美源伯根 (ABC) 2007 Q2 法說會逐字稿

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

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

Later we will conduct a question-and-answer session and instructions will be given at that time.

(OPERATOR INSTRUCTIONS).

As a reminder, this conference is being recorded.

I would like to turn the conference over to our first speaker, Mr.

Mike Kilpatric.

Please go ahead.

Good morning, everybody.

Welcome to AmeriSourceBergen's conference call covering fiscal 2007 second 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 you to our SEC filings, including our 10-K report for fiscal 2006.

Also, AmeriSource assumes no obligation to update the matters discussed in this conference call and this call cannot be taped without the express permission of the company.

As always, those connected by telephone will have an opportunity to ask questions after our opening remarks.

Here is Dave Yost, AmeriSourceBergen CEO to begin our remarks.

Good morning, and thank you for joining us.

We had a strong March quarter and first half of the fiscal year.

Operating revenues were up 9% for the quarter to $15.3 billion, a $1.2 billion increase over last year.

Operating margin in the pharmaceutical segment was 135 basis points for the quarter, and 130 basis points for the first half, continuing our trend of operating margin expansion this segment, 8 basis points in the quarter.

Operating expenses as a percentage of operating revenue continued to trend down well over 2%.

The company's EBIT was $221 million for the quarter, and EPS from continuing operations was up 11% to $0.68.

Excluding last year's $0.06 a share benefit of special times that Mike will detail, our EPS was up 24% for the quarter.

On a similar basis, for the six months year to date, our EPS was up 34%.

We generated over $400 million in cash in the quarter, repurchased $35 million of our stock and ended the quarter net debt free once again.

Strong and steady performance, and this quarter's performance was on top of a strong March quarter last year, when revenues were up 15% and EPS was up 33% on a gap basis.

We have lots of momentum at AmeriSourceBergen in a solid and growing market.

There are several industry issues I would like to address as well as our M & A activity, but first I'd like to comment on our news release from last night regarding our Orlando, Florida drug distribution center.

Yesterday, the DEA temporarily suspended our license in our Orlando, Florida facility for DEA controlled products.

This suspension stems from a DEA investigation of internet-based pharmacies.

The DEA alleges that the Orlando ABC facility did not maintain effective controls against diversion of controlled substances, specifically hydrocodone to four internet pharmacies.

This suspension applies only to our Orlando facility.

We hope to have this temporary suspension resolved quickly.

It is important to note the following, all four listed pharmacies had an active DEA license to sell DEA-controlled products at the time we sold them.

For years, AmeriSourceBergen has had an anti-diversion program as well as a DEA-approved suspicious order monitoring program in place at Orlando and throughout the country.

ABC is cooperating fully in this investigation.

Alternate arrangements are currently being made to get controlled products to our customers.

We received the suspension yesterday, and are working with the DEA to resolve this issue as quickly as possible.

As a reminder, AmeriSourceBergen has led the industry in channel integrity issues such as buying product only from the manufacturer.

We do not expect this temporary suspension to have a material impact on our earnings.

And now, regarding our M & A activity.

On March 26th, we filed our form 10 with the SEC for our previously announced tax-free spin merger go public transaction, which will combine our long term care assets and our PharMerica segment with the long-term care assets of Kindred.

To refresh your memory, the new entity will be the second largest in the industry with revenues of almost $2 billion, we are awaiting SEC review and approval and are on track to complete the transaction during the current June quarter.

On March 28th, we announced an agreement to acquire Bellco Health for $235 million.

Bellco has revenues of about $2 billion and is composed of several business units, each of which is an excellent fit within ABC.

Bellco Drug, servicing independent drugstores in the New York Metropolitan area, is a great complement to ABC's drug company.

Bellco Generics has an established generic telesales operation which fits nicely into the drug company's generic drug program.

American Medical Distributors dialysis business compliments our existing capabilities in this area.

Bellco's focus on customer service is as strong as any organization in the industry.

When we complement Bellco's service package with ABC's programs such as our third party performance plus network good neighbor pharmacy program and ABC's broader product offering, well be well positioned in the New York Metropolitan market which is the most concentrated independent pharmacy market in the U.S.

We filed for approval with the FTC under Hart-Scott-Rodino on April 6 and hope to close the transaction during the June quarter.

On April 2, we announced the acquisition of Xcenda for $25 million.

Though relatively small, Xcenda is a great addition to our broad based manufacture offering, and will complement Lash and NNCR.

Xcenda is a leading pharmaco economic and health outcomes consulting company, based in Tampa, developing strategies and tactics to a clinical and economic value of treatments for pharma and biotech companies.

We are very excited about both of these acquisitions and the extremely talented executives and organizations that come with them.

Good things happening on the M & A front, completely consistent with the strategy we have continued to articulate, well run, moderate sized acquisitions in the brand pharmaceutical generic and specialty distribution with closely related space such as packaging, with good potential operating synergies.

With this quarter's activity, we will have committed to spend about $400 million this year on acquisitions in addition to the $300 million we spent last fiscal year.

I'd like to turn to some industry issues.

First, AMP, or average manufacture price, the CMS computed product costs for generics that will establish the ceiling for retailer state Medicaid product reimbursement.

You will recall that the ingredient component is only 1 of 2 components the retailer will receive for reimbursement.

The second component being the dispensing fee, which is established by each state.

ABC will not buy or sell AMP but it continues to be of performance because of the impact to our retail customers.

You will also recall our concern with AMP has been that it accurately reflects the retail channels, excluding long term care, hospitals, PBMs, mail order and other outlets with other different patient service offerings.

At this point, we're gaining confidence that AMP will be calculated appropriately.

The implementation date on establishing AMP was originally July 1, but that could be delayed.

Importation continues to hit the news occasionally, we are convinced the safety issues against importation are so compelling that this issue is not likely to get traction.

Market introduction of generic biotech drugs, sometimes called biosimilars, has also been in the news with some predictions that legislation could be passed as early as this year.

We think that's unlikely at this time.

And also note that implementation will probably take several years after legislation, since this is a very complicated matter with significant patient safety issues.

Though we are uncomfortable talking about specific products, the recent news coverage of anemia products with bears mentioning due to our strong specialty business, particularly in EPO-based products.

Our understanding is the current issue regarding these products relates to dosage and offlabel usage.

Our opinion, it is too early to assess the impact, if any, to our business.

Questions regarding specific products should be addressed in the appropriate manufacturer.

Due to our strong specialty and institutional business, these anemia products represent about 7% of our Pharmaceutical Distribution revenue, about half in specialty, and half in traditional drug.

Generics and particularly generic introductions contain to be important to AmeriSourceBergen.

Our customer mix of independents, regional chains and food/drug combos provide us great opportunities for the sale of generics.

We look for the balance of calendar '07 and '08 to be strong years for generic introductions.

At AmeriSourceBergen we continue to focus on the basics, we continue to be comfortable with revenue growth for the year of 9 to 11%, which does not include the impact of the pending Bellco acquisition or impact if any of EPO related products.

As noted in our press release, this month we received an antitrust litigation settlement that will provide a net benefit of $0.05 per diluted share and raise our GAAP yearly EPS guidance by that $0.05 a range of $2.45 to $2.60 per share to a range of $2.50 to $2.65 per share.

We also raised our cash generation guidance by $150 million to a range of 575 to $650 million.

Lots of good things happening at ABC and another strong quarter.

Here's Kurt for some added color.

Thanks, Dave.

Good morning, everyone.

This was another solid quarter with the continuation of many of the positive trends we've been seeing for some time.

In our core distribution businesses, we again saw an expanded gross margin, improved operating efficiency, disciplined working capital management, and another quarter of operating margin expansion, with improved returns on capital deployed.

In the drug company, the year-over-year improvement in gross margin was drawn by the same factors we've been executing against for some time.

First, we executed well under our fee for service agreements, which drove fee incomes slightly ahead of our internal expectations.

It is important to remember, though, that since we have now fully anniversaried the fee for service model transition, the incremental year-over-year improvement was less this quarter than in the December quarter as expected.

We continue to show discipline around customer mix, pricing, and contract compliance against an industry backdrop that we would characterize as stable but competitive.

We also further differentiate ourselves in our chosen customer segments with the continued innovation and integration of our various customer solutions and service offerings, and last, we again benefited from strong generic pharmaceutical growth.

Although we experienced less benefit from new generic product launches this quarter versus last, we continue to drive above market generic growth due to increased customer signups for our PROGen generic formulary and our successful efforts to better control generic customer leakage.

Our footprint in independent retail, small and mid sized chains and food drugstores is a clear differentiator for us, as all of these customers depend on us for their generic product selection.

In addition to driving greater value for these customers, distributors like ABC play an integral role of getting new generic product into the market and into patient's hands, oftentimes within 24 hours of a new generic product launch, saving countless dollars for patients and payers alike.

As we look forward, our confidence in improved generic product sourcing continues to grow as our activities with new and emerging internationally based generic manufacturers who seek access to our attractive customer base continues to make solid progress.

Below the gross margin lines, substantial productivity improvements continued in the quarter.

Under the optimized program, we continue to derive incremental benefit from our warehouse and automation system investments.

This, in combination with increased unit volume, drove operating expenses down again in the quarter in line with our expectations in both dollars and as a percentage of revenues.

In addition, we continue to work in Canada to further rationalize our current network of 13 distribution centers to reduce costs and add capacity to keep growth markets.

We are well under our way with our integration planning of Bellco.

As Dave indicated, Bellco is an excellent fit with a number of our existing businesses within ABC, and we expect the integration to be a smooth one.

And it will position us well in the very attractive greater New York Metropolitan market.

So all in all, a very solid second quarter performance by the drug company, which heads into the second half of the year with excellent momentum.

The packaging group, while still a relatively small contributor to ABC, also had another solid quarter, well ahead of a year ago performance.

Our business model transition continued at American Health Packaging, with the expected volume reduction in its lower margin bulk to bottle business.

The continued strong growth in its proprietary generic product offerings, with the launch of 11 new generic items for various end-use markets.

This transition is driving substantially improved operating margins and returns on capital versus year ago levels.

Anderson Packaging, our U.S.

contract packaging business for branded manufacturers, had another excellent quarter with 5 new program launches.

Year to date, Anderson has won a record amount of new business, which will drive continued growth well into 2008.

To accommodate this new business, during our second quarter we approved construction of a new 260,000 square foot production facility for Anderson in Rockford, Illinois.

This will bring the packaging group's total production capacity to approximately 1.5 million square feet.

We continue to see an accelerating trend by large branded manufacturers to outsource noncore activities like packaging.

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

First with regard to long-term care, the big news remains the pending spin-off.

However, while we've worked to complete this transaction, we remain committed to running the business.

Revenues in the second quarter were up slightly over 5%.

Importantly, our national footprint and customer facing technology offerings allowed the business to capture market share gains against its largest competitor.

In recent new business, wins in the second quarter, should drive strong patient gains over the next 6 months.

Long term care's gross margin, was up slightly over year ago levels on an improved patient acuity mix and as expected, slightly lower PDP reimbursement rates were offset by the return of some manufacturer rebate dollars which were absent in 2006.

Operating expenses were negatively impacted by approximately $1 million due to higher than expected bad debt expense and some transition costs related to the pending spin-off which were expensed in the quarter.

Looking forward, we're now biased toward a slight upward revision in our manufacture rebates versus our previous guidance.

We are confident the business will meet our financial expectations for the year.

Now turning to PMSI.

As we've shared in the past, PMSI is the nation's leading single-source provider of cost-containment outsourcing solutions for worker's compensation and catastrophically injured populations.

The PMSI business has a market leadership position, very attractive financial metrics, and very good growth fundamentals.

Importantly, however, the business has begun to experience increased customer pricing pressure from competitors, and the unit's second quarter financial performance came in below our internal expectations.

While revenues were up a modest 2%, to $114.6 million for the quarter, EBIT was down at $8.6 million versus $9.2 million in the prior year.

To position the business for the future, we recently rebuilt the management team, restructured the sales organization and had begun implementing a number of significant enhancements to its technology platform in order to reduce costs and improve the unit's customer interface cape abilities.

This was a very good niche business with good growth prospects.

However, we do expect the second half of the year to be more challenging due to the continued impact of recent customer price adjustments as well as higher expenses from the recent investments.

We expect EBIT margins to be in the 7% range on flat revenue growth for the year.

It's important to keep in mind that this business represents less than 5% of ABC's consolidated ebit.

Now, turning to the specialty group.

The group had another quarter of above market growth with revenues up 27% from prior year levels.

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

The oncology business also continued to benefit from its recent semiexclusive distribution agreement with a major biotech manufacturer, with the distribution of certain products to the physician market.

Importantly, other distribution businesses in the group again performed well in the quarter.

Besse Medical, which distributes vaccines and specialty projects to non-oncology physician practices, enjoyed strong top line and bottom line performance driven by excellent market penetration of certain newer physician administered products.

To further build out its manufactured service offerings, the group has completed three acquisitions year to date.

Integration activities related to the first quarter acquisitions of IGG America and Access Medical are proceeding smoothly.

And in early April, we announced the acquisition of Xcenda.

Xcenda will enhance the group's ability to provide applied health comm and pharmaco economic studies to both its branded and biotech manufacturer client base.

Other planned investments to support the specialty group's continued growth remain on track.

Expansion of oncology supplies distribution center in Dothan, Alabama was completed this past quarter, on time and on budget.

The new headquarters location for the group in Dallas is on plan to open in the June quarter.

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

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

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

All in all, another very solid quarter, as we look to the second half of 2007, we remain exceptionally well positioned.

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

The integration of 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 manufacturer partners and are carefully building 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 second half of 2007.

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

Thanks, Kurt, and good morning, everyone.

Another solid quarter by any measure with strong performance in our core distribution businesses with strong revenue growth, operating margin expansion and strong cashflows which led us to raise our free cash flow expectations for the year.

Before I get to our consolidated results, I would like to remind everyone that our March or second fiscal quarter has been our strongest quarter from an earnings and margin perspective due to the higher number of manufacturer price increases during the March quarter and this year was no exception.

Certainly our fee for service agreements have somewhat mitigated the historic volatility of the quarterly contributions from price increases, however, the 20% or so of our brand named business that is still subject to the timing of manufacturer price increases continues to benefit the March quarter more than any other quarter.

Now, starting with our consolidated results for the quarter.

Our operating revenue was up a strong 9%, driven by our drug and specialty units within Pharmaceutical Distribution, which grew 5 and 27% respectively, and 1% of the consolidated increase was due to our prior year acquisitions.

That strong revenue growth, which is in line with our 9 to 11% revenue increased targets for the year, in turn drove a 12% increase in operating income, despite a 2% negative year-over-year impact of special items.

Regarding those special items, included in our consolidated gross profit was a small benefit of $1.8 million resulting from manufacture antitrust cases compared to a similar benefit of $9.4 million in the prior year.

Reflected in our consolidated operating expenses for the quarter was a negligible net amount of facility consolidation, employee severance and other costs, compared to $3.6 million of similar costs last March.

The net after tax charge for special items in the current year was $0.3 million, or $0.00 per diluted share compared to a net after tax benefit of $3.9 million dollars or $0.02 per share in the prior year quarter.

Below the EBIT line, net interest expense increased $2.5 million to just under $10 million, reflecting higher net average borrowings during the quarter compared to last year.

You may remember that last March we had $5.8 million of other income, primarily from the sale of an equity investment and an eminent domain settlement.

Our effective tax rate for the quarter was 38.5 % and ex-special items, which include nondeductible long term care transaction costs was 37.9% in line with our 37 to 38% expectation for the year.

You may recall that our effective tax rate in the prior year quarter was 34.5%, and benefited from certain tax adjustments which provided a $5.5 million benefit to income tax expenses last March and positively impacted prior year EPS by $0.03 per share.

EPS in the quarter was $0.68, up 11% over last year's $0.61.

However, excluding net special items, asset sales and tax adjustments which netted to $0.00 per share in the current year, EPS of $0.68 would be up an even stronger 24% compared to last year's $0.55 on the same basis as the prior year had a $0.06 per share benefit from the items I previously detailed.

This 24% increase was driven by the 16% increase in Pharmaceutical Distribution operating income and a significant drop in diluted shares outstanding to 191.8 million, down 19 million shares or 9% from last year, reflecting our share repurchases over the last 12 months, net of option exercises.

Moving to the Pharmaceutical Distribution segment, our top line increase of 9% was again aided 1% by acquisition.

As I previously mentioned, the specialty group grew 27%, and continued to benefit from the same trends I discussed last quarter.

Above market growth of the oncology franchise, including the benefits of a semiexclusive distribution agreement signed in the last half of fiscal '06, and the introduction of new physician-administered products distributed by Besse Medical, also in the last half of last year.

As these items annualized in the second half of the year, our full year specialty revenue growth will moderate to the mid-20% range.

The drug company grew its operating revenue 5%, driven by its institutional business as retail sales were flat due to our discontinuance of service to a large, lower margin customer that we mentioned last quarter.

We continue to expect consolidated Pharmaceutical Distribution operating revenue growth as well as overall operating revenue growth to be in the 9 to 11% range for the year.

This growth does not include the impact of our pending Bellco acquisition, which we indicated has revenues in the $2 billion range annually.

Depending on the timing of the close of this transaction in fiscal '07, Bellco could add 1% to the full year range.

In addition.

Dave touched upon earlier the controversy regarding anemia drugs and to be clear, our fiscal '07 revenue guidance does not include any material negative impact to our sales of these anemia drugs, and we will continue to monitor any new developments in this area.

Gross profit margins increased by 7 basis points over the prior year quarter as performance under fee for service contracts generic sales growth above market and strong price appreciation within the drug company more than offset a decline in the specialty group gross margin due to their lower margin distribution businesses growing faster than their higher margin service businesses.

From a LIFO perspective, we had a $1.6 million charge in the quarter compared to an $8.5 million charge in the prior year quarter as the significant decline in price and certain large generic products which came off their exclusivity period in fiscal '07 offset in part the brand name price increases for the quarter.

For the six months our LIFO charge is $8.9 million , compared to $15.4 million last year.

Operating expenses as a percentage of operating revenues improved by two basis points in the quarter compared to the March '06 quarter, reflecting continued strong operating leverage offset in part by the impact of acquisitions as expected.

As a result, EBIT margins in the quarter expanded by 8 basis points to 135 basis points and for the 6 months were 130 basis points up 14 basis points over the prior year period.

We continue to expect operating margins for the year to expand in the single digit basis point range.

Most likely at the high end which obviously implies that the second half of the year will have margin expansion less than the first half as expected.

Again, this is due to the timing of manufacturer price increases and the quarterly progression of fee for service contribution to fiscal '06 results, where we were still signing new contracts in early fiscal '06, which enabled us to have more favorable comparisons in the first half of fiscal '07.

Now, turning to PharMerica, revenue growth of 5% was driven by long term care, which contributed 317 of the $431 million of revenue in the quarter.

From an operating income standpoint, LTC generated $6.8 million of the segment's $15.4 million, down slightly from last year.

Kurt detailed the issues confronting PMSI where revenues were relatively flat, up 2%, and competitive pressures drove down gross profit margins resulting in a $700,000 decline in operating income during the quarter compared to last year.

We continue to make investments in PMSI and expect their operating expenses in each of the next two quarters to increase by 3 to $4 million, reflecting those investments and in combination with the competitive market pressure, will result in a challenging second half of the year for PMSI.

Now, for cashflows and balance sheet, where we once again had tremendous performance.

Cash generated from operations for the quarter was better than expected $423 million dollars, bringing our 6 month totaling of cash generated from operations to $711 million, higher than the robust $703 million at this point last year.

Although some of the first half increase is due to favorable payable timing and will reverse in the second half, we will continue to generate strong cash in the second half net of changes and working capital and as a result, we are comfortable in raising our free cashflow estimate for the year by $150 million to a range of 575 to $650 million from our previous range of 425 to $500 million.

This continues to assume a Cap Ex spend of 100 to 125 million dollars for the year.

And after spending $29 million on Cap Ex in the quarter, we are at $57 million through the first six months.

From a statistical standpoint, as I mentioned last quarter, all of our ratios continue to be impacted by specialties above market growth, as generally that group has higher DSOs, lower inventory days and greater DPOs than the drug company.

As a result, DSO's increased to just under 20 days in the quarter to just under 17 days last year, primarily due to that mix as well as due to the Canadian acquisitions.

Average inventory days on hand during the quarter were 28, down a day from last year, and DPOs were up about 2 days due to timings and the mix impact.

Our debt to total capital ratio at the end of March was 23%, up from last year, reflecting our 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 $1.6 billion at the end of March, our net debt to net capital ratio was less than 0 once again.

Net of the favorable working capital dynamic at the end of the quarter, and factoring our maintenance cash level of approximately $200 million, We continue to have great opportunities to deploy additional capital, and this quarter we focused on signing the Bellco and Xcenda deals, where we committed $260 million of our capital.

While share repurchases were modest this quarter at $35 million, keep in mind that we have repurchased $980 million of our stock in the last 12 months and 20% of our outstanding shares over the last 2.5 years.

Year-to-date we have spent $365 million dollars to repurchase stock, which is well ahead of the pace necessary to meet our 450 to $500 million guidance for the year.

At the end of March, we have $387 million dollars open under our current share repurchase plan.

So to summarize, another strong quarter of revenue growth, margin expansion and cash generation leaving us with great momentum and flexibility going-forward.

Our EPS guidance, which is on a GAAP basis, has been increased by $0.05 to reflect the net positive impact of an antitrust litigation settlement that has been received in April, and will benefit our third quarter EPS.

Our EPS guidance for the year on a GAAP basis is now $2.50 to $2.65, and continues to include $0.09 to $0.11 from our long term care business.

When the LTC spin occurs, long term care's results will transfer to discontinued operations and we will adjust our EPS guidance from continuing operations to reflect the spin.

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

Thanks, Mike, we'll now open the call to questions.

I would ask you to limit yourself to one question until we've had -- everyone's had an opportunity.

Then, if there's time, can you ask additional questions.

Go ahead, Ryan.

Okay.

(OPERATOR INSTRUCTIONS) Our first question will come from the line of Eric Coldwell with Robert W.

Baird.

Go ahead.

Thanks, much.

Wanted to come back to the issue around PMSI and the negative EBIT comp in the quarter..

If I'm doing the math right it looks like your impact was about $0.002 Seems like a lot of focus on the division for a pretty small earnings impact.

Could you just clarify how much worse you think it could be, and how much of a distraction this could be in the second half of fiscal '07.

Let me talk a little bit about the distraction.

The question is, is the PMSI core?

No, PMSI is not core, but it's a logical extension of our business, we think it's a good business.

It does not have a big capital -- it's not a capital intensive business and we think we can make good returns here, and we have a good plan in place to turn it around.

Kurt, I don't know if you want to talk about any of the specifics?

I'm happy to.

I think the reason we gave a little bit of focus was really to give a little more perspective about the second half of the year, Eric, because we're going to see the business be a little more challenging in Q3 and Q4.

We are making some investments there, the investments are primarily in the areas of technology, both facing out to the customers' primarily web-based E-services type applications that are around really helping the bill adjusters do their job more efficiently, and then we do have a number of investments going on internally to strip out paperwork frankly, document management systems, and some other procure-to-pay applications to take some head count out, and be more efficient internally.

As Dave said, I think the thing to keep in mind here, it's small, it's 5% of the business, it's noncore, but it does have a market leading position.

It's got a great financial model.

And it's one that we think is worth investing some money in, and becoming successful again and re-establishing its leadership in the marketplace.

Thanks, Eric.

Thanks, guys.

Our next question will come from the line of Robert Willoughby with Banc of America Securities.

Mike, can you detail the spike in the AR again, you mentioned something there, I don't think I picked up everything, and what's your expectations for working capital savings at Bellco?

Robert, I think I said from a DSO perspective, our DSO's are up about 3 days year over year, that's because the specialty group is obviously growing faster than the drug company, and the specialty group in its distribution to physicians or physicians typically have a much higher DSO than do the pharmacies serviced by our drug company.

So as we increase our sales in specialty faster than the drug company, that will drive our DSO up.

Is there a Pharmerica issue in the quarter on the receivables front?

No, Pharmerica is up year-over-year, again reflecting the shift that occurred during Med D but not a significant increase.

I think the second part of your question was, Bellco.

We think that when we make the Bellco acquisition and we wrap them into the rest of our company and follow our fee for service contracts, there's some opportunity, obviously, to take inventories down.

They are on some fee for service, but not as extensive as we are.

Thanks, Bob.

Thank you.

Our next question will come from the line of Larry Marsh with Lehman Brothers, please go ahead.

Thanks, good mourning.

Just a question and a clarification, the question's on specialty.

Obviously this has been a big grower for you guys, the last 10 years, 5 years, obviously, since you brought it on.

And I just want to make sure I'm hearing the message correctly on anemia.

Based on your comments, I guess, Dave implying that anemia is correctly somewhere between 15 and 20% of total specialty volume, is that the case and is this the category that's been growing kind of at or above market for you guys?

And how -- I guess you're saying that you're not assuming any change in growth rate there.

Just a little bit of clarification of what sort of delta may take place in the marketplace.

I know you're not predicting any particular product changes.

A couple things, Larry, what we said it was, it was 7% of our total Pharmaceutical Distribution revenues, I think one of the things that's overlooked is that half of that revenue is in our traditional drug company half in specialty, and that's because our traditional drug company has a strong institutional business which has a great appetite for these products.

You did hear correctly that we have not taken any adverse impact on those products into our forecast, but I think it's very important to note here that the talk and the speculation has been about decreased growth rates.

It's not been about any decreases in the product.

And we're watching very carefully what the suppliers have to say about this.

I carefully what the suppliers have to say about this.

I think it's basically these products are going to increase at a decreasing rate, perhaps.

But they've had very strong growth in the past and we think they're very very strong products going-forward.

It's fair to say you haven't seen any changes of behavior up to this point?

We haven't.

I think it's clearly too early to tell.

But so far 'very steady as she goes as far as work is concerned.

A quick clarification, for Kurt, on PMSI, a follow-up on Eric's question.

You talked about changing the management team.

Have you talked about who's running that division for you and -- it seems like based on these investments and your view of the business, why couldn't you get back to say 10% margins at some point in the future?

That's clearly the goal, I mean, it's a business, it's had those kind of margins for a long time.

What the business is responding to here are some fairly innovative technology-based newcomers into the marketplace that are coming in at lower price points and trying to get a foothold on PMSI's large large space, frankly.

They really are the largest player in this industry by multiples.

We do have a new team there.

We have a new President, we have a new CFO.

We have a brand new sales and marketing team, all with experience primarily on the payer side of the marketplace.

Which is as we talked about in the past is the client base for PMSI.

It's a young energetic innovative group of individuals and they really seem to be getting their arms around the issues here.

They do have a competitive challenge here, and what we don't know is, we've got to do some repricing into the marketplace.

Where that repricing ultimately settles out, we would like to get back to 10%, it may be that this book of business survives and can be maintained and grown at a slightly lower EBIT margin than that, but it's still -- even if the EBIT margins given the working capital investment, It's still very very attractive in terms of returns and cashflows.

The gentleman we have running the business right now is Mark Holyfield.

Mark has been with us for a number of years and ran a number of the core operations of PMSI before we elevated him to the present role here about a year ago.

Very good.

Okay.

Our next question comes from the line of Glen Santangelo with Credit Suisse, please go ahead.

Dave, I also had a question on the specialty business.

You know, based on what you wrote in the press release, it sounds like you had a mix shift within that business this quarter that seemed like it created a drag on the margins of the overall distribution segment.

Could you just maybe elaborate a little bit on what you saw in that mix shift and maybe if you can in any way quantify how much that hit the margins this quarter, that would be helpful.

Okay.

Glen, this is Mike.

I'll take that.

I think what we said is the lower margin distribution businesses continued to grow faster than the higher margin services businesses.

That drives down the overall gross margin in that basis.

I don't think there's anything unusual there, that's the same dynamics that we had in the first quarter.

And, when we gave our guidance at the beginning of the year, we expected about 15 to 20% overall growth and we bumped that up to the mid-20s.

And that additional growth is coming from the distribution side which puts some pressure on those margins, but it continues to be a strong growing business for us and we're very happy with its performance.

It's fair to say that the distribution end of the specialty business will be growing faster than the services component for the remainder of the year?

I think that's correct.

The distribution we said is going to be -- we said it's going to be in the mid-20% for the year.

It will anniversary some new business that we had entered into in the last half of last fiscal year.

So by the end of the year, you should be back to approximately a market growth level.

Just to make sure there's no doubt that we really like this business, this is a business where the new -- new products are entering the market, great appetite for value added services, so this is really a good spot for us to be in.

Thank you.

Thanks.

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

Great.

Good morning.

Just wondering about two topics related to the margins, Mike.

First, a few major drugs, generics lost exclusivity during the period.

Can you talk about the relative impact of the loss of exclusivity on the business as we think about sequential changes in the margins?

And the branded price inflation you mentioned in your prepared remarks, not as much of a factor as it was a few years ago, but still meaningful.

How much seasonality do you expect at this point, a year into having most of your fee for service deals in place?

First, Tom, obviously there were no big new generic introductions during the quarter until the tail end of the quarter which didn't have any meaningful benefit in this March quarter, and certainly, we did have some big products that were in exclusivity during the first quarter, so our introduction of new products went down quarter over quarter on the generic side and just the opposite on a price increase side.

Where from a price increase perspective, as I said, March historically has been the biggest quarter for price increases and this quarter was no exception.

The volatility is a lot less today under our fee for service environment than it has been historically and I think if you go back and look two years ago, for example, you'll see that we had margin -- sequential margin expansion between the December and March quarters of nearly 50 basis points, we're talking closer to 20 basis points in the current December to March.

So I think that gives you some indication of the lessened volatility between the quarters is.

As we're thinking about the second half of the year versus the March quarter or the December quarter.

I guess how volatile are we thinking between quarters on the margins?

Well, I think I think our overall operating margin guidance gives you some flavor for that, where we said that, we're up 14 basis points for the first 6 months and we're going to be up in the high single digit basis point for the range.

So I think, if you do the math there the second half is obviously going to be below the first half and the biggest impact is from the price appreciations, the fee for service, or -- on the sequential basis, the price appreciation and some of the early generic introductions in the first half of the year.

Tom, I'm sorry, this may not address your question, but one of the things I want to make sure we don't get too focused on this generic product introductions is being a driver of profitability in generics.

It is an additive benefit.

But our generic business, our PROGen business is up 30% over year levels.

Part of that is brand to generic conversions.

We're driving significant market share gains in our existing accounts with improved compliance and we have new customer signups, so there's a lot that's behind the generic picture than just this conversion pipeline that we're watching these days.

The other thing we're careful, we don't want to keep piling on here.

Everybody focuses, there's a lot of attention when new products come in.

What sometimes misses attention is, you know, as the number of manufacturers perhaps abates over time, the products increase in price.

So people look at the introduction, but you've got to follow the lifecycle of the products, and one of the things that makes it attractive is you constantly have products coming in and products maturing in the life system mix, so it's very attractive to us over time.

Thanks.

Our next question will come from the line of Randall Stanicky from Goldman Sachs.

Just given the increased cash flow guidance, I'm going by back in some of the balance sheet flexibility with potential for increased leverage.

Just curious first as to why not increase the buyback and then what would be the triggers to re-evaluate your size of the intended buy back, particularly in the context of the expectations for smaller deals going-forward on the M & A side.

Talk about the buy back and Dave can jump in on the M & A, Randall, obviously, we continually revisit our stock buy back on a periodic basis and we'll continue to do that going-forward.

I think the $35 million was a relatively modest amount in the quarter, keep in mind that we had -- we were in the midst of an acquisition which limited the amount -- limited the time we could enter in the marketplace during the quarter, and I think again, keep in mind, how active we've been in the last year with just under $1 billion over the last 12 months bought back, and certainly over the last couple years, where we bought back over 20%, just around 20% of our shares.

So we are not -- we're not reluctant to buy back our shares, certainly we'll continue to measure buying back our own shares versus the opportunities we have to grow our business through acquisitions, and in this quarter, we focused on the acquisition side.

Yes, and Randy, I will just say on the M & A side, we're not opposed to doing a deal well in excess of $200 million dollars, but I will tell you, we're going to continue to be very very disciplined on the M & A front.

I will tell you with the private equity money out there, chasing deals, sometimes the amount of leverage that people are putting on deals drives the price way up, and we've been standing down.

But we continue to be very active in the M & A as we talked about, we have $400 million committed for this year after $300 million the year before that, so we're very very active in the space, but I will tell you the watch word for us is discipline.

Is there a certain cash comfort level on the balance sheet we should be thinking about?

Or is it more of a -- more of an opportunistic type of process?

I think the maintenance level of cash that we would have on our balance sheet at any one time that could not be invested would be in the $200 million range.

We have plenty --

Anything above that is available for investment.

Yes, there's plenty in that range, there's plenty of flexibility here.

Incredible amount of flexibility.

Thanks a lot.

Thanks.

Our next question will come from the line of David Veal with Morgan Stanley.

Please go ahead.

Thanks for taking my question, you've been aggressive in driving efficiency gains and operating leverage in the drug distribution business with stuff like PKMS.

I wonder if you can give us an update on how we should think about SG&A levels over the next couple quarters and over what time frame we may get to the 150 basis points you talked about.

I'll talk a little bit about the dynamics and Mike, we can think a little bit about how we want to handle any guidance you want to provide here.

Obviously, David, the investments that we started some years ago continue to bear fruit.

In fact, we still have a lot of opportunity ahead of us in putting engineered standards into our warehouses that really drive labor savings and there's still a large penetration opportunity for those kind of engineered standards in our traditional drug company facilities, so we're finding loads and loads of opportunity, these things are yielding returns ahead of our original specs when we committed the capital to the investments.

A number of our facilities today are operating well below the 150 basis point level.

There's 100 basis point level.

So that gives you some sense as these facilities gain scale and these technologies take hold that you can really drive very very efficient production environments.

And obviously mix and how our customers will change our mix over time because some are more expensive to serve than others, we'll have an impact on the overall level here, but I think the good news is, we continue to see significant opportunities ahead of us to continue to take costs out and become even more efficient.

So Mike, I don't know if you can pick it up from there?

No, I think we mentioned last quarter we expected operating expenses as a percentage of revenue and Pharmaceutical Distribution to be in the 180 basis point range, and we'll stick to that for the rest of the year.

As I mentioned last quarter, expenses were going to go up sequentially during the year due to compensation, due to some of the investments we talked about, and also, due to acquisitions, and, keep in mind even some minor acquisitions of service businesslike we made in the specialty group this year with IGG and our Canadian specialty acquisition.

You know, influenced that operating expense to revenue metric by roughly about 4 basis points this quarter.

Your point is well taken, David.

There's clearly operating leverage here and we'll continue to capitalize on it.

Your next question comes from the line of Lisa Gill with JPMorgan.

Good morning, and thanks for taking my question.

I was wondering if we could come back to the generics, I know you talked a lot about it here.

But when we look at the utilization trends by your customer, you were saying that those using your programs today have increased by 30%, but can you talk about what penetration rate you're at today and where it can go?

Secondly as we think about the new products that are coming to market, for example, like Norvest, can you talk about just the lifecycle of the generic, is it that much more profitable for you during the exclusivity period?

Maybe I'll take a swing at this and the other guys can chime in where I miss some pieces.

The penetration rate is something we spent a lot of time trying to understand.

I mean, we get down to very specific details with accounts.

And try to understand their patient patterns and what a particular store ought to be driving in terms of generic volume.

In many cases, as you know, we build compensation arrangements around them meeting certain thresholds in terms of generic utilization and their purchases from us, it's hard to give you a statistic that says, hey, we're -- we think we're at 80% and we think we still have another 15 points of opportunity ahead of us here.

We have not measured it quite like that, it's more on a store-by-store basis so I can't give you a rollup.

But we are finding ourselves more and more successful in increasing that penetration rate and just to clarify what I tried to say was the PROGen program has grown 30% in revenues year over year, which is a combination of a lot of things that are coming into this.

As we talk about new products, and a lifecycle of the new product.

Obviously, the best scenario for us is where we have an authorized generic that's introduced with a competitor.

Fewer manufacturers are better than more.

We tend to wind up with less price reduction on the generic and yet with traditional generic margins, so we wind up with a situation where we enjoy what would be considered maybe abnormal profitability for our 6-month period of time.

That's got to be measured against a market basket where we have other markets that come to market.

Where there isn't a perforce challenge, there's multiple manufacturers that come in and the price point is well down below the branded price, and often times what happens in that scenario, there's a quick shakeout of the manufacture entered on that product.

Often times they build product.

Hope to get a meaningful market position, they don't.

They let their product go in the marketplace.

Once that's worked its way through the system, we see the generic pricing on that particular item rise.

Just to Dave's point earlier, the portfolio here is what we find very very exciting.

But as a general rule, when there's fewer manufacturers on a particular product or because of a perforce challenge or because it's a hard to manufacture product that tends to be a pretty good situation for us.

Where we sit in the channel.

The other thing I would add on this whole issue of leakage, we talked about that before, and tracking that that's one of the attractions that we had to the Bellco sales acquisition or the part of Bellco drug we picked up.

They have some sophisticated programs where they track generic usage, and use their group to stop that leakage, we think it's going to have a very positive impact on our penetration rates with our current customers using their programs.

Thank you.

Thanks, Lisa.

Our next question comes from the line of Charles Boorady with Citigroup.

Please go ahead.

Good morning.

The revenue guidance for 9 to 11%.

What will take you to the higher end of that range?

Does that include acquisitions or is that an organic expectation?

It's organic expectations.

We don't have anything in there for closing of Bellco at this point.

In terms of any specific drivers that would have caused that acceleration from what you reported in your traditionally strongest quarter?

Well, I don't know that there's any -- specific new big customers built in or anything else.

I think it's going to be pretty steady as you go with drugs growing at market and specialty, as we said, will continue to be higher than market, though trending down toward market toward the end of the year as the anniversary, the two events we talked about that occurred in the last half of last fiscal year.

In some respects, Charles, you're a little bit of a slave to your customers, as your customers continue to do well, you do well.

So if we've got some -- our customers doing very very strong with the market growing, that will take us toward the top end of that range.

Got you.

On the anemia question, is it both J&J and Amgen's products that you're distributing?

I'm wondering how good the visibility is that you have on the end of market demand for these drugs in terms of how long the lag would be before you saw it if there were a slowdown or reduced consumption of these products and whether there could be inventory builds or other things going on that would mask slowdown in the consumption.

In terms of anemia products, yes, we look at multiple manufacturers when we track the products.

Not much inventory buildup out in the field in our opinion, these drugs are pretty much consumed as they're sent out.

Though we do not have insight into what's happening in the physician's office, but they're pretty much buying the product on demand so we don't think there's any inventory out there.

Any way to get a potential read on potential changes in demand because analysts following those manufacturers are predicting more than a slowdown, in some cases, they're predicting actual declines.

You're mentioning you're assuming it doesn't decline, but grows slow.

The answer is, we don't have any insight into that, Charles.

Is that material?

I know it's a small percent of the revenues, how material -- if it were to shrink instead of grow slower, is that enough to move the needle on your guidance?

I think it's pretty -- I think the way you can look at it, it's 7% of our business, if there's a 10% slowdown, it's still, you know, 0.7% or less than 1% of our total reps, which is within that 9 to 11% range.

So you'd have to have a pretty big decline before it would impact our guidance and growth rates.

A lot of people are not talking about slowdowns, they're talking about the growth rates slowing down.

So it's -- it's growing at a slower rate, so it's one of the beauties of a broad based product offering.

We're not totally dependent on any class of products.

It makes our business very attractive.

In view of the time, we'll take one more question.

Okay.

And that question will come from the line of Ricky Goldwasser with UBS.

Please go ahead.

Ricky, you're a strong close.

Thank you very much for taking my question.

Good morning.

A couple of questions, just really kind of to address generics again.

I know you talked obviously about the impact of the 180 day products and what happens when is you exit 180 days, and I think, Dave, you also talked about the fact in a margin distribution business were very strong due to price inflation and somewhat offset by a few products.

So can you just kind of quantify, is the negative impact from these products on drug distribution gross margin?

Was both sequentially and year-over-year, i.e., compared to the branded and compared to the 180 day exclusivity.

And then on the flip side, on the generics that you sell, do you also sell your own private label generics?

Maybe I'll take the latter one, Ricky and Mike will chip in on the first side.

We don't have a branded generic line today within AmeriSourceBergen that we have out in the marketplace.

It's under our trade name.

With one exception, we are building out a line of hospital units dose generic products that are branded under the American Health Packaging today that's a facility we have in Columbus.

I talk about the model transition, and we're finding that to be an attractive space.

We're generating good margins for ourselves on those types of products and we're being somewhat successful on getting market penetration on it.

It's a very specific application in a hospital type environment.

I want to make sure, absent that which is relatively small, when you look at the total generic offering, we do not have our own controlled label.

And is that something that you're looking to extend into in the future?

It really does not have much appeal to us right now.

That is the case in Europe, quite frankly, we've looked at the European models, at this point we don't think there's much to be gained from the labels.

It's important to note that a big difference in this country versus Europe is that the consumer does not see the label.

So a lot of the private label that the wholesalers have used in Europe is a function of the consumer getting the physical package.

And in this country, of course, the consumer gets the pills in a vial, so the label has very little impact, I think.

And just back to your -- the first part of your question, Ricky, just to clarify, generics were a great contributor if year-over-year as Kurt mentioned and our PROGen program and being a big contributor to our margin improvement year-over-year.

Sequentially in our first quarter versus or second quarter, there were not any large product introductions in the second quarter, the contribution from that piece of the generic business was less than it was in the first quarter.

But is it that the shift from the 180 -- in December quarter, you had profits, all these products had 180 day component that you talked about before whereas in the March quarter you don't have that so it -- does this change a negative impact on the basis points for these specific products?

And I know you don't usually talk about product by product.

But just an example.

We would have had less contribution from those products in the second quarter than we did in the first quarter.

And as well on a year-over-year.

Well, I think -- you know, outside of the exclusivity we expect these products to contribute again on a portfolio basis at least as much as they did last year, when they were part of our brand portfolio, and again, I don't want to get into every specific product, but that continues to be the case on a portfolio basis.

Okay.

Thanks, Ricky.

And thank you, to everybody, for joining in on this call today.

I'd now like to turn the call over to David Yost who would like to make some final remarks.

I would just like to thank everybody for joining us, at AmeriSourceBergen we continue to focus on the basics and in closing I'd call your attention to the three important metrics we tracked closely, which is revenue, operating margin and cash.

For the quarter, and the first six months, we delivered good revenue growth and expanding operating margin.

And we generated a strong cash and expect to continue that trend for the balance of the year.

Thank you very very much for your continued support.

Go ahead, Ryan.

Okay.

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