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AmerisourceBergen Corporation (NYSE:ABC)

F1Q09 Earnings Call

January 22, 2009 11:00 am ET

Executives

Michael Kilpatric - Vice President, Corporate & Investor Relations

David Yost - President and Chief Executive Officer

Michael DiCandilo - Executive Vice President, Chief Financial Officer

Analysts

Glen Santangelo - Credit Suisse

John Ransom - Raymond James

Larry Marsh – Barclays Capital

Eric Coldwell - Robert W. Baird & Co. Inc.

Lisa Gill - J. P. Morgan

Erin Wilson - Banc of America Securities

Ricky Goldwasser - UBS

Charles Boorady - Citigroup

Charles Rhyee - Oppenheimer & Co.

Richard Close - Jefferies & Co.

Helene Wolk - Sanford C. Bernstein & Co.

Harlan Sonderling - Columbia Management

Operator

Good morning ladies and gentlemen and welcome to the AmerisourceBergen Fiscal 2009 First Quarter Earnings Conference Call. (Operator Instructions).

I would not like to turn the conference over to our host Mr. Michael Kilpatrick. Please go ahead.

Michael Kilpatric

Good morning everybody and welcome to Amerisource Bergen’s conference call covering fiscal 2009 first quarter results. I am Mike Kilpatric, Vice President of Corporate and Investor Relations. Joining me today are David Yost AmerisourceBergen President and Chief Executive Officer, and Mike DiCandilo, Executive Vice President, Chief Financial Officer and Chief Operating Officer of AmerisourceBergen Drug Corporation.

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 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 2008.

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

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

Here is Dave Yost, Amerisource Bergen’s President and CEO to begin our remarks.

David Yost

Good morning and thank you for joining us. AmerisourceBergen had a solid December quarter, our first fiscal quarter, following a strong fiscal year that ended in September. Our revenues, operating margin, and EPS were all up over the same quarter last year, reflecting the resiliency of our company and the wholesale pharmaceutical industry. We continue to do a good job controlling our costs and our receivable days and both are down versus last year.

Our two primary growth drivers, generics and specialty distribution services, were strong contributors to the quarter. Revenues were $17.3 billion, up over last year and up $180 million over last quarter. The revenues reflect the negative impact from the loss of direct warehouse business to a large retail chain customer that was discontinued July 1, 2008. Net of this warehouse business revenue would have increased 4.8% over the same period last year.

Operating margin continued to expand. You will recall our operating margin has expanded in the mid single digit basis points in each of the last three fiscal years and this quarter’s increase of three basis points was in line with our expectation of continuing that trend. This year we expect our operating margin to expand in the low to mid single digit basis points.

Our margin increase was driven by our strong generic sales, excellent expense control, and good fee-for-service performance. We spent fewer dollars running our business this quarter, excluding special charges, than we did this quarter last year, demonstrating excellent internal discipline.

Controlling costs is part of our operating mindset at AmerisourceBergen and is reflected in a philosophy we call CE 2. CE 2 stands for customer efficiency and cost effectiveness. Customer efficiency relates to delivering what the customer wants and needs and is willing to pay for and cost effectiveness means challenging every element of every expense.

EPS of $0.73 was up 12% on a GAAP basis. You may recall that the December quarter of last year was positively impacted by $0.04 from a $10 million litigation settlement and a $1.4 million net of special items. If that 4% is excluded our EPS this quarter is up a robust 20%.

Revenue in our proprietary generic program PRxO(NYSE:R) Generics Solution increased in double digits versus last year and our AmerisourceBergen’s specialty business ABSG grew 5% reflecting the excellent fundamentals of the specialty market coupled with our unequal broad base solutions offering for this market.

So what is to like about the quarter, as we continue to track to deliver the results in this fiscal year that we outlined in October?

Before I hit some company specifics I would like to comment on what we are seeing in our nation’s capital. Obviously the new administration has only been in office a couple of days, but we think that healthcare reform will be addressed as soon as the stimulus package is resolved.

Within healthcare we think the immediate focus will be on the $46 million or so uninsured and particularly providing them access to pharmaceutical therapy due to its cost effectiveness. The recent expansion of the SCHIP program to an additional four million more children, passed by the house, is a step in the direction of expanded coverage in our opinion. The clear take away here is that we think government paid pharmaceutical care will be expanded under this administration and anything that increases the volume of pharmaceuticals dispensed is good for our industry and Amerisource Bergen.

Now regarding our industry, the wholesale distribution industry continues to reflect strong fundamentals. While IMS Health forecasts that the growth has slowed versus historic standards, it is important to note that the industry continues to grow in an economic climate that could easily be described as turbulent. IMS is forecasting 1% to 2% total market growth in calendar year ’09 with increased growth rates in the outer years. Our forecasted revenue growth incorporates this market sentiment which will hopefully prove conservative providing upside to the industry. I would continue to describe the selling environment within the industry as competitive, but stable.

Now I will speak on matters a little closer to home. AmerisourceBergen Drug Company, ABDC, had a strong quarter driven by product mix and cost control. We continue to focus on the right customers. Customers where we can provide value added services that are recognized by the customer.

As I mentioned previously, our proprietary generic program, PRxO(R) Generics Solution, had a double-digit increase in revenue this quarter far outpacing our total revenue change in the drug company. Both operating costs and receivables were closely controlled. We ran our drug company and total business with fewer expense dollars this year than last year despite continued investment spending, most notably on a new ERP system for the drug company and corporate office. Our day sales outstanding, DSO, are down both year-over-year and sequentially, demonstrating good management and excellent customer relationships, again, the right customers.

In the quarter we benefited from new fee-for-service agreements that continue to reflect our value to our manufacture partners. Of particular note, we have signed an agreement with Pfizer, our largest supplier, with a fee-for-service provision to take effect January 2010, about one year from now. As I have noted previously, our relationships with our manufacturers, in part due to fee-for-service, have never been better.

Although it is early in the year, we expect brand name price increases in the 5% range, or slightly higher, in line with our earlier expectation, mitigated of course by our fee-for-service agreements.

AmerisourceBergen’s Specialty Group, ABSG, had a strong quarter across its broad spectrum offering with revenues up 5% and an annual run rate now of over $15 billion. Our oncology supply group was up 3% over last year. Although the ESAs’, erythropoietin stimulating agents, continue to be down this year versus last year and last quarter as expected, other products and services more than outpaced the shortfall. We continue to be extremely well positioned in the specialty business with a broad offering of solutions to both manufacturers and physicians that is unequal in the market. Our services business had particularly good performance this quarter.

AmerisourceBergen Packaging Group, APBG, is on track to meet our expectations for the year and is extremely well positioned to benefit from the continued manufacturers outsourcing of packaging we expect.

The AmerisourceBergen management team is now totally focused on the pharmaceutical distribution and related services business and that focus continues to drive performance.

Since we expect to generate significant cash this year and with the continued financial turbulence in the market, it is appropriate to reiterate our position upon acquisitions. We are receptive to acquisitions and have spent over $1 billion in the last seven years on acquisitions. Our largest, Bellco Health, at $162 million was completed last year. We have said that the $200 million or so acquisition in our basic business for pharmaceutical distributions including specialty or related services like packaging would have appeal to us, but we would consider something larger in this space if it made sense. Although no acquisitions are contemplated in our guidance, if the tightened credit market results in unforeseen opportunities we are in an excellent position to respond quickly both financially and organizationally.

Before I turn the floor over to Mike for some added color, I want to emphasize my optimism for the wholesale pharmaceutical distribution industry and ABC’s position in that industry.

The fundamentals of the industry continue to be strong as far out as any of us can see. The ABC circle of life continues to hold. The older people get the more drugs they take, the more drugs they take the older they get. The growth engines for ABC, generics and specialty, continue to be the premier space within the industry. At our investor day we described our company and industry as resilient and that description continues to hold in the current financial environment.

Our guidance remains unchanged from that provided at the beginning of our fiscal year. In anticipation of your question, this January is off to a nice start, but it is still early in the quarter and of course early in the year.

Here is Mike.

Michael DiCandilo

Thanks Dave and good morning everyone. I am very pleased to report on a quarter that is solid in every respect and very straightforward, with earnings above expectations for the quarter. It is a tremendous start to a new fiscal year and should give everyone even more confidence in our ability to deliver strong results in a tough economic environment.

Our growth drivers of generics and specialty were very much in evidence during the quarter and combined with stellar expense control generated operating margin expansion.

In addition to our operating income growth our significant year-to-year share reduction helped us generate very nice double-digit EPS growth. We continued to manage our working capital very well with our normal seasonal increases in inventory and we reduced DSO’s both sequentially and on a year-to-year basis.

Now I am going to turn to the income statement which I will walk down starting with our top line growth.

Revenues increased 0.3% from the prior year in line with our expectations. Net of the decline in Walgreens’ warehouse sales, which we discontinued on July 1 of 2008, sales would have increased 4.8%.

Drug Company revenues were down 1% as very impressive 9% growth in institutional sales, including the growth of sales to our largest PBM customer, nearly offset the reduction in Walgreens’ warehouse sales.

Our specialty group grew 5% despite one month of OTN sales still remaining in last years quarter, with strong growth broadly across virtually all of its distribution and services companies. Our scale in specialty distribution combined with the breadth of our value added services to biotech suppliers and physicians uniquely positions us as the leader in this fast growing segment of the market.

The packaging group, which represents less than 0.5 of 1% of our total revenue, but 5% of our operating profits, was down in total revenue versus the December quarter last year due to delays in certain of its customers receiving FDA approvals for new drugs, but continues to be on track to meet forecasts in fiscal 2009 as the contract packaging outsourcing trend remains very favorable.

Gross profit margins in the quarter were up a strong three basis points versus last December driven by the double-digit growth in our proprietary PRxO(R) Generics Solution program, increased contributions from our fee-for-service agreements and good profit growth in our Specialty Services companies.

We did have two gross profit items of note in the quarter which had the net effect of offsetting each other. First, during the quarter we signed several new fee-for-service agreements and recognized $10 million of fees in the quarter related to prior periods as a result of signing the new contracts. This benefit to gross profit in the quarter was offset by the second item, a loss on our flu vaccine program of $13 million. This loss was primarily due to a write-down of excess flu vaccine inventory at the end of December as a result of a soft flu season. To put this into perspective, our total flu vaccine season revenues were under $100 million and our total gross profits for the season, which encompasses flu sales in both the September and December quarters and also includes the inventory write-down, was a loss of approximately $1 million.

Turning back to our prior year quarter, last December’s gross profit included $11.6 million of litigation gains, including $10 million from a competitor and $1.6 million from supplier anti-trust litigation. Excluding these items from the prior year gross profit, our gross margin would have been up nine basis points in our current year quarter.

Our LIFO charge in the quarter was $5 million versus $3 million in last year’s quarter, reflecting a strong supplier price increase environment.

Operating expenses in the quarter, excluding facility consolidation and employee severance costs, were down slightly compared to last year, consistent with our guidance for the full year. This decrease represents our continued discipline and attention to costs at every business unit and corporate department through out ABC and is reflective of our CE 2 customer efficiency cost effectiveness philosophy. This decline was achieved despite increased investments in our business transformation program as we outlined during our Investor Day in December.

As a reminder, we expect to spend $100 million during fiscal 2009 on our ERP enabled business transformation program, 2/3 of which we expect to capitalize and 1.3 of which we expect to impact operating expenses.

From an operating margin perspective the combination of increasing gross profit margins and expense control led to three basis points of operating margin expansion in the quarter, in line with our guidance of low to mid-single digit basis points operating margin expansion expected for fiscal 2009.

Interest expense of $14 million declined 14% from the prior year quarter due to lower net borrowings and reduced variable borrowing rates on our revolver.

Our effective tax rate in the quarter of 38.6% was up slightly over last year and we continue to expect our annualized effective rate to be in the 38.4% range.

Our EPS growth from continuing operations of 12% exceeded our income from continuing operations growth of 4%, due to the significant $12 million or 7% reduction in average outstanding years, compared to last December’s quarter, primarily as a result of our share repurchase program over the last 12 months. Excluding the prior year quarter benefit from litigation gains net of special items of $0.04, EPS from continuing operations in the quarter of $0.73 were up a very impressive 20% compared to last year.

Now let’s turn to our cash flow and the balance sheet.

We used cash from operations in the quarter of $304 million compared to usage of $101 million in the prior year December quarter. As a reminder, we typically build our inventories by two to three days in the December quarter to prepare for supplier closings for the holidays which, combined with payables timing, often results in cash usage for our first fiscal quarter. Inventories are already down in January and we continue to expect to generate free cash flow in the range of $460 to $535 million for the full year in fiscal 2009.

We had $42 million of capital expenditures in the quarter and continue to expect approximately $140 million of CapEx for the year. From a statistical stand point DSO’s were down ½ day from last year and averaged 18.3 days for the quarter. I know that customer payment insolvency trends are on everyone’s radar in this economic environment and we continue to be pleased with the decline in our DSO and to date we have not seen any deterioration in our customer aging.

Obviously we are going to continue to monitor the financial health of our customers very closely and we are well served by having a diverse customer base that lacks significant customer concentration, with Medco being the only customer contributing greater than 10% of our revenue or receivables.

Our average inventory days on hand during the quarter declined by ½ day to 26 days and average payable days were up about a day from last year.

From a share repurchase perspective we bought back $88 million of our shares during the quarter and continue to expect to purchase approximately $350 million of our shares for the full year.

Our gross debt to total capital ratio at the end of December was 30.4%, in line with our stated goal of 30% to 35%.

Now turning to our fiscal year 2009 guidance, our diluted EPS from continuing operations range of $3.08 to $3.25 per share remains unchanged, as do the assumption supporting that range of 1% to 3% revenue growth, operating margin expansion in the low to mid-single digit basis point range; free cash flow of $460 to $535 million; and share repurchases of $450 million evenly through out the year.

To summarize, another strong quarter and a great start to fiscal 2009 driven by both our growth engines, generics and specialty, with the expense in working capital management you expect to see from us.

Now I will turn it back to Mike Kilpatric.

Michael Kilpatric

Thank you, Mike. We will now open the call to questions. I would ask you to limit yourself to one question and a follow-up until we have had an opportunity for everyone to have a chance and then you may ask additional questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Glen Santangelo with Credit Suisse.

Glen Santangelo - Credit Suisse

I just have two quick questions. In your opening remarks you kind of suggested that you saw revenues in your generic program up double digits. I am kind of curious, is that really just a function of the patent expirations, or are you seeing some increased penetration within your customer base in terms of your generic book of business? What I am really trying to get a sense for is as the generic fill rate climbs is anybody trying to purchase generics on their own or are your clients basically coming to you more with the help of your generic One Source program.

David Yost

I am glad to answer your question. It is a function of three things. It is a function of new products increased utilization, but increased penetration as well. I would say, to answer your question specifically about our customers, we find our customers relying on us more and more for their generic decisions and it is a great value that we bring to them by searching the market for the best value in generics and in bringing that to them. Generics continue to be a big emphasis for us and it is definitely getting some traction. Thank you for the question.

Glen Santangelo - Credit Suisse

Dave, maybe I could ask a follow up question on Longs. Now that the CVS merger is kind of closed, I think you have some contract protection through some point in 2010 or 2011. Have you really had any kind of conversations with Longs kind of post that deal closing and do you have any sense for, kind of, what they may be thinking?

David Yost

We really haven’t Glen. I mean our focus at this point has been on the integration. Assisting them, assisting CVS with the integration of Longs. That is our primary focus and we really don’t have anything new to report on the status of our contract or Long ongoing relationship.

Operator

Your next question comes from John Ransom with Raymond James.

John Ransom - Raymond James

Some of the early data out there suggests a little bit of a rebound in prescription volumes in January. Do you think this is a head fake or a couple of weeks of bad data or are you seeing any signs that the market might be stabilizing to rebounding?

David Yost

First of all, we said on a number of occasions, I think you have to be a little careful with just looking at prescription data, because whether the prescription is a generic or a brand name makes a big difference to us. Whether it is a 30-day supply or a 90-day supply makes a big difference to us. Whether it is specialty drug or a traditional drug makes a big difference. More to the point I think you have to be really careful about looking at short-term trends within a week or two to figure out what is going on long-term.

You described it as a head fake, but I think you just have to be careful with short time frames.

Operator

Your next question comes from Larry Marsh with Barclays Capital.

Larry Marsh – Barclays Capital

Dave, it didn’t take long for you to communicate some good news on Pfizer moving to a fee-for-service relationship. I know you sort of threw out a provocative statement, the Analyst Days, so that was that. I would like to get a little bit of elaboration now that it is official as to the supplier’s thinking along the process, because they were obviously very adamant about not doing it.

Then how do we think about your other big hold [inaudible] who I think you also said could move to a fee-for-service in the next couple of years.

Then finally how do we think about impact, if any, on kind of the quarterly trends starting next fiscal year?

David Yost

We think Pfizer signing is a good endorsement of fee-for-service. We have said all along that we think the fee-for-service brings mutual benefits to both sides, you know the trading partner relationship, and we think Pfizer moving in this direction, even though it doesn’t take effect until 2010, is a good sign for us and for the industry. We are a little uncomfortable talking about the specifics of it, but we think it is a very good sign. There is one of our other large suppliers who does have a fee-for-service agreement, but it doesn’t have man of the traditional functions, so we hope that they would view this as positive.

Mike do you have anything to add to that?

Michael DiCandilo

Yes, just from the quarterly trend perspective, Larry I think as we get into 2010 you will see more of an equal spreading of the profit that we made from that agreement. Historically it has been concentrated in the March quarter, because they have had large January price increase for a number of years, with some spill over into the June quarter, and I think you will see that leveled across the entire year.

Operator

Your next question comes from Eric Coldwell with Robert W. Baird & Co. Inc.

Eric Coldwell - Robert W. Baird & Co. Inc.

Most of my questions were addressed, but I was just hoping we could get the quantification on the ESA results besides the qualitative comments. Could we get the nominal dollar sales in oncology related ESA’s and also the trends on growth quarter-to-quarter and year-on-year.

David Yost

Eric, just as a reminder to everybody, our expectation was that the ESA sales would be down in fiscal 2009 about 20% from their run rate in the fourth quarter of fiscal 2008. In the quarter they were down about 12%, so a little bit less than the 20% we expected. That still remains our expectation for the year and as a total percentage of revenues in the oncology related ESA’s are still just under 2% of our total revs.

Operator

Your next question comes from Lisa Gill with J. P. Morgan.

Lisa Gill - J. P. Morgan

Dave, can you maybe just go into a little bit more detail on what you are seeing on fee-for-service agreements? I mean it was what five years ago that the first agreements were signed. Now we are finally getting to where everybody will be under fee-for-service. Are you seeing the increase every year that we had anticipated five years ago, as far as, as you do more services that he manufacturers are paying for that?

Then secondly, Mike if you could comment on specialty. I mean specialty is a way that Amerisource has differentiated themselves in the market place and it is clearly a higher margin business. Can you maybe put some parameters around what that has contributed to your growth as far as the three basis points? Did one basis point of that come from specialty?

David Yost

We may chime in on both of these together, Lisa. First of all, on the fee-for-service I will tell you, I think I have said on a number of occasions, you know this is a new way we are going to do business and I don’t think anybody is going to go back any other way.

I would say that the discussions and negotiations we have had as we have moved into the second, you know our third generation fee-for-service, have been good both for us and the manufacturer. I think what fee-for-service allows both of us to do is to focus on what is important to the manufacturer and the way to tell what is important to the manufacturer is what he is willing to pay for and what he is willing to incentivize us to do. We are very happy with how it has progressed and we continue to get more efficient in the eyes of meeting the expectations of the manufacturers as we go forward.

The one point I would make about the specialty business, I just want to emphasize in the specialty business how important all the value added services that we provide in this business are. It is not just about distributing the product; getting it to the right place, at the right time, at the right price, which continues to be very, very important, but it is all of the ancillary services that we provide both to the physician who is frequently dispensing this product and the manufacturer as well. It continues to be a business that we like a lot. It has great growth potential. As we go forward, particularly as we [lack] the erythropoietin issues, we are excited about the space of new products coming there.

Michael DiCandilo

To add on to what Dave said, and as a result of a lot of those value added services, the guidance we gave back at Investor Day was we would expect operating margins in the specialty group to be in the range of 155 to 165 basis points for the year, which is substantially above the operating margin guidance we gave for the drug company, which in the 103 to 109 basis point range. To the extent that specialty grows faster than the drug company, at those higher margin rates it does contribute an increasing share of that gross profit growth. I think those are the parameters that people should have in mind.

Operator

Your next question comes from Robert Willoughby with Banc of America Securities.

Erin Wilson- Banc of America Securities

Thanks, this is Erin Wilson actually, in for Bob today. Most of our questions have been answered, but do you have an estimate of what facility consolidation costs will be for the year?

Michael DiCandilo

Yes, we expect them to be pretty low for the rest of the year. What we had in the first quarter was a little bit of a continuation of our CE 2 program and also reflected the consolidation that we continue to do up in Canada where we’ve reduced the number of DCs, particularly in the Montreal and Toronto area. So X this quarter, I think very minimal costs are forecast for the rest of the year.

Operator

Your next question comes from Ricky Goldwasser with UBS.

Ricky Goldwasser - UBS

First of all on the generics side you talk about the revenues up double digits. What do you think the growth was for the market? Is the growth you are seeing above market or in line with it?

Then there were a number of products that moved from exclusive status to multiple players in January. Is the environment you are seeing around these products in line with your expectation?

Then lastly, on the specialty question, what are the normalized growth rates for specialty going forward? I mean this quarter, obviously, there was still the OTN set back, but starting next quarter what should we be factoring in for the top line on the specialty side?

David Yost

The first question, Ricky, in terms of the market growth we think we are growing faster than the market, because we are getting increased penetration with our customers on the generic side. So, we think our double-digit growth is outpacing that in the marketplace.

Mike, do you want to talk about the other?

Michael DiCandilo

Yes. In specialty, Ricky, I think our guidance for the year is 5% to 7% and in the first quarter the 5% reflects that fact that we still had a bit of an anniversary issue with OTN. Actually OTN sales in October of last year their revenues would have been up closer to that 7% figure. As we move through out the year I would expect them to be in a little bit of a higher end of that range.

David Yost

Traditionally the specialty business, or what we call the specialty business, has grown about 2x what the overall market has. Since we have such a large share of the market it is hard for us to dramatically out perform that. But, I think going forward, thinking in broad terms, the specialty market growing twice that of the traditional market is probably the right range.

Operator

Your next question comes from Charles Boorady with Citigroup.

Charles Boorady - Citigroup

First, can you identify some of the main specific sources of operating expense reductions in the quarter and size the opportunity for additional reductions over the course of this year and next?

David Yost

I will tell you it is really broad based. When I talk about it being a mind set and this CE 2 being a philosophy I really mean that. I was just recently in the center of Sacramento, you know a distribution center; Mike and I walked in there and I will tell you they outlined half a dozen items that had not been present the last time I was there. It is just a demonstration of how it has really gotten down to the grass roots level.

You will recall we streamlined our executive ranks, so we have hit both the top end of the expenses and the bottom end. We are very excited about our business transformation, which we are looking to have technology replace some of our expenses. I will tell you, there is just not a single expense that we do not challenge. We have got our associates very involved in this. It is not unusual for me to get a couple of emails a day from associates with some ideas on how we can save some money.

So, I think we have been successful in really getting that operating philosophy pushed down to our people I do a little video at the end of every quarter for the associates and it is one of the things we start out with. So, I think we have pressed that down and we are not done. I mean, I think we can continue to drive costs out of the system as we go forward and we are very optimistic that we will continue to run this business with the same dollars this year that we ran last year.

Operator

Your next question comes from Charles Rhyee with Oppenheimer & Co.

Charles Rhyee - Oppenheimer & Co.

I have two questions; the first one is for Dave. You know at the beginning you talked about the potential for healthcare reform here and you highlighted access to pharmaceuticals as a positive. Can you perhaps address the potential on the flip side as government takes a better stake in providing healthcare? You know the concerns over price controls on drugs itself?

Then secondly I have a question for Mike. I think last year when you were providing guidance you talked about access to commercial paper to fund daily working capital was sort of limited, meaning that you wanted to keep more cash on hand to fund daily working capital. Can you give us a sense on what is happening in the commercial paper market; are you back into it and what do you think going forward here?

David Yost

From the 50,000 foot level of how the additional pharmaceutical coverage gets reimbursed is still being kicked around. I would not be surprised, though, that if the pharmaceutical coverage increases it could very well involve some kind of rebates or the like from the manufacturer participants that could in fact be directly to the government. I think those details remain to be seen, but what is really encouraging to us is the fact that in the discussions that are on going in Washington, and we are participating in them, the efficacy of pharmaceutical therapy is being acknowledged.

The issue here, particularly for the uninsured, is the uninsured are getting coverage now. They are frequently getting it in the hospital emergency room which is the most expensive medium for the care to be administered. So, if you can increase the pharmaceutical coverage, if you can get people on pro-active therapies, you can keep them out of the emergency room. There is a very high likelihood here that this could be a self-funding initiative. That the amount that is saved through people, the uninsured, showing up in emergency rooms you can actually fund the pharmaceutical therapy.

The good news is that this is a very positive discussion that is going on. As I mentioned in my prepared remarks, when the stimulus program is addressed, and I think we are talking about days for that, I think the next issue that is going to be addressed is healthcare. At this point the devil is in the details, of course, but we are very encouraged by the dialogue that is taking place and the prominence that the pharmaceutical therapy is taking in that discussion.

Michael DiCandilo

Charles, in regard to the liquidity market, certainly the last time we talked I think was in regard to the Lehman Brothers issue and the freezing up of the commercial paper markets. I think with the government intervention that has happened since then the liquidity markets have eased up some and we like most others are able to access those market pretty readily at prices that have really normalized. I think our borrowing costs under both our revolving credit facility and our securitization facility, which accesses the commercial paper market, averaged between 3% and 4% for the quarter. That was actually down from short-term rates that were in the 5.5% range or so last year and it was one of the reasons our interest expense was down.

So, we feel a lot better about the short-term markets. The long-term capital markets are still tight and rates are still very high versus norms, so I think we are going to continue to tread cautiously and keep our eye on the environment. We are very happy with our balance sheet today and the flexibility that it gives us.

Operator

Your next question comes from Richard Close with Jefferies & Co.

Richard Close - Jefferies & Co.

Mike, I think you said the ESAs you were looking for, part of your forecast was down 20% in fiscal ’09 from the fourth quarter run rate, and you mentioned, I guess, down 12% in the first quarter. It seems you are doing a little better than you thought at the beginning of the year. Is there any reason that we would move backwards towards that 20% down year over year?

Michael DiCandilo

I think you are right Richard, we did do a little bit better than we expected, but we are going to continue to have the 20% guidance. It is early in the year. I don’t think there has been any new news that would generate any further reduction, but I think it is still early and we will keep that guidance right now.

Operator

Your next question comes from Helene Wolk with Sanford C. Bernstein & Co.

Helene Wolk - Sanford C. Bernstein & Co.

I have two questions, first starting with the gross margin improvement. I wanted to understand what the mix is between the progress on generics and specialty versus the loss of the Walgreens contract and the low margin of that contract.

Secondly, on the restructuring charges on the expense management side, with the bolus of restructuring in Q1 should we expect a bolus of savings and what is the timing expectation around those?

Michael DiCandilo

I will handle the first one. From a gross margin improvement perspective I think the order that we had some of the comments in really determined the magnitude of their importance. Certainly the generics growth, I think, was far and away the most important element of the gross margin improvement. Certainly our mix was helped by the loss of the low margin warehouse business, but some of our growth also came from some of our larger customers, who received very favorable pricing and some of that was offset. Far and away I think the generic double-digit growth was the most important factor. I would say second was the growth in the specialty services.

David Yost

Helene, what was the question on restructuring? I missed that.

Helene Wolk - Sanford C. Bernstein & Co.

On the restructuring charges in Q1, which you mentioned or stated on the call, would be significant relative to the balance of the year, should we expect some pay back or you talked about closing DCs. Should we expect to see some pay back or expense savings on the operating expense line and how should we expect those to flow on terms of the progression?

David Yost

First of all Helene, before Mike gets into the details, I want to make sure you understand that we do not anticipate closing any distribution centers during the balance of this year, so I want to make sure that we make that clear.

Michael DiCandilo

The amount of the costs that we did incur during the quarter were $1 million Helene, so it is not a huge amount in relation to our total expenses. As I mentioned, some of that came from our CE 2 program and those savings are built into our forecast for the year of expenses being down versus fiscal 2008. Some of that came, as planned, from some of the Canadian consolidation work that we have done and that is also factored in our guidance of expenses being below last year.

Operator

Your next question comes from Harlan Sonderling of Columbia Management.

Harlan Sonderling - Columbia Management

My question is for Mike on the cash use in the quarter. It is materially above that of the cash use in the prior year period. I wanted to know is that simply opportunistic buying by you and what might the prospects be going forward?

Michael DiCandilo

The cash usage was $300 million in a quarter as we stated versus $100 million last year. A lot of that was due to the inventory build up that we would normally have from a seasonal perspective and some timing in the accounts payable. One thing to keep in perspective is that this is a business that does $200 million a day in activity and whether the month end is on a Monday versus a Tuesday versus a Wednesday can have some impact on timing at the end of a quarter and I think that is all we saw at the end of December.

I think I mentioned during my comments that the inventory levels that increased significantly between September and the end of December are already down in January. So that inventory increase that we saw has flowed through and we don’t see any change to our estimates for the entire fiscal year where we continue to expect our free cash flows in the $460 t0 $535. So, just a little bit of timing in how we built the inventory and how the payables came through, but no real changes from historical trends that should impact us for the year.

Operator

Your last question is a follow up question from John Ransom with Raymond James.

John Ransom - Raymond James

You sound like you are a little more willing to use your balance sheet on the acquisitions side. Could you just tell us what is out there? I mean I know there are a couple of regional wholesalers left, but what kinds of things are out there that they could move the needle?

David Yost

Well you know John there continue to be opportunities out there. There are a half dozen or so regional wholesalers out there. There are still a couple of co-ops that are out there. Within the specialty business there are some specialized companies that could broaden our broad service offerings.

We definitely keep our eye open. In these turbulent financial times what may well happen is that smaller companies who had trouble accessing the credit market in the past might have a little bit more trouble and might appeal to us. We are very receptive, as I mentioned. The biggest one we have done was last year, Bellco. I will tell you, one year later we are very happy with how that acquisition turned out.

Michael Kilpatric

Now I would like to turn the call over to David to make a few final remarks.

David Yost

Thanks everybody. Again, I want to just thank you all for joining us and just tell you that we continue to be very optimistic about our industry and the position that we have within that industry. We think our key growth drivers of generics and the specialty are the premier space within a premier industry. We look forward to sharing our continued success with you in April when we announce our second quarter fiscal results.

Thank you very much.

Operator

Ladies and gentlemen, this conference will be available for replay after 1:00 pm today until January 29, 2009 at midnight. You may access the AT&T Executive Playback Service at any time by dialing 1-320-365-3844, entering the access code 980631.

That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service.

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Source: AmerisourceBergen Corporation F1Q09 (Qtr End 12/31/08) Earnings Call Transcript
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