美源伯根 (ABC) 2007 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Amerisourcebergen quarterly earnings call. [OPERATOR INSTRUCTIONS] As a reminder, today's conference call is being recorded.

I'd now like to turn the conference over to Mike Kilpatric.

Please go ahead, sir.

Good morning, everybody.

Welcome to Amerisourcebergen's conference call covering fiscal 2007 first 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 today, we will make some forward-looking statements about our business prospects and financial expectations.

We remind you that there are many risk factors that could cause our actual results to differ materially from our current expectations.

For a discussion of some key risk factors, we refer to you our SEC filings, including our 10-K report for fiscal 2006.

Also, Amerisourcebergen assumes no obligation to update the matters discussed in this conference call, and this call with not be taped -- 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's Dave Yost, Amerisourcebergen's CEO to begin our remarks.

Good morning and thank you for joining us.

Lots to like about our December quarter and the star of our fiscal '07.

Operating revenues were up 16% to a record $15.7 billion.

Operating margin in the pharmaceutical segment expanded again in the quarter, 21 basis points, year-over-year.

The Company's EBIT was up 25%.

EPS from continuing operations was up 34% for the quarter to $0.63.

We generated $288 million of cash in the quarter and ended the quarter with 1.2 billion of cash after buying back $330 million of our shares.

We continue to have great financial flexibility.

Before I discuss some industry issues, I'd like to put some color on the revenues.

Our operating revenues were up over $2 billion from the December quarter last year.

Pharmaceutical distribution, which accounts for essentially all of the revenues delivered a 16% revenue increase, slightly more than half from our drug company, including about 1.5% from our acquisitions primarily Canada, and the remainder from our specialty unit, Amerisourcebergen's Specialty Group.

Revenues for Specialty Group were up 40% for the quarter.

This is on top of the 30% plus increase Specialty Group delivered in our fiscal year that ended in September.

Since Specialty Group revenues are now well over the $10 billion annual run rate, we reported last quarter, it's such an important part of our business, I'd like to provide some detail.

Our large specialty business differentiates us from our peers.

There are many ways to define the specialty distribution related services business.

For Amerisourcebergen, our specialty business is essentially defined as products and services delivered to or for the physician and the manufacturers.

The products are predominantly injectables and administered in physician's offices.

The services we provide drive this business.

The margins in the distribution part of the specialty business are very similar to the distribution margin, and our drug distribution company.

The services offered by Specialty Group are unequalled in the market and include reimbursement counseling and patient assistance programs, certified medical education, group purchasing dynamics, unique analytics on products and processes, and third party logistics.

These services involve literally thousands of people including physicians, registered pharmacists, registered nurses and licensed social workers.

In fact, our largest location in Amerisourcebergen from a people standpoint is our last group in Charlotte, North Carolina.

So two very important elements of our specialty business.

It is physician and manufacture-focused and services drive the revenues.

This wide array of services puts us in excellent position to capture large market share of new products coming in the market.

In our drug company where revenues again were excellent, our focus is both retail and institutional.

In retail, we focus on independents, food/drug combos and regional drug trains.

In institutions, we have focused on hospitals and alternate site settings such as dialysis clinics.

We have a very balanced customer base and have enjoyed balanced growth this quarter within that base.

It is important to note that our customer concentration is limited with no customer having over 10% of our operating revenues and our largest customers delivering our biggest revenue increases.

We do not expect revenues to continue at the same percentage increase for the balance of the year because we'll anniversary our Canadian acquisitions and the impact of Medicare Part D and discontinue business with customers that don't meet our profit targets including one with almost $1 billion worth of revenue but low margins.

The 9 to 11% revenue increase for fiscal '07 reflects market growth in the drug company and growth in Specialty Group in the 25% range.

Before I leave the topic of revenues, I want to reemphasize that the large revenue increase was delivered with operating margin expansion.

I would continue to describe the sell side environment as competitive but stable.

On August 7, we announced our intention to spin our PharMerica long-term care assets on a tax free basis to our shareholders, combine the asset with Kinder's long-term care assets and immediately take the new enterprise public in a 50/50 merger vehicles.

A dividend in the $150 million range is expected to be paid back to Amerisourcebergen.

We're on the same time schedule originally announced.

We hope to complete the transaction by the end of March.

On Monday, we announced a CEO of the new combined company.

I have known Greg Weishar personally for many years as have many in the industry.

He brings superb industry knowledge and operational experience as well as a great leadership style and integrity to the new enterprise.

I am very excited that he has take be the job.

On to some industry topics.

First, A&P, or average manufacture price that will be the basis for Medicaid reimbursement on generics sometime late their year.

CMS has published their proposed guidelines for establishing A&P and the industry is now in a common period that ends February 20.

The implementation date has not been firmly established.

The key issue in our opinion is that prices received by pharmacy benefit management mail order facilities be excluded from the calculation of A&P since those prices are not readily available to retailers in the market.

It is also important to note that the states have the ability to adjust dispensing fees so A&P is only part of the reimbursement the retailer will receive.

Generics continue to be a growth engine for our drug distribution company.

Our customer mix provides us great opportunities for generics.

Our pro generics formulary offering where we make the generic decision for our customers continues to grow well above the market, while individual items that might have large variance with the brand name products sometimes get high profile attention it is important to note that our offering is a market basket of over 2,000 items that taken in a total provide great value to our customer and good profitability to us.

Generics continue to provide us with the opportunity to provide value to both the manufacturer and the dispenser and allows us to differentiate our offering from our peers.

Generics were a strong profit contributor in our December quarter and we look to continue to benefit from the robust pipeline of new generic offerings in 2007 and beyond.

The Wal-Mart $4 price point for selected generics that received some disproportionate press coverage has had essentially no impact on our customers.

Our customers provide a convenience, service, value offering to largely third party pay patients that dramatically different than the offering of big box retailers.

Third party access continues to be very important to our customers which is why our third party network of over 5,000 stores, the third largest in the country, continues to be an important revenue driver in our retail segment.

During the December quarter, we completed three acquisitions totaling $144 million which Kurt will detail.

Our position on acquisitions continues to be consistent and very disciplined.

The modest sized acquisition 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 is straightforward.

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 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.

On our last call, we said we would review our dividend policy with our Board as we do each year, and in November, we doubled our dividend.

As I turn the call over to Kurt, I want to emphasize my enthusiasm for our industry and the role ABC plays in that industry.

In the three decades I have been active in the industry, I can never remember a period where our future looked so bright.

Here's Kurt.

Thanks, Dave.

Good morning, everyone.

This was a very solid quarter by almost any measure.

While all of our businesses performed well in the quarter with the licensed Specialty Group growing revenues by 40%, the drug company made the largest contribution to overall profitability with a significantly expanded operating margin.

This was a result of an improved gross margin in combination with excellent operating expense efficiency driven by our productivity program Optimiz.

The improved gross margin was driven by the same factors we've been executing against for sometime.

Solid performance under our fee for service agreements, disciplined around customer mix, pricing, and contract compliance, continued innovation and integration of our various customer solutions and service offerings and strong generic pharmaceutical growth.

Sales of our generic formulary ProGen were up strongly in the quarter and well above the overall generic market growth.

This growth was principally due to our successful efforts to better control generic customer leakage.

In addition to increased ProGen customer signups and better Generic product launch processes.

Improve generic product sourcing, particularly from new international manufacturers remains an exciting opportunity we continue to explore.

While we experienced balanced growth across our various customer segments, our footprint in independent and small chain community pharmacies 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 including food/drug combos.

These two customer classes depend on us for their generic product selection.

Below the gross profit line, we made progress in a number of key areas as well.

While we are now complete with the reconfiguration of our distribution network, substantial additional productivity improvements continued in the quarter.

The benefits from our warehouse system investments in combination with increased volume drove operating expenses as a percentage of revenues down significantly in the quarter well below our internal expectations and was a major contributor to the 15 basis point improvement for the segment.

Work continued in Canada further rationalized our current network of 13 distribution centers to reduce costs, improve productivity, and add capacity to key growth markets.

With three acquisitions over the past 18 months, we are now a solid number two player with $1.5 billion in revenues.

Our timing in Canada was excellent and we continue to be welcomed by pharmacy and manufacturer customers alike who are looking for a strong alternative choice in that market.

So all in all, a very strong quarter performance by our traditional drug distribution business, which heads into the remainder of the year with excellent momentum.

The packaging group while still a relatively small contributor to ABC had another solid quarter exceeding internal expectations for both revenues and operating income.

Our business model transition continued at American Health Packaging with the expected volume reduction in lower margin bulk to bottle business, but the continued strong growth in its proprietary generic product offerings with the launch of six new generic items for various end use markets.

Anderson Packaging, our U.S. contract packaging business for branded manufacturers had an excellent quarter with eight new program launches.

Importantly, Anderson also achieved a record amount of new business awards, which will drive continued strong growth well into 2008.

As a result, we are now evaluating the need to add production capacity in Rockford, Illinois to accommodate this additional demand.

Our acquisition of Brecon Pharmaceutical in the UK, slightly less than a year ago continued to show good momentum with its clinical trials path [Inaudible] business off to a record setting pace in the first quarter.

With the recent announcements by some large branded manufacturers, we see an increased opportunity for the outsourcing of noncore activities like packaging as a means to lowering costs while maintaining product quality.

Now turning to PharMerica, which is comprised of our long-term care pharmacy business and PMSI, our Worker's Compensation business.

First, with regards to long-term care, the big news of course remains the pending spin-off, however, as we said last quarter, in the interim, we remain committed to running this business and we saw continued improvement in the unit's performance during the December quarter.

Revenues again showed strength up 7% driven by higher bed count and improved acuity mix.

Our national footprint in customer-facing technology offerings continued to generate share gains against our largest competitor.

Better gross margin stability and good operating leverage from the additional sales volume generated a solid operating income contribution in the quarter.

Having now completed our negotiations with both manufacturers and PDPs we see greater gross margin stability in calendar year 2007 as slightly lower PDP reimbursement rates will be offset by the return of some manufacture rebate dollars absent in 2006.

Now turning to PMSI, our Worker's Compensation business.

PMSI is the nation's leading single source provider of cost containment outsourcing solutions for Worker's Compensation and catastrophically injured populations.

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

From a performance standpoint, the business met our expectations in the first quarter.

Importantly, however, as we shared at our investor day, the business is experiencing pricing pressure from new market entrants.

So to position the business for future success, this past year we rebuilt the management team and developed a technology investment plan to further automate certain core processes and improve its customer interface capabilities.

In addition, to further broaden its service capabilities, during the quarter, we completed the acquisition of Health Advocates, a leading provider of set aside services for a new and growing need under Medicare Part D. The acquisition performed in line with our expectations and integrations proceeded on plan.

Overall, the PMSI business enjoys a market leadership option, very attractive financial metrics and solid growth prospects.

We are pleased with the development to date and we remain confident in our ability to grow this business over the long term.

Now turning to the Specialty Group.

The group had another quarter of above market growth with revenues up 40% from prior year levels.

The top line was driven by an especially strong performance by our oncology franchise which of course was supported by an ever growing pipeline of new products that continue to grow ahead of the broader drug market and a new semi exclusive distribution agreement with a major biotech manufacturer for the distribution of product to the physician market.

Importantly, other distribution businesses within the group performed well.

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

The group's performance in the quarter was moderated somewhat by flu vaccine volume up over the prior year, but below our internal expectations.

To further build out its manufacture service offerings, the group completed two acquisitions in the quarter.

IGG of America and Access MD.

IGG of America is a specialty pharmacy and infusion services businesses focused in IBIG, a specialty blood derivative.

The acquisition broadens the service offering of the group's U.S. bioservices business unit.

Access MD is a Canadian provider of support services to manufacturers, physicians, and patients of injectable and biological therapies.

Its business is very similar to that of the last group and allows our Specialty Group its first entrance into the Canadian marketplace.

Other plan investments to support the Specialty Group's continued growth remain on track.

Expansion of oncology supplies distribution center in Dofin, Alabama and a new headquarters location for the group in Dallas remain on plan to open in the next six months.

One of the keys of our success in the specialty has been the array of services we ramp around our core logistics capabilities.

Many of these services are unique, often proprietary, and not readily replicated by competitors.

Add to this our existing scale and it's clear we have a very strong market position.

So, all in all, a very solid quarter.

As we look to the remainder of 2007, I believe we remain 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 as was evident in the quarter.

The fee for service model was fully implemented, which has improved earnings quality and lowered risk.

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

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

We look forward to a strong 2007.

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

Thanks, Kurt.

Good morning, everyone.

It's great to present outstanding results that were broad based and met or exceeded our goals in most areas including strong profitable revenue growth, outstanding operating margin expansion, solid cash flow, and active capital deployment including three modest acquisitions and significant share repurchases.

We continue to have an extremely solid balance sheet which I'll detail and continue to be very excited about our momentum 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 revised fiscal 2007 guidance.

Now starting with our consolidated results for the quarter, as we indicated in our press release earlier this month our higher than expected operating revenue increase of 16% was drive by both our drug and specialty units within pharmaceutical distribution, which grew 11% and 40% respectively.

And Dave highlighted the 1.5% contribution of our acquisitions.

That strong revenue growth in turn drove a 25% increase in consolidated EBIT for the quarter despite the negative year-over-year impact of certain special items.

Regarding those special items included in our consolidated gross profit for the current quarter was a small benefit of $1.9 million resulting from manufacturer antitrust cases compared to a benefit of 18 million in the prior year.

Reflected in our consolidated operating expenses for the quarter was $6 million of facility consolidation employee severance and other costs, most of which related to costs of the long-term care transaction.

In the prior year quarter, we had $8.8 million of facility consolidation severance and other costs, primarily from our IT outsourcing initiatives.

Note that because many of the LTC transaction costs are not deductible for tax purposes, the net after tax charge for special items in the current year was $5 million or $0.02 per share compared to a net benefit of $5.7 million or $0.03 per share in the prior year quarter.

Moving below the EBIT line, we had $8.1 million of net interest expense in the quarter compared to $6.5 million in the prior year reflecting lower levels of average invested cash on hand this quarter compared to last year, primarily due to our increased share repurchases.

Our effective tax rate for the quarter was 39.1%, up from last year's 38.5% rate.

Excluding the impact of the nondeductible long-term care transaction costs, our normalized effective rate would have been 37.9% and we continue to expect our normalized effective rate to be in the 37% to 38% range going forward.

Diluted EPS from continuing operations of $0.63 in the quarter was up 34% over last year's $0.47.

And excluding net special charges and rounding of $0.02 in the current year was $0.65, up 48% from last year's $0.44 also excluding special items.

This increase again was driven by the outstanding EBIT growth and significant reductions in average diluted shares.

Our average fully diluted shares outstanding for the quarter were 195 million down over 15 million shares or 7% from last year as a result of our share repurchase programs net of option exercises.

Moving to the pharmaceutical distribution segment.

Our top line increase of 16% was again aided 1.5% by our acquisitions, primarily ABC Canada.

Almost half of the 16% increase was driven by the higher than expected 40% increase in specialty, primarily from our oncology distribution franchise including the benefits of a semi exclusive distribution agreement signed in the last half of fiscal '06 and the introduction of new physician administered products distributed by Bessy Medical.

With some of this new business annualizing in the second half of this year, we now expect the Specialty Group to grow their top line in the mid 20% range for the year, up from the 15 to 20% range we indicated in December and this mid 20% growth expectation was the primary reason we raised our consolidated top line growth guidance for the year to a range of 9 to 11% from our original 7 to 9% guidance.

While not as spectacular as the Specialty Group's growth, the drug company grew its top loan a better than market 11% including Canada and its well balanced growth positioned it to be the primary driver of our pharmaceutical distribution gross margin expansion in the quarter.

Strong performance in the generic and fee for service areas were the key reasons for the expansion.

As you may remember, we were still in the process of finalizing many of our fee for service contracts in the December quarter of last year, and we benefited from those contracts being in place for the full quarter this year.

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

From a LIFO perspective, we had a charge of $7.3 million in the quarter, slightly higher than the $6.9 million charge in the prior year quarter.

Operating expenses increased 7%, well, below our revenue growth and as a percentage of revenue we're 178 basis points, down a significant 15 basis points from the prior year quarter.

The combination of our productivity gains from optimizing the drug company and economies of scale and specialty more than offset our infrastructure investments as well as offsetting the impact of our acquisitions.

We are in a scale business and have often spoken about our ability to handle more volume at a very low incremental cost and with our distribution network fully in place, we realized those deficiencies this quarter.

As a result of both the gross margin expansion and reduced expense margin, our pharmaceutical distribution EBIT margin for the quarter was 125 basis points, up an impressive 21 basis points over the prior year.

This margin expansion combined with our 16% top line increase helped drive our operating earnings in this segment up 40% for the quarter on top of the prior year quarter where operating earnings also grew over 40%.

Now, turning to the PharMerica segment.

Revenues of $436 million were up 6.5% versus the prior year quarter with LTC revenues of $318 million increasing 7%.

Gross profit margins were up slightly year-over-year while expense margins were also up 58 basis points in the quarter to 23.9% mainly due to the Health Advocates acquisition and related integration.

As a result, EBIT margins were down slightly to 4.3% from 4 .5% in the prior year quarter.

In line with our internal expectations, long term care contributed $9.1 million of the segment's $18.9 million of operating income in the current year quarter.

Now for cash flows in the balance sheet.

Cash generated from operations for the quarter was a better than expected $288 million compared to 231 million generated in last year's first quarter.

We had some benefit in the quarter from favorable payables timing, and as a result, our annual cash flow guidance is unchanged.

From a statistical standpoint, all of our ratios have been impacted by specialty's 40% growth as generally that group has higher DSOs, lower inventory days, and greater DPOs than the drug company.

As a result, DSOs increased to 19.6 days in the quarter compared to 16.9 days last year primarily due to that growth as well as the Canadian acquisitions.

Inventory days on hand during the quarter were 28 days, down 4 days from last December reflecting less seasonal build in the drug company and the specialty growth.

DPOs were up almost two days due to timing and the mix impact.

CapEx for the quarter was $28 million and we continue to expect capital expenditures for the year in the range of 100 to $125 million.

Our debt to capital ratio at the end of December was 24%, up from last year, reflecting our increased share repurchases but still well below our target ratio of 30 to 35% and with the cash and short-term investment balance in excess of $1.2 billion at the end of December, 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 $330 million worth of our shares leaving $422 million outstanding under our share repurchase program at the end of December.

In addition, we spent approximately $144 million on acquisitions during the quarter which Kurt detailed.

Now, moving to our updated guidance.

We increased our revenue guidance to its current 9 to 11% earlier this month and with our stronger than expected first quarter results, it now makes sense to increase our EPS guidance for the year and we have increased the range by $0.05 to a range of $2.45 to $2.60 as usual on a GAAP basis.

This takes into account the $0.63 first quarter results that included $0.02 of special charges and the expectation that we will have additional long term care transaction costs in the second quarter probably close to the same $0.02 impact we had in Q1.

Once again, we will update our annual guidance when we finalize the long-term care spend.

So to summarize, a great start to '07 with very strong operating and financial performance with more to come.

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

Thank you, Mike.

We will now open the call to questions.

I would ask you to limit yourself to one question only until all have had an opportunity and then if there's time, you can ask additional questions.

Thank you. [OPERATOR INSTRUCTIONS] Our fist question is from Glen Santangelo from Credit Suisse First Boston.

Please go ahead.

I just had a quick question, I was curious to maybe probe into the margins a little bit more.

Clearly, your op margins were up big 21 basis points.

I'm trying to figure out how much of that expansion came from the specialty side versus the core drug distribution side?

Because I think if I heard Mike's comments correctly he was kind of saying that more of the growth came from the straight distribution in specialty.

So if that's the case, should I read into it that maybe more the margin expansion came from generics on the drug distribution side?

Glen, I think you are correct.

Operating margin expansion was driven by the drug company side and was a combination generics were a strong contributor as well as the year-over-year fee for service impact and the operating efficiencies in that unit.

With the Specialty Group, with the 40% growth, that was obviously weighted to its distribution business.

As we talked about during investor day in December, that distribution piece has an operating margin closer to the overall drug distribution business 1% or so than the 2% weighted average that the Specialty Group has as a whole because of its services.

So with distribution growing faster than services, the Specialty Group had some dilution in its margin for the quarter.

Okay.

Thanks for the comments, guys.

Thanks.

Next question.

Next question is from Bob Willoughby from Banc of America Securities.

Please go ahead.

Hi, Dave or Mike, the share repurchase guidance seems relatively modest next to the year-to-date activity we've seen and what's on the balance sheet and when's coming.

What precludes you from raising it at this point?

Well, Bob, I think included in our guidance continues to be the expectation that we would spend 450 to $500 million.

Obviously, we've got $422 million remaining under our current authorization, and I think as in the past, we would not hesitate to go higher if the opportunity presented itself but at this time, we're going to continue with the guidance.

I think you can look a little bit at past history and over the last 2.25 years we've returned about $2 billion to shareholders through share repurchase programs and in the absence of finding any accretive acquisitions which we continue to look for, our alternative is to return that money back to the shareholders and we'll do so.

We obviously have a lot of cash, Bob, so we don't -- lot of financial flexibility here.

Good observation.

Thank you, Robert.

Next question, please.

Larry Marsh from Lehman Brothers.

Please go ahead.

Thanks, and, yes, it is a big quarter for you guys.

Clarification of something just to make sure I'm hearing it correctly.

Last quarter, Mike DiCandilo, you talked a little bit about single digit basis point expansion operating margins in your drug division.

Is the implicit assumption as part of your expansion in your guidance that that margin will be a little bit more than single digits or are you keeping that solid?

I just have another clarification after that.

We're keeping that same place, Larry.

It's the first quarter and our first quarter last year, we had the biggest increase for this quarter versus the other years so the rest of the quarters.

We're comfortable with that single digit increase year-over-year.

It's early in the year, Larry, and a lot of things can happen but we're not backing off of that at this point.

Great.

Just a clarification, if I could, I think, DiCandilo, you talked about the scale business and some of the cost trends being benefited because more top line.

I think Kurt, you talked about, I think, what was it the Optimiz program bringing costs down well below what you thought for the quarter is it really a combination of both things that are driving that steadiness of costs or is one more than the other driving that benefit?

Larry it's Kurt.

They were both contributing.

I mean, we've -- we have called out over the last five years those expenses that we could were kind of one-time in nature for Optimiz, but there have been cost along the way that we've been spending in Optimiz that are period expenses that have started to leave the P&L here and then add to that the benefits of the technologies beginning to mature in the distribution centers, us being able to wring out labor, costs, and particularly through productivity standards and a lot of what we've been working on here is beginning to come into sharp relief.

You begin to see the benefit in the quarter.

Volume clearly has always been an added benefit here and has been a part of this business model for many, many years.

Both were at play here in strong order.

I'll tell you what, we're not done.

We continue to work at it, for those of who you have joined us through our big distribution centers, we've got our operating costs there down under 1.5 -- 150 basis points.

We continue to be very, very excited about the opportunities there and we continue to have efficiency gains in our specialty business as well.

What we're expanding our facilities down there, which is going to give us some productivity gains and the big revenue that we brought on there we've done at a low incremental costs.

We continue to be bullish on our operating opportunities here.

Great, thanks.

Thanks, Larry.

Next question, please.

From Eric Coldwell from Robert W. Baird.

Please go ahead.

Good job this quarter.

Question is related to specialty.

Within distribution, does your margin change materially if you get a greater influence from Bessy Medical versus say oncology?

I'm thinking in particular the strength you've shown in opthalmology recently.

Then as a follow-on, could you talk a little about the flu market dynamics?

It looks like we're going to have pretty substantial oversupply next year and how you plan to respond to that?

Those will be my questions.

Eric this is Mike.

I'll take the first part and I'll give Kurt the second part.

There's not a big difference in the margins between Bessy and oncology.

Yes.

Flu, Eric, was a little bit of a disappointment for us.

I did, in the prepared comments, say we were up over last year.

We were pleased with that, but we were down from our internal expectations.

Frankly, we didn't get nearly as many doses from the manufacturers that we thought we were going to get, and so our total volume was down.

Demand was down and therefore there was a gross profit contribution we were expecting in the Specialty Group this quarter that didn't materialize.

And every year is different with flu.

We'll plan for next year based on kind of what we see coming down the pike.

Sometimes this happens with this particular product area.

It's one of the benefits of the scale that we have of ABC and specialty.

It doesn't -- we can absorb these kinds of things when they happen.

We've had other years where we've had extraordinary results from that particular product line.

Right.

If I could just follow-on.

Were you in a position where you did in fact distribute everything that you were able to buy or did you actually have to eat any inventory this year?

No, we distributed successfully everything that we took delivery on.

Great.

Thanks so much, guys.

You bet.

Next question, please.

Is from Charles Boorady of Citigroup.

Please go ahead.

Thanks.

I wonder if you can quantify for us, I know you really haven't in the past, but is there any way to quantify at least generally the contribution to the overall EPS growth year-over-year from specialty and generics?

We're pretty careful not to break out the generics.

We think that's pretty competitive, but as I mentioned, generics were a contributor in this quarter and we continue to be very, very bullish on our generics opportunity as we look forward with the products coming off patent in 2007 and beyond.

Some people peg that number as much as a $10 billion in '07.

We continue to be very, very bullish on that.

Our Specialty Group as you'll recall is really broken up into two pieces, there's the distribution piece which has operating characteristics not dissimilar to our basic distribution business, but then the large services offering that Kurt talked about.

And that continues to grow and have great growth profit opportunities.

Especially--.

Charles, from a general standpoint, I mean, the guidance I think we gave at investor day as to their contribution is roughly 20% of our operating revenue generating operating margins in the range of 2%.

That's still evident this quarter.

And probably as detailed as we want to get.

Right.

Okay.

Guys, as a follow-on, you mentioned M&A and you gave some parameters.

I'm just curious how far outside the box you are willing to look and use on specialty distribution in particular things like dental or animal health et cetera?

We're not very comfortable going very far outside the box, right now because the box is working pretty well for us.

We think the place we are is a good place to be and whereas we continue to expand our specialty services businesses, we look to stay pretty close to our [knity], Charles.

Thank you.

Next question, please.

Is from Christopher McFadden from Goldman Sachs.

Please go ahead.

In the specialty business, which obviously contributed greatly to the performance in the quarter.

You've talked about a large customer that added.

I'm wondering if you could just comment on market share that you think you're gaining elsewhere in the specialty arena, and then related to that, could you talk a little bit on the completion of your facility integration?

I'm just wondering, Mike, is there a tail either of working capital or other sort of benefits that come as you've completed that project?

Thank you.

You want to take specialty?

Why don't you take the first, Kurt, and I'll get the second.

Okay.

The specialty is benefiting right now from, as we indicated last summer, Chris.

We wrote a large contract, a semi exclusive contract with a large biotech manufacturer, directly to the physician market, we're in the first year of that contract, so as we look to the second half of the year, we'll be anniversarying that particular item.

That particular contract, so we expect growth to slow because of that.

I would tell you, we expected that our ability to retain share with oncologists in the country has remained stronger this year than what we had planned for frankly, and which is good, and I think it speaks to a lot of the services and the offerings that we've spoken about this morning that these physicians don't feel as though they can go to another provider and get the same level of support and service for their practice.

So the business continues to do well.

There is a point of course we keep calling for gliding down to market-type growth rates.

That still is our expectation, but we keep being presented with opportunities that put us in an advantageous position that just always seems to be something that comes in that allows that business to keep the top line and the bottom line growing handily.

So we're calling for market growth but we keep getting upside surprises internally here.

At the risk of piling on, Chris, I would just say, one of the things that really works to our great advantage is new products.

Because what we think we're doing is capturing a disproportionate market share of new products because these wide array of services we have.

The future continues to look pretty bright.

You want to talk about facilities?

Yes.

Just about working capital efficiency.

I mentioned our inventory days on hand during the quarter was 28 days which is down from 30 days last quarter which is noteworthy because we're in the end of December time frame where traditionally inventories have spiked up.

And I think that speaks well to a couple of things.

One is, just again, the communication we have with the manufacturers as -- or the enhanced communication we have with the manufacturers as a result of the entire fee for service transition, which has helped us through that period as well as the efficiency, Chris, that you alluded to by having fewer distribution centers on hand that are larger and more automated and, I think, we're starting to see some of the working capital efficiency from having that network in place.

In addition, I think one of the things I mentioned earlier is specialty does have an impact on that overall days on hand because they typically move in high-priced injectables, have carried less inventory than the drug company on average and so they're above average growth contributes to that as well.

And Mike where do you think you'll be on DSOs at the end of the year?

I think you're going to continue to be in that 19 to 20-day range.

It may creep up a little bit because of the mix.

Thank you.

Thanks, Chris.

Next question, please.

Is from Lisa Gill from JP Morgan.

Please go ahead.

I also had a clarification.

I was wondering, Kurt, when you talked about the long term care business, did you say that now you are receiving rebates again from the manufacturers?

And secondly, I think that I understood that you said you were taking market share from largest player in the industry.

Is that correct?

Yes.

Yes to both of your questions, Lisa.

Yes.

We did -- we finished the contracting process with the manufacturers this fall which is the normal schedule.

We were somewhat successful.

I think that probably it's true for all the players in the industry.

Some of the manufacturers that were cautious because of CMSs guidance in '06 have kind of worked through their issues there, have gotten more confident and comfortable that rebates are allowable, and they have put more money back on the table.

There have been a number of brand name manufacturers that put money on the table that were absent in 2006.

That was my comment.

So that's good.

Now, that is offset by lower reimbursement rates with PDPs.

One in particular that we as an industry have worked through here, but there was some money taken off the table there.

So we've kind of called for a neutral effect, if you will, for those two items in the P&L for calendar year '07.

And just as it relates to the market share, yes, we are clearly gaining beds here at the expense of our largest competitor.

I think it speaks to a very customer focused orientation that our business unit has.

We have made some innovative investments in some technology offerings that are gaining traction in the marketplace and are giving us a little bit of a leg up from a competitive standpoint.

And so the business has got some nice momentum at the top line right now, we expect that to continue in the second quarter as the business enters into NewCo.

And then just as a follow-up, when we talk about these PDPs and the relationship, does this trigger change our control or will things just continue and you'll continue to have your separate contracts and separate entities throughout 2007?

There will not be an effect from a change of control.

The contracts will continue and then NewCo will go into its own contract and cycle this summer for the PDPs and the fall for the manufacturers.

Thanks very much.

Next question, please.

Is from Tom Gallucci from Merrill Lynch.

Thanks for all of the color.

Mike, I was just curious how you are thinking about the seasonality of the business these days with the fee for service fully in place at this point?

How much smoother is it and how many ups and downs should we see quarter to quarter?

Tom, I think what you're seeing is a lot less volatility than what we've been used to historically.

I think certainly we'll still benefit from those quarters that have large price increases like the March quarter but much, much less than we have in the past.

I think a good price increase quarter in this environment is really a sweetener, not the driver.

And in the same vein, like we had in the September quarter when price increases are far and few between, it's a small detractor and it's not going to ruin your quarter, either.

So we feel very good about the lessened seasonality, the lessened volatility in our business.

Help with the manufacturers as well, Tom, I'll tell you it's just a lot more rational way to run the business.

And as we talked about we've anniversaried, essentially anniversaried our fee for services.

It's the way this industry's going to run going forward.

I'll tell you, it makes a [Expletive] of a lot of sense to us and our suppliers as well.

Following up on your comments there, Dave, anniversarying the implementation of fee for services.

We think about it, I guess all of those agreements were really in place as you got into calendar '06.

So is this sort of a, I guess, the last quarter sort of outside your margin improvements due to those fee for service agreements anniversarying at this point?

Yes, Tom I think we're pretty much at a steady rate going forward.

We continue to negotiate and improve -- have productivity improvements but we're at a steady state at this point.

Thank you very much.

Thanks, Tom.

Next question, please.

Is from Ricky Goldwasser from UBS.

Please go ahead.

Good morning and congratulations for a very good quarter.

Thanks.

Just a couple of follow-up questions.

First of all, just to help us determine what is sustainable growth forward in terms of the operating margin expansion so we can distribute our job in modeling.

As far as generics is very good contribution, can you give us some more color on what's a sustainable level for operating expansion going forward, direction would be, and what directly the impact on margin now that Simvastatin's exclusivity period has ended, just we'll figure out what the moving part is.

So with Simvastatin it obviously had very positive impact in the second half of calendar year '06 ending their exclusivity period directly what does that mean to margins?

Then on the specialty business is your specialty business to physicians benefiting from [Inaudible] consolidation that we've seen in the industry in 2006 and if so do you think you will continue to benefit there in calendar year '07?

Ricky, let me start out with -- we've got a lot of stuff to cover there.

First of all, in terms of the operating margin expansion, Ricky, we finished off last year in the pharmaceutical distribution segment with operating margin of 115 basis points and we said that we've had single digit basis point expansion throughout the year for the total of the year.

We're still comfortable with that.

This quarter we're at 125 so we're comfortable with that range going forward.

Clearly, the individual -- some of the individual products in generics we don't like to talk about individual products.

We have them coming off patent on a phase basis, so it's part of the benefit we have of such a large offering of our generic offering that a couple of items is not having that big of an impact for us, but there's no question that our pro generics program is getting a lot of traction.

Kurt mentioned they we're adding new customers.

We're expanding our generic offering within the customers we've already got by cutting down leakage so generics is a big driver for us going forward.

We look out at '07 some big products coming off patent.

We're in great shape to take advantage of them.

We've really improved our new product launch.

That's a big driver for us going forward.

I think she had a question on operating expense guidance for the remainder of the year.

I think it's a little bit dependent upon the mix and the growth, Ricky, but certainly I would expect the operating expenses to be in the 180, 180s from a basis point perspective for the year, a little bit higher than they were this quarter obviously we expect to grow our expenses somewhat sequentially the rest of the year and that's due to a couple things.

One, we had some acquisitions in the first quarter that weren't here the whole quarter so they'll add expense as we move on in addition, our, just compensation cycle is pretty much tied to a calendar year basis, so you'll see some uptick there, and as we said, we've got a lot of infrastructure investments coming in the next six months particular I had in specialty.

So I think you'll see some uptick in dollar expenses and as a percentage, you'll probably creep up a little bit for the year, but certainly they are going to continue to be a driver of that operating margin expansion that we've talked about in the single digit basis point range for the year.

And Ricky, just not to drive this story into the ground but in terms of the consolidation and specialty business, it's really not a big issue for us.

If the implication is manufacturers as they maybe pick up some of the new biotech companies is that a positive or negative for us, it's really neutral.

In fact some of the largest pharmaceutical manufacturers, we don't mention specific names but some of the biggest ones in the biotech business are also the biggest customers we've got in our specialty services businesses.

So we really cater to both ends of the spectrum, the new biotech company's got a brand new product that's never been in the market before as well as a well established manufacturer.

Well, actually, David, my question was on the other end we're seeing some off the -- I think some fear competitors into the physician business and physician offices business that were acquired last year and I was kind of, like, asking are you taking away share from them?

Well, we're continuing to do very well in the business, Ricky, primarily because of the large service offerings that we have, and I think sometime a little confusion about , getting into this business and just having the distribution network of it, and that's really only one piece of it.

The services is what really drives that business.

I think one of the reasons that we haven't seen any erosion in our market share even though other -- we've had some other entrants here is that they've not been able to duplicate the services.

They may have been able to duplicate some of the distributions, but not all of the services that go with it.

We continue to have a very, very strong market share.

As we said, we expect a little degradation, we really haven't seen it.

Thanks, Ricky.

Next question, please.

From John Ransom, Raymond James.

I was just curious some qualitative comments about the independent pharmacy channel and how they're coping in this difficult operating environment?

Anything you're seeing that would suggest they are stabilizing pharming or what are your concerns there?

I will tell you, John, I've been in this business a long time, well over 30 years.

I've been hearing about the demise of the independent pharmacist I think my entire career.

We all know you're old as [Expletive].

These guys at the table keep reminding me of that, John, which is pretty depressing.

I got to tell you, I opened up my mail this morning, John, a little anecdotal, but I opened up my mail this morning from one of our big customers, a single store operator in the south.

He sent me his financials.

I'll tell you what, he's doing just fine.

His prescription count is up.

He's got a lot more generics going through his business.

His margin is up.

He's a happy camper, very pleased with his year and he wanted to share it with me.

I will tell you, I think the independents are doing fine, John.

I got to tell you, most of them operate more than one store.

I think the average independent owns like 2.3, 2.4 stores.

They continue to have a unique niche based on value, convenience, and service and we do not see them going away in the future.

They continue to do very, very well.

I think the very large warehousing chains have their hands full with some of the integration they're doing.

We think the independents are going to do just fine.

I'll tell you, they've done just fine over the years.

John, it's Kurt, I'll just chime in here.

It is important that we keep them plugged into lives and that we keep them plugged into the payor system in this country.

That's one of the reasons we began investing in PPN, three or four years ago to build that network out and now it's the third largest network in the country.

Frankly, our independents today wouldn't do business outside that network at this point in time.

That's a clear differentiator for us.

I think we were out at the forefront in that forward thinking and putting that network together and it's fundamental to the offering we've got today.

In fact, we find our independents wanting to get closer and closer to us than they ever have in the past.

That's all positive because we think we can really add a lot of value to their businesses.

Okay, my other question relates to -- I think we're jumping around, but fee for service.

Is that an ongoing process?

Is there a kind of once a year where you sit down and assess that?

Are the contracts likely to be changed and any direction more favorable to you, more favorable to the manufacturers?

Are there adjustments being made, inflation's been running a little bit higher than we would have thought, et cetera, et cetera?

How should we think about that as an ongoing process some.

Fist of all, you shouldn't think of it as an ongoing process, there is no cycle to it the way we talked about with the long-term care business, I mean, as our industry went -- as the distribution industry went into these negotiations with manufacturers, we signed contracts one year in length, some four, five years in length.

So there in is no normal contracting cycle if you will it's manufacture specific and Dave got into it a little bit in his earlier comments.

The feedback we're getting is the manufacturers are delighted with the transparency that they have, the level of trust that's been improved between our side of the marketplace and their side.

It's being driven by these agreements.

I think they fundamentally know more than ever now even more than three years ago the value that the distributor brings to their side of the marketplace and how valuable it is to have a true understanding of real demand on their products.

I think they're driving a lot of efficiencies in their own production environments by having a better sense of true demand.

The long and short of this thing is, I don't think we see really any significant change in this going forward.

We'll just continue -- our game here at this point in time is just execute as best as we possibly can under those contracts to keep these manufacturers delighted with what we do.

But you don't see -- there haven't been any examples of changes in economics one way or the other.

Really don't.

Thanks, John.

Thank you.

We'll take two more quick questions in light of the time.

Very good.

Next is from Andy Speller from A.G. Edwards.

Thanks, guys, I'll stay to the one question limit.

Just a question about interest expense for the year.

I think at the end of the fourth quarter you said something around maybe 12 to 14 million worth of interest expense?

Mike, any help there?

Yes.

I don't think we gave an interest expense target for the year.

I think we were a little bit over 8 million in the first quarter and I would expect that sort of rate to continue throughout the year.

Obviously, we've spent more money on share repurchase so our average cash invested is going to go down.

I would expect the interest rate to -- or, excuse me, the interest expense to be substantially over where we ended last year.

Okay, thank you.

Thanks, Andy.

And the last caller, please?

From Steve Halper from Thomas Weisel Partners.

Dave, you made a comment in your prepared comments around A&P and you were stating that you believe that PBM mail order purchases should be excluded from that calculation.

Could you just expand on that comment and why the Company's taken that viewpoint?

Well, the thought here, Steve, is that these mail order facilities which are very, very large are literally buying in some cases items by the pallet load and probably getting huge volume discounts as a result of that.

And we just want to make sure that it's a level playing field and that the prices that go into A&P are readily available to all retailers in the marketplace.

So we think that's a separate class of trade that should be excluded just like other classes of trade, for example a hospital should be included that the A&P, the really key thing is that that price be available to all of the participants in the marketplace.

That's our point, Steve, and the retail organizations have a similar view and they are making that case, as are we, we think very effectively in Washington.

Thank you.

Thank you very much for everybody attending today.

For those of you who want to talk to us further, we'll be at the Merrill Lynch conference in February 8, next month.

And with that, I'd lake to turn it over to Dave Yost for a few closing remarks.

Thanks.

I'd just like to again thank you for joining us.

I think I'd sum the quarter up pretty succinctly by saying strong revenue, expanding margins, cash generation, great opportunities in generics and specialty distribution and services, strong fiscal and operating discipline.

We think it's as easy as ABC.

Thank you, very much, for your continued interest.

And ladies and gentlemen, this conference is available for replay after 2:30 p.m.

Eastern time today through January 31, at midnight.

The dial-in number is 1-800-475-6701.

The access code is 857491.

Again, this conference is available for replay after 2:30 p.m.

Eastern time today through January 31, at midnight.

The dial-in number is 1-800-475-6701.

The access code is 857491.

And that does conclude your conference for today.

Thank you for your participation.

You may now disconnect.