美源伯根 (ABC) 2013 Q2 法說會逐字稿

Ladies and gentlemen, we'd like to thank you for standing by, and welcome you to the ABC second-quarter earnings teleconference call.

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

Later, we'll conduct a question-and-answer session, with instructions being given at that time.

(Operator Instructions)

As a reminder, today's call will be recorded.

I would now like to turn the conference over to your host and senior facilitator, Ms. Barbara Brungess.

Please go ahead, ma'am.

Thank you, Steve.

Good morning, everyone and welcome to AmerisourceBergen's earnings conference call covering our second-quarter fiscal year 2013 results.

I am Barbara Brungess, Vice President, Corporate and Investor Relations, and joining me today are Steve Collis, AmerisourceBergen President and CEO, and Tim Guttman, Senior Vice President and CFO.

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 a discussion of some key risk factors, we refer you to our SEC filings, including our 10-K report for fiscal 2012.

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

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

Now, here is Steve Collis to begin our comments.

Thank you, Barbara, and thank you to everyone for joining us on this busy morning.

I am pleased to report that AmerisourceBergen delivered solid performance in our second quarter of fiscal 2013, with revenues of $20.5 billion, and earnings per share of $0.87 in the March quarter, both up 4% over the same period in the prior year.

We had a very difficult comparison in generics this quarter, and we benefited from efforts we made to redeploy capital into share repurchases late last fiscal year, and earlier this year.

Tim will detail our financial performance and our guidance for the rest of the year.

But as we look ahead, there are many moving pieces that will potentially impact our results, and we expect that our adjusted diluted earnings per share from continuing operations will be in the lower half of the range of $3.04 to $3.14.

We accomplished a great deal in the March quarter.

We completed the implementation of our SAP system, following the conversion of our last distribution center to the SAP system.

We took a few very important steps to significantly strengthen our business, reinvigorate our focus and greatly enhance our opportunities to provide long-term value to all of our stakeholders.

We announced an agreement to sell our contract pharmaceutical packaging business, AndersonBrecon, we signed an agreement to sell our underperforming Canadian drug distribution business, and most importantly, we entered into a new strategic long-term relationship with Walgreens and Alliance Boots.

All of these decisions were strategically undertaken to ensure that AmerisourceBergen has further improved our positioning to generate sustainable long-term growth.

ABC already had a strong foundation, and we will now have enhanced scale, upon which to continue to develop innovative and value-added services and solutions for all of our customers, both healthcare providers and pharmaceutical manufacturers, alike.

It is has been just over a month since we announced our unprecedented new agreement with Walgreens and Alliance Boots.

As I said when we made the announcement on March 19, we have before us an extraordinary opportunity to leverage global supply chain efficiencies and best practices, with the largest pharmacy retailer in the US, and the leading international pharmacy-led health and beauty group.

As we have continued to explore ways to collectively improve patient access to pharmaceuticals, while increasing the efficiency of the healthcare system, I am more convinced then ever that this partnership will unlock tremendous value across the supply chain, not only for AmerisourceBergen, but for all of our customers and suppliers, and our new partners as well.

There are three basic components to the new relationship.

First, we have signed a ten-year comprehensive pharmaceutical distribution agreement with Walgreens, which includes not only branded products, but also generics and specialty drugs for Walgreens retail stores, mail order and specially pharmacies.

The contract is effective September 1, 2013, and while the initial phase will include products that Walgreens has traditionally sourced from distributors and suppliers, over time, AmerisourceBergen will assume the distribution of the products that Walgreens has historically self-distributed.

This contract significantly expands our historical relationship with Walgreens, and will yield $25 billion in incremental revenues for AmerisourceBergen in the fiscal year 2014.

Second, AmerisourceBergen will have access to generics and related pharmaceutical products sourced through the Walgreens Alliance Boots development joint venture.

This relationship will improve AmerisourceBergen's access to globally-sourced products, and further strengthen our proprietary ProGen formulary.

Importantly, AmerisourceBergen will over time be able to source products through the JV, not just for the Walgreens stores, but for our entire customer base.

I would like to call our third bucket the platform leverage.

We have agreed to work collaboratively to share best practices and leverage the expertise of all three partners across all of our various platforms.

Together, we share a vision for enhancing and preserving the role of community pharmacy throughout the world, and we bring unique capabilities to facilitate that worthwhile goal.

I've just returned from the NACDS annual event in Florida, where I personally met with many manufacturers and chain customers.

At several of the meetings, the three companies and our teams had joint meetings.

These interactions affirmed that the vision and strategy for our relationship creates truly unparalleled knowledge, capabilities, and leadership.

In international markets we will work cooperatively with Walgreens and Alliance Boots to expand our manufacturer services businesses and specialty businesses.

Alliance Boots' increasing activity with European biotech manufacturers and AmerisourceBergen's expertise in commercialization and patient support services offer manufacturers additional platforms to expand patient access to biotech products in Europe and beyond.

Our goal is to provide manufacturers with integrated solutions for clinical trial logistics, global third-party logistics, and product support services, by leveraging AmerisourceBergen's market-leading world career and consulting services businesses, and Alliance Boots' vast experience in global markets.

I am thrilled with the degree of collaboration we've experienced thus far with our new partners, and with the tracking and governance mechanisms we are building into our relationships to ensure we properly measure our respective performance over the long-term.

Finally, in consideration of the value creation inherent in this new relationship, and in an effort to ensure long-term interests are aligned, Walgreens and Alliance Boots have given the right to purchase a minority equity position in AmerisourceBergen over the next four years.

Over the long-term, we expect significant earnings accretion and other benefits to accrue to AmerisourceBergen as a result of this transaction, and we are very pleased to have our partners share in our future success.

We have submitted all required regulatory filings, and are expecting to receive regulatory approval in this current quarter.

In the weeks since we made the announcements, I have personally met and spoken to many of our customers and suppliers, and I'm pleased to report that we have been very encouraged by the open and honest dialogue.

Across our entire organization, we remain absolutely committed to meeting the needs of all of those with whom we have the privilege of doing business.

We have endeavored to demonstrate as broadly as possible that our intent is to strengthen our entire business, and thereby provide even greater service and more innovative solutions to all AmerisourceBergen customers, and to all of the manufacturers whose products we distribute and support in the marketplace every day.

The healthcare landscape is changing rapidly, and we need to continuously explore ways to drive efficiency without sacrificing the quality of care and service delivered.

Ultimately, we all share the same crucial objective, to help ensure that patients have access to the best possible care, and the medication therapies they need to improve their lives.

I truly believe it is a great time to be an AmerisourceBergen customer and supplier.

In the months and years ahead, we will be making meaningful investments in our core business and infrastructure, and we will be seeking ways to improve the products and services we provide, with the help of our global partners.

Turning now to the performance of our business units in the March quarter.

Revenues in AmerisourceBergen Drug Corporation were up 4%, due primarily to an increase in sales volume resulting from our previously-announced new contract with our large PBM customer, offset in part by the loss of a food and drug combo GPO earlier in the year.

ABDC's revenues will of course, ramp significantly in the second half of the year, as we begin to onboard the volume from the new Walgreens contract.

We have already begun the process of incorporating their store locations into our store systems, and we'll continue to run test and pilots over the course of the summer and even to begin to ship certain lines to ensure a smooth transition on September 1.

We've also already begun to look at the opportunities for enhancing our Good Neighbor Pharmacy programs, with the help of Walgreens and Alliance Boots.

Whether it's through an improved ProGenerics formulary, proprietary front of store products our new share clinical systems that will facilitate third-party contracting, we believe there will be compelling new offerings for our independent customers in the years ahead.

Our new partners share our goal of strengthening Good Neighbor Pharmacy, and enhancing and preserving the role of independent community pharmacy.

Our institutional segment, including both hospitals and alternate sites continues to perform very well.

We have made significant progress in expanding some of our best-in-class specialty capabilities into the hospital market, in an effort to continue to support physicians who treat oncology patients, even as the site of care sometimes changes.

As the specialty markets evolve, we want to, we continue to find innovative ways to support all of our customers who want to care for patients, who are being treated with specialty products.

Operating income in ABDC was down year-over-year, as expected, due to the decline in operating margin, which resulted from the implementation of the new large PBM customer contract, and fewer significant generic launches available to offset that pressure in the quarter.

Overall, trends in brand inflation, generic utilization, and even generic price inflation continue to be positive.

As I mentioned earlier, we have very difficult comparisons on generic launches in fiscal 2013, but those improved significantly in fiscal 2014.

We will see further operating margin degradation in fiscal 2014, as a result of onboarding the Walgreens contract.

But once we anniversary that impact, we fully expect to return to a model where we are able to meaningfully increase our operating margins on an annual basis.

AmerisourceBergen Specialty Group revenues were up 4% in the quarter, due to strong sales in ICS, our third-party logistics business as well as ASD and Besse.

We had somewhat disappointing results in our oncology business, as physician practices continue to face economic challenges in the face of declining reimbursement rates.

Clearly, there's been pressure on specialty physicians, especially those in smaller practices.

In addition, under the sequestration legislation, Medicare physician reimbursement rates for Part B drugs were cut on April 1 from a rate of average selling price, or ASP, plus 6%, to a rate of ASP plus 4%.

We've been hard at work in Washington to help members of Congress and regulators at CMS and elsewhere to understand that physician reimbursement has not just been cut by 2%, it is essentially being cut by over 30%.

Specialty physicians and especially oncologists had already maintained an ASP plus 6% was inadequate reimbursement to reimburse physicians for the services rendered to procure, store and administer Part B drugs.

As we have previously noted, we have seen a trend of small practices selling to larger practices, or in some cases, to hospitals.

We continue to believe that patients are best served in the community practice setting.

Not only do patients tend to have better outcomes, but the costs of care are lower in the community setting.

We are hopeful that, at a minimum, the sequestration cuts will be reversed, but at this time, it is difficult to know when or by what mechanism that would occur.

Furthermore, since the reimbursement rate just changed on April 1, we cannot be certain if we have seen the full impact of the rate cuts at this time.

It is possible that the growth rates of our sales to specialty physicians, both oncologists and other specialists, may continue to slow over the course of the second half of our fiscal year.

Fortunately, as oncology sales have slowed, our other specialty businesses have been growing at above market rates.

These businesses do have somewhat lower margins than oncology business does, so there's been a mix shift toward lower-margin businesses in ABSG, and that growth was not enough to overcome to the decline in the contribution from oncology.

While the specialty market is changing and working through near-term challenges, our specialty franchise remains a key differentiator for AmerisourceBergen, and an important driver of our long-term growth.

The investments we have made to ensure that we are participating to some degree in entire lifecycle of biotech and other products, across all sites of care, combined with the efforts we have made to strengthen our core business and expand our customer's ability to provide specialty products, gives me great confidence that we will continue to be the leading edge partner for all who care for patients, who require specialty products.

Revenues in the segment that is comprised of our manufacturing services business was up 47%, due in large part to contributions from World Courier, which were not included in the prior year.

Operating income was up 5% over the prior year, which was below our expectations, as some sluggishness that we experienced in the December quarter carried over into the March quarter, particularly in World Courier.

We are seeing signs of improvement in April, and we expect World Courier to have a strong second half of the year.

As I mentioned earlier, we continue to be very excited about the long-term potential for our manufactured services businesses, both in the US and elsewhere in the global marketplace.

Before I turn it over to Tim, I want to reiterate a theme I mentioned earlier.

AmerisourceBergen has always been deeply committed to the pharmaceutical supply channel.

The investments we've made in our own business and through acquisitions over the last few years have strengthened our platform, and our new strategic long-term relationship with Walgreens and Alliance Boots dramatically improves our ability to drive sustainable long-term growth for all of our stakeholders.

As I look ahead, I have great confidence that we are invested in the right markets, and that we'll be able to meet our long-term growth objectives of mid-teens earnings per share growth, even with the dilution impact expected from the warrants that were issued to Walgreens and Alliance Boots.

There's never been a better time to be a customer, supplier, associate, shareholder or other stakeholder in AmerisourceBergen.

We have a great deal of work ahead of us, but I'm confident that our associates will continue to bring dedication and creativity to every task and opportunity that lies ahead.

And that we will continue to meet, if not exceed, the expectations that all our partners have in us.

Now here is Tim.

Thanks, Steve, and good morning, everyone.

I'm pleased to be able to report another solid quarter for ABC.

As has been our practice, my comments on our financial results will be on a GAAP basis.

Near the end of my prepared comments, we will provide forward-looking guidance for non-GAAP adjusted EPS for the full fiscal year.

We are now at the halfway point of our fiscal year 2013, and we're pleased with our progress an in d what we knew would be a challenging year.

As a reminder, last year's March quarter had the full benefit of two high-volume generics, which were in their exclusivity periods.

The highlights for the current March quarter are solid top line growth in both our core drug business and specialty, even with one less business day, growth in our generic revenues, excluding the customer loss that Steve mentioned, and very good free cash flow, and as a result our cash balance is north of $1 billion again.

This quarter we had three announcements related to transactions.

During my prepared comments, I will cover financial reporting impacts from our new Walgreens Alliance Boots relationship, and the pending sale transactions with Drug Canada and AndersonBrecon.

We are now classifying Drug Canada as a discontinued operation.

Their quarter and year-to-date operating results have been removed from our March 13 and March 12 results from continuing operations.

Additionally, the estimated loss on the sale of Drug Canada is also recorded in discontinued operations.

AndersonBrecon had previously been classified as a DO in our fourth-quarter 2012.

The gain on the sale of AndersonBrecon will be recorded within the DO line upon transaction closing.

Let's start our review of current second-quarter results.

Revenues were $20.5 billion, up about 4%, compared to last year's quarter.

This is solid performance, even with a headwind from the difference in generic conversions year-over-year.

Our revenue growth was primarily due to our new PBM contract beginning last October.

Gross profit was $717 million in the current quarter, up 5.5% compared to last year's quarter, with a gross margin of 3.49%.

Our World Courier acquisition contributed roughly $65 million of gross profit in the current quarter.

Excluding World Courier, our gross profit was down year-over-year due to lower contributions from our pharmaceutical distribution segment.

Let's move to operating expenses.

This quarter, operating expenses were $367 million, up about 21%.

This increase is due primarily to the operating costs of World Courier, which were not in the prior year.

This quarter marks the first quarter that we have an expense associated with warrants that we issued to Walgreens and Alliance Boots.

We used an independent third party to calculate the fair value of the warrants.

At March 31st, the warrants had a value of $314 million, using a binomial lattice model approach.

Per the accounting rules, we started to expense these warrants from the date of issuance, March 18, through March 31, about $3.8 million.

We will account for these warrants under variable instrument accounting rules, and as a result, the fair value has to be remeasured each quarter-end based on valuation assumptions which include our stock price and volatility of our stock price.

Consequently, the expense will not be a fixed amount each quarter.

Moving to operating income.

We had $350 million in the current quarter, a decrease of about 7%.

The decrease is due to lower gross profit in our pharmaceutical distribution segment.

Our operating margin was 1.71%, down by 20 basis points, compared to last March quarter.

Moving below the operating income line, interest expense of approximately $18.5 million in the March quarter decreased 21% compared to last year.

Moving to income taxes.

Our effective income tax rate in the current March quarter dropped to 38.3%.

This is the result of reclassifying Drug Canada to discontinued operations.

For the full fiscal year, we'd expect our tax rate to be in the range of about 38.2% for continuing operations.

Our GAAP diluted earnings per share from continuing operations in the current March quarter was $0.87.

The warrant expense, equivalent to $0.01 negative, was not contemplated in guidance previously given.

Adding back the $0.01 means we would be at $0.88 on a non-GAAP adjusted EPS basis, an increase of $0.04, or about 5% over the same quarter last year.

Our EPS benefited from an 11% reduction in average diluted shares outstanding versus the prior year's quarter.

At March 31, 2013, we had about 231 million shares outstanding.

We did not buy back any shares during the current March quarter.

Let's spend a few minutes discussing our segment results for the March quarter, starting with pharmaceutical distribution.

Total segment revenues were $20.1 billion, up by about 3.5% versus the same quarter last year.

The increase was due to two primary drivers.

One, growth at our drug company, about 4%.

As mentioned previously, new volume from our PBM customer, offset by the contract line wind down of our food drug combo GPO customer.

And two, growth at our specialty business, about 4%.

Specifically, our ASD, Besse Medical, and ICS businesses, offset by weaker than expected revenue performance in our oncology business.

These sales growth percentages are before intrasegment eliminations, consistent with how we've communicated these percentages in the past.

Total segment operating income decreased $34 million or 9% to $329 million, in the current second quarter.

Most of the decrease is related to the drug company.

Drugs decrease is due to lower contributions from our PBM contract, and the loss of the food drug combo GPO contract.

We also had a sizable headwind from oral solid generic launches, offset somewhat by better generic price appreciation.

In terms of specialty, they had higher contributions, directly related to the increased revenues at ASD, Besse Medical and ICS.

However, these increases could not offset the decrease from our oncology business.

As Steve mentioned, oncology's income is being negatively impacted from lower revenues, as community practices face more challenging economics, due to the changing government reimbursement.

We expect this trend to persist for the remainder of the fiscal year.

Moving to the other reporting segment.

As a reminder, this segment is comprised of consulting services and World Courier.

Segment revenues increased nearly $140 million to $435 million.

Most of the increases are from World Courier.

This business did experience some revenue softness, as new business slowed somewhat in late calendar 2012, and is carried over into our March quarter.

However, we are starting to see an improved pipeline for customer RFPs, and recently we've had several account wins that will positively impact our June and September results.

Operating income for the other segment increased about $1 million or about 5% from the same quarter last year.

The increase is related to contributions from World Courier.

Our consulting business had a decrease in operating income, due to higher operating costs, as they ramp up for new initiatives.

Previously, we've given guidance that World Courier would contribute $0.06 to $0.10 of earnings in fiscal 2013.

We now expect to be near the lower end of this range, due to the revenue softness we are cycling through.

We remain positive about the prospects for meaningful, long-term returns from World Courier.

And as Steve mentioned, we now see even greater opportunities further out, as we explore new business with Walgreens and Alliance Boots globally.

Switching gears, I'd like to comment on our two announced business sales, both recorded in the discontinued operations line in our P&L.

We are waiting for regulatory approval on both transactions.

We expect that both transactions will close in the June quarter.

For Drug Canada, in our March 2013 quarter, we've recognized expense of $166 million in the DO line.

Almost all of this is related to the expected loss on sale.

Now let's turn to our cash flow.

Overall, we are pleased with our free cash flow performance for the current March quarter.

We generated about $950 million of free cash flow in the three months ended March 2013.

For the current six-month period, we now stand at approximately $655 million of free cash flow, about the same level as last year.

Some of the free cash flow benefit was the result of timing.

Our last business day in March was a Friday.

Friday is typically our strongest AR collection day, and AP invoices due over the weekend were paid Monday.

We finished the quarter with a cash balance of approximately $1.3 billion.

Before I provide fiscal 2013 guidance, let me cover, quickly, key updated fiscal 2012 numbers, since our financials will be revised to pull Drug Canada out of continuing operations.

We would expect to issue adjusted fiscal 2012 ABC consolidated and segment quarterly numbers via an 8-K soon after we file our March 10-Q.

Total consolidated revenues will be revised to $78.1 billion.

Consolidated operating income will be revised to $1.3 billion.

And finally, diluted EPS from continuing operations will be revised to $2.96.

Now, let's cover our fiscal 2013 guidance.

EPS, Our full-year non-GAAP adjusted EPS from continuing operations remains unchanged, a range of $3.04 to $3.14, which excludes two items.

One, the negative impact from warrant expense that we recorded in SG&A, and two, the expected LIFO charge from onboarding the Walgreens brand distribution business.

We now expect to be in the lower half of the range, due to lower contributions, primarily from our oncology business.

And also a $0.02 negative impact from dilution, on applying the treasury stock method of accounting to the warrants.

Going forward, whenever our average quarterly stock price exceeds the average strike prices of the warrants, then the warrants will be dilutive to our share count for EPS purposes, including the June and September quarters.

One final comment about adjusted EPS guidance.

Our guidance includes the effect of revising our Q1 2013 EPS results from continuing operations, as we have pulled out Drug Canada and classified it as a discontinued operation.

Keep in mind that we'll have deal costs in the June quarter, and on-boarding costs, including the one-time Walgreens rebate, in the September quarter.

Based on this, we now expect our adjusted EPS to be pretty even for the June and September quarters.

Our key guidance assumptions are as follows.

Revenue growth, revenue growth will now be in the 11% to 13% range, off the revised fiscal 2012 revenues.

We expect revenues to accelerate in the second half of fiscal 2013, as we begin to service certain lines of Walgreens prior to September 1, and add new brand lines for our large PBM customer.

Additionally, the headwind from brand and generic conversions decreases significantly in the second half of our fiscal year.

Operating income and margin.

We have many moving parts, and because of this, our operating income will now be down 3% to 5% for the year, as compared to the revised fiscal 2012 operating income.

Let me cover operating income dollars first, and this excludes any impact from the warrant expense, and the LIFO expense.

The two drivers of the operating income decrease are, one, deal costs, and the ramp-up of operating expenses, including the one-time rebate we're paying, again in quarters three and four respectively.

And two, lower contributions now from our oncology business, and somewhat lower contributions from World Courier, and the delay in reducing legacy IT operating costs, where we previously expected to see savings in our September quarter.

Additionally, our operating margin will decrease in the 24 to 29-basis point range, from the revised fiscal 2012 margin of 1.67%.

This represents a decrease in our operating margin of 16 to 17 basis points from our previous guidance.

The decrease in margin is due to the two items I just mentioned.

Additionally, the third item negatively impacting margin is the increase in revenues from our PBM customer, and the new Walgreens contract.

These three items I called out are all negatively impacting margin by about 5 to 6 basis points each.

Free cash flow.

We expect free cash flow to be in the range of $100 million to $200 million, which includes the significant working capital build to support the Walgreens contract.

This includes CapEx of at least $220 million.

Share repurchases.

Our share repurchase expectation continues to be $400 million in fiscal 2013.

Before I wrap up, let me comment briefly on LIFO.

We continue to operationalize the Walgreens contract.

This means that we are working to understand the brand inventory build, primarily occurring in July and August.

For example, the brand inventory build could be $1 billion or more.

This means we are likely to have an unusually high mix of branded inventory at fiscal year-end.

As we have commented in the past, brand inflation has been in the 9% to 10% range the last couple of years.

This could translate to a non-cash LIFO expense of $100 million or more.

In our June quarter, we expect to be able to forecast our annualized LIFO expense, as we'll have clarity on brand inventory requirements.

This means that we will be in a position to record a nine-month true-up to our LIFO annualized expense.

The remaining 25% of the annualized LIFO expense will be recorded in the September quarter.

One final LIFO comment.

The incremental EPS benefit of $0.20 in fiscal 2014 from the Walgreens Alliance Boots transaction that we highlighted on March 19 did not include a LIFO assumption.

Given the complexities around LIFO and the timing of on-boarding the Walgreens generic business.

This wraps up my prepared comments this morning.

I appreciate your patience as we work through the financial details, and thank you for your continued interest in ABC.

Now, here's Barbara for Q&A.

Thanks, Tim.

We will now open the call to questions.

We ask that you please limit yourself to one question and a brief follow-up, so we can accommodate as many callers as possible.

Go ahead, operator

(Operator Instructions)

We will now take our first question from the line of Mr. Robert Jones of Goldman Sachs.

Please go ahead.

So Steve, you mentioned -- you mentioned the joint venture, and how this benefits the ProGen program from the better generic purchasing.

Before AmerisourceBergen was included with Walgreens and Alliance Boots, Walgreens had sized what they thought the purchasing synergies were from their joint venture.

Can you maybe just help us think about the potential savings that could be realized over time from this particular part of the agreement with Walgreens and Alliance Boots?

First of all, this is fairly complex work that involves many other parties, the generic manufacturers.

These are global organizations.

Almost all of them we met with the CEOs of all these organizations over the last few days, and almost all of them have established relationships with all three companies.

So we really are creating an unprecedented platform here, and it's going to take time.

We're a significant amount of generic volume to almost all of these suppliers' global business.

So we're going to be very thoughtful and planful about this, we really expect that the benefits from the Walgreens Alliance Boots Development relationship would really start accruing in fiscal year 2015, which would also coincide for when we have the full run rates from the generic distribution.

But we expect that this will be significant, because we think we've got a significant value proposition back to the manufacturers.

The scale that we have, the ability to do long-term contracting, and that message has really been well received.

These various conversations that, I had an accelerated amount of conversations in the last few days, and we did a lot of those conversations on a joint basis, have been very encouraging.

So we think that this is going to be probably one of the most significant areas of opportunity that we have between the three companies, especially from 2015 on.

That's great.

I guess also, Steve you mentioned the goal of significantly improving margins beyond fiscal 2014, it kind of ties into this arrangement.

Can you give us any goal posts around your expectations?

Can the Company, given its new customer mix, and factoring in this unique contract, can it get back to historical operating margin levels?

And is that something you're thinking about in the next few years?

It's Tim, I'll take this one.

Again, Steve, in his comments mentioned meaningful growth in the operating margin expansion.

Again we have to cycle through the onboarding next year.

But getting to 2015 and beyond, historically, we've been in the high single digit kind of range, and again, I think we'll get back there in terms of growth, and that's our expectation.

Got it, and then if I can just sneak one more in, Tim, while I have you.

I know back when the arrangement was struck, there was some discussion around hedging, around the warrant dilution.

Any update there, and is that something you are still contemplating?

Thanks so much.

Yes.

No, great question.

We did talk about it.

We continue to do a fair bit of work on hedging.

We're at the point now where we're looking at some different alternatives, Bob, and we have a Board meeting in the middle of May, where we're going to make some recommendations.

But we'll have an update in the June quarter, but it's still top of our list to do that.

Our next question comes from the line of Tom Gallucci of Lazard Capital Markets.

Please go ahead.

First a housekeeping one maybe for Tim.

I just want to make sure, it sounds like the cost to implement the Walgreens contract and deal-related costs are included in the guidance as sort of a negative, so A is that right?

And B, care to size maybe what you're going to be spending to implement it?

No it's, Tom, you're right, it is in our guidance, we call that out, again one of the reason why our margin is down, we called out the basis point drop, so definitely in our guidance.

We don't want to really call out the specific pieces.

I did give some, I did give some -- a broad range, broad stroke in terms of about 5 to 6 basis points for that first bucket, which is the deal costs, onboarding costs, which includes the rebate.

So that's about as far as we're willing to go at this point.

Okay.

And then, Steve, in your prepared remarks, you talked about lots of conversation with various constituencies, including customers, I think some of us have done our own work at talking to people in the channel.

Can you maybe dive a little deeper into the conversations you've had, and what customers are asking you in terms of both the opportunities that they're looking for as a result of this?

And as well as some of the concerns maybe that you've heard?

And how you sort of balance those?

When we made the announcement, obviously it was big news, I think we really caught a lot of people by surprise, which is a good thing.

We, given that it was a very confidential relationship.

So I think we had -- there was definitely about as much upside or downside in the communication plan as maybe in any other investment, or transaction contract that we've entered into, and certainly in my experience.

So the team was very well-prepared.

We met with all of our top 20 customers in person.

We've met with, as I said, all the key suppliers.

And I think we've got long-term relationships with many of the customers and our industry tends to have long-term relationships, and very integrated relationships with our customers.

So I think the history of our industry has been that the wholesale has been strong, it's good for the customers, and this, this agreement, we believe, strengthens and adds to our long-term prospects in a virtuous way.

So those conversations we've been able to do in person, and we've all been very active, and I think that the tone has really landed up in a very good way.

People understand us, we've had a talk through the equity component has been one of the concerns.

Board seats, we've discussed.

The Board seat lands up being commensurate with the holdings in AmerisourceBergen, there's various options and the right to purchase stock in the open market.

We had to explain all these different things.

We've got very large sophisticated customers.

We've got smaller customers.

We've got large suppliers that probably understand what the Walgreens Alliance Boots Development Corporation, what the goals were.

We've got some that never heard about that before.

We really are -- we've been very planful, very thoughtful, but I'm sincerely tell you that where we sit one month after announcement is in a good place, with the majority of our customers, almost all of our customers and suppliers.

Okay.

Thanks, Steve.

Our next question will come from the line of Mr. Glen Santangelo with Credit Suisse.

Please go ahead.

Maybe I'll follow-up.

Tim, I was kind of curious about just looking at the year-over-year results in the drug corporation, it kind of seems like the operating profit was maybe down a little bit more than maybe what I expected.

And it sounds like you're suggesting that maybe Lipitor and Zyprexa would have been on that exclusivity this quarter last year had a big part to do with that.

As you move out into Q2, if we were to strip out the specialty issue, as well as some the start-up cost around WAG, is your overall drug business, is it positive year-over-year in terms of operating profit?

Glen, we are down in Q2 in this segment, right?

And I gave a little bit of color in terms of most of that being drug.

Probably two-thirds drug, about one-third specialty.

You know, moving out for the second half of the year, though, drug will be down year-over-year, even if you strip out, even if you strip out some of those items.

Again most of that due, what we said, from day one, just a very challenging full-year generic comparison, and repricing of the PBM contract.

Okay.

Maybe if I can just ask one follow-up then.

It kind of sounds like within the oncology business, that the challenging environment is going to persist into the second half of the fiscal year.

And I think you called out, it's just a challenging environment for the community specialists.

Could you just elaborate a little bit more on that, Steve, and maybe what's driving that, and what the issue is, and then ultimately how you rectify that situation to reinvigorate the growth within that segment?

Thanks, Glen.

It's an excellent question.

I had 19 years with the Company last week, and almost all of that has been closely watching oncology business.

These have very smart business people.

They're dealing with very expensive therapies.

And the ASP plus 6% has been for Medicare, which is typically about half of each practice, is somewhat finely balanced, it's more or less of a break, you could say almost a breakeven on a lot of these therapies.

They don't often actually buy entirely at ASP because of some other measurement in the reimbursement calculation.

So cutting this down by 2% was not expected, so as we got into the end of March, I think a lot of practices started looking at their patients and maybe looking at treating Medicare patients in a different way.

Or referring them to hospitals, so we started to see some impact, and that could be further accelerated here, depending on what happens with the sequestration cuts.

There could be some budget resolutions in the next quarters, but everyone's well aware of the, you don't me to opine on the situation in Washington, but it's extremely frustrating.

I have personally been along with James Frary, Payton Howell, Rita Norton, a lot our leaders just very, very engaged in Washington, and trying to explain that this is not a 2% cut.

We took the time in our comments to illustrate why this is not a 2% cut for that small part of the margin, a spread that our customers are receiving, it's similar to a 30% to 40% cut in that already fairly low margin.

So it's of concern, and it could accelerate larger practices acquiring smaller practice, which is a good trend for us.

We have a lot of the larger practices ION and members of oncology and supply customers, but we've also seen, say for example, take a town like Louisville, Kentucky.

Five years ago there were over 20 community practices, there's only a handful now.

And what's happened is that the hospitals have acquired them, and many times those becomes 340B practices and in about a third of the case, AmerisourceBergen customers, so it's not like we lose the business.

But you lose the patients to community setting, we don't have a comparative to ION in the hospital setting, and it's why we've been adjusting some of our business goals to look at oncology more in different sites of care.

Sometimes it's based on the oral formulation, sometimes it's based on the oncology in a hospital setting or an outpatient setting.

Or a specialty pharmacy setting so I think I probably answered a lot on that question, but I hope that's, it's a complicated issue, and as you can see, we're on it.

Our group is as well-positioned in the industry as we've ever been, but these are issues that could really change the way cancer patients get treated.

Thanks for the detail, Steve.

Our next question will come from the line of Robert Willoughby of Bank of America.

Please go ahead.

Steve, maybe kind of the same question.

Do you think it's realistic to assume the higher inflation rate on the specialty drugs continue?

Aren't you expecting other cost management efforts by healthcare payers to contain that trend, and would that influence your business?

Yes, so manufacturers take price increases, that doesn't mean that the ultimate net pricing goes up by that much.

Again, specialty drugs, the physician administered like Part B type drugs, I would say, I don't have the exact data in front of me, but it's not as high as 8% to 9%, which is our traditional brand inflation.

And it would not be feasible to do that because of Part B reimbursement.

When we talk about specialty drug inflation that's been in therapies like for rheumatoid arthritis, multiple sclerosis in particular has had very high brand inflation, that has slowed somewhat this year.

Tim, do you have any comment?

No, I think you're right, Steve, it's just not, the trends on the oral side you just don't see on the specialty side.

What are the payers doing?

How are they slowing that rheumatoid arthritis trend?

Well I think a lot of it has been managed by limited networks.

One of the visions for our partnership is to do more specialty products in the community setting, whether it's through -- it's Walgreens, Good Neighbor Pharmacy, I think a lot of our customers are very interested in that.

We have a very strong what we call an ultimate side segment.

That's something that we're planning to have a specialty network that's for qualified participants, that AmerisourceBergen has been very involved in.

And then we do a lot of work with payers and try help them understand what some of the trends are.

I note the growth in our consulting services business, which helps with not only patient access, but with managed care communication planning, product launch support, including pricing decisions, comparative effectiveness, these sort of areas.

So we've got well-developed practices, whatever the need of the manufacturer or the provider is.

And I think we're going to have, we're going to be a key participant in any of the sites of care, or any of the different formulations that arise.

Thank you.

Our next question will come from the line of George Hill of Citigroup.

Please go ahead.

Maybe to follow-up on Glen and Bob's question.

Tim, can you talk a little bit about the severity of the impact in the oncology business, maybe remind us again about how big oncology is inside the specialty business, and kind of the rate at which you're seeing the deceleration?

Well, Bob, or George I'm sorry.

Let me just, again on Glen's comment I talked about that.

For this quarter we had about a $33 million change in that segment.

Operating income, again, about two-thirds by drug, one-third is related to specialty.

And we did have really good growth from our three businesses, the ASD, Besse Medical, and ICS, just not enough to offset oncology.

So I mean, we don't want to get into a lot of specifics, but again, you can kind of look at what I just provided there.

Oncology is about 40% of ABSG revenues.

Those three businesses I talked about are about 60%.

And again if you put -- put oncology in perspective with ABC, it's probably 7% of total ABC.

So again, clearly an important business, but we're starting to see, as Steve mentioned, some revenue declines that are persisting, and we felt it was appropriate to call them out as we go forward in the 3 and 4.

Now, that's great color, and then maybe just a quick follow-up.

Given you're talking about the --

Just make one clarifying comment, it's important when we talk about oncology, we are talking specifically about oncology supply and ION businesses.

That enables us to -- the physician services and contracting we do in ION have been very meaningful, and when we do other sites of care, we don't get those contract benefits.

So that's why it's been important.

It's been, as a great business for ABC.

We've been a great partner to oncologists, so when we talk about oncology, here in this context, we're talking about specifically oncology supply, and ION businesses.

We are doing a lot of other oncology in our ICS business, in our ASD business, and more and more now, health systems business where we think we're going over $4 billion in oncology sales into the hospital channel.

So I just think it's important to clarify some of that.

Okay.

Steve, that's great clarification.

And then I guess, my follow-up question was going to be, it seems like a lot of this could be stemming also from the 340B initiative at the hospital organizations.

All the data I see would seem that they all want to step up 340B program launches and utilization.

Could you talk about how you expect that to impact mix?

Well, we service a lot of 340 B hospitals.

I mean, there has been a trend, I believe, 40% of hospitals in the US are now 340B enabled or eligible.

And we're going to see what the impacts of the Affordable Care Act implementation are, and what's going to happen with accountable care organizations.

So again, some of these trends are very interesting.

You should be assured, ABC's monitoring that.

We believe we're well positioned, but we're finding out here, it does affect our mix and the margin implementations depending upon mix, how mix changes based on different sites of care and different changes.

Some of these trends we, we'll keep on trying to point them out to you when we have clear indications of where they're going, but not, there are about as many moving parts in the whole health system as at anytime in my career.

Okay.

I appreciate the color.

Thanks.

Our next question will come from the line of Steven Valiquette of UBS.

Please go ahead.

Just to drill down on Tom's earlier question a little bit further.

I guess besides just positive discussions with customers, I think there may already been some recent contract renewal examples that can serve as tangible evidence of customers not worried about potential conflicts of Walgreens.

I guess without going into specific details, can you just confirm whether or not you've already made some progress in renewing some retail contracts, following the announcements of Walgreens?

Well, thanks, Steve.

We did resign our largest buying group customer, that's about a thousand stores, $2 billion in revenue.

I personally met with their board over the last few weeks, and many of their members, and they understand what we're trying to do here.

Again, I think one of the key comments I made, our new relationship with Walgreens really is pro the channel.

We're bringing a tremendous amount of lines into the system.

We're enhancing the productivity we're going to have in our distribution centers and the independents understand that the wholesale industry is their best friend.

Some of the benefits that we're going to be having, which is looking at the clinical platform together, looking at third-party contracting.

I think definitely one of the immediate benefits I'm seeing is the front store, what can we do to help G&P stores do even a better job in the front store requirements that their customers are expecting, a newer more modern environment.

Orientation toward healthier products.

More vaccines, et cetera.

We've talked through all these, and I think, I think our customers are trusting us on this, and they will see us bring more benefits to their Good Neighbor Pharmacy program.

And the recent signing is was a vote of confidence in us, absolutely.

Yes.

That's perfect.

Thanks.

Our next question will come from the line of Ms. Lisa Gill of JPMorgan.

Please go ahead.

I just had a couple questions around points of clarification.

Tim, when you talked about 2015, and you talked about high single digit, were you talking about margins in 2015 being high single digit or the growth rate that you think you can go back to in 2015?

Growth rate.

The increase in Bips, Lisa.

And then, secondly, Steve, you made a lot of comments around global opportunities with Alliance Boots and Walgreens, have you identified anything specifically that you think will have some impact in the next year or so or do you view these as longer term opportunities?

I think in terms of meaningful earnings, to be honest, I don't think we'll see anything in the business development side in the next year.

We work it on a couple joint manufacturer services, RFP responses.

If those work, that could be great test cases.

But some of these programs are a lot smaller.

I think they could be chances to make investments collaboratively between the three of us, but those are dependent on the right opportunities emerging, and they fit the criteria.

And of course, we all three are independent companies.

We've got our own set of respective shareholders.

But when I talk about that third bucket just, again, some of the meetings we had this week were -- were really moving the dial up.

This transaction that we announced has caught a lot of people's attention and I believe it's people are waking up to the fact that it's a truly unique global platform with tremendous leadership capabilities, talent on all sides of the table.

So I am really bullish on what the relationship's going to mean to our shareholders and customers.

And do you think that others will have to respond to this, Steve?

Do you think we'll see other type of purchasing consortiums on a global basis because of this, based on the conversations you've been having out in the marketplace?

Yes, I mean, it's a great question.

And I understand why you'd ask it, but it's not up to me to speculate on what the outcomes could be.

We saw the announcements this morning, so again, I think all -- all of the, all of the large US wholesalers do a great job.

We're all very tight with our customers.

And I think, it's just hard again, there's not many Walgreens out there.

There are not many Alliance Boots out there, and of course, I'm particularly proud of AmerisourceBergen's capabilities and position in the channel.

Okay.

Great.

Thank you.

Our next question will come from the line of Ricky Goldwasser of Morgan Stanley, please go ahead.

Thank you for fitting me in.

So I have, some -- some question here.

So first of all, just a point of clarification, I think to Lisa's point, you're saying that you're going to see single-digit basis points growth or expansion in margin once 2013, the base year 2014 is behind you.

So should we basically, when we think about our long-term models and the impact here, should we think about AmerisourceBergen going back to 2013 type of margin by 2016?

Yes Ricky, again, I mean, it's early.

We haven't even looked at plans.

We've got a lot of runway to go here.

But certainly our goal has always been to lap and to onboard Walgreens the best we can, best to our abilities.

And then in 2015 start getting back to historical growth, which again is that high single digit is what we need to get our EPS in the mid teens.

So I mean, at this point, I think that's pretty much all I'd like to say, but, but we're very confident we can do that.

Especially when you get out to those years.

As Steve mentioned earlier we have the benefit of procurement JV kind of kicking in, and again with the slower ramp-up, but we're confident that we can get the high single digits.

Okay.

And then I know it's very early on but have you seen any change in the competitive behavior from your distribution peers?

I mean, Ricky, it's very good question, but no, we don't expect it to be.

No, I don't think so.

No.

It's again, it's only a month, but no, we don't think so.

We -- we think again, all three of us are public companies.

We report to shareholders, and we don't expect that there should be any discernible change in competitive trends because of this transaction.

Okay.

Thank you.

Our next question will come from the line of Charles Rhyee of Cowen.

Please go ahead.

Question for Tim here, can you go over your comments around the LIFO charge and how you expect that to come out?

And then can you help walk us through how that will impact and when we think about fiscal 2014, you kind of made some comments about it not being incorporated into the $0.20 incremental benefit from Walgreens?

Yes.

Sure, Charles.

Let me go back and recap LIFO.

It's certainly a complicated area.

It really depends on how we onboard.

How much inventory we have to build.

We're working through that conversion plan, which will probably be done at the end of May.

So we'll have a much better idea again.

And just how much brand inventory we have to bring on, but to service a large customer with all those locations, again for the 2013 impact, you have to bring on a lot of brand inventory.

And again, as I mentioned in my prepared comments, it's really going to impact the mix.

Typically in inflation, right, in LIFO you have high brand inventory, high inflation rate, but you also have generics.

Well we won't have that generic inventory from Walgreens until next year.

So again that's the reason why we're going to have the high LIFO expense this year.

Again, the way we do our calculation is, we always estimate LIFO on a full-year basis.

So when we're in June and we close the June books, we'll basically have to do a catch-up entry on that full year so we'll have to book nine months, a year-to-date true up.

So whatever entry, whatever number we come up with, nine months of that will be booked in the June quarter, and then the remaining 25% in the September quarter.

Again, non-cash item.

The other, and again your second question about 2014 is kind of what I covered earlier, it's just at this point we haven't calculated anything on LIFO for, for 2014.

I think as clear it will be less because we're going to transition generics during 2014.

But at this point, we still don't know how quickly that will come, and when we'll get that business fully onboarded.

So when we know more details later in the year, we'll update everyone.

Okay.

But so but when we think about 2014, though, because we're going to, we're going to take the charge here in fiscal 2013 and we'll have some generics in 2014, the absolute number will be less?

Absolutely.

I fully expect again, knowing what I know today, that charge will be less than 2014.

Again because we're going to have some amount of generic inventory that will offset that brand high inflation so yes, definitely less.

One last clarification on that.

In your guidance you don't back out LIFO charges or credits, right?

Even though we know them as being non-cash?

Well, typically in the past, LIFO has always been our GAAP numbers, right?

Everything we presented historically, LIFO has been in.

But this year, for 2013, because it's such a large number, it's moving around, we don't fully know the number, it's not in our forward-looking guidance for 2013.

In the $3.04 to $3.14 there's no LIFO impact in there.

Again, in the number we gave for incremental for 2014, there's no LIFO assumption in there either.

Okay.

That's helpful.

Thank you.

You're welcome.

Thanks, Charles.

Operator, I think given the late hour, we'll take one more question, please?

And that last question will come from the line of Mr. John Ransom of Raymond James.

Please go ahead.

It's always dangerous when I try to do math, so I'm not going to try.

Could we just recap just to make sure everybody has this.

When you talk about your new guidance, your unit results coming at the bottom of the range, can you just total up again what was not contemplated in your original guidance, so we can have kind of an apples-to-apples look?

Yes.

Sure John.

Really it's really kind of comes down to a couple things.

One being the change in what I would call the base business.

The softness in the oncology revenues, mostly, a little bit of softness in World Courier.

And the third, the third item there is just, we always talked about getting some benefit to our P&L in the fourth quarter, post SAP implementation, and again we won't have that.

So those three items really impacted our guidance, and --

So you're not including the warrant dilution, you're not including --?

No, no.

No let me get to that.

Okay.

That's one bucket, and the other bucket is clearly a couple pennies from warrant dilution.

And again, as we look out today for the rest of the year, and where our share price is today, we just made an assumption that our share price for 3 and 4 will be higher than that strike price.

Okay.

And when you look at that, we'll have to add some equivalent dilution, we'll have to add some shares into our share count.

That's going to cost us $0.02.

So it's warrant dilution, oncology, World Courier, all of that should total $0.06, $0.07?

Something like that.

We haven't sized it, but that's the most we're going to comment.

Okay.

That's fine.

And then my other question is, can you just go back to the oncology reimbursement, was that sequestration, or was that a specific cut to Medicare B?

John, it was sequestration.

So April 1, and again I think regulators just don't understand, they say, well, a 2% cut should be manageable.

It's not a 2% cut, because the practices don't have any ability to impact that ASP.

That ASP stays fixed, and what they have to work with was, was a 6% over that ASP number, it's now 4% over that ASP number.

It's definitely going to be impactful.

And to be clear, so you're thinking, it's not that you're getting less margin yourself, it's just that you're losing some practices to the bigger consolidators because they can't take the --

Yes.

In my comments, and I said that there has been a trend toward practices selling -- you have seen cardiology, for example, was very, very profound.

In oncology, it's been a couple -- we've lost a couple of practices a quarter.

Many of them selling to other larger practices.

Most of the cases, those larger independent non-US oncology practices are our customers.

You've got, market share in oncology has always been well-known and understood.

But we actually are seeing that trend toward practices selling, we think it could be, enhanced now or accelerated now, because of this additional reimbursement pressure.

Okay.

Perfect.

Thank you.

Thanks John.

And now, before we go, Steve would like to make some final comments.

Yes.

Thank you, everyone, for your attention today.

I know we went a bit longer than planned, and we wanted to give you all -- as many of you as possible to ask questions, because today's call was certainly more complex than our calls have been historically.

But we appreciate your attention and interest in ABC.

Operator, maybe we could close the lines and we'll just let Steve finish his comments.

We had some feedback, sorry.

Okay.

Again, so we sincerely appreciate your attention and interest.

It is clear that this was a momentous quarter for ABC, and we believe with the various steps we've taken this quarter, including our performance in this quarter, that we've significantly expanded our position in the supply channel.

And we have an opportunity to continue to create accelerated value for all of our stakeholders.

Thank you very much.

Thanks, Steve, and before we go, I'd just like to highlight a few of our upcoming events.

As we noted in our press release, we'll be attending the Bank of America Healthcare Conference in Las Vegas on May 14, The UBS Healthcare Conference in New York on May 20, and the Goldman Sachs Healthcare Conference in Rancho Palo Verde, California, on June 12.

That concludes our call for today, and now I'll turn it back to the operator.

Thank you.

Ladies and gentlemen, that does conclude our conference call for today.

We'd like to thank you for your attention at today's ABC second-quarter earnings teleconference call.

And thank you for using AT&T.

Have a wonderful day.

You may now disconnect.