about $1.5 billion of business will move to a competitor earlier than expected.

While we continue to sign up new business based on the strength of our programs, it is important to note that with the July customer losses, the 15% revenue growth delivered in the March and June quarters will not be repeated in the September quarter.

It is reasonable to expect our revenues in the Pharmaceutical Distribution segment to grow more in line with the high-end of the market in the high single digit revenue area, net of acquisitions.

We will provide more clarity on future revenues as part of our FY '07 guidance with our next quarter's results.

I would continue to describe the pricing environment in Pharmaceutical Distribution as competitive but stable.

It is important to note that our industry is very large, at a run rate approaching $260 to $270 billion with few multi-billion dollar accounts.

On July 11th, we announced the acquisition of Rep-Pharm Inc., solidifying our position as the second largest wholesaler in Canada with our third acquisition there in less than a year.

We're very happy with our experience in Canada, our fourth step in distribution outside the U.S.

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

As 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 in purchasing our own stock.

Our acquisition criteria is straight forward; well-run companies in the pharmaceutical supply channel with operational and/or managerial synergies with attractive growth prospects and good margins are a strong pathway to that criteria.

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.

After spending very little money on acquisitions in FY '04 and FY '05, so far this year we have spent about $0.25 billion in the small number of acquisitions that were strictly in line with our focus.

We targeted Canada.

We targeted European packaging and identified and ultimately acquired Brecon.

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

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

With our strong cash position, we will continue to review our dividend policy with our board, as we do every year, as well as our share repurchase program.

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

Now Kurt will provide some color on the quarter.

Thanks, Dave.

Good morning, everyone.

Today I will touch on the performance of each of our key business units, review some of our key objectives for the remainder of '06 and highlight a few of our opportunities as we look to 2007.

We're obviously pleased with our consolidated financial results for the quarter which exceeded the high-end of our internal targets on most key performance indicators, including a notably improved performance in our PharMerica business unit, which I will touch on in a few minutes.

We posted a very strong performance in our drug distribution segment, driven by a continued solid recovery in the drug company and another strong performance by the Specialty Group.

We were particularly pleased with the stable gross margin performance in the segment versus year-ago levels, in spite of continued stronger than expected revenue growth by our larger, lower-margin customers and a sale side pricing environment we would characterize as stable but competitive.

The gross margin performance was largely driven by three factors.

First, continued solid execution under our new fee-for-service agreements.

And through our transformed program, where improved customer contract compliance, particularly in the area of generics, was again an important factor.

And third, our continued discipline around customer mix and pricing.

Just a couple of brief comments regarding fee-for-service.

We continued to successfully work through a small number of contract renewals this year.

Negotiations have been smoother as manufacturers have gained a greater appreciation of the benefits of this new model to their own business.

Going forward, we see further improvement in buy side economics, in part as a result of improved fee terms and in part due to our own ability to perform under these contracts which has matured significantly this year.

Our generic sales were up nicely in the quarter, well ahead of our internal expectations, due in part to our successful launch of Simvastatin, as Dave mentioned, also improved performance around controlling customer leakage, primarily with retail accounts.

This trend bodes well for the fourth quarter and 2007.

On the generic sourcing side, we continue to see interesting new opportunities open up, particularly with new international manufacturers who seek access to the U.S. market, and in particular, our hard-to-reach independent retail customer base.

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, opened in early June on schedule and on budget.

Two consolidations were completed in the third quarter, and more and more consolidation will be completed by the end of September, bringing our total consolidations for this year to six.

We will finish the year with 28 distribution centers, down from 51 five years ago.

We are likely to have a small number of additional consolidations in 2007, bringing our final network in the U.S. into the mid-20's.

Benefits of the Optimiz program will continue to accrue in 2007 as further implementation of new warehousing system and productivity standards will provide additional cost savings.

Our acquisitions in Canada this past year represent a whole new set of opportunities for similar type cost savings.

Now with the anticipated addition of the Rep-Pharm television, our Optimiz discipline and capabilities will be implemented in Canada to rationalize our current network of 13 distribution centers, to reduce costs, improve productivity, and add capacity to key growth markets.

We'll provide more details on our plans as we turn the corner on 2007.

Net of the impact of acquisitions, operating expenses as a percent of revenues were down modestly from year ago levels.

As investment spending related to transform, to integrate our customer solutions sets and drive better gross margin performance, offset near-term productivity gains.

So all in all, we made some very solid progress stabilizing our margins through fee-for-service in the transform and Optimiz programs and are confident more improvements will be made, going forward.

The packaging group had another solid quarter, with continued strengthening of the product launches at American Health Packaging and Anderson Packaging.

Our acquisition of Brecon Pharmaceuticals is off to a very strong start.

I spent time last week in the U.K. visiting Brecon and was pleased to see financial performance ahead of our internal expectations and our integration capability proceeding smoothly.

In recognition of its capabilities and quality, Brecon was recently given a Global Supplier of the Year award from a top U.S. brand manufacturer, one of only two awards given to an internationally-based outsourcing provider.

We expect the packaging group to continue to make a solid contribution for the remainder of 2006 and it's pipeline bodes well for 2007.

Now turning to PharMerica.

While this continues to be a transitional year for PharMerica, we saw a notable improvement in the long-term care unit during the June quarter.

Top line performance was again strong, with revenues up 8% versus year-ago levels with better gross margins stability and improved operating efficiency as our pharmacy automation investments help to further reduce costs.

Our national footprint and customer facing technology offers continue to generate share gains against our largest competitor and smaller players who continue to have a difficult time with the Part D transition issues.

Importantly, this morning we announced that PharMerica has entered into a new comprehensive service agreement with our largest customer, Beverly Enterprises.

Under the terms of this agreement, PharMerica will continue its role as the sole pharmacy services provider to Beverly through the spring of 2009, with further contract extensions possible.

Through this agreement, we will be able to support Beverly's drive for continued leadership in patient care by helping them create best-in-class care settings for the patients they serve.

Extra costs directly related to the Part D transition continued in the quarter but down from last quarter.

This quarter's impact was roughly $1.5 million, with a similar amount expected again in 4Q.

Manufacturer rebates were in line with our reduced expectations.

Part D reimbursement rates driven by favorable PDP mix were again better than expected but still not sufficient to offset the reduction in manufacturer rebates.

As we have indicated previously, we are now in the middle of PDP negotiations for calendar year 2007.

To help close this gap, we are seeking PDP contract amendments in certain places to either secure better reimbursement rates or drive operational improvements, primarily around co-pay's and prior authorizations, to lower our administrative costs.

And of course, we will also seek to recover lost rebate dollars in our negotiations with manufacturers that will begin this fall.

Lastly, turning to the Specialty Group, the group had another excellent quarter of strong sequential growth, driving revenues past $9 billion on a latest 12-month basis, 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.

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

A number of new exclusive or semi-exclusive distribution agreements were entered into during the third quarter.

To support the Specialty Group's continued growth, we approved a number of investments for the group during the June quarter, including a significant expansion of oncology supply's distribution center in [Dofin], Alabama, and a new headquarters location for the group in Dallas.

Both new facilities will open during fiscal year 2007.

In addition, during the quarter, we opened a new facility in Reno, Nevada to establish a stronger western presence and support the growth needs of the group's various distribution units.

Lastly, integration activities around NMCR continue to proceed smoothly during the quarter.

So all in all, a solid quarter with improvements in some key areas, which bodes well for the remainder of the year and into 2007.

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

Thanks, Kurt.

And good morning, everyone.

I am very pleased to present our third quarter results which reflect revenue and earnings growth above our expectations, improvement in PharMerica and significantly reduced net interest expense and despite significant share repurchase activity, we once again ended the quarter with an extremely strong balance sheet.

As usual, I would cover both our consolidated and segment results, comment on our strong cash flow and balance sheet trends and finish with an update to our fiscal 2006 guidance.

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

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

Starting with our consolidated results for the quarter; operating revenue was up a higher than expected 14.6%, driven by both our drug and specialty units within Pharmaceutical Distribution.

That strong revenue growth in turn drove a 12% increase in consolidated EBIT.

Included in our consolidated gross profit for the current quarter was a benefit of $4.6 million resulting from manufacturing and trust cases.

In the prior year, gross profit was benefited by $7.8 million, relating to the net positive impact of a favorable settlement from the manufacturer antitrust case, a charge due to a generic manufacturer bankruptcy and a write-down of certain automation inventory.

Reflected in our consolidated operating expenses for the quarter within the facility consolidation, employee severance and other line, was a $17.3 million gain from the sale of the former Bergen headquarters in Orange, California, offset by $17.2 million in other facility and severance costs.

These costs include an increase in a compensation accrual of $13.9 million as a result of an adverse decision in an employment-related dispute for a former Bergen CEO who was terminated before the commencement of the merger discussions that led to the creation of ABC.

While we intend to pursue our legal options with regard to this matter, the accounting rules obviously require us to accrue the current judgment.

In the prior year quarter, we also had $3.7 million of facility consolidation costs.

Equity compensation expenses were $4.9 million in the June quarter and were negligible in the prior year, again, as a result of our current-year adoption of FAS 123-R.

Moving below the EBIT line, we actually had $600,000 of net interest income in the quarter, a significant improvement from the $11.3 million of net interest expense in the prior year, reflecting the impact of rising interest rates on our invested cash and a reduction in long-term financing costs.

Our effective tax rate for the quarter was 36.9%, up slightly from last year's 36.4% rate, which benefited from certain tax adjustments.

Our effective tax rate should be in the 37 to 38% range going forward.

Diluted EPS from continuing operations of $0.58 was up a strong 21% from last year's $0.48, again driven by the strong growth of our Pharmaceutical Distribution segment, PharMerica's improvement, and a reduction to net interest expense and our weighted average outstanding diluted shares.

The net positive after-tax impact of the litigation gains in the facility consolidation and employee severance costs was $2.9 million or $0.01 per share in the current year quarter, similar to the $0.01 per share net benefit in the prior year quarter for the previously noted items.

Our average fully diluted shares outstanding for the quarter were 207.3 million, down nearly 1.5 million shares from last year, as a result of our share repurchase programs net of option exercises.

Moving to the Pharmaceutical Distribution segment; we had a top line increase of 14.5% aided 1.7% by our acquisitions, primarily ABC Canada.

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 continued strong growth in the Specialty Group.

As Dave mentioned, our growth rate in the fourth quarter should moderate to the 9 to 11% range as a result of the acquisition-related customer moves.

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

Our institutional business grew 17%, driven by Specialty and by our large customers in the alternate site space.

And retail growth in the quarter was 11%, once again helped by our Canadian acquisition.

Our Pharmaceutical Distribution gross margin of 303 basis points increased by seven basis points in the quarter, due to strong performance in both the fee-for-service and generic areas, which offset unfavorable customer mix.

Our acquisitions also positively impacted our gross margin.

In addition, our gross margin in the prior year quarter was unfavorably impacted by $13.5 million of charges due to the generic manufacturer bankruptcy and the technology inventory write-down that I previously mentioned.

From a LIFO perspective, we had a small credit of $1.3 million in the quarter, compared to a charge of $3.2 million in the prior year.

The LIFO charge year-to-date is $14.1 million, approximately $3 million higher than the prior year nine-month charge.

And we continue to expect a $15 to $20 million LIFO charge for the year.

Operating expenses as a percentage of revenue were 193 basis points, up two basis points from the prior year quarter.

However, if you will exclude the impact of our acquisitions, the expense margin was actually three basis points lower year-over-year, as our productivity gains from Optimiz offset our investments in our sales and marketing and IT infrastructures, as expected.

As a result, our Pharmaceutical Distribution EBIT margin for the quarter increased to 110 basis points, a five basis point improvement over the prior year, and for the nine months, was 114 basis points, importantly, up 10 basis points over the prior year.

We continue to expect our operating margin for the year to be at the low end of our 115 to 125 basis point range as a result of our customer mix.

Turning to PharMerica, revenues of $424 million were a record high, up a strong 8% versus the prior year.

Our EBIT margin was 6.5% in the quarter increased a significant 124 basis points from the prior year and was up even higher sequentially.

The gross profit margins were relatively flat year-over-year, while expenses as a percentage of revenues were down significantly in the quarter to 22%.

Personnel expenses were flat year-over-year, despite the sales increase and $1.5 million of M&A-related expenses.

And we also benefited from a $3.2 million reduction in our sales tax liability in our workers compensation business.

With our year-to-date operating margin sitting at just under 5%, we now expect that PharMerica's operating margin for the year will be at the high-end of our 4 to 5% forecast.

Turning to cash flows and the balance sheet; cash generated from operations for the quarter was above expectations at $178 million, and for the nine months, was an impressive $881 million.

This is ahead of our revised operating cash forecast for the year of $600 to $700 million, and accordingly, we are raising our forecast for the year to a range of $700 to $800 million.

We expect that cash generated from income in the fourth quarter will be more than offset by a net increase in working capital in the quarter, primarily due to the timing of payments to manufacturers.

The cash generation in the quarter was really driven by earnings, with a small benefit from working capital.

DSO's increased to just over 17 days in the quarter, from 16 days last year, impacted by continued above-market growth at the Specialty business which had higher DSO's than the drug company, and also increases in PharMerica's DSO's due to slower reimbursement under Medicare Part D. Inventory days on hand during the quarter were 29 days, consistent with the March quarter, and down six days from last June.

We continue to expect our inventory balance to be in the $4 to $4.5 billion range for the end of the year.

CapEx for the quarter was $29 million, and for the nine months was $89 million.

And most likely will be at the low end of our guidance for the year, which is in the range of $125 to $150 million.

Our debt-to-capital ratio at the end of June was just over 20%, up slightly from last year.

And with a cash balance in excess of $1.6 billion at the end of June, our net debt-to-capital ratio was less than zero once again.

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

And during the quarter, we did repurchase $374 million worth of our shares, leaving $244 million remaining under our share repurchase program.

We have now spent $506 million on repurchases during the fiscal nine-month period, exceeding our previous target of $400 to $450 million for the year.

And we expect to continue to be active in the market during our fourth fiscal quarter, subject to market conditions.

In addition, as mentioned in our press release, we would expect to close on our Rep-Pharm acquisition by the end of the fiscal year.

To summarize, another solid quarter driven by higher than expected top line growth, double-digit operating earnings growth, and continued significant cash flow.

From a guidance standpoint, we are raising our fiscal 2006 EPS forecast on a GAAP basis from our previous range of $2.06 to $2.21 per share, to a range of $2.16 to $2.24 per share, which includes the net benefit of $0.11 from special items, all of which have already been realized in our first nine-month results.

This assumes an EPS range of $0.51 to $0.59 for the fourth quarter, excluding special items, which should net to zero.

We expect operating revenues to be in the 12 to 13% range for the year, which assumes 9 to 11% growth in the fourth quarter.

Finally, as previously mentioned, our operating cash flow guidance for the fiscal year has been raised to a range of $700 to $800 million.

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

Thank you, Mike.

We'll now open the call to questions.

All right. [OPERATOR INSTRUCTIONS] Our first question today comes from Merrill Lynch from the line of Tom Gallucci.

Please go ahead.

Thanks.

Good morning.

Was hoping to go get a little more granularity on the revenues and the margins in the drug business.

You mentioned a new different items; the faster growth of bigger customers, new business in Specialty.

Can you pinpoint what accelerated -- I think last quarter you talked about having a more difficult comp in the fiscal third quarter and we expected a slowing, but you still had the same kind of year-over-year growth that you saw in the second quarter.

So arguably something got a little bit better.

Was it -- there some new business wins or did one of those particular areas grow faster?

I would say several things, Tom.

You kind of hit -- it was a series of a lot of things.

Number one, we think we got a little lift from the Medicare Part D, so that helped us.

We clearly had some of our customers make acquisitions, and that helps.

We continue to win new business.

We're very excited about the program offering we've got.

I mentioned -- just coming back from Las Vegas, we had a very strong showing out there with customers.

And we continue to have our Specialty business, particularly in the distribution end of it as Kurt mentioned, make new wins and have a big increase.

It is really been -- it's really been across a lot of different places, as opposed to pinpointing one individual customer or one individual product line.

Okay.

You mentioned, Kurt, I think it was, that the generics business grew faster than you were looking for -- or had expected.

Can you tell us how fast that did grow year-over-year?

Tom, appreciate the question.

I don't think we can go there with you.

But we clearly saw an acceleration.

I think part of that is probably Part D-related.

Part of that is very good work done by our salesforce in the drug company spending more time with the accounts, looking at the data, to make sure they're being compliant against their contracts, making sure they're buying up to the maximum amounts they ought to have in their pharmacies.

And really just making the pitch to them that buying on our formulary programs is the best value for them, and we see that traction here.

Of course, you had this unusual item that Dave highlighted, which was the Simvastatin launch, which is a bolis of activity right near the end of June that helped the quarter as well.

Even without Simvastatin, we would have been up nicely.

Thanks, Tom.

Thank you.

Thank you for your question.

Next we will take a question from Banc of America from Robert Willoughby.

Please go ahead.

Hi, Dave or Mike.

How should we think about interest income in future periods?

You really don't appear to be spending the cash quickly enough for it to trend down.

I guess you have a couple payments are announced, possibly, but is that a number that should trend up in perpetuity, here?

Certainly, Bob, we benefited from the third quarter having a higher invested balance.

And we have spent some of that throughout the quarter based upon our share repurchase activity, which was very high in the third quarter as well.

So as we go into the fourth quarter, I would expect that my average invested cash is slightly lower than it is in the third quarter.

And that interest expense should go up modestly in the fourth quarter.

And as we continue to whittle that cash balance down, I think you will continue to see that somewhat, going forward as well.

We did end the quarter with approximately $150 million or so less cash than we did at the end of the previous quarter.

Thanks, Bob.

Thank you.

Next we have a question from Lehman Brothers from Larry Marsh.

Please go ahead.

Thanks and good morning, everyone.

Maybe just a little bit of elaboration on how you describe the margin environment, both I guess, Dave and Kurt.

I think you sort of said it was either stable and competitive or competitive and stable.

Would you characterize the sell margin environment as being consistent with what you saw, say six months ago?

Or has there been any change?

Maybe just elaboration, as well -- it sounds like, Kurt, you're saying that the buy margin environment has gotten better for you.

And you continue to see that as continuing to improve in the future.

Could you elaborate on that?

And just maybe put that in context of the environment today versus what you've seen over the years -- the drug business?

Let me just first comment on the competitive market.

Stable but competitive and competitive but stable, we would say that's the same thing.

So we're together on that.

I would say it is not dissimilar to where it has been for the last six months.

It has always been a competitive business that we're in, but we're not seeing anything outlandish in the marketplace.

We've had a couple of regional wholesalers be absorbed by a -- two large competitors.

We think that will have a stabilizing impact on the market long-term.

So we're finding kind of steady-as-she-goes out there.

On the buy side, Larry, I did express some optimism looking forward.

And a part of that is, as I mentioned, is a lot of the agreements that we entered into last year were multi-year agreements, and a number of them have fee escalators in there.

With a second and third years, we're going to have better income opportunities for ABC than the first year of the contract.

So that lays ahead of us.

We're looking forward to that for 2007.

Frankly, I think we've just gotten better.

These are performance-based contracts, and I've seen the strength of our organization improve throughout the year in our ability to get to those performance-based payments more accurately and max those out.

And we'll have more opportunity to do that next year.

So I see the buy side piece of the P&L becoming a larger contributor this next quarter and then into 2007.

We're optimistic about the way things look that way.

Okay.

I will stop.

Thanks.

Okay.

Next question, please.

Okay.

Thank you.

The next question comes from Goldman Sachs from the line of Christopher McFadden.

Please go ahead.

Good morning.

This is Jennifer Hill for Chris McFadden.

I just want to build on the operating margins in the Drug Distribution business, kind of building on Larry's question.

The operating margin is 1.14% year-to-date, and now you expect it to get to the low end of your 1.15 to 1.25% range.

What takes the margin in the fourth quarter up versus what it was in the third quarter at 1.1% under fee-for-service?

And then also, when you step back and look at what your targets were in the beginning of the year and now you're expecting to be at the lower end of that range, what were the primary factors driving the lower end -- meeting the lower end of the range?

And how do you take that and look at where you think margins can go in '07 and beyond?

Okay, Jennifer, that's a lot of questions, and I will start and and Kurt can chip in.

Certainly, we continue to expect continued operating margin growth as a result of all the good things we've talked about, both from a generic program perspective, as well as the benefits we continue to realize from our transformed program.

We've made good progress throughout the year.

We have -- and we're going to continue to make good progress as we go forward.

Those opportunities -- many are still ahead of us.

So I think we're going to continue to progress.

We've talked about the out years growing in the single-digit basis point margin range -- operating margin range, and we're not backing off of that at all.

As far as being at the low end of our range for the year, again, our large customers who have the best pricing have grown faster than the overall market, and that's put some pressure on us, and particularly -- or additionally, in our Specialty Group, we have had just spectacular growth, well above market.

However, a lot of that growth has been in their distribution businesses, which have a lower overall margin than some of their service businesses.

And therefore, the weighting of that growth puts some pressure on that EBIT margin.

But when you look at things in total -- we're looking in a year where we have double-digit revenue growth, double-digit gross profit growth, and double-digit operating margin growth.

Results we're very proud of.

I think she wanted you to tie to the fourth quarter results -- why it would be up versus the first -- this last quarter and the first nine months,so they can get us into the range.

Again, certainly, Kurt, the impact of our -- some of the generic introductions late in the year, I think the impact of -- the continued impact of our transformed program are two key factors in that continued growth.

And not to mention, as Kurt did earlier, we've continued to sign fee-for-service agreements throughout the year and still have some upside in the fourth quarter.

Just to put it in perspective, Jennifer, to hit the low end of our range, 115 basis points from where we sit now, we have to have 118 basis points in the Pharmaceutical Distribution in the fourth quarter.

And we're very comfortable with that and that low end of the range from 115 to 125.

Thank you.

Thanks, Jennifer.

Thank you.

Our next question comes from Citigroup from the line of Oksanna Butler.

Thank you, good morning.

Can you tell us with respect to the fourth quarter, have a -- quite a range there, what might be some of the key drivers in terms of the range?

And also, you have mentioned your improved ability to perform under these contracts.

Can you just explain a little bit further what exactly has improved there?

Thanks so much.

Oksanna, this is Mike.

I will handle the range and Kurt can talk about the other factors.

I think first you've got to remember that we have fewer significantly outstanding shares than some of our competitors. $0.01 for us is a little over $3 million pre-tax.

A range of $0.04 either way, you're talking about $12 million for a company doing close to $15 billion in operating revenue.

From that perspective, I don't think the range is that great.

Secondly and importantly, in our fourth quarter every year we have our LIFO true-up.

And based upon our past experience, we have had some big fluctuations because that's a very dynamic calculation.

You may remember last year that we had a $15 million credit in our fourth quarter from our LIFO calculation, which certainly adds to the volatility and justifies the range.

Just on the contract side -- I think just put it in context -- we've got multiple contracts now in place with multiple manufacturers, each one is customized to the particular needs of that manufacturer and what they want to get accomplished in the channel.

Some of them have very specific performance targets, even down to the distribution center level.

Whether it is around days inventory on hand, fill rates to customers, returns performance, contract charge-backed administration activities, all of those things that make up our relationship with the manufacturer, they are different in each one of these contracts.

It is just taking our organization, as you would expect, time to get comfortable with the contracts, learn the contracts, learn our obligations under there and then perform against them to the maximum of our ability.

And that has just strengthened through the year.

And I am saying as we head now into the fourth quarter and '07, that our ability to hit the maximum numbers under those contracts, I think, is better now than it has ever been.

We look forward to that.

Okay.

In terms of the range in the fourth quarter, then, bottom line, it doesn't sound like you are -- your level of confidence in terms of the operations is pretty strong.

Yes, absolutely.

Absolutely.

Thank you.

Thanks.

Thank you.

We have a question from J.P.

Morgan from the line of Lisa Gill.

Please go ahead.

Thanks very much.

We've talked a lot about revenue growth.

And one of the areas of revenue growth is obviously Specialty.

I am wondering if you could perhaps walk us through -- without giving exact numbers, I know you don't like to give a lot of detail around Specialty.

What are we seeing as far as the difference in margins?

Is that part of the reason that we're seeing some of the margins compressing in the third and fourth quarter, as Specialty continues to grow?

Or is it really just new customers that were at a lower margin?

And then secondly, Kurt, I was wondering if you could talk about your longer term outlook and plans for PharMerica?

And how you things going as far as contracting for 2007?

I will start off, Lisa.

You hit upon a key issue with Specialty.

It is growing very fast, as you note, and what's happening is that our distribution business there is growing faster than our services business.

Not to say that the service businesses aren't growing well, but they're just being outpaced by the distribution business.

And the distribution business and the Specialty business has a lot of the same characteristics that are demonstrated in other distribution business, that is relatively low margins.

You're actually spot on that.

That's having an impact and that's part of what we define as mix and having a big impact on our margins, going forward.

PharMerica, as I mentioned in the prepared comments, Lisa, we're in the middle of PDP negotiations right now, this is for calendar '07, so starting January 1.

And I would say the discussions are good.

I think the PDP's have recognized the value and the importance of long-term care pharmacy as a separate care setting from other types of pharmacies.

We're in these discussions with a really positive mind set.

And the early indications are strong that we will able to improve our operating efficiency and improve our reimbursement rates as we head into next year.

That is all very positive.

It is still open as to whether or not what we will get in that negotiation will make up for the gap in rebates that we were receiving from the manufacturers.

We're hoping it will.

We're not sure it will.

We have another bite at the apple, which is that we will reenter into negotiations for rebates with manufacturers this fall, which is when he have historically have done it, it's a fall activity.

And we will again make our case with our manufacturing partners of the importance of this care setting, the importance of being able to get their particular product dispensed in those care settings.

And so we see some very nice developments in PharMerica.

We don't want people to get ahead of us, but I think we're seeing a strengthening in the operations.

We started to allude to that last quarter.

We saw some of that come through nicely this quarter.

And I think we're going to see a continued strengthening in the model now as we finish up the rest of calendar year '06 and then into '07.

Do you view it as part of core operations, going forward, for AmerisourceBergen going into '07 and beyond?

You know, Lisa, we've said is would -- we've never said it's core, what we've said it, it's not core but it is a logical extension of our business.

We would continue to make that case.

Great.

Thanks.

Thank you for your question.

We have a question from the line of Robert W. Baird from Eric Coldwell.

Please go ahead.

Thanks very much.

One specific question and then one market question.

First on the specific question, you highlight performance and service opportunities in drug distribution that can drive better profitability under your distribution service agreements.

I am curious now that Bergen is integrated, whether there might be any Greenfield opportunities, such as adding internal redistribution centers that could drive the profitability beyond the current levels?

Eric, you are onto something that I think we have to be careful that we don't talk too much about.

It is an opportunity for us.

It is somewhat competitive.

We do have some capacity there.

And we're actively looking at ways to use -- a variety of redistribution models to generate some additional fees from manufacturers.

I can't go any further than that.

That's clearly an opportunity for us.

Thanks.

My market question or general question is, I think it gets back to what Dave started the call off with, which is a couple of macro issues like AMP.

As we look at AMP, and it is obviously a topic of increasing debate and confusion, I just want to verify that the only impact Amerisource currently sees, potentially in '07, is an indirect impact stemming from the impact on your customer base.

A, can we verify that?

And B, what should we be looking for over the next six months or so as the main things, main characteristics, main catalysts before AMP based systems kick in -- what should we be looking for as to give us a clue as to whether things are unfolding favorably or unfavorably?

Well, first Eric, you are absolutely right, it's indirect.

It is about how our customers are getting reimbursed.

And because of that, we're obviously interested in working very closely with CMS.

I think as the debate unfolds, I think it is going to be determined by whether or not CMS understands the pricing nuances in the marketplace between different classes of customers.

That's the important thing to establish because it is very important that that definition of AMP be established correctly.

And what goes in and what does not go in are very, very important.

So we're encouraged by the audience that we are getting from CMS, and we just want to make sure that definition is properly stated.

Dave, are there any events on the calendar that we should be looking for in terms of special CMS meetings or public events that we could keep our eye on over the next five to six months?

It is a good question, Eric.

At this point, there is not.

There are no big public hearings that I know of.

Most of the work is behind the scenes, various trade organization are working on it, we're working with them and we're working to make the case known.

But there is no event that I think you can point to at this point.

Perhaps when we get closer to January 1st, there might be.

Okay.

Thanks very much.

You bet.

Thank you.

Our next question comes from the line of Credit Suisse from Glen Santangelo.

Please go ahead.

Yes, Dave and Kurt -- just a quick follow-up question on PharMerica.

This quarter you didn't provide any updated guidance.

I think in the past you had said you expected 4 to 5% margins in that division now.

As the acuity level rises within the nursing home sector and revenues go up, shouldn't we also assume that margins are going to go up commenciate with that?

And as the generic mix improves in that business as well, shouldn't that all be translating into higher margins?

If you could elaborate a little bit more on the strength this quarter?

And then kind of comment on the margin outlook and the revenue outlook over the next couple quarters, that would be helpful.

Thanks.

Right, Glen.

You're right.

One thing I didn't comment on this morning and I have in prior quarters is the favorable acuity mix that the sales team is achieving in the long-term care business.

Not only are they winning business referenced by the 8% revenue growth, but they're winning the right type of business.

On a -- said another way, on a per patient basis, the patients were winning take more meds than the patients we're losing, if you will.

And so that drives operating efficiency in the business.

And you're absolutely right on generics as well.

Generics are additive to the profitability of the business.

So those things in combination with more leveraged over the fixed cost base of the 80 pharmacy network means that most of those revenue dollars, the gross profit attached to that is dropping straight down to the EBIT line, and we would expect to see EBIT margin expansion in the business.

Having said that, I think Mike's comment was that we expect to be at the high-end of our range now, which was 4 to 5%.

Okay.

And so what about generics in the Beverly contract?

Do they offset each other?

Or how do we think about that?

I understand the question, but it is really not one I think we're at liberty to discuss, given the specific nature of that agreement and that customer.

Good news is, we've got that contract solidified and we're very happy about that.

Okay.

Thanks.

You're welcome.

Thank you.

Next we'll go to UBS with Ricky Goldwasser.

Please go ahead.

Good morning.

Just a few follow-up questions.

First of all, just to make it clear, on the Specialty side, I know you talked about Specialty margin -- or Specialty distribution margins being lower and driving overall margin down.

My first question there is, are you seeing Specialty environment being up more competitive than it used to be?

Also, what would have been the trends for drug distribution margin excluding the Specialty business?

Ricky, let me first talk about the issue with Specialty -- and I don't want to make it sound worse than it is here.

The point that I wanted to make is we're growing our distribution business faster than the service business in the Specialty business, primarily oncology is very big growth area for us, and that is a very competitive business, and that has been experiencing very attractive growth.

And that has put pressure on the margins as we've gone forward.

It is the mix issue with more distribution business in Specialty than services business.

The long-term trends in the total business are up 10 basis points for the nine months year-to-date in our distribution business, and we've not broken out the Specialty and the drug company margins.

So should I look at it as drug -- as Specialty business still overall has better margins than the core distribution business?

But just within Specialty the mix was less favorable this quarter?

Yes, this is Mike.

That's absolutely right, Ricky.

Okay.

And then just one more follow-up, I know there has been a lot of discussion on margins and buy side and sell side.

Is what we're hearing here, when you look into '07, you're expecting to see some improvement on buy side margin than what you're going to be paid from Pharma, which is going to offset potentially more challenging environment on the sell side?

Are we kind of looking ahead?

Or are we back to times where buy side -- some sponsors the sell side were kind of -- a year ag,o the premise was that yes, we have fee-for-service, but then we're also going to try and increase sell side margins at the same time.

You want to be very careful about providing '07 guidance.

As I said we'll provide '07 guidance when we release next quarter at our fiscal year end, as is traditionally been our case.

I just will reiterate what our long-term guidance has been, and that is that we expect to grow our revenues in line with the market -- the high-end of the market net of acquisitions.

And we expect to have single-digit expansion in our operating margin going forward.

So there are a lot of puts and takes to get to that margin, and we haven't broken out specifically the buy side, the sell side and the like.

But we're very comfortable with that long range guidance as we sit here today.

The 115 to 125 that you have given for '06 should be how we view the longer term?

What you should view for the long-term, Ricky, is that we expect to grow our operating margin in the single digits year-over-year and grow our revenues at the high-end of the market.

Okay.

Thank you.

Thanks.

We have time for two more questions.

Okay.

Thank you.

We'll go to AG Edwards with Andy Speller.

Please go ahead.

Thanks, guys.

Good morning.

Two questions.

One for Mike on the balance sheet and the payables line.

Seeing that number continue to go up, is that a function of the new fee-for-service contracts?

Or how should we look at that line on a go-forward basis?

Yes.

The payables number has gone up a little higher than the 15% revenue growth, when you compare it back to September or the previous June.

Some of that just happens to be timing at the end of the quarter, Andy.

Obviously, pushing $200 million of business through today, timing can have an impact.

And that's one of the reasons when I gave my cash flow guidance for the year, I kept it at $700 to $800 million, although we were already higher than that through nine months at $881 million because I would expect, in the fourth quarter, some of the benefit that we have gotten on that payable line will reverse.

From a structural standpoint, no big difference in terms with either our brand name or generic manufacturers.

Secondarily, on your new Canada operations, can you just size that business for us once you close on the upcoming acquisition?

And are you going to start breaking that piece out for us on a go-forward basis?

Andy, it is Kurt.

After we close the Rep-Pharm transaction, it will be -- have an annualized revenue line of about $1.6 billion, and --

We don't plan to break it out, Andy.

We don't think it is big enough issue.

Okay.

But that is included in terms of the way you break out institutional and retail -- that all falls in the retail line?

Currently, the majority is in the retail area.

It is almost all retail.

It is retail business which is what attracted us to --

Andy, I am getting the high sign, here, that the number should be $1.4, not $1.6.

I am looking at some growth numbers and I'm getting out ahead of the team here.

This is great, Andy.

We haven't established goals for next year.

It is good to get some of these place cards set.

Okay.

Thanks a lot, Andy.

Fair enough.

Thank you, guys.

You're welcome.

Thank you.

Our last question comes from Raymond James from the line of John Ransom.

Please go ahead.

Do you have any hard it is to appear clever following all of these smart people?

That's put me to the back of the line. [multiple speakers - inaudible] Covered you for five years, and I am still in the back of the line.

That says a lot right there.

You have to get a faster finger.

Well, it is this some Ma Bell phone system in Florida.

My question, going back to Specialty, would be the old mule for a minute -- your competitors, obviously, Bristol -- McKesson exited their relationship with OTN and then Cardinal has just given up and gotten out of that business.

Talk a little bit why you're zigging and they're zagging and what it is?

Obviously, you've been fabulously successful in that business, you've doubled your revenues, et cetera.

But what is it -- what is your secret sauce, from the outside looking in, that's different from what other people see in that business?

I would say, John, there is kind of two issues.

One of them is scale, and the other one is services.

And having a small piece of that business and just providing the merchandise really doesn't cut it, it really doesn't get it done.

Okay.

What we have is -- first of all, we have huge scale, we're by far the largest oncology distributor in the United States.

We clearly have the scale.

And as Kurt mentioned, we're actually expanding the distribution facility that handles that business.

But in addition, we have a wide array of services.

And it is everything from reimbursement, counseling for the positions and the manufacturers to position educations.

Which, somewhere in the United States, almost every weekend we've got some physician education business going.

So it is the wide array of services that goes along with that business and makes it very attractive to us and the momentum that we have in that business.

Okay.

And then my other question -- we do a lot of work with the big chains and obviously they're telling -- and it shows in the numbers, there is a market share shift going on in retail accelerating towards the big guys.

And some of the little chains don't seem to know what to do with $2 dispensing fees and extended payment terms under Part D. And we hear stories about them sending some of that Part D business -- they're happy to send it to over to Walgreens and they don't have the front end business, et cetera.

I know you guys are huge champions of that channel, but in your guide is there a little edge about maybe some bad debt or some loss of market share in that customer channel?

And do you have to -- you talked about new customer wins, are you having to step on the market share accelerator a little to offset some channel pressure?

John, I will go first and I'll let Kurt -- he's probably going to want to chime in.

I'll tell you what, we just came back from our exposition in Las Vegas, and I will tell you, I was eyeball to eyeball with literally hundreds of customers.

And I will tell you, their optimism for the channel to chain work was contagious on me -- and with me.

And we presented them with a wide array of services to help them run their businesses better, whether it is our diabetes shop, our Good Neighbor Pharmacy, our generic program, the verbal medical equipment and so forth.

So the short answer to your question is no.

I think that channel is alive and well.

I think it provides a very valuable service.

And as I told folks in my prepared remarks, I think independent and small chains are going to prosper in the years ahead.

Kurt, you were there too.

That was clearly the message we were conveying and getting positive feedback on, John.

We see fundamental shifts towards consumer-directed healthcare in that country, which means that patients are going to be responsible for making more of their care decisions.

And we think that plays straight into the hands of an independent pharmacy because their value proposition -- the amount of care that you get and the cost for that care is extremely good value proposition for patients.

And plus, the care setting is moving down to a more local level and out of institutional campus-type settings.

I think we see a lot of things, from a macro standpoint, that's going to continue to aid that group.

Clearly, they're frustrated with Med D, clearly they are frustrated with the reimbursement slowness, and we've had to help them get through that a little bit.

But I think that we're through the worst of that, and I think they're starting to see some light at the end of the tunnel and are optimistic about the future.

I would also say, John, given the fact that our two competitors have just made acquisitions in this space, bought regional wholesalers -- I would say that they're endorsing that.

Not that I am looking for them for endorsement, but I would say the fact they bought in there would indicate that they think there is great potential there, as well.

Got you.

Thanks a lot.

Thank you very much, everybody.

Really appreciate your participation today.

And now I would like the turn the call over to David to make some final remarks.

I guess I would just end by thanking you for joining us and for your interest in AmerisourceBergen.

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

We're very happy with our double-digit revenue, gross profit and EBIT that we reported this quarter, and our strong cash -- the 10 basis points expansion, our operating margin in Pharmaceutical Distribution business that we had for the first nine months.

We think that our broad customer mix and our position in Specialty and the opportunities in generics really provide great opportunities going toward.

So we look forward to reporting our year-end results in 90 days or so.

Thank you very much.

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