美源伯根 (ABC) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the AmerisourceBergen's fiscal year end call.

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

Later we will conduct a question and answer session.

Instructions will be given at that time.

If you should require assistance during the call, press star then zero.

As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Mr. Mike Kilpatric.

Please go ahead.

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

I'm 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 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 discussion of some key risk factors, we refer to you our SEC filings included in our 10k 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 comments.

Here is David Yost, AmerisourceBergen's CEO to begin our remarks.

Good morning, everyone and thank you for joining us.

AmerisourceBergen had a strong September quarter ending a strong fiscal year.

As noted in our press release this morning, operating revenue for the quarter was up 13% for a record $14.6 billion.

For the year, the operating revenue was also up 13% over $56 billion, also a record.

Operating margin in the Pharmaceutical Distribution segment continued to expand in both the quarter and the year.

Our EPS from continuing operations was $0.61 for the quarter, up 27% net of special items and on the same basis up 30% for the year.

In the five years since the merger, we have grown our EPS from continuing operations at a compounded growth rate of over 15%.

We generated over $800 million of cash for the year and ended September with $1.3 billion of cash on our balance sheet making us net debt free and providing the Company with unprecedented financial flexibility.

There's lots to like about the quarter and the year and even more to like about the future.

Mike will detail our FY '07 forecast but the highlights are, we expect FY '07 to be in line with our long-term goals.

We expect to grow operating revenues at the high end of market growth in the 7 to 9% range, driven in part by our strong Specialty business and completed acquisitions, expand our Pharmaceutical Distribution segment operating margin, grow our EPS by 15%, and generate free cash in line with net income.

The topics of AWP, average wholesale price and AMP, average manufacturer price, have been in the new of late, so I'd like to address them before I hit some company specifics.

We do not buy or sell merchandise under AWP or AMP.

We essentially buy and sell merchandise on WAC, or wholesale average costs.

Specifically the price that we are invoiced by the manufacturer.

Any impact of AWP or AMP on AmerisourceBergen is indirect.

That is, it may affect us because our customer may be affected, but of course, many different things may affect our customers.

The definition of AMP, which may be used in the future for some generics reimbursement to some of our customers has not been established by CMS, though proposed rules for calculation are expected to be released very soon for public comment.

On behalf of our customers, we are working very hard at many levels to insure their interests are properly presented in this process.

A key issue surrounding the entire discussion of pricing our industry is that of transparency.

We are very comfortable with transparency since we have been selling products on a cost plus basis to our customers for many years where cost is totally transparent.

Transparency is also a key feature of the Fee-for-service model with our suppliers.

On the [CDS] Caremark merger, we really don't know any more about is than what we read in the press.

With such a merger it might make our third-party provider [inaudible] Pharmacies, now some 5,000 strong, the third largest in the nation with over 100 million covered lives, even more significant, because choice will continue to be important to both payors and consumers.

Last week, we announced that we reached a definitive agreement with Kindred health to complete the PharMerica Long Term Care transaction we announced on August 7.

The transaction is the same as we outlined at that time.

We plan to spin our PharMerica Long Term Care assets on a tax free basis to our shareholders, immediately merged those assets with Kindred's long-term care pharmacy assets and a 50/50 merger [inaudible] and immediately take a new entity public.

A dividend of up to $150 million is expected to be paid by PharMerica Long Term Care to ABC before this spring.

This is an extremely exciting transaction for shareholders, associates, customers and suppliers.

The new company will have almost $2 billion from revenues from day one and be a strong number two player with no number three even close.

It will have the scale, focus and market position for significant growth.

Since the AmerisourceBergen merger, we have seen firsthand the power that can be unleashed by such activity when the best of each partner is carried forward.

We expect the transaction to close in the first calendar quarter or our second fiscal quarter.

Accenture has been engaged to help us with the early integration planning replicating the technique that was used so successfully in the case of AmerisourceBergen.

On the topic of M&A, during the September quarter we completed the previously announced acquisition of a Canadian pharmaceutical wholesaler Rep-Pharm for $48 million solidifying our position as the number two pharmaceutical wholesaler in that market and essentially completing our move into Canada that begun a year ago.

We are very happy with our experience in Canada.

After the close of the quarter, we announced the closing of the acquisition of Health Advocates for $85 million, which will bolster our very successful Worker's Comp business with an expanded product offering, new customers and an extremely talented group of people.

Yesterday, we announced our acquisition of IgG for $35 million plus an earn out, a relatively small specialty pharmacy business focused on [RGIG] which has proven excellent niche for our AmerisourceBergen Specialty Group manufacturers.

Once again, we have expanded modestly in an area we know well.

On our strong cash position, let me reiterate our position on acquisitions.

We will continue to be very disciplined in acquisitions.

And the modest sized acquisitions, below $200 million, is our sweet spot.

We would consider something larger if it made good strategic sense though it is reasonable to expect modest acquisition activity.

Our acquisition criteria's straightforward.

Well-run companies in the pharmaceutical supply channel with operational and/or managerial synergies with attractive growth prospects and good margins is a strong pathways to that criteria.

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

But our strong cash position, we will continue to review our dividend policy with our board as we do every year and continue to execute our share of repurchased program when appropriate.

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

AmerisourceBergen, we continue to have a single focus, that as a pharmaceutical supply channel.

This space continues to be very attractive representing market stability with good organic growth from both modest price increases and new product introductions.

Generics provide us enhanced margin opportunities and an opportunity to differentiate our offer.

Our business continues to be a business where father time is our friend.

The older people get, the more drugs they take.

The more drugs they take, the older they get.

The ABC circle of life.

Our customer base and pharmaceutical distribution is skewed toward the fast growing specialty distribution and services.

Within the traditional drug company, we have a good mix of business with no one or two customers dominating our revenues and a very balanced mix among independence, regional chains, hospitals and alternate sites all with good potential for strong generic sales.

We have great continuity in our management team and understand our markets well.

The same folks that delivered the discipline performance the last five years resulting in the compounded 15% EPS growth are working hard on FY '07 to deliver more of the same.

We look forward to seeing many of you at our three-hour investor day meeting in New York on December 13.

We will be as disciplined with your time as we are with our cash and customers but we'll drill down on several industry topics of interest.

The theme of our meeting and our year is The Power of Smart Growth.

Here's Kurt with some added color.

Thanks, Dave.

Good morning, everyone.

Today I'll update you on the performance of each of our key business units and share a little bit more of our perspective regarding the generics market play and provide a few more details about our Worker's Compensation business.

Since we just made an acquisition in this area and the business will be subject to segment reporting after the long term care spin-off.

First, let me reiterate Dave's comments regarding 2006.

On a consolidated basis, we met nearly all of our key goals and objectives with earnings well ahead of our guidance for the outset of the year.

We were particularly pleased with the strong operating income growth up 26% for the quarter and 18% for the year.

We met our margin guidance range for the Pharmaceutical Distribution segment and importantly, significant additional earnings were contributed below the line due to stronger than expected cash flow.

The Drug company had another solid quarter in September, closing out a strong year as the business successfully completed the transition to its new Fee-for-service operating model.

In 2006, we executed extremely well under these Fee-for-service contracts.

Our guidance in 2007 assumes the same level of continued high performance with 2006 now established as an important baseline year.

There is also an important intangible benefit to the Fee-for-service model change.

ABC's uniquely collaborative approach along with our willingness to embrace greater transparency and our demonstrated efforts to secure the safety supply channel has significantly improved the level of trust between us and our manufacturing partners.

This was an important foundational achievement as we seek to further expand our role in the pharmaceutical supply channel.

Revenue growth for the quarter was strong across all customer classes and ahead of our expectations.

Prescription growth driven by the Medicare Part D was a contributing factor in the quarter.

Importantly, we were also pleased to see continued stability around the gross margin, which was driven by the same three key factors we've discussed all year.

First, solid execution under our Fee-for-service agreements.

Second, strong generic growth.

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

Just a moment on generics.

Our generic sales were up strong again in the quarter and well above the overall generic market growth for the year.

The growth was principally due to several new product launches, increased pro gen customer signups, improved performance around controlling generic customer leakage and also improved generic product launch processes.

The discipline we established in 2006 nodes well for the next year, with over $10 billion of branded product expected to lose patent protection in 2007.

There is a clear overcapacity of finished dose manufacturing for generic products worldwide with even more capacity scheduled to come online.

As a result, we're seeing a number of new sourcing opportunities open up, particularly from new international manufacturers who seek access to the U.S. market, and in particular, our difficult to reach retail customer base.

Our footprint in independent retail is a clear differentiator for us.

We have a franchise-like group of over 2500 Good Neighbor Pharmacy stores and we have substantially increased our position with regional retail chains who also depend on us for their generic product selection.

Below the gross margin line we've made progress on a number of key areas.

As planned, we completed one distribution center consolidation in the fourth quarter bringing our total consolidations for the year to six.

We finished the year with 28 DC's including 6 new Greenfields, down from 51 five years ago.

While we are planning two to three additional small consolidations in 2007, we are complete with the reconfiguration of our distribution network.

Importantly, however, benefits from the Optimiz(R) program will continue to accrue in 2007, as further implementation of new warehousing systems and productivity standards will provide significant additional cost savings in the coming years.

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

With the new addition of the Rep-Pharm acquisition, our Optimiz(R) disciplines and capabilities are being implemented in Canada to rationalize our current network of 13 distribution centers to reduce costs, improve productivity, and add capacity to key growth markets.

Our timing in Canada was excellent.

Now as a solid number two player with over 1.5 billion in annual revenues, we are being welcomed by pharmacy and manufacturer customers alike, who are looking for a strong alternative choice in that market.

Operating expenses as a percent of revenues were down from year ago levels as productivity gains from Optimiz(R) more than offset targeted investment spending in sells and marketing and IT to integrate our customer solution sets and drive better gross margin performance.

So all in all, a strong year performance in the drug company with excellent momentum as we head into 2007.

The Packaging group, while still a small contributor to ABC , had another solid quarter capping a very strong year performance exceeding nearly all of its key performance targets.

Anderson Packaging, our U.S. contract packaging unit, had an especially strong performance in the quarter with five new product launches.

And our acquisition of Brecon Pharmaceuticals in the UK earlier this year, continue to provide the group with new opportunities.

The pipeline of new products at both American Health Packaging and Anderson Packaging continue to strengthen in the fourth quarter.

This, in combination with our investment plans in the coming year, bodes well for the group to be another strong contributor in 2007.

Now turning to PharMerica, which is comprised of our Long Term Care pharmacy business and Worker's Compensation business.

First with regard to our Long Term Care pharmacy business.

Of course the big news is the pending spin-off, however, in the interim, we remain committed to running this business and we see a continued improvement in Long Term Care unit during the September quarter.

Top line performance again shows strength with revenue up 6% in the quarter and 7% for the year.

In the fourth quarter, the unit also demonstrated better gross margin stability and good operating leverage due to additional sales volume.

Our national footprint and customer facing technology offerings continue to generate share gains against our largest competitor.

We continue to incur extra costs directly rated to the Part D transition of roughly 1.5 million, similar to the amount we had in Q3.

We are now mostly completed with our PDP negotiations for calendar year 2007.

Reimbursement rates will remain consistent with 2006 levels, and in certain cases we were able to drive operational improvements primarily around co-pays and prior authorizations to lower our administrative costs.

We are currently negotiating with pharmaceutical manufacturers regarding rebates for calendar year 2007.

Now turning to our Worker's Compensation business.

While we often refer to this business as PMSI, because that's its most prominent trade name, it is in fact comprised of four separate business units.

The most recent addition, of course, was our fourth quarter acquisition of Health Advocates, a leading provider of Medicare set aside services for this new and growing need under the Part D benefit.

The Worker's Compensation group of businesses in total is the nation's leading single source provider of cost containment outsourcing solutions for the Worker's Compensation and catastrophically injured populations.

PMSI's business strategy is to provide innovative, pharmacy centric, cost containment solutions that help insurance payers, its customers, to manage the administration and overall cost of care while improving a patient's quality of life.

Key services include retail network pharmacy management, home delivery pharmacy services, clinical risk management, coordination and distribution of medical equipment, realtime claims administration and now Medicare set aside services.

In addition to the Healthcare Advocate's acquisition, in 2006 we rebuilt the management team and developed the technology investment plan to further automate certain core processes and approve its customer interface capabilities.

The business enjoys a market leadership position, very attractive financial metrics and solid growth prospects.

We planned to share more details about this group of businesses at our upcoming investor day in mid-December.

Lastly, turning to the Specialty Group.

The group had another quarter of strong sequential growth driving revenues to $10 billion annually.

This concluded another excellent year on top of a number of excellent years.

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 other distribution businesses performed well.

Besse Medical enjoyed strong top line and bottom line performance in the quarter, driven by excellent market penetration of key physician administered products.

At ICS, the group's third party logistics business benefited from its new semi exclusive distribution agreement with a major biotech manufacturer for the distribution of product to the physician market.

Integration activities around NMCR continued to proceed smoothly during the quarter, and we're excited about the addition of IgG.

Lastly, to support the Specialty groups continued growth, we approved a number of investments for the group in 2006, including a significant expansion of oncology supplies distribution center in Daphne, Alabama, and a new headquarters location for the group in Dallas, which will drive administrative efficiency and allow the group to work more closely together.

Both new facilities remain on track to open in 2007.

So, all in all, a solid quarter and a solid year.

As we look to 2007, I believe we are exceptionally well positioned.

We have unique channel positions in the two most important product areas, generics and biotech.

The integration work from the ABC merger and its inherent risk is behind us, but with meaningful benefits still ahead of us.

The Fee-for-service model is fully implemented which has improved earnings quality and lowered risk.

We have substantially improved our trust equation with our manufacturing partners and are carefully building out our service offerings to them as they focus on their core competencies.

And finally, of course, we have the financial resources to execute our strategies.

We look forward to a solid 2007.

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

Thanks, Kurt.

Good morning, everyone.

I'm very pleased to present our fourth quarter and fiscal year results, which have met or exceeded our goals for the year in every financial category, including revenue and operating income growth, operating margin expansion, interest expense, cash flow and returns to shareholders.

We have ended the year with an extremely solid balance sheet and we are very excited about our fiscal year '07 prospects in all of our businesses.

As usual, in my comments this morning, I will cover both, our consolidated and segment results, comment on our strong cash flow and balance sheet trends. and finish with some color around our fiscal 2007 guidance and the impact of our institutional pharmacy spin.

We did have certain special items that had no net impact on EPS in the current quarter, that I'll detail in my consolidated review, and also remember that we had a $71 million net of tax or $0.34 per share charge in the prior year quarter relating to our early retirement of debt and my referrals to prior year results will generally exclude this item.

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

Now starting with our consolidated results for the quarter.

Operating revenue was up a higher than expected 13% driven by both our drug and specialty units within pharmaceutical distribution.

For the year, our top line growth of 13% far exceeded our expectations.

That strong revenue growth in turn drove a 26% increase in consolidated EBIT for the quarter and an impressive 18% increase in operating income for the year.

Included in our consolidated gross profits for the current quarters with a benefit of 8.9 million resulting from manufacturer antitrust cases.

There was no litigation benefit in the prior year quarter.

Reflected in our consolidated operating expenses for the quarter was $7.8 million in facility consolidation, employee severance and other costs.

Two-thirds of which related to costs of the Long Term Care transaction.

As many of these transaction costs are not deductible for income tax purposes, the after-tax charge for these items was $6.3 million.

In the prior year quarter, we had $12 million of facility consolidation, severance and other costs primarily from our IT outsourcing initiatives.

Equity compensation expenses were just under 5 million in the September quarter and were $16.4 million for the year.

These costs were negligible in the prior year as a result of our current year adoption of FAS 123R.

We would expect equity compensation expenses to increase to the mid $20 million range in fiscal 2007 as we move another year away from our 2004 vesting acceleration.

Moving below the EBIT line.

We had $800,000 of net interest income in the quarter, a significant improvement from the $9.4 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 from our prior year debt refinancing.

For the year, our net interest expense of $12.5 million was down an impressive 45 million from last year's $57 million.

Our effective tax rate for the quarter was 37.6% down from last year's 38.3% rate as expected.

We continue to expect our effective tax rate to be in the 37 to 38% range going forward, depending on our mix of tax free versus taxable invested cash.

Diluted EPS from continuing operations of $0.61 in the quarter was obviously well in excess of last year's $0.10, and including the prior year impact of the debt retirement charge of $0.34 and special charges of $0.04, the current year $0.61 was up a strong 27% from last year's $0.48.

This increase was again -- this increase again was driven by strong EBIT growth and the reductions in net interest expense and our weighted average outstanding diluted shares.

Note that the net after-tax charge from the facility consolidation cost and litigation gains was $900,000 or well less than $0.01 per share in the current year quarter compared to the $0.04 charge for similar special items in the prior year quarter I just mentioned.

For fiscal 2006, our GAAP EPS from continuing operations of $2.26 includes the net benefit of $0.11 of special items including litigation settlements, facility consolidation costs and the second quarter asset sales in tax adjustments.

Our average fully diluted shares outstanding for the quarter were 201.4 million shares, down over 8 million 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 13% aided 2% by our acquisitions, primarily ABC Canada.

This increase was obviously higher than the 9 to 11% expected for the quarter and was driven by continued strong balance growth in the Drug Company, new business wins across all segments and continued above market growth in the Specialty Group.

The customer mix in the quarter was 60% institutional and 40% retail.

Our Institutional businesses grew 16% driven by Specialty and retail grew 9%, once again helped by our Canadian acquisitions.

Our Pharmaceutical Distribution gross margin of 3.16% in the quarter decreased by 4 basis points from last year yet reflected strong performance in both the Fee-for-service and generic areas which partially offset unfavorable customer mix and below average price appreciation.

Our acquisitions also had a positive impact on our gross margin.

From a LIFO perspective, we had a credit of $15.1 million in the quarter compared to a similar credit of 15 million in the prior year quarter.

The LIFO credit for the year was 1 million compared to a credit of $4.1 million in the prior year.

The fourth quarter credit was driven by fewer than expected brand name price increases in the quarter as well as the impact of significant branded to generic conversions.

Looking forward to fiscal 2007, we would expect a LIFO charge in the range of 10 to $15 million.

Operating expenses as a percentage of revenue were 197 basis points, down 5 basis points from the prior year quarter, as our productivity gains from Optimiz(R) offset our investments in our sales and marketing and IT infrastructures, as expected, as well as offsetting the impact of our acquisitions and increased incentive compensation.

In addition, we had nearly $6 million of asset writedowns in the Drug Company relating to certain real property and IT investments in the current year quarter, and you may remember that we had a $10 million bad debt charge in the prior year quarter at one of our Specialty drug units.

As a result, our Pharmaceutical Distribution EBIT margin for the quarter was 120 basis points and for the year was 115 basis points, importantly up 7 basis points over the prior year.

This margin expansion, combined with our 13% top line increase, helped drive our operating earnings in this segment up 21% for the year, an accomplishment that we take great pride in as expanding our operating earnings and margin has been our company focus all year.

Now turning to PharMerica.

Revenues of $422 million were up 5% versus the prior year quarter with our Long Term Care revenues of $305 million increasing 6%.

Gross profit margins were up slightly year-over-year while expenses as a percentage of revenue were down 87 basis points in the quarter to 23.2%.

This reduction in expense as a percentage of revenue was largely due to a reduction in bad debt expense in our Worker's Compensation business and along with our LTC revenue growth help drive our EBIT for the quarter to $21.6 million from just under $16 million last year.

Our Institutional Pharmacy business contributed $8.5 million of the PharMerica segment's EBIT in the September quarter and $32.3 million of its operating income for the fiscal year.

Now for cash flows in the balance sheet.

Cash used in operations for the quarter was $77 million, as expected, and for the year cash generated from operations was an impressive $807 million.

This was well above our original range of 5 to $600 million for the year and our revised forecast of 7 to $800 million and demonstrates the ongoing attractiveness of our Fee-for-service model.

From a statistical standpoint, DSOs increased to 19 days in the quarter compared to 16.5 days last year, primarily due to the continued above market growth of the Specialty business which has higher DSOs than the Drug Company, and the Canadian acquisitions.

Inventory days on hand during the quarter were just under 30 days consistent with the June quarter and down 2 days from last September.

The DPOs were consistent with the prior year quarter.

CapEx for the quarter was $24 million and for the year was 113 million, leaving us with free cash flow for the year well in excess of net income.

Our debt to capital ratio at the end of September was 21%, well below our target of 30 to 35% and with a cash and short-term investment balance in excess of $1.3 billion at the end of September, our net debt to net 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 $243 million worth of our shares, leaving $752 million outstanding under our share repurchase programs.

For the fiscal year, we spent $749 million on repurchases, significantly exceeding our original target of 4 to $450 million for the year, and we also spent nearly $300 million on acquisitions including the Rep-Pharm acquisition which closed in September.

Now moving to our guidance for fiscal '07, which gets a little bit complex with our Institutional Pharmacy transaction.

Because the transaction is a spin, we will continue to have LTC numbers in our results from continuing operations through the date of the spin.

At which time the results will be reclassed to discontinued operations.

As a result, our EPS guidance includes LTC's full-year numbers and we will adjust our guidance when the spin occurs in fiscal 2007.

We expect Long Term Care to contribute a range of 9 to $0.11 to our earnings in fiscal 2007, and that contribution is included in our EPS guidance of $2.40 to $2.55.

This compares to our fiscal 2006 EPS from continuing operations of $2.26, which included the net benefit of $0.11 from special items previously discussed.

Netting out the $0.11 benefit from these items from our fiscal '06 results in an additional $0.01 for rounding, our guidance for '07 represents EPS growth in a range of 12 to 19%.

To drive this EPS growth, we expect operating revenue to grow at the high end of the market in the 7 to 9% range most likely higher in the first half of the year.

Operating margins in Pharmaceutical Distributions should grow in the single digit basis point range with most of the impact coming from gross profit increases as expense margins are expected to be relatively flat as operating leverage in the Drug Company will be offset by infrastructure and IT investments in our Specialty and Packaging business units.

Net interest expense will be significantly higher in fiscal '07 than '06 as invested cash will be lower in '07 due to the share repurchases made in the current year and those expected to occur in fiscal '07.

We would expect to repurchase 450 to $500 million of our shares in fiscal '07.

As we have consistently stated, now that the Fee-for-service transition is complete, we expect free cash flow to approximate-- to approximate net income and be in the 425 to $500 million range, including capital expenditures which are expected to be in the 100 to $125 million range.

And finally, average diluted shares outstanding should be in the 194 million to 198 million range.

So to summarize, we had a very solid finish to fiscal '06 with strong double digit revenue and operating income growth, margin expansion and great cash flow.

And we enter fiscal '07 with outstanding momentum and significant financial flexibility.

With that, I'll turn it over to Mike Kilpatric for some final comments and Q & A.

Thank you, Mike.

We'll now open the call to questions.

I would ask that you limit yourself so that others also have an opportunity to ask questions.

Go ahead, Barbara.

[OPERATOR INSTRUCTIONS] Our first question comes from the line of Larry Marsh with Lehman Brothers.

Please go ahead.

Thanks and good morning.

Thanks for all of the details.

Guys, really wanted to drill down my questioning on two things.

One would be Specialty.

Based on the round numbers you gave us, it looks like Specialty was up like 40% year-over-year.

It seems like it was up about that much for the full year as well.

So, you're continuing to show substantial growth there.

I guess a lot of oncology business.

How do we think of that business going forward?

And is there a little bit of elaboration what you want to do with your dominant oncology platform?

And then if we back out Specialty, I guess back out to two customers you called out last quarter that you've lost, it seems like the internal growth rate you're assuming for '07 is only about 4ish, 4 to 5%.

Is that a reasonable way to look at it?

Could that be on the conservative side in your view?

First of all, Larry, the 40% is really on the strong side, it's more like the mid 30s but very, very strong, as you very appropriately point out.

One of the issues we've got with that business, Larry, as you're alluding to, is the fact that we've got such a large market share that it's hard to grow-- capture additional market share so we'll look for that business to grow more in line with the market as we go forward.

Now that market is growing faster than the overall pharmaceutical market but again we're not going to be capturing additional market shares at the same rate that we had going forward.

So our revenue increase there would be more modest.

Not quite as low as you anticipated in the 4 to 5% range, but more in line with the mid to high teens growth of that market.

Thanks.

Just elaboration a little bit on the oncology strategy that --

That continues to be a very, very important strategy for us, Larry, not only is it important in terms of large multi-billion dollar market, but one of the things we really like about that business is the opportunity to provide a wide array of value-added services.

Not only do we have new products coming into that market, which are very, very important many of the new entities that are entering the market will enter there, but also a wide array of value-added services.

We have a large reimbursement counseling business which is very instrumental to new companies bringing new products to market.

We have a physician education program.

We have a third party logistics program.

There are just a lot of things that we can do for biotech companies as they bring new products to market that the larger, more established pharmaceutical companies don't need.

Very, very exciting space for us.

Thanks.

Thank you, Larry.

Next question?

Our next question comes from the line of Tom Gallucci with Merrill Lynch.

Thanks, good morning.

Mike, I was just hoping you could drill down a little on gross margin trends?

I know you gave some high level color there, but I thought maybe it would have been a little bit better given you mentioned Fee-for-service being good, generics growing very strong.

I was a little surprised to hear you mention below average price appreciation.

So, can you talk about, maybe, the sales side margin trend and how significant price appreciation or lack there of is for you guys these days?

Yes, sure, Tom.

Obviously, in our new model price appreciation is not as big a factor as it was previously.

And our Fee-for-service performance was very strong and was a big contributor to the quarter as well as the generic performance that we mentioned earlier.

Certainly, the new product introductions were strong.

That helped our generics, and as Kurt mentioned, we continued to add customers to our pro-gen program and we continue to increase our compliance.

So all of those had a very strong impact.

I think from a price increase perspective, I think price increases for the year for brand named drugs were pretty strong, probably above the 5% that we had forecast at the beginning of the year, but were probably weighted more towards the earlier part of our fiscal year than to the fourth quarter and the fourth quarter did not have a lot.

So it's a good thing, it's one of the things we said about the Fee-for-service model.

It's going to provide us with more consistency and less volatility.

And it did just that this quarter.

It also will temper the quarters where's there's higher price increases.

On the sale side, Tom, I describe the markets as stable but competitive.

That said, that's clearly contributing to our performance going forward.

Then you've got the mix from the Specialty business, the Distribution businesses, and Specialty grew exceptionally strong which Larry commented on, and that had a mix issue on the margin as well holding it down a little bit.

Can you quantify the Specialty impact on the segment margins?

I don't know that we want to fine line it, Tom, but certainly when you've got 35% type growth with the distribution businesses with margins similar to our normal drug company, that is going to -- they grew a lot faster than our Services businesses which did very well, but, obviously, the weighting shifted more towards the Distribution-like margins.

Okay, thanks.

Next question, please.

Yes.

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

Go ahead.

Thank you and good morning, and again, thanks for the detail on your prepared comments.

Kurt, you mentioned in your prepared remarks that you had completed a number of PDP renegotiations, and so two questions connected to that.

One, can you give us a sense of what portion of your PDP relationships you renewed coming out of the first year of the program?

And then just an industry context question.

There's obviously one very notable contract dispute that continues to go on within the institutional pharmacy space.

Do you have any sense as to whether the outcome of that contract dispute will have sort of any spillover effect in terms of how you think about pricing dynamics for the market overall?

Obviously not for 2007 but as you think about sort of 2008 particularly you guys have given the size of that particular PDP organization.

Thanks.

Thanks, Chris.

I think first of all, we've got to go back in historical context.

Remember, we took a strategy early on here with the PDPs that we would contract very, very broadly.

I think that proved to be very successful for us as we kind of entered '06.

As we got into the negotiations for '07, we then contracted very broadly and literally have agreements in with virtually everybody.

We do have a couple that we're still working on and we're still working through a contract with, I think the one you're alluding to here, that large player who is trying to understand really what the value of the Long Term Care pharmacy service offering is and what the right compensation level is for that.

We remain very optimistic that we'll get a contract in place for them.

As I mentioned, we did not have economics taken out of the contracting effort.

In fact, the economics with are very much stable versus '06 levels.

And we were able to clean up some of the contracts, so our costs administrated those contracts has been down.

So I think that's all in that positive.

We do have a big player out there that obviously has some views that they want to have heard and we're going to continue to negotiate there.

Whether that contract has broader market ramifications for the next round of contracting a year from now, tough to say at this point and time, we just don't know.

Do you have an expectation in terms of when you think you'll bring closure to that particular negotiation?

We'll certainly have it done before we head into the new calendar year.

So sometime this fall.

Great.

Thanks for the detail.

You bet.

Next question, please.

Hi.

Our next question comes from the line of Lisa Gill with J.P. Morgan.

Please go ahead.

Hi, thanks, it's Atif Rahim for Lisa Gill.

When you provided guidance last year, you provided a range of EBIT margin expectations in the Pharmaceutical Distribution segment.

Could you perhaps outline your EBIT margin goals for the segment in '07 and perhaps what'll be the driving factors behind these?

Yes, Atif.

This is Mike.

I think we guided to single digit basis point growth in that operating margin in Pharmaceutical Distribution for '07.

I think the key components to that growth are going to continue to be good operating leverage in our distribution businesses, continued strong performance on the generic side, solid Fee-for-service contribution and relative stability on the customer side.

Okay, anything on the [South Side merger] in particular?

Some of your competitors have talked about pressure there while others are saying it's stable.

You know, we continue to see some adverse impact from customer mix.

Our big customers, I think, are going to continue to grow faster but we think we'll you know, more than overcome some of those factors with those other items that I mentioned.

As we described earlier, we would describe it as stable but clearly competitive industry as most industries are.

Thank you.

Thank you.

Thanks, Atif.

Next question, please some.

Our next question come from the line of Glen Santangelo with Credit Suisse First Boston.

Please go ahead.

Dave, I just want to follow-up on some of the macro comments you made at the beginning of the call regarding the transition of generic reimbursement next year towards average manufacturing price.

Are you having any discussions at all with your clients regarding this?

Obviously you serve a big chunk of independent.

Do you think that kind of the change hits these guys by surprise or the incremental transparency that CMS is promising next year, do you think it has really any impact from an indirect point of view on your business through them?

Any sort of comments would be helpful.

Yes, Glen.

I'd say, it's not going to hit them by surprise.

It's something we've been talking to them about.

We're very involved in the process on their behalf trying to make their views known what's important to them, known in the CMS circles.

So I don't think they're going to be surprised by it.

And at the end of the day, we've got to see whether it's a positive or negative for them as they go forward.

There are a lot of different dynamics in their business, but one thing I would say about this group of independent and regional chains, Glen, is they've shown a great adaptability over the years.

The 30 years I've been in this business, I've seen them adjust to a lot of different things.

I think one of the things that may well come out of this is incentives provided to all retailers to dispense generics, which I think will be very, very positive for them.

Okay, thanks.

Thank you, Glen.

Next question, please.

The next question comes from the line of John Ransom with Raymond James.

Please go ahead.

Hi.

Good afternoon.

I guess good morning still.

You guys have pretty much skinnied down your business to being a pure drug wholesaler and kind of looking at maybe over time a diminishing opportunity in the independent resale channel.

I know in the short term you can get by buying back stock and taking some share but longer term, strategically, where do you want to put your capital to try to growth this business beyond what the pressures in the Pharma marketplace will allow you to grow?

First of all, John, when you talk about us being a truer player, that's in the broadest definition of pharmaceutical distribution.

I mean, right now, we're very, very heavily in the specialty business, which has great growth potential, and a wide array of value added services with that.

We're in the packaging business where we've made some acquisitions and that continues to grow.

We're very strong in generics, which we think had some opportunities in terms not only of sourcing but perhaps in packaging and the like.

So when we look at this business, John, we look at it from a very, very broad context.

Not limited to just any specific customers, whether we have those customers now or whether we don't but in that broad channel, and I will say, when you take a step back and look at that channel, we've think it's a very good place to be.

Again, it's got good organic growth rates.

And there's not a lot of businesses you can look back and you can take a step back at and look at it and see this good organic growth rate and they're kind of kidding you around here about our ABC Circle of Life and father time is our friend, but it's one of the underlying fundamentals that makes this business very, very strong.

So I you will tell you, we continue to be very, very bullish.

We've got a lot of cash and we look around at other things. but I will tell you to date we certainly haven't found anything that we like as well.

So we'll continue to enhance it there, John.

We're certainly not complacent.

But we will be very, very disciplined, but we like this channel.

Just to follow on that.

I know Mike's going to police me but this is sort of still look a question and a half.

John, you haven't done it yet so keep going.

You're the man.

You guys talked about a worldwide over capacity in finished product generic manufacturing, but then also some of yours cousins have talked about, maybe there are certain generic product where's it makes sense to make it yourself and try to-- as maybe there are AWP pressures and generic margin pressure generally that maybe it makes sense over time to take a step out of that manufacturing process and get into self sourcing.

How do you think about that over time?

Do you think it's going to be better to be a buyer of that or do you want to be a maker of it at some point?

John it's Kurt.

We've become students of this whole thing pretty actively in the last couple of years.

I think it's the rare exception where you'd want to get in and self manufacturer.

There's so much low cost production capacity coming on line that you would constantly be chasing that world as to where set up your manufacturing assets.

And our view at this point in time is we can get nearly that same benefit by just being really smart and choosing our partnerships and contracting effectively.

When we talk about contracting, there's contracting for finished goods but there's also different kinds of contracting breaking down the value supply chain up to the point of API manufacturers and so forth.

And we're really studying the value chain from the active molecule down to the point of finished product including packaging and understanding where we can get into those pieces of the marketplace and contract effectively and capture more margin for ourselves.

And our bias right now is that we will be effective doing, getting our margins through contracting as opposed to self manufacturer.

Now there may be an exception we stumble across down the road where something knocks our lights out and we just say this is something we've got to do, it's too good of opportunity.

But we've been doing this for a couple of years.

Nothing like that has yet kind of shown up for us.

So that's kind of our bias.

It's probably more than we should be sharing here but that's kind of our [inaudible] at this point.

As you look at that generic cycle, could you please remind us again what point in the cycle is the most beneficial to the drug wholesaler, is it the first six months?

Is it when the price settles down?

Is it after the price spikes out the bottom?

Because we're looking at a lot of different little mini cycles here over the next 24 months.

We just wonder if, for example, is it going to get better for you, for example with the Zocor, or is it better for you now, or just remind us of kind of how that cycle may have evolved over time?

John this is Mike.

I think we've been pretty consistent in talking about the fact that on a portfolio basis, we make as much gross profit dollar per unit on a generic as we do on a brand name.

I think that holds throughout the generic cycle.

Certainly in the six-month exclusivity period there's certain opportunities from a -- for us to get the product on the shelves of our retailers on a very fast basis and get compensated for it from the generic manufacturers.

And we take good advantage of those opportunities and that certainly a limited time period.

But, following that exclusivity period, our negotiating power is very high and we do very well to maintain that high margin per unit.

Thanks a lot.

We've got time for one more question, please.

Wonderful.

Our last question comes from the line of Eric Coldwell with Robert W. Baird and Company.

Please go ahead.

Thanks very much for the details and the good quarter.

Appreciate your comments about making future investments in your future which will offset some of the gross margin upside that you might see next year.

I was hoping you could highlight the two to three biggest areas that you're going to be investing in?

If you could give us some sense of the amount of the incremental expense versus just maintenance expenses?

And then, finally, if you could give us some time that you expect to conclude the majority of these incremental investments so we can in the future enjoy some of the gross margin upside as well as the operating expense leverage?

Thanks, very much.

Eric, it's Kurt.

I'll talk a little bit about where we see the opportunities to invest, and maybe Mike can do a little bit of sizing on the dollars here to the extent we can provide guidance on that.

We're just wrapping up large investment program for the Drug Company with Optimiz(R), it's a $450 million program.

We're convinced that money was spent very well and the returns are better than we expected.

We're very pleased with how that whole thing came out.

So, we're kind of turning our attention to some of the other business areas.

We talked about some investments in Specialties.

Specialties has grown dramatically.

They're bulging at the seams in Daphne, Alabama, at their oncology supply facility.

So we made a commitment to build that one out in '07.

And we talked about the corporate headquarters for Specialty group because, frankly that group has grown dramatically down in Dallas and they're scattered around in various offices down there, and we think there's real benefit to getting them under one roof and more closely together in the same office.

So we're investing there.

We're clearly going to continue to invest in Packaging next year.

The Anderson Packaging business is an asset intensive business, in the sense that you've always got to have capacity on the ready, if you will, so when a branded manufacture comes in, they can understand exactly what their pipe will be running with in that facility.

So, we're going to be investing heavily at Anderson.

We'll be doing some investment spending at Brecon.

This is all-- this is not maintenance and so forth.

This is to accommodate growth as we see it coming down the channel.

Then of course our Worker's Comp business.

You know we grade our paper pretty hard here.

We probably, behind the investments that we should have been making in that business the last couple years and but we're on it now.

We've got a very defined investment program for the Worker's Comp business for next year, primarily around IT systems to bring those systems up to speed.

It's a fairly significant investment.

And-- but we are a market leader in that place-- in that business and we need to continue to invest in that business so we stay that way, so we've got dollars targeted for there as well.

So those are three areas no real surprise there.

That's kind of what we have in the works for next year.

As you know, these investments then have a residual effect for years beyond once we get them in place.

Eric, just to maybe give you a couple of different metrics here as to how that investment affects us.

I think I said earlier that would have operating margin expansion, but that would be primarily in the gross profit area and the expense percentage to revenue would be relatively flat.

What that implies, if our revenue growth is 7 to 9%, our expenses are going to be growing this that same range.

I think without the investments that Kurt detailed, you would probably see an operating expense growth in the lower single digits, probably well under 5%.

So I think if you look at those two metrics, you get an idea of what we're reinvesting here.

I think the other way to look at it is also the CapEx.

For the last few years, our CapEx has been heavily concentrated on building out our distribution network, and it came down, obviously, last year because we only had one of our Greenfields and we've kept the range the same this year, 100 to 125 as we ended last year at 113, and part of the reason is some of those investments, again, that Kurt detailed, particularly the expansion in the Specialty Group where we're building two buildings, both a headquarters building and expanding our Daphne facility.

Right.

Those are two areas that you can focus on.

That's really great detail and I appreciate you going through that.

I guess what I'm trying to ask in a pleasant manner here is that, will there be a point in fiscal '08 or fiscal '09 where you've caught up to the investment cycle on Specialty, on Packaging, on the Worker's Comp unit, and the Drug Company, to where you can enjoy both the gross margin upside, if that's still persisting at that point, as well as the operating expense leverage so we can have a perhaps even greater acceleration in firm-wide EBIT margin beyond fiscal '07.

Is that something that you're looking for or do you really anticipate this being a more steady Eddie pace of single digit margin improvement into the long future?

I know you haven't given your guidance that way yet, but, what direction should we be thinking of here?

Eric, it's Dave.

We're just into '07 here, and we're certainly not providing any guidance for '08.

I hear the question loud and clear.

One thing I want to make sure is that the fact that we're focused on expanding our operating margin here has not been lost.

We're committed to doing that.

Last year we delivered on that.

We expect to deliver that again this year.

As we get out to '08 and '09 and start to harvest some of these issues, could we expect to have that continue and perhaps accelerate, I guess the easy answer, Eric, is yes, all things being equal but all things never stay equal.

A lot of things pop up and a lot of things change, but I will tell you we're clearly focused on expanding our operating margin.

It's been a big focus for this company, as Mike had talked about in his comments.

We take great pride in the fact that we grew the revenues.

We also expanded the margin and that had a real big driver on our EBIT.

So we're continuing to expand that margin, Eric.

It's a long-term goal.

I would be very surprised if you didn't see it as we get into the outgoing years.

That's great.

Thanks very much.

Thanks, Eric, and thank you, everybody, who's been on the call and asked questions today.

As Dave said, we'll be hosting our annual investor day on December 13.

We'll look forward to seeing many of you there.

It's from 12:00 noon to 3:30 p.m. eastern time at the Grand Hyatt in New York.

If you want to sign up, contact us at 610-727-7429.

Also we'll be attending the C.S.F.B. conference November 15 in Phoenix.

Now Dave would like to make some final remarks.

They'll be short.

I just again want to thank you very much for joining us and thank you for your interest in ABC.

We continue to be very, very excited about this company.

I will tell you we ended up with a strong quarter and strong year.

We've got great momentum going in '07.

Lots to like about this company, good revenues, margins experiencing stong EBIT, strong balance sheet, cash generation.

We are very, very excited about where we're headed and we appreciate your interest and we look forward to seeing you on December 13.

Thank you.

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