美源伯根 (ABC) 2008 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the AmerisourceBergen second fiscal 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).

And as a reminder today's call is being recorded.

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

Mike Kilpatric.

Please go ahead, sir.

Good morning, everybody.

And welcome to AmerisourceBergen's conference call covering fiscal 2008 second quarter results.

I'm Mike Kilpatric, Vice President of Corporate and Investor Relations, and joining me today are David Yost, AmerisourceBergen President and CEO, 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 2007.

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

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

And here is Dave Yost, AmerisourceBergen's CEO and President, to begin our remarks.

Good morning, and thank you for joining us.

Our pharmaceutical distribution segment delivered excellent results in our second fiscal quarter ending in March.

I will address separately our Other segment which contained our PharMerica Long-Term Care operation last year but not this year and our PMSI Workers Compensation business in both years.

But first the highlights in Pharmaceutical Distribution.

In the Pharmaceutical Distribution segment, total revenues were $17.8 billion, up 9% for the quarter.

Bulk revenues decreased significantly to $552 million as some of that revenue was captured in operating revenue making total revenues a more relevant number.

And as Mike will detail, we are now making total revenue our revenue guidance and analysis metric.

This was our largest operating and total revenue quarter in our history.

Our operating margin on total revenue in the Rx distribution segment expanded a very strong 9 basis points to 134 basis points to revenue, reflecting a gross margin expansion due to a robust manufacturer pricing and generic environment, and decreases in our operating expenses as a percent of revenue.

Net of our Bellco acquisition, we spent less absolute expense dollars running our core drug company this quarter versus last year with a strong revenue increase.

Consolidated diluted EPS was up 21%.

Excluding the impact of PharMerica Long-Term Care the previous year, the EPS was up 26%.

We generated $192 million of cash for the quarter, with good asset management by driving our inventory and receivables days down.

We delivered strong return on committed capital and return on invested capital.

All in all, excellent performance.

At AmerisourceBergen we continue to focus on the basics -- increasing revenues, controlling costs, managing our inventory and receivables.

You will recall that in January we announced our intention to pursue a sale of PMSI, our worker's compensation business, and speculated that if the sale process were to produce an acceptable price PMSI would be listed as discontinued operations beginning in the March quarter.

After reviewing final bids from interested parties, we have decided to discontinue the sale process of PMSI since the final bids did not reflect our valuation of PMSI's potential.

Although we had significant interest, and strong first and second round bids, we saw final bids decrease significantly following the collapse of Bear Stearns and further tightening of credit markets.

We continue to think that PMSI can be a strong contributor to ABC, and we will devote our efforts to achieving that end.

The disappointing financial results of PMSI this quarter reflects in part the distraction of the sale process, and we look to PMSI to be on track in the September quarter and into FY '09.

As I mentioned last quarter, PMSI has an outstanding management team and a dedicated team of about 800 associates that has historically delivered fine results in the face of changing markets and increased competition and we expect to return to that tradition.

It is important to keep PMSI's contribution to our earnings in perspective.

When PMSI was hitting on all cylinders, they accounted for 5% of our earnings, and today PMSI is in the 2% range.

The total performance of the Other segment is complicated by the fact that last year's numbers for the quarter included the contribution of PharMerica Long-Term Care operation, which was spun on a tax-free basis to ABC shareholders in July, and immediately combined with Kindred's long-term care assets and then take it public.

The PharMerica operating results are not allowed to be classified as discontinued operations due to our long-term pharmaceutical supply contract with the new company.

Now, turning to some industry issues.

First, market growth.

IMS reported last month their assessment that the market grew in the 4% range for calendar year 2007, and have forecast total market growth in the 3% to 6% per year range for the next three calendar years with calendar '08 in the 2% to 3% range.

Since the slower-than-historic growth is strongly influenced by the impact of generics and because we have a strong market share in the fast-growing Specialty business, we continue to be confident in our ability to deliver strong financial performance in the forecasted market environment.

Regarding the California pedigree.

The California Board of Pharmacy has voted to delay the implementation of a required pedigree on all products to July 1, 2011.

Though AmerisourceBergen would have been prepared to implement the regulations as proposed, we are delighted about the delay so the issue can be addressed on a national level, and a more costly patchwork of unique state regulations can be avoided.

This week, national legislation was introduced in Congress which provides a planned national approach to the pedigree issue.

Regarding AMP, or average manufacturer price.

Due to the lawsuit filed by NCPA and NACDS highlighting the flaws to the calculation of AMP as currently proposed, the implementation of AMP has been delayed.

The court case will probably not be resolved until late this calendar year, at the earliest.

There is also a legislative effort in process to correct the deficiencies but my guess is that will also stretch into our next fiscal year.

ABC, as well as others in the industry, have been actively involved in this issue, but essentially there is nothing new to report.

Regarding the manufacturer pricing environment.

We are not seeing anything anywhere, including Washington, to lead us to believe that the brand manufactured pricing will be any different this year from recent history.

We expect brand manufacturers to increase prices in the 5% range for the entire year.

The price increases continued to be strongest in our March quarter, and that was true again this year, with our March quarter price increases slightly ahead of the pace we experienced last year.

Of course, fee-for-service with brand name manufacturers mitigates the impact of price increases as we have noted on previous occasion.

Regarding the customer pricing environment.

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

There are not a lot of single customer multi-billion dollar wholesale opportunities in the market, which itself speaks to market stability in a total market approaching $300 billion in size.

Individual skirmishes tend to be somewhat anecdotal but we are not seeing any broad-based irrational pricing in the market.

While on the topic of revenues, it is important to address our anemia business, the erythropoietin stimulating agents, or ESAs, and the impact these products are having on AmerisourceBergen, particularly our Specialty Group.

Sales of ESAs in oncology were down 45% in the March quarter versus the previous year and accounted for 2% of total revenue.

March quarter oncology ESA sales were down about 7% from the December quarter.

You will recall that it was in March 2007 the FDA issued their black box warning on ESAs.

We previously expected oncology ESA revenues to stabilize in our June quarter.

We now think we could experience added pressure from ESAs for the balance of the year.

Again, it is important to note that oncology ESAs are 2% of total revenues.

Revenues this quarter in our Specialty Group were also affected by the $800 million of annual OTN revenues lost in November of this fiscal year due to its purchase by a competitor.

Though ABSG, our Specialty Group, is clearly weathering some head winds, it is important to recall the very strong historic performance delivered by this unit and the key strategic space this unit holds.

With our $12 billion of revenues, we are the largest distributor by far of Specialty Rx Products and Services to the specialty physician market, exactly the territory where new and innovative products will undoubtedly enter the market.

Finally, discussing revenues, I am going to address generics.

As we have noted frequently, generics provide us great opportunity to provide value, both up and down the supply channel.

For the manufacturers, we aggregate demand across our customer base and provide daily delivery to our geographically diverse customer base within our prime vendor distribution model.

For our customers, we searched the market for the best generic value, including price, quality of product, reliability of supply, and continuity of color, shape and size of pill.

Our generic business continues to grow faster than the market.

We continue to increase generic penetration among existing customers, as well as add new customers, as our progenerics is one of our programs that differentiates ABC from our competitors.

Generics as a percent of revenue dollars are in the low double-digits to our retail business and growing nicely.

To the extent that the total pharmaceutical distribution market growth rate has been impacted by total generic penetration reflects opportunity for distributors like AmerisourceBergen and particularly AmerisourceBergen with our strong customer base of independents, regional chains, food/drug combos, and clinics that rely upon us for their generics decisions.

I recently met with the advisory board of our Good Neighbor Pharmacies who continue to be very optimistic about their businesses and the role they will continue to play in health care.

GNP now numbers about 2,900 stores and we look to be at our '08 goal of 3,000 stores by our fiscal year end.

Our Good Neighbor preferred provider network has over 5,000 stores.

On the M&A front we were actively engaged in the bidding process of the regional wholesaler that was recently purchased by a competitor.

The continued interest of our peers in this space continues to validate our strategy.

Our October $162 million acquisition of Bellco Drug, our largest acquisition ever, continues to meet or exceed our expectations on all key metrics.

We will continue to invest in the future and our ability to meet the future needs of our customers.

This includes a business transformation program, a part of which is a new ERP system for the drug company and the corporate office, and an expense plus capitalized cost to be spread over the next three to five years, which is included in our CapEx guidance.

We continue to be on schedule and on budget on this program, and have our systems integrator on board.

Mike will make some additional -- will provide some additional color on our narrowed EPS guidance.

But I would like to emphasize that our revised guidance continues within the original range and reflects a narrowing of the range at the top end reflecting, primarily, reduced PMSI expectations, as well as slower market growth and continued pressure on anemia product sales in oncology.

Within the second half, we expect the September quarter to be stronger than the June quarter.

Before I turn the floor over to Mike, I want to emphasize my enthusiasm for our industry, and the role that ABC plays in it.

The fundamentals of our industry continue to be very, very strong.

Our FY '08 features a streamlined organizational structure, the largest acquisition in our history, and the right segments to capitalize on generic opportunities and new specialty products entering the market.

We continue to execute on the basics of revenue generation, cost control, and asset management, while continuing to provide outstanding service and programs to our customers, key differentiators for AmerisourceBergen.

We look forward to continuing our history of strong operational and financial performance.

And here is Mike for some added color.

Thanks, Dave, and good morning, everyone.

We are very pleased with our excellent second quarter and first half of fiscal 2008 results, as our pharmaceutical distribution performance was strong again -- strong once again in every financial category.

We have a number of items to discuss today that impact our consolidated results and forecasts including PMSI, our switch from operating to total revenue guidance, our modifications to our fiscal 2008 guidance, and the inclusion of our former LTC business results in our prior year numbers, all of which I will detail.

First, I would like to remind everyone that our March or second fiscal quarter has traditionally been our strongest quarter from an earnings and margin perspective due to the relatively higher number of brand name manufacturer price increases during the March quarter.

And this year was no exception.

Certainly, our fee-for-service agreements have somewhat mitigated the variability of the quarterly contribution from price increases.

However, the 20% or so of our brand name business that is still subject to the timing of manufacturer price increases continues to benefit the March quarter more than any other.

Now, moving to revenue classification.

Historically, on our income statement, we have provided breakouts for both operating revenue in bulk deliveries to customer warehouses.

Our margin analysis has focused on operating revenues, as bulk deliveries' gross profit and expense were both negligible as the majority of this revenue represented direct shipments from the manufacturer to our customer -- customers' warehouses.

As a result of our contract extension and expansion with our largest customer earlier this year, we began in the March quarter to transition a significant amount of business previously conducted on a bulk delivery or direct basis to being serviced out of our distribution centers on an operating revenue basis.

Over $700 million, or 5% of our 13% operating revenue growth this quarter and the significant decline in bulk delivery revenue, resulted from this transition.

Our ongoing bulk delivery business is expected to be in the $1.8 billion range annually.

And because of its insignificance to our total revenue, we will begin to discuss our operating ratios and give revenue and margin guidance on a total revenue basis only.

As a result, our annual revenue guidance is now a range of 7% to 9% total revenue growth, rather than the 7% to 9% range of operating revenue growth, and our operating margin expansion guidance in the low single-digit basis point range still holds, only it is on a total revenue base measure.

Now, moving to our consolidated results.

Total revenue increased 8% to $17.8 billion, driven by 9% growth in Pharmaceutical Distribution, which included a 3% boost from the Bellco acquisition.

Consolidated operating income was up 7% as Pharmaceutical Distribution EBIT grew a robust 16% and more than offset the $15 million EBIT decline in our Other segment.

$7 million of the Other segment decline relates to our former PharMerica Long-Term Care business which is once again included in our prior year numbers, causing an apples to oranges comparison to fiscal '08.

Special items were negligible in both the current and prior year March quarters.

Net interest expense of just under $19 million in the quarter was up 89% over the prior year, as expected, due to reductions in interest income as average cash balances were significantly less than last year at this time due to our share repurchase activity.

Our effective tax rate for the quarter was 38.9%, up from last year as expected, reflecting less tax-free investment income.

We continue to expect the effective tax rate to be slightly north of 38% for the full year.

Diluted EPS in the quarter of $0.82 was up $0.14, or 21% compared to the prior year quarter, and excluding PharMerica Long-Term Care's $0.03 contribution in the prior year, was up $0.17 or 26%.

This increase was driven by the 16% increase in Pharmaceutical Distribution operating income, and the significant reduction in average outstanding shares net of the impact of the increase in interest expense.

Average diluted shares outstanding were 163.3 million, down nearly 29 million shares, or 15%, from the prior year, reflecting our share repurchase activity over the last 12 months.

Now, moving to the Pharmaceutical Distribution segment where our performance in the quarter was outstanding.

Total revenue was up 9% driven by the Drug Company which increased 8% and Bellco which contributed 3% of the top line growth.

The Specialty Group was essentially flat, up less than 1%, as expected, due to the anemia drug situation and the OTN acquisition earlier this fiscal year.

Anemia drugs used in oncology represented 2% of total revenues in the quarter and were down 45% from the prior year quarter.

The Drug Company growth was driven by our institutional customers including significant growth from our largest PBM customer where we have expanded our relationship during the current year.

Retail customer revenue was flat compared to last year's quarter.

Our packaging group, while very small in relation to our overall segment results, continues to perform well, led by Anderson Packaging, which opened its newly-expanded production facility in March and now has the single largest pharmaceutical packaging facility in the United States.

Gross profit increased 10% during the quarter, and gross profit margins expanded by 5 basis points driven by strong brand name drug price appreciation and increased generic drug contributions.

As we noted last quarter, a large brand-name manufacturer, which raised prices in December, 2006, and did not raise prices in the December, 2007 quarter, was expected to raise prices during the March quarter.

And that did happen, contributing to our strong results.

Generic results benefited from increased customer compliance as well as a couple of new introductions during the quarter.

We had a LIFO charge of $9.6 million in the quarter, compared to $1.6 million last year, reflecting the strong brand name price increases during the March quarter.

We currently expect a charge in the $15 million range for the year.

Operating expenses as a percentage of total revenue were 169 basis points, down 4 basis points from the prior year, reflecting strong leverage in the Drug Company as virtually all of the dollar increase in our expenses resulted from our acquisitions, primarily Bellco.

Operating income was up 16%, with operating margins expanding in the quarter to 134 basis points, up 9 basis points versus the prior year.

After six months, segment operating income is up 8%, with margins expanding by 2 basis points.

Now, turning to our Other segment, formally known as PharMerica.

Again, the current year results include only PMSI, and the prior year includes both PMSI and long-term care.

As I previously mentioned, long-term care contributed just under $7 million of operating income to the segment's operating earnings in the prior year's second fiscal quarter.

As Dave mentioned earlier, we have terminated our sale process with PMSI and are focused on more closely aligning them with ABC and continuing to make progress with their turn-around plan that we have spoken about the last couple of quarters.

Unfortunately, our progress as reflected in the financials has been slower than we expected, which is reflected in this quarter's numbers, where revenues have declined by 8% to $105 million, and operating profit declined by $7.8 million to $800,000.

This reduction resulted from both declines in gross profit due to competition and reductions in reimbursement, as well as increases in expenses where we continue development on our customer-facing IT initiatives.

While we expect some improvement in the second half of this year, and substantial improvements in fiscal '09, it is likely that PMSI operating margins for fiscal 2008 will be in the 2% to 3% range, down from the 5% margins previously expected for the full year.

Now, let's turn to our consolidated cash flows in the balance sheet.

We generated cash from operations of $193 million for the March quarter, and $92 million for the first six months of fiscal 2008.

We continue to expect our cash generation to be back-ended for the year, and have maintained our free cash flow estimate of $450 million to $525 million.

We had capital expenditures of $28 million during the quarter, and $55 million for the six months on pace with our annual $125 million guidance.

We continue to have a strong focus on asset management and our success in this area is reflected in our working capital statistics as inventory days on hand during the quarter were 25 days, down nearly 3 days compared to March of '07, and DSOs were down 1 day to 19 days and DPOs were flat year-to-year.

From a share repurchase perspective, we bought $84 million of our shares during the March quarter, and have now bought back $395 million of our shares in the first six months of fiscal 2008.

We have $302 million remaining under our share repurchase program.

And based on our first half activity and expected cash flow in the second half of fiscal 2008, it is likely that we will use a substantial amount of the remaining $302 million authorization in the second half of the fiscal year and exceed our 2008 share repurchase target of $400 million to $500 million.

One final note on our capital structure, our debt to total capital ratio at the end of March was 29%, just under our target range of 30% to 35%.

Now, moving to our fiscal 2008 guidance, our revised annual diluted EPS guidance is $2.77 to $2.87 for the year; within our original range and reflects a narrowing of the range by lowering the top end.

This top end reduction primarily reflects reduced PMSI expectations, declines in anemia drug revenues below our original expectations, and slowing market growth.

Said another way, with our GAAP diluted EPS of $1.48 for the first six months, we would expect diluted EPS in the range of $1.29 to $1.39 over the second half of our fiscal year, with the September quarter expected to be higher than the June quarter due to the anticipated timing of certain manufacturer price increases.

This updated EPS guidance reflects our total revenue guidance of 7% to 9%, and Pharmaceutical Distribution segment operating margin expansion in the low single-digit basis point range.

Our increased share repurchase assumptions should result in even fewer average outstanding shares than previously expected for the year, now down 12% to 13%, the benefit of which will be offset in part by higher net interest expense.

Now, let me take a minute to express some high level thoughts about fiscal '09 in light of the recent reduction in market revenue growth estimates by IMS.

Keep in mind that we have not yet started our detailed bottom-up planning process for fiscal '09, which we will commence shortly.

Our long-term EPS growth target of 15% reflects market revenue growth, margin expansion in the single-digit basis point range annually, and free cash flow approximating net income.

As we have said to many of you in the past, we are very comfortable with this target when market revenue growth is in the mid to high single-digits.

To the extent market growth is below this range, in the low single-digits, it becomes more difficult to meet the mid-teens EPS target.

Although if the lower market revenue growth is due primarily to brand to generic conversions, we can certainly offset some of the slower revenue growth with increased margin expansion.

As it pertains to fiscal 2009, if IMS's near-term revenue growth guidance of 2% to 3% proves to be accurate, we can certainly see a clear pathway to low double-digit EPS growth in fiscal '09.

However, mid-teens EPS growth would be more challenging.

As usual, we will give detailed guidance for fiscal '09 when we release our fiscal '08 earnings in the fall of this year.

So to summarize, a great quarter, excellent six-month results, and a fiscal year that remains in our original guidance range despite a couple of hurdles.

And now, I will 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 with a follow-up.

And if there is time, you can ask additional questions after others have had a chance.

Go ahead, Tony.

(OPERATOR INSTRUCTIONS) We will take our first question from Lisa Gill with JPMorgan.

Please go ahead.

Thanks very much, and good morning.

Just looking at the change in the relationship with your largest clients, moving from bulk over to operating, Dave, I think you said it added roughly $700 million to operating sales in the quarter.

So if we think about this going forward, are are you really lowering your growth rate from just a pure operating to operating standpoint to more like the call it 2 to 4% range?

Or am I looking at that incorrectly?

And secondly, can you just give us some color as to why it is that you moved from a bulk relationship to operating?

Are you providing additional services for that client?

Or is there some other reason?

Let me take the second part first, Lisa, and then Mike can chime in on the first one.

The really big -- the really additional service that we provide, when we move revenues, from bulk to operating, is daily delivery.

When you think of bulk, bulk are distribution, and bulk revenues, what they are, is think of it as pallets of merchandise and bulk merchandise that never go into inventory and that go to the customer in one big fell swoop.

When we move to operating revenues, that inventory is -- the inventory is coming out of our warehouses on a daily basis, so the customer can replace his inventory and have his demands on a daily basis.

So the added value that we're providing the customer when we move from bulk to operating revenue is that he is growing on our inventory, and the full breadth of inventory on a daily basis, and really allows, the customer, any customer, to link up his production, his filling of prescriptions, without having to maintain as big of an inventory, without having the size of the inventory, which can be substantial, very large customers and kind of where you put it, but also having to deal with the inventory turns.

So it is a value-added service.

And it relates to getting that inventory on a daily basis.

And so Dave, are you getting paid for that value-added service so if previously it went from bulk to operating, should we assume that the margins will also be slightly different than what it was previously?

Right, its value add to the customers and value add to us and we expect to get coverage sated and do get compensated for the value that we bring to our customers.

And Mike, any thoughts on how we should be thinking about the gross rate, the underlying growth rate, if you X-out what is happening here here in the shift from bulk to operating?

Lisa, We started with operating revenue guidance of 7 to 9 and you can see the operating revenue was up 13% for the quarter.

And you know, X the 5% contribution from the shift, we would have continued to be in the 7 to 9% range.

So I think the way to look at this is we simply have had a shift.

The operating revenue is going to be above the 7 to 9%.

But on a total revenue basis, with bulk coming down, in total, we are going to be at 7 to 9.

There has been no reduction of the operating revenue guidance.

Okay.

And then --

It is actually higher.

Okay.

Great.

And then just one follow-up question to that, as we think about on what IMS is talking about, and they're talking about 2 to 3% and perhaps a lot of that is coming from generics, can you just remind us all what the correlation has been to ABC versus what IMS has said in the past?

Well, traditionally, we have grown faster than the IMS numbers, Lisa.

And that is a function of a couple of things.

The biggest single thing is we're very strong in the specialty group, and you will recall the specialty group has grown like two X the market, our specialty group right now has a couple of head winds.

One of them is the loss of OTN, which is purchased by one of our competitors, in November, that was an $800 million account, and they have some head winds on the anemia products sales to oncology which is about 2% of our total revenues.

But absent that, they are growing in double-digits and doing well.

So that helps us grow faster than the market.

That's one thing.

And secondly, we have had some institutional customers that -- and other customers who have grown faster than the market.

So traditionally, we've outperformed the market in the last several years.

Great.

Thanks very much.

And allowing me to squeeze in that extra one.

The next question in the queue will be from Robert Willoughby with Bank of America securities.

Please go ahead.

Actually a couple of related issues.

If the pharma industry Dave is growing at the levels you suggest are possible next year would there any real need for incremental working capital for you or can we model some flat to down assumption.

And then if you look at reduced capital needs or certainly capital needs not growing, you've been a leader with boosting the dividends here, over the past couple of years, but the yields are still ridiculously low, given the capital requirements of your business now.

So when do we see kind of a more meaningful shareholder bid put in place?

First of all, I want to make sure that we're not confirming the IMS numbers.

What we're trying to do is just trying to postulate if the market were to grow, in that range, that we would -- how we would be able to postulate our own growth.

In terms of our dividend, Bob, what we have traditionally done is we have traditionally reviewed that on an annual basis, at our year-end board of directors meeting in November, and we've done that the last several years, and I would expect that to be a normal agenda item for that November meeting.

You can talk about working capital.

Robert, as far as working capital, we continue to expect very good performance and I think you're right, if revenue growth is light, that is less incremental new working capital and we continue to do very well in managing our inventories, and managing our receivables and we expect strong cash flows, as we go forward, and that is an important piece of the model in -- regardless of the revenue growth environment, and we will provide a kicker to help drive our bottom line EPS faster than that top line.

So absolutely, we expect it to be a continuing contributor.

And to that point though, I would think that isn't the market currently dramatically different?

It is is a new business model and the Fee-for-Service world, that takes a great deal less capital and have you visibility there on.

Why is the traditional annual check on the dividend normal?

Why is this not semi-annual?

I mean isn't there an opportunity to do that much more, as I don't think you're getting credit for the share repurchases?

Well, that is a fair call, Bob.

Traditionally, we've done it annually, and we could review it more than that, but traditionally, we've done it on an annual basis and I probably would not see our board doing it more than that.

The important call out though I think you've made is an excellent one and that is the efficiency of the whole working capital model and I will tell you, when you look at -- when you look at the working capital's percent of revenues, and how it has come down the last few years, it is -- it is extraordinary without question.

And you know, currently we're using that money of course to buy a lot of shares back.

Good call out.

Thanks.

Thank you.

Our next question in the queue will come from the line of Larry Marsh with Lehman Brothers.

Please go ahead.

Thanks.

And good morning.

Thanks for updating us on the industry and a good drug update.

I guess Dave, my question really is to sort of drill down this PMSI process, which I think is just a very disappointing outcome to say the least -- my question is, you're calling out a turn-around that you're going to drive yourself, so in any organization, when you're subjected to being up for sale and losing customers, it is just challenging environment, and obviously, that is reflected in gross margin, down what, 20-some percent on a gross margin basis in the quarter.

So as you sort of think about looking out for the next two years, what gives you any real confidence that Mark and his team has been there for several years, is going to be able to drive this turn-around?

And I know you talked about the analyst day, Mike, the 70 to 9%, kind of the sustainable margin in this business, and yet, we're below 1% here, and losing customers.

Where do we see the improvement besides this idea that technology is going to get us there and what gives you confidence and the board confidence that Mark is the guy who is going to do it for you?

Look, Larry, thanks.

I mean they're all good questions.

And I think you're completely correct, it is is a challenging environment, for the team, the one -- the one caveat I would give you is we would be -- or PMSI would be in a turn-around situation regardless of ownership.

Part of the appeal to others in the sale process was going to be this turn-around plan as well.

So it is something we've got to go through and that business has to go through regardless.

I think we've got a very strong management in place, as we have said in the past, this is a management team that took over kind of late in 2006, with some downward pressure on the business, and I think some of the customer losses that started the downturn were already in place, before this team took over, and Mark and -- Mark Hollyfield our President and Mark Augustine, our Chief Financial Officer for that business unit have put together a pretty strong turn-around plan which included building out an IT infrastructure as we separated from PharMerica, and making the customer experience more interactive and easier.

And certainly they have made great progress in building that infrastructure, certainly the sales process was a distraction, and probably delayed some of the benefits, but I think it is a team that is very focused on pushing forward, making sure we're focusing on the right product lines within that business, and part of this whole turn-around will be more closely integrating this business with ABC, and getting some benefit from things like shared services, and integration with some of our other business units, particularly with the Pharmacy Services business, which is very closely aligned with ABC.

Larry, I would chime on here a little bit and just say one of my clear tasks clearly as CEO is to make sure I have the right leadership in all of the right pots at AmeriSourceBergen.

That is one of the things I get charged with the board and get paid for.

And I will tell you, I think we've got it.

I think we're got it at PMSI.

And you pointed out it is a pretty challenging environment to go through a merger or sale process, and I can tell you, we know that as well as anybody.

It wasn't that long ago that we were going through a merger process, and I had been through it three times in my career, and I will tell you that team has weathered the storm quite well, the distraction quite well.

And had held on to most of their key customers, and I think they're in good shape.

And look, we will be plotting the progress and we will be reporting it to you, and you will be seeing how that progress progresses over the next several months.

But I would say with the clear focus now on the turn-around, and the clear focus now on what they're about, I would be very disappointed if we don't see some big changes there.

Okay.

Great.

And just I wanted -- one quick clarification, for Mr.

Michael DiCandilo, you call out the oncology volume in your specialty business being down 45%.

Are you saying with your oncology -- excuse me, your anemia volume, was ex-oncology in your business?

Yes, we -- the numbers we reflected in our prepared comments, Larry, was the anemia drugs for oncology uses were 2% of total revenues, down 45%.

In total, anemia drugs are a little bit over 5% of our total revenues, with the other 3 1/2% or so concentrated on the dialysis business which has not been affected to the -- nearly to the extent and pretty much not at all, compared to the anemia uses for oncology.

We thought that if we focused on the oncology issue, Larry, that's kind of where the controversy is.

The institutional use has not been dramatically affected.

Okay.

Great.

Thank you.

You bet.

Thank you.

Our next question will come from Charles Boorady with Citigroup.

Please go ahead.

Thanks.

Good morning.

The first question of reclassification of bulk from the large customer, are there any other accounting or financial implications of that move, for example with accounting for inventories or anything else like that?

There is no financial or accounting implications, Charles.

I mean simply we're working off a different measure.

And one way I think could be helpful for people to keep in perspective, we've talked about the pharmaceutical distribution operating margin expansion being in the low single-digit basis points, previously, when you were looking at operating revenues, for fiscal '07, that operating margin was in the 120 basis points -- it was 120 basis points.

If you computed that off of total revenues, it would be 112 basis points.

So I think when people look at last year to this year, and they should be looking at the 112 basis points as the base measure from which we expect to have single-digit basis points margin expansion.

Great.

And now, the follow-on, appreciate your responses to the questions on uses of capital, generating a lot of cash, which is great.

In one of your competitors has been more aggressive, if that's the right way to describe it, at acquiring -- including independents, which as you mentioned is good validation of your business mix, and your model.

And also of OTN, which is good validation of your specialty strategy.

But I wonder whether those are acquisitions that you contemplated and whether you think your decision to buy your own stock back, seeing it, as being undervalued, was an appropriate thing to prioritize over making acquisitions that could have been strategically beneficial?

Especially in light of the expected slowing of organic top line.

Good question, Charles.

I mean the first thing I would point out is we made the biggest acquisition we ever made in our history this fiscal year, just about seven months ago when we bought Bellco and Bellco was a traditional wholesaler and had the added benefit of having a large dialysis business, and a generic telemarketing business that we liked very much but it was a traditional wholesaler, very strong in the New York market, which is very strong independent market.

So the answer to your question is yes, we actively are involved in the process.

We looked at Mccleary that was simply -- that was bought by one of our competitors, and announced within the last 30 days, we had a bid, we were very much involved in the process, and our bid was not the high bid.

We looked at OTN, actively involved in the OTN process, a business we know very well, with our large specialty business, had some great operating synergies, and again, we were outbid.

So I think the answer to your question Charles, is we're very much involved in the process.

We will continue to be very disciplined in our use of capital.

And we will compare that to buying our own stock back.

I sometimes laugh when I'm talking about in eternally, I say the nice thing about buying our stock back, we knows the guys who run it, we know our business very, very well, we are are not taking any chances.

But we will continue to be involved in the process.

We look at a lot of opportunities.

We've got a very active business development program.

And we will continue to be engaged.

All right.

Thanks.

You bet.

Thank you.

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

Please go ahead.

Good morning.

Just wanted to ask about two things.

First, you mentioned generics a few different times in the remarks here.

And penetration into the client base being up.

So I was wondering on the topic of generics, one, how are you going about and succeeding in terms of getting that penetration up in existing customers?

What types of things can you do there?

And are you seeing any different ability to profit on generics?

And then the second question would be on the anemia-related drug category.

You lowered the expectations a bit, and what have you factored in there for incremental degradation from private pay, payers, changing their guidelines, or is that mostly just based on sort of what you're seeing stemming from the Medicare changes?

Well, Tom, let me start off with the generic penetration.

I mean we're doing several things.

First of all, we're doing a lot better job of monitoring it now with our customers, we provided them additional incentives, so that we are getting the total market basket of their purchases, and not having us supply the health and beauty and over-the-counter product and missing the generics.

We've got a telemarketing operation now which I would picked up from Bellco about seven months ago, and we're continuing to emphasize with our sales force.

And Mike and I ended our day yesterday with talking -- addressing a group of about 150 sales people on the West Coast and generic was a key issue for us.

So I think it is a function of focus, Tom.

It is a function of proper incentive.

And it is a function of new programs.

And you put all of those together, and we will get some great traction.

And in addition, it is a lot higher profile with our customers than it was two or three years ago.

And I think the customers are realizing that kind of cherry picking other people's programs probably doesn't make a whole hell of a lot of sense an we're better off dealing with a prime vendor model which has made them so successful in the past.

So it will continue to be a focus for us, Tom, and a big differentiator.

Tom, as far as anemia drugs, again, I will reiterate, this is the baseline, 2% of our business today, from today's baseline, obviously ODAC has -- the panel has come down with certain recommendations to restrict further usage, and the estimates that I've seen in the marketplace have been from a 20 to 40% further reduction in anemia drug use for oncology, and our expectations are in that range for further decline.

And then just the profitability or the ability to make money on generics, has that changed at all in the last year?

Not at all.

We've done very, very well.

We've done well, Tom.

And part of the reason is, the customer base that we service on generics is really hard to reach without a distributor like AmeriSourceBergen.

It is geographically adverse.

It is the independents and the regional chains and clinics and the like.

So we got a good spot in the distribution channel for that.

And I will tell you, I think generics will continue to be a differentiator for us and enhance our profits as we go forward.

Great.

Thanks.

You bet.

Thank you.

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

Please go ahead.

Just sticking on the generics topic, just two related questions.

First, there has also been some news around [risperdal] with (inaudible) Teva the exclusively and obviously the FDA subsequent appeal.

Can you just clarify whether your guidance assumes that exclusivity or are you factoring a competitive launch from that product?

Yes, I mean we're expecting Teva to continue with exclusively in the quarter and we will remind everyone no one single drug will make that big of a difference to a single quarter.

Certainly, as we've said in the past, our sweet spot for generics is during the six-month exclusivity period and typically where there is more than -- where there is two people battling it out for market share.

And that's our sweet spot.

But again, it is one element in a lot -- with a lot of moving parts, in a quarter, and it is not going to make or break us.

Sure.

And actually, on that topic, I mean one of those battling it out spots certainly is protonics where it is right now a three generic markets and you guys are sitting in a pretty good position to see what is a pretty unclear market outlook for that product.

Do you have any color, visibility, or expectations as you look at the rest of the year for that market in terms of what you're seeing on ott generic side?

We really don't.

We got to be a little careful about talking about specific products, but I will tell you, when you've got three suppliers, multiple suppliers like that, it works out very well for us.

And you know, that was a nice sweetener for the March quarter.

We look for [risperdal] to be a nice sweetener for us in the fourth quarter.

So it is one of those things that makes this business very, very attractive, is you're not betting on a specific product and you're not betting on a specific manufacturer.

You're really kind of a winner no matter how it comes out.

And with our diverse customer mix, it makes it very, very attractive.

Okay.

Great.

Thanks, guys.

You bet.

Thank you.

Our next question will come from the line of Ricky Goldwasser with UBS.

Please go ahead.

Thanks for taking the question.

A couple of follow-ups, first to clarify on Randall's question on [risperdal].

Does your guidance it comes to market or does your probability -- whether is some uncertainty whether the FDA will win the appeal?

And then secondly, as far as fiscal year '08 guidance, firstly, if you can quantify, what is the percentage of the $0.08 that you -- the adjustment that you made to the upper end of the guidance range, what is the impact of PMSI and oncology versus market growth?

And when when you talk about pricing, 5% for the entire year, is this 5% for calendar year '08 or fiscal year '08?

Ricky, this is Mike.

I will try to answer all of those questions.

If I missed something, I'm sure Dave will jump in here.

First with [risperdal], our expectation is that it is going to come -- it is going to come to market in the fourth quarter and as I said, it is one product and it is fot going to make or practice from our perspective our fourth quarter.

I think the second question was with the lowering of the top end of our range, by $0.08, what was the relative contribution of the three factors, that we mentioned, I would say that PMSI was more than half of that, probably in the 4 to $0.05 range, with probably 2 to $0.03 market street and 1 to $0.02 from the reduced anemia drug expectations.

And I think your final question was 5%.

Our 5% price appreciation, was that for the calendar year or the fiscal year, and that is a fiscal year expectation.

And just following up on that, if we see the same trend that we saw back in '04 where we're in an election year during the September quarter and manufacturers didn't take not just the increases but rather pushed it to November post the election, then we might see some pushover from fiscal year-- from September quarter to December in terms of EPS impact?

And we got to keep in mind this election back from 2008 two 2004, and back in 2004, we did not have Fee-for-Service in place.

And Fee-for-Service mitigates largely the impact of price increases, except for those couple of customers in significant supplier customers that we have, that still have variability in our inventory management agreements.

And so we would be much more concerned about whether one of those particular manufacturers had a price increase, or didn't have a price increase, rather than the general market slowing down in the September quarter, because if the general market slows down, from a price appreciation perspective, in the September quarter\, number one, we've got an offset with Fee-for-Service, and number two, it probably has some impact on our LIFO charge expectations for the year, which would probably be less.

Thanks, Ricky.

Thank you.

Thank you.

We will take our next question in queue from Glen Santagelo with Credit Suisse.

Please go ahead.

David, Mike, thanks.

I just wanted to follow-up on the guidance question.

It seems like you lowered your top end of the range here by $0.08 and Mike, I think if I heard you correctly, you sort of are attributing almost a nickel of that to PMSI and another one to two cents with anemia and really with respect to your base business, what are you saying?

The only impact you're seeing from a decelerating market is a penny or two?

Is that the right way to think about it?

And then I just have a follow-up question on generics.

It is a couple of pennies, Glenn.

I mean I think if you look at our original guidance for the year, is our drug distribution revenue guidance was based on mid single-digit revenue growth.

And obviously IMS has just come out for the entire calendar year of '07 and said the revenue growth was just under 4% for '07, and the expectation for calendar year '08 was 2 to 3%.

So you kind of put those numbers together, which overlap our fiscal year, and we're probably a percentage point down from what our original expectation was.

And I think, Glenn, I think you've got it.

Absent PMSI, and the anemia head winds, which we tried to quantify, and still have some uncertainty to it, our base business is doing very, very well.

And it continues to hit on all cylinders.

And Dave, if I can just follow up on one question, with respect to market growth, it seems like all of the change in the growth rate is predominantly coming from the brand to generic conversions and we're not really seeing any significant erosion on the volume side, at least from what I can see in the IMS data so are we seeing anything different on the profitability in generics in the current environment versus what we saw last year or is it all pretty much business as usual.

I think it is pretty much business as usual Glenn.

We're continuing to have great opportunities in generics, and there is good callout in that, as the -- as the top line is impacted by generics, it gives us the opportunity to have margin expansion as we go forward.

And that's why, as we look out at '09, for example, we're not giving hard guidance there, we're just trying to give people some comfort, the fact that even if the market does slow down, we can grow our EPS faster than that, and part of that is margin expansion, and part of that is coming from generics.

So very good callout.

We got time for one more question.

Thank you.

That question will come from the line of David Deal with Morgan Stanley.

Please go ahead.

When we think about the 4% market growth last year, it is becoming increasingly obvious that the U.S.

Pharmaceutical market is becoming more mature.

When you think strategically are there other verticals that would be adventurous or is there potential avenue for overseas expansion?

It is a good question, and we continue to monitor.

As far as overseas right now, and we watch it very, very closely.

Not a lot of interest right now, because they are struggling with this whole issue of importation, and I forget the name of it, they call it parallel, parallel trade between countries, and that has got some of the manufacturers a little jittery, and the whole distribution model I think is going through a change within Europe.

We moved into Canada, a couple of years ago, very happy with that expansion.

And keeping our eyes on the other markets.

But at this point, nobody else -- no other markets have great appeal to us.

Good callout.

We continue to look for other products that our customers could possibly use.

Maybe they're buying from someone else.

So that is another opportunity for us.

Thank you.

Thanks.

You bet.

Thank you all very much for joining us today.

And for those who want to hear more about the AmeriSourceBergen story, we are at a number of health care conferences throughout May and June.

So we will be around for those opportunities.

And with that said, I would like to turn it over to Dave for some final comments.

Well, thanks, Mike.

I would just like to say again thank you for joining us.

So we're very happy with our second fiscal quarter.

We think we are really -- we've ended it on -- we've ended the quarter on a very positive note.

We had strong revenues.

We had expanded gross margins.

We had decreased costs.

We had expanded operating margins.

Strong asset management and good cash generation.

So lots and lots to like about AmeriSourceBergen and lots and lots to like about our industry.

And we look forward to reporting our continued successes with you.

Thank you very much.

Thank you.

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