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Executives

Barbara A. Brungess - Vice President of Corporate & Investor Relations

Steven H. Collis - Chief Executive Officer, President, Director and Chairman of Executive Committee

Tim G. Guttman - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Analysts

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Glen J. Santangelo - Crédit Suisse AG, Research Division

Robert P. Jones - Goldman Sachs Group Inc., Research Division

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Ricky Goldwasser - Morgan Stanley, Research Division

Lisa C. Gill - JP Morgan Chase & Co, Research Division

John W. Ransom - Raymond James & Associates, Inc., Research Division

AmerisourceBergen Corp. (ABC) Q3 2013 Earnings Call July 24, 2013 11:00 AM ET

Operator

Ladies and gentlemen, we'd like to thank you for standing by and welcome to the AmerisourceBergen Third Quarter Earnings Teleconference Call. [Operator Instructions] As a reminder, today's conference call will be recorded.

I would now like to turn the conference over to your hostess and facilitator, Ms. Barbara Brungess. Please go ahead, ma'am.

Barbara A. Brungess

Thank you, Stephen. Good morning, everyone, and welcome to AmerisourceBergen's Earnings Conference Call covering our third 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, as well as our quarterly filings for fiscal 2013.

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

Steven H. Collis

Thank you, Barbara, and thank you to everyone for joining us this morning. I am pleased to report solid performance for AmerisourceBergen in our third quarter and first 9 months of fiscal 2013. Let me start by highlighting a 13% increase in revenue, which was driven primarily by our base business and less of a headwind from generics. During the quarter, we have had only a modest amount of new volume from our Walgreens contract. As we look ahead to the end of our fiscal year '13, while there are obviously still some moving pieces that could potentially impact our results, we are comfortable narrowing our forecasted range for adjusted earnings per share from continued operations for the full year to $3.06 to $3.11.

As we reviewed our performance, it was clear to me that, as usual, AmerisourceBergen accomplished a great deal in the June quarter. Our priorities continue to be to strengthen our business, advance our strategic initiatives and generate long-term value for all of our stakeholders. In accordance with those objectives, we completed the divestitures of our Canadian drug wholesale business and our contract packaging business. Most significantly, we obtained regulatory clearance for the equity portion of our new long-term strategic relationship with Walgreens and Alliance Boots. In light of the expansion of the scale of our business, we improved our financial flexibility by commensurately expanding borrowing capacity under our revolver and securitization programs. Our associates have worked tirelessly on these diverse objectives while keeping their eye on the ball and ensuring that our current business is performing well, and we continue to meet and exceed the expectations of our customers and the patients we all ultimately serve.

It has been just over 4 months since we announced our strategic relationship with Walgreens and Alliance Boots, and I am more convinced than ever that we have before us, an incredible long-term opportunity, not only to increase efficiency with which healthcare is provided in the U.S., but also to expand the reach of pharmaceuticals across the world and improve patient access to medications across many geographies. Working in conjunction with Walgreens and Alliance Boots is proving to be very collaborative as we work to implement the 3 key components of the relationship, namely, the pharmaceutical distribution agreement with Walgreens, the access to the Walgreens and Alliance Boots purchasing joint venture and the leveraging of our collective strengths in different platforms, both domestically and internationally. In addition, we always believe the equity warrants that were issued as part of the agreements not only gives our partners the opportunities to share in our future success, but also clearly differentiates our relationship. We are proud to be collaborating with 2 of the world's leading and most successful healthcare companies, and I am very pleased with the energy and creativity with which we are moving forward.

In our various customer and manufacturer meetings, I am constantly reminded how fortunate we are to play such an integral role in the changing health care landscape. The health care marketplace is one of the most complex in the world, but we believe that complexity yields opportunities. AmerisourceBergen's diverse range of services and unique scale and reach places us in a pivotal position to take advantage of both opportunities by improving the efficiency with which products are launched, distributed and dispensed, and by helping to ensure that patients have access to the full complement of therapies that are available today. The strategic initiatives we have undertaken in the last several months have strengthened our ability to provide greater service and more innovative solutions to all AmerisourceBergen's customers and to all of the manufacturers whose products we distribute and support in the marketplace every day. The increasing rate of change demand that we continuously explore ways to drive efficiency without sacrificing the quality of care and service delivered, and we are excited to be able to do that with the help of global partners.

Turning now to the performance of our business units in the June quarter. Revenues in AmerisourceBergen Drug Corporation were up 16% due primarily to an increase in sales volume relating from our previously announced new contract with our large PBM customer, and less of a headwind from generic conversions in the quarter. ABDC's revenues will continue to ramp up in our fourth quarter as we begin to serve all of Walgreens stores under our new contract.

We are making great strides in preparing our network for the on-boarding of the Walgreens pharmacy distribution business. In addition to increasing capacity of certain aspects of our infrastructure, we are running pilot programs which, to date, have enabled us to transact with about 6,000 of Walgreens pharmacy locations on a daily basis. That number will continue to increase as we approach the September 1 start date of the new contract. Pharmaceutical Distribution is, of course, our primary area of expertise and the foundation of our business, and we remain quite confident that we can provide outstanding service to Walgreens without sacrificing any of the excellent service our other customers have come to expect from AmerisourceBergen.

Over the last several months, we've had an open dialogue with our customers about what a stronger AmerisourceBergen could ultimately mean for them. Tomorrow, I'll be attending our annual retail tradeshow in Las Vegas where we will be showcasing our vision for the future of pharmacy and renewing our commitment to our independent customer base. Whether it's through an improved Pro Generics formulary, proprietary franchise store products, new shared clinical systems that will facilitate third-party contracting or enhanced payer relationships, our partnership with Walgreens and Alliance Boots will help drive compelling new offerings for our independent customers in the years ahead. Our new partners share our goal of strengthening Good Neighbor Pharmacy and enhancing the role community pharmacy plays in the provision of health care. We absolutely believe that the innovation that this new relationship will inspire will drive the next generation of services to our community pharmacy customers, and we believe that this message is being understood and accepted by the marketplace.

Our institutional segment, including both hospitals and alternate sites, continues to perform very well. Our efforts to expand some of our best-in-class specialty capabilities into the hospital market to support physicians who treat oncology patients continue to gain traction as many of our large health system customers expand their outpatient offerings.

As the specialty market evolves, the breadth of our expertise is more important than ever. The collaborative approach we've deployed over the last few years, both internally and externally, drives us to utilize all the capabilities of ABC to meet evolving customer needs. Our work in this area is one of the best illustrations of how we can drive mutual value for our customers by leveraging our portfolio across different size of care.

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 contract, the loss of Topco and fewer significant generic launches available to offset that pressure in the quarter. As expected, trends in brand inflation, generic utilization and even generic price inflation continue to be strong. As I have mentioned previously, we have had very difficult comparisons on generic launches in fiscal 2013, but those improved in fiscal 2014. This was our first full quarter that all of our DCs were operating on SAP, and we are very pleased with the performance of the system and advanced business analytics that this system affords us. The SAP implementation was, from planning to completion, over 5 years of incredible effort by ABC associates. It is that system that has really placed us in a position to essentially double our volume over the next year or so, and I am incredibly grateful for the professional effort that so many people at ABC contributed to at the highest level that got us to this position today.

AmerisourceBergen's Specialty Group revenues were up 5% in the quarter due to strong sales in ASD and Besse. As expected, our Oncology business slowed in the quarter on a year-over-year basis as physician practices continue to face economic challenges in the face of declining reimbursement rates. Specialty physicians continue to work through the significant reimbursement cuts that resulted from sequestration. And while all practices are challenged, the smaller practices are hit the hardest. We continue to work in Washington to help members of Congress and regulators at CMS and elsewhere to make sure they understand the full impact the cuts have had not just on physician impacts, but also on patient access. We believe that in order for the health care system to operate at optimum efficiency, health care providers must be fairly reimbursed for the services they provide to all payer categories. We also continue to believe that patients are best served in the community practice setting. Not only do patients tend to have better outcomes being treated in a dedicated specialty setting, but current data supports that the cost of care is lower in the community setting. We are hopeful that at a minimum, the sequestration cuts will be reversed in the current months. But at this time, it is difficult to know when or by what mechanism that would occur.

While Oncology Supply sales declined year-over-year, sales stabilized on a sequential basis. Fortunately, as Oncology sales have slowed, our other Specialty businesses have continued to grow above market by winning unique distribution opportunities and progress. These businesses do have somewhat lower margins than the Community Oncology business does, so there's been a mix shift towards lower margin business within ABSG, and their growth was not enough to overcome the decline in operating margin contribution from Oncology Supply. While the specialty market is changing and working to near-term challenges, the expertise and capabilities we've developed over the years and investments we've made help ensure that we are the premier partner for manufacturers of specialty products and for providers who administer specialty products to patients.

Turning now to the Other segment that is comprised of our manufactures services businesses, revenues were up 17% due in large part to contributions from World Courier, of which 1 month was not included in the prior year. Operating income was up 18%, driven in large part by good performance in World Courier. We continue to be very excited about the long-term potential for our manufacturer services businesses both in the U.S. and elsewhere in the global marketplace.

Looking ahead, we are still working through our detailed business planning process and will give our full fiscal 2014 guidance in our new fourth quarter call. As we have previously stated, we expect our new Walgreens contract to provide incremental revenues of $25 billion in fiscal 2014, and to contribute a net $0.20 of adjusted earnings per share in fiscal 2014. As we on-board the Walgreens contract, we will see further operating margin degradation. But once we anniversary that impact, we expect to return to a model where we are able to meaningfully increase our operating margins on an annual basis.

There are many moving parts in late fiscal 2013 and 2014 in addition to activities and cost associated with on-boarding Walgreens. These tailwinds include more generic launches in fiscal 2014 versus 2013, better industry top line growth due to the generic calendar and the gradual influx of the uninsured into the health care system. The headwinds include unplanned expenses of at least $10 million in our distribution segment to comply with now pending track and trace regulations, and continued pressure in our Oncology business at the current run rate. This headwind could be mitigated if reimbursement rates improve. But it could also -- would be worse if low reimbursement rates persist and physician practices increasingly struggle with the economics.

Overall, our base business is solid, and we do not have any large contract renewals on the horizon. Our business also provides us with tremendous cash flow, and we anticipate that cash flows will be strongest in the second half of fiscal 2014. While ABDC has plenty on its plate at the moment, we continue to look for opportunities to invest in our platform to provide for sustainable long-term growth. We believe the scale and breadth of our offerings sets us apart in the industry and is a key driver of our future success. It is an exciting 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 am confident that our associates will continue to bring innovative and market-leading solutions to all of the challenges and opportunities that lie ahead, and that we will continue to meet the expectations that all of our partners have in us.

Now, Gary's turn.

Tim G. Guttman

Thanks, Steve, and good morning, everyone. As has been our practice, my comments on our financial results will be on a GAAP basis. As expected, we have 2 unusual material expense items that are negatively impacting our June 2013 quarterly results, the LIFO charge and the equity warrant expense.

Our LIFO charge was exceptionally high at $122 million, and the warrant expense was $36 million. As a reminder, our previous EPS guidance excluded these 2 items due to their variability and difficulty in forecasting. For clarity, I will provide additional comments this morning on our adjusted results, which will exclude the impact of these 2 noncash expenses.

We now have 9 months completed in our fiscal year 2013, and we're pleased with our progress in tracking to our expectations. The highlights for the June quarter include solid top line growth in our core drug business, very good operating performance in our World Courier business and excellent free cash flow of $681 million through the first 9 months, slightly ahead of our expectations and setting us up well as we prepare to implement the Walgreens contract.

Let's start our review of our quarterly results. Keep in mind that we sold our Canadian drug distribution business and our contract packaging business this quarter. Their operating results are reflected as discontinued in both the current year and in the revised financials for the prior year. In addition, this marks the last quarter that we have an incremental benefit from the World Courier acquisition in our financial results as we have now anniversaried the May 2012 acquisition date.

Revenues were $21.9 billion, up 13.3% percent compared to last year's quarter. Our revenue growth was primarily due to our large PBM contract that began last October, and a much smaller headwind from brand-to-generic conversions.

Gross profit decreased to $562 million due to the LIFO charge of $122 million that I mentioned previously. This charge represents 9 months of our anticipated full year or annual charge. As expected, this charge is material due to the substantial brand inventory build, over $1 billion, we will have in the fourth quarter as we prepare for the Walgreens business beginning in September. Based on current inflation and inventory mix estimates, we'd expect our Q4 LIFO charge to be in the $50 million range. Our gross profit also included about $6 million of antitrust litigation settlements received in the June quarter. Excluding the LIFO charge, our gross profit would've increased nearly $17 million or about 2.5% due to the 1 extra month of World Courier contributions of about $30 million. 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, total operating expenses were $428 million, up about 24%. Our operating expenses are impacted by the 1 extra month of World Courier's operations. Demonstrating our focus on expense management, our operating expenses for the Pharmaceutical Distribution segment are up only 2% year-over-year, while revenues have increased significantly.

Incremental operating costs specifically to support the new Walgreens distribution contract were not meaningful this quarter. These costs, primarily labor and IT cost, will ramp up beginning in early Q4.

Included in GAAP operating expenses is warrant expense of $36 million. The current value of the warrants at June 30, 2013, as determined by an independent third party, was $467 million, which is an increase of about $153 million from the March 31 value. The increase in the warrant valuation is due to the increase in the ABC share price and also the increase in the ABC share price volatility assumption.

This quarter we also had special charges of about $20 million or an equivalent $0.05 negative EPS impact, primarily related to professional fees associated with completing our Walgreens and Alliance Boots transaction. Included in this $20 million amount is also a loss related to subleasing a closed distribution center below our current lease cost.

Operating income. Our operating income was $135 million. However, backing out the LIFO charge and the warrant expense, our adjusted operating income would have been $293 million or a decrease of about 10%. The decrease is due to lower gross profit in our Pharmaceutical Distribution segment and the additional onetime special charges that I just discussed.

Our adjusted operating margin was 1.34%, down by 34 basis points compared to last June quarter.

Moving below the operating income line. Interest expense of approximately $18 million in the June quarter decreased about 23% compared to last year due to the debt that we paid off last September.

Income taxes. Our effective income tax rate was nearly 45%. However, our income tax rate is being negatively impacted by warrant expense. The current valuation of our warrants, the $467 million at June 30, 2013, that I referenced earlier, is in excess of our March 18 warrant valuation of $242 million, which approximates the amount of expense that we will be able to deduct for tax purposes. Any dollar amount in excess of the initial warrant valuation will not be deductible. The excess amount is considered a permanent tax difference.

On an adjusted basis, which means we are removing the nondeductible dollars associated with the warrants, our effective tax rate for the June 2013 quarter was 37.4%, which represents a tax provision of about $102 million.

This quarter, we did have a favorable tax adjustment related to the reversal of a reserve that coincided with our federal tax return filing. Excluding the impact of the warrants and any nondeductible tax amounts, we'd expect our full year fiscal 2013 tax rate now to be approximately 38% for continuing operations.

Our GAAP diluted earnings per share from continuing operations in the June quarter was $0.27. On an adjusted basis, adjusting for LIFO, warrant expense and the negative tax rate impact, our diluted EPS from continuing operations was $0.73, a decrease of about 1%.

Our EPS benefited from an 8% reduction in our average diluted shares outstanding versus the prior year's quarter. At June 30, 2013, we had just under 231 million shares outstanding.

Let's spend a few minutes discussing our segment results for the June quarter, starting with Pharmaceutical Distribution. Total segment revenues were $21.5 billion, up 13% versus the same quarter last year. Growth at our Drug Company was approximately 16%. The majority of the increase was due to our new contract with our large PBM customer. This quarter, we expanded our brand business with our PBM customer as we added one new large brand manufacturer that the PBM previously self-distributed. This incremental business is at the typical margin for our PBM customer. We also had increased revenues from the Walgreens pilot programs. But this revenue basically offset the negative revenue impact from the Topco contract loss. Additionally, our top line growth clearly benefited from having a much smaller headwind from brand-to-generic conversions.

Our Specialty business grew a solid 5% year-over-year. We continued our pattern of excellent growth at our ASD, Besse Medical and ICS businesses. These 3 businesses were up a combined 16%. Our Oncology Supply business, down about 10%, continues to be challenged on a top line basis due to reimbursement pressures and the migration of business to the hospital setting, and also brand-to-generic conversions. These sales growth percentages are before interest segment eliminations, consistent with how we've communicated these growth rates in the past.

Total adjusted segment operating income decreased $20 million, or about 7%, to $287 million in the June quarter. Both Drug and Specialty had decreases in operating income year-over-year. Drugs decrease was due to lower contributions from our PBM contract and the loss of the Topco contract. We also had loss of a contribution from oral/solid generic launches. These headwinds were mostly offset 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 completely offset the decrease from our Oncology Supply business.

Moving to the Other reporting segment. As a reminder, this segment is comprised of Consulting Services and World Courier. Segment revenues were $467 million, an increase of 17% from in last year's quarter. The increase was primarily due to World Courier having 1 extra month of operations included in the June 2013 quarter as compared to the prior year quarter. However, looking at the World Courier revenues on an equivalent sales per day basis, their revenues increased about 10%, primarily due to additional contract wins.

Operating income for the Other segment increased 18% to $25 million for the same quarter last year. The increase was solely related to contributions from World Courier. This business had 1 extra month of operations compared to last year's quarter, but World Courier also had several new business wins and they managed expenses tightly. We expect World Courier to contribute $0.06 to $0.08 earnings in this fiscal year.

Our Consulting business had a decrease in operating income of about 8% primarily due to timing. A key program shifted to July this fiscal year versus being recognized in the June quarter last year.

Now, let's turn to cash flow and liquidity. As I mentioned earlier, we are very pleased with our free cash flow performance, $681 million for the 9-month period. This is just slightly ahead of last year, while absorbing a working capital increase on our new PBM contract. We ended June with a cash balance of approximately $1.6 billion.

In the June quarter, we purchased about 2.1 million shares of our common stock for a total cost of $116 million. Our share repurchases basically offset employee stock option exercises in the quarter. For the 9 months, we are now at $401 million of share repurchases, which is essentially what we said we'd buy back this year.

Moving to our hedging program. As a reminder, this program enables ABC to offset a reasonable amount of the anticipated share dilution, which will occur upon the exercise of the warrants. Earlier in the June quarter, we entered into 4 capped call options that gave ABC the right to purchase a specified number of shares from the investment bank in calendar 2016 and 2017 at agreed-upon or fixed prices. We will use proceeds from the exercise of the warrants to purchase these shares. At June 30, the investment bank has completed about 20% of the hedge, and we've incurred cost of roughly $43 million, of which we paid $28 million and accrued the remaining balance. For accounting purposes, the $43 million of hedging cost has been reported as a decrease against equity, similar to how we account for share repurchases. We expect the hedge to be completed by fiscal yearend. However, at any time, we can instruct the investment bank to adjust or end the hedging activities based on market conditions.

One final item before we get into 2013 guidance. As many of you know, we recently announced that we increased our liquidity by amending our senior credit and securitization facilities. With these 2 amended facilities, we have increased our liquidity by nearly $1 billion, which enables us to meet short-term working capital demands from the new Walgreens contract, and most importantly, to increase longer-term flexibility as we now have liquidity available for 5 more years. We thank all of our partner banks that continue to support ABC.

Now, let's recap our fiscal 2013 guidance. EPS. Our full year non-GAAP adjusted EPS from continuing operations is now $3.06 to $3.11. Year-to-date, we are at an adjusted EPS of $2.35. Please remember that our range excludes 3 items: one, the LIFO charge for fiscal '13; two, the impact from warrant expense that we record in operating expenses; and three, the tax impact from the warrants as a portion of this expense is not deductible for tax purposes.

Revenue growth. Revenue growth remains in the 11% to 13% range from our revised fiscal 2012 revenues, which excluded our discontinued operations.

Operating income and margin. Excluding the impact from LIFO and warrants, we continue to expect our operating income will be down 3% to 5% for the year as compared to the revised fiscal '12 operating income. And our operating margin will decrease in the 24 to 29 basis point range from the revised fiscal '12 margin of 1.67%.

Free cash flow. We expect free cash flow to be in the range of $100 million to $200 million, which reflects the significant working capital build to support the Walgreens contract. This also includes CapEx of about $240 million, of which about $50 million is to support our new Walgreens contract.

Share repurchases. As mentioned previously, for the 9 months, we stand at $401 million in share repurchases, which is essentially what we guided for the year. At this time, we expect to stay near this level due to short-term capital needs to support the Walgreens contract implementation, specifically inventory purchases and CapEx.

Now, before I wrap up, let me cover 3 key items related to our fiscal 2014 guidance. First, just to reconfirm, the incremental fiscal year 2014 guidance we gave relating to the Walgreens transaction, the net $0.20 EPS benefit, this amount excludes any accounting impact from LIFO and the warrants. Also, we expect the $0.20 to be mostly back-end-loaded in terms of our quarters because we are incurring startup expenses early and ramping the Walgreens generic revenues during the fiscal year.

The second item. As we look ahead to fiscal 2014, we plan to provide guidance and report our financial results on an adjusted basis in order -- in an effort to improve clarity and transparency. We will continue to report our GAAP results, but we will also report adjusted earnings. Our definition of adjusted EPS means we will exclude the following items: We will exclude the expense associated with the equity warrants, and this also includes backing out the negative tax impact from the portion of the expense that is nondeductible; we will exclude LIFO charges or credits; we will also exclude acquisition-related costs, which include intangible amortization. Any special onetime restructuring, litigation and severance expenses will also be excluded. And additionally, we will calculate our adjusted EPS using an adjusted diluted share count. This share count will exclude the accounting dilution resulting from the impact of the unexercised equity warrants.

This quarter, upon further accounting research and consultation, we determined that the fair value of the warrants, which is yet to be expensed, over $400 million at June 30, should be included as assumed proceeds in the treasury stock method calculation. This inclusion can reduce or actually eliminate the dilution impact of the warrants, which are currently in the money. As a result, the warrants were anti-dilutive for the quarter and for the 9 months ended June 30, 2013. We believe that using an adjusted share count is appropriate as the share count calculation is complex and also has a high degree of variability. This will ensure a consistent approach with investors when calculating and forecasting our share count going forward.

And finally, the third item regarding our guidance. With the on-boarding of the Walgreens contract, as we have discussed in the past, we will have a sizable working capital investment. We expect our working capital to improve the second half of fiscal 2014. Because of this, we'd expect that our share repurchases will be much greater the second half of the fiscal year to coincide with our working capital improvement.

As I wrap up my comments, let me say that we are pleased with our results through the 9 months. We've accomplished a significant amount this fiscal year with our ABC team, and we are well positioned for our last 3 months to meet our expectations for the full year. Thank you for your continued interest in ABC. Now, here's Barbara for Q&A.

Barbara A. Brungess

Thank you, Tim. We will now open the call to questions. [Operator Instructions] Please go ahead, Stephen.

Question-and-Answer Session

Operator

Our first question will come from the line of Mr. Tom Gallucci with Lazard Capital Markets.

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Tim, you mentioned that you had some more business with, I guess, your biggest PBM customer in the quarter, and there were some pilot programs going on with Walgreens. We got a lot of questions about gross margins in the quarter. Could you just sort of convey where gross margins came in versus your expectations and if they were pressured, I guess, incrementally by the Walgreens pilots, as well as the extra business to, I assume, with Express?

Steven H. Collis

Yes, thanks, Tom. Yes, sure. I would say that externally, our gross profit margins were probably a little bit lower than what people expected, but internally, they were in line with what we thought. Again, we had a mix shift within our Drug Company; 2 of our large customers, the PBM and Walgreens, both had incremental revenues this quarter, and again, at lower margins. We also had a little bit of a mix shift in our Specialty business, the 3 businesses I called out, their revenues are growing faster versus Oncology. So I mean overall, pretty much in line with what we expected. But again, I think the important thing is we managed our expenses really well this quarter, and from an operating margin standpoint, we're right in line with the range that we gave earlier in the year. And remember, earlier in the year, we guided down 24 to 29 basis points. So from an operating margin standpoint, we're right in line with that.

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Okay. And then Steve, I think in your prepared remarks, you sort of alluded to the idea that conversations with customers were going well. You also said you've been meeting with manufacturers. Can you maybe give us a little bit more color on the things that the customers are focused on, as well as what the manufacturers are focused on with you and, I guess, any update or thoughts on sort of the timing of benefiting from the joint venture with Walgreens on the purchasing side?

Steven H. Collis

Yes, thanks, Tom. So a couple of things. Just this thing we started with manufacturers, we actually met with, probably, our largest manufacturer partner last week. And I think just a lot of interest in doing more programs at the retail level. A lot of acknowledgment that the scale and reach that we have has really been greatly enhanced intrigue on the international side. On the customer side, the idea really is strengthening and enhancing the role of community pharmacy. And again, the first time that Greg Wasson and Stefano Pessina and I discussed this transaction, it came down to how do we accomplish that, what are the different attributes that all of our companies have that can help us accomplish that. And 4 months into it, obviously, the focus in the Drug Company has to be in the contract implementation. But we're very mindful of the fact that our customers are expecting to get strategic benefits from this transaction, so we're looking at third-party contracting, we're looking at clinical platforms, we're looking at front-store products, even some of the very advanced services that Walgreens has, the Take Care Clinics could reach in some of those into the community setting. So all of that is very positive, and we're thrilled about the collaboration that we're seeing. On international side, Tim and I were in London with the Alliance Boots folks. Just a talented, successful team of professionals that we think we can do a lot of good work with over the next couple of years.

Barbara A. Brungess

Thanks.

Operator

[Operator Instructions] Our next question will come from the line of Glen Santangelo of Crédit Suisse.

Glen J. Santangelo - Crédit Suisse AG, Research Division

Tim, I just want to follow up with some of the comments you were making when you were discussing the accretion from the deal. I think I heard you correctly, you seem to suggest that the accretion next year will be more back-end-loaded, and I was wondering if you could maybe elaborate a little bit on why that's the case. I mean, obviously, the branded revenues are going to roll on pretty soon. Is it more a function of the timing when generics roll on or is it more of a function of the timing of the benefit from the JV?

Tim G. Guttman

Thanks, Glen, and good morning. No, clearly, it's related to the ramp-up. We're ramping up now, in July, we're starting the hiring process for our distribution centers. So ramp-up expenses earlier, and then we start with the brand business. And that generic business ramps up over time, so over the fiscal year. So again, a lot of it's timing: expenses earlier and the generics later. And that's really why kind of looking at it from a high level, we expect the earnings to be better the second half of the year.

Glen J. Santangelo - Crédit Suisse AG, Research Division

And maybe if I could just sort of follow up. Steve, there's been a fair amount of concern about the company's ability to ultimately get much better generic pricing from this JV. And so I'm kind of curious, 4 months after the deal's been announced, are you still comfortable with sort of the level of discounts you'd be able to get through your generic purchasing? I mean, how much visibility do you have into what you think your new pricing will look like at this point? So I'm just trying to gauge how comfortable you are in terms of the ability to garner those savings.

Steven H. Collis

It's complicated, right? And I'm really not being evasive. We've got a lot of work to do. Again, we came in to this relationship as the third largest entity, and again, we're not really a party to the JV that was already established between Walgreens and Alliance Boots, and we've been buying to that, we're just the third contracting party in that joint venture. So we have a lot of confidence, we've spent a lot of time, we would have a significant role in the joint venture, including consigned associates. But I think our goal is to be very successful in the long term. Most of the parties on the other side, the generic manufacturers, are large public companies. They have their own forecasts. Again, we'll be contracting for 13% to 15% of the world's generics volume. So we've been very thoughtful and deliberate, and the game is to be successful in the long term. And we are more convinced than ever that, that is going to be accomplished.

Barbara A. Brungess

Thanks, Glen.

Operator

Our next question will come from the line of Mr. Robert Jones of Goldman Sachs.

Robert P. Jones - Goldman Sachs Group Inc., Research Division

There are some concerns highlighted last quarter relative to the Oncology business, and now, you're making mention of softness related to the oncology reimbursement landscape again this quarter. Growth overall for ABSG seemed to be up sequentially in year-over-year. Just trying to get a sense of how we should be thinking about the overall Specialty segment or the overall ABSG segment in the back half of this year and into next year. I know you guys had laid out kind of annual ranges at your Investor Day. Any comments relative to those ranges of how we should be thinking about that segment going forward?

Steven H. Collis

Again, I think we would -- looking at how we can communicate this, so Oncology, our traditional Oncology segment is really sales through Oncology Supply to community oncologists. And that clearly, as we announced, has been 10% down this quarter compared to the same quarter last year. That's not really -- we don't believe it's through loss of market share. It really is that, that some smaller practices have sold to larger practices, many of which are our customers, and we sometimes take -- obviously, larger customers get a better deal, and a smaller customer is more challenged by the ASD formulary. So that has been some of the impact. There also have been some practices that sell to health systems. In about 1 in 3 cases, we would be the wholesaler there. So we do benefit, but again, that's not as high a margin as we have in Oncology business based on the ION and Oncology Supply portfolio. But the other trend that I think is worth noting is that oncology products are often in different formulations now. Many of them are oral; they service through specialty pharmacies. That's a very strong segment and our ultimate cash segment within the Drug Company, but also in specialized programs that we do, say in our ASD and in non-oncology, in our Besse Medical segment. And these are very close manufacture programs often with registries and unique data components to them. And I think we've highlighted in the release, we have strong capabilities in Specialty and you've seen that come through with -- in our above market growth in our ASD and Besse businesses, in particular, and some unique manufacture programs in our ICS business, which, by the way, we think we've got a good opportunity to take some of those programs internationally.

Tim G. Guttman

Yes, Bob, I would say that your question about the margins, the operating margins that we put up for Investor Day, we're still in the range but we're priced to the lower end of that range for Specialty, and again, a lot of that is the mix shift right to the lower margin businesses, ASD, Besse Medical, ICS. But also, remember back in the March quarter, we guided down on our range, we kind of moved down to the lower end. So again, that $0.03 or $0.04 movement last March was really pegged to Oncology, right? So that's probably what you could see maybe going into next year in terms of kind of a little bit of a headwind until reimbursement improves or until we kind of anniversary because again, we -- that was March of last year. So until we anniversary, that's potentially what you're looking at, again, as the headwind for next year.

Steven H. Collis

And it's also important, Bob, just final point, I know we've talked a lot about this, but we're not backing off anything in our Oncology business. Tim and I were down with the oncology guys a couple of weeks ago. I think our customers need us more than ever. There's an opportunity to carry on adding incremental value then. We're very committed to being the leader provider to oncology practices as we have been for well over a decade now.

Robert P. Jones - Goldman Sachs Group Inc., Research Division

Got it. No, that's truly helpful. And then just one housekeeping question, Tim. You mentioned 3 major adjustments to when you give fiscal '14 guidance, and I'm sure I can go back and look at the transcript, but I just want to be clear on the warrants. Is the change there really for us to think about the warrants as not impacting the adjusted P&L at all at this point, the expense will be removed? And then any dilution that could have happened will also now be excluded? Am I thinking about that right?

Tim G. Guttman

Yes, you're thinking about that correctly, right. It impacts operating expense, it impacts -- the warrants, impact the tax rate, and of course, the accounting. There's an impact from the accounting dilution on the share count, and we're stripping that out, again, because of complexity and variability in our share price. And a big part of stripping that out, too, is the fact that we've implemented a hedge program which will address the share dilution. So that's why we feel like it's appropriate to back that out and not impact in terms of this interim period when the warrants are unexercised.

Barbara A. Brungess

Thanks, Bob.

Operator

Our next question will come from the line of Mr. Willoughby of Bank of America Merrill Lynch.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Tim, just to be clear on the D&A, are we just going to carry forward the current run rate here without any incremental inputs from the Walgreens, Alliance Boots aspects? Or are you looking at backing out some historical deal amortization as well?

Tim G. Guttman

No, I think, Bob -- Bob, thanks for the question. No, I think we will -- historically, the number's not that significant, so we are thinking about backing out all of it, the historical also, and it's probably about $0.01 a quarter. Most of it -- most of that though is from the last 2 deals, World Courier and TheraCom, but there is a little bit extra that we felt like we should back out.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Okay. And obviously, there were some news from WellPoint today that the Amerigroup contract's going to move earlier. Any thoughts on sizing that one as yet or too soon for you guys to make a guess there?

Steven H. Collis

No, too soon, and again, the margin is not that significant for us, Bob. But certainly, we hope our PBM customer is a very strong grower, and you've seen that in the revenue enjoyed in the Drug Company this quarter.

Barbara A. Brungess

Thanks, Bob.

Operator

Our next question will come from the line of Ricky Goldwasser of Morgan Stanley.

Ricky Goldwasser - Morgan Stanley, Research Division

Steve, in the prepared remarks, you talked about the significant margin expansion opportunity post fiscal year '14. So if you can just help us with how we model the progression for '14, '15 and '16. If you could quantify for us kind of like the step down in margin in fiscal year '14, and then what should we expect in fiscal year '15? I know in the last conference call, you guys talked about high single digit, I think it was 8 to 10 basis points, expansion in '15. So at this point, are you still sticking with that, or given that some time has passed, you are seeing some potential upside to that number?

Steven H. Collis

Well, we're really deep in our fiscal year '14 planning process, and I think you'd see from the caliber of Tim's comments here, we have a lot more moving financial pieces than we have historically have. As somebody once said, it's not as easy as ABC anymore. But we do really -- I think the we had talked a lot prior to the announcement of the Walgreens-Alliance Boots deal about improving our operating margin in fiscal year '14, and we relayed the focus on that. Then came along this transaction and $25 billion in incremental revenue, and a lot of the top line revenue's really brand, and we're implementing the generics over time. And part of that is just not entirely known how we will implement the generics. Clearly, once we anniversary the whole contract, it will be better for us on a margin perspective. We also are -- and we're working through this, of course. When you bring on a contract of this size, some of the expenses that will be taken on right away in September, but also in the first couple of months, will probably be enhanced and then will settle down over time. So I think just to give you the answer you're probably looking for, our expectation right now is that in fiscal year '15, we would see a high single digits operating margin increase. That's where we'll be guiding to. But we're deep in fiscal year '14 now, so we hesitate to get too explicit about fiscal year '15. But Tim's probably the better guy to ask about this though.

Tim G. Guttman

Yes, Steve, I would definitely agree. I mean, '14 will take a little bit of a step back with all that incremental revenue coming on board. For '15, we definitely will have margin expansion at least. And again, I say at least high single digits. And I would expect that to get better after that, again, as we kind of ramp up and enjoy some of the benefits of this transaction. That would be our internal expectation.

Ricky Goldwasser - Morgan Stanley, Research Division

So when -- again, just when we think about the step down in '14, just because we're trying to kind of like figure out how to model this, should we assume a similar magnitude of the step down that you saw when you brought on the Express business given that Walgreens, yes, it's a bigger contract, but it does have both branded and generics, or should the impact be greater than that?

Steven H. Collis

No, Ricky, that's a tough one, right, because we're still in our planning process, I mean. But I don't think the step down will be as great as what we had this year with Express, right? Because again, next year, you have both the brand and some generics coming on board.

Operator

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

Lisa C. Gill - JP Morgan Chase & Co, Research Division

I just had a follow-up question around the JV purchasing opportunity from 2 fronts. One, Steve, is there any way to quantify what you expect the synergies or savings to be over time? And then secondly, when you talk about your ProGen, can you talk about what your penetration rates are today and where you think they could go based on this new opportunity around pricing on the JV? Do you see a lot of opportunity in your existing book of business where you can really increase that penetration rate because you're not there today? How should we think about that?

Steven H. Collis

Lisa, I mean, there's a lot of interest, and we don't believe -- a lot of interest in exactly what the contribution will be from the JV, and we're really, as we said -- it's complicated, right? We're buying from a Swiss entity, it's a new relationship, it's a groundbreaking relationship. So we really feel like we're giving enough guidance. We feel like that $0.20 that we've talked about for next year is much as we're comfortable saying right now. And clearly, the benefit will be much more enhanced in fiscal year '15 when we're distributing all the generics. So I think that's a lot of about what we said and -- on that front. Your second question was around ProGen. We do believe that this is going to strengthen ProGen. I think almost every customer inherently recognizes that not only ourselves, but the whole wholesaler industry has been a good part of the community pharmacy. From our perspective, those community pharmacies and all the customers that buy generics from us have always been essential to the success of our business, and that probably even becomes more so because we believe we're going to have really terrific programs to bring them, greater product portfolios, not only in generics, but in brands store, and also the non-purchasing programs. So I think, as Tom had asked earlier, and I think almost every customer inherently recognizes that. And on Friday, I'm giving a speech to a couple of thousand of our stores and certainly will be emphasizing that. And I think our customers really understand that, and the good news is manufacturers also recognize that this is a truly unique partnership that has got a lot of legitimacy to it because of equity pieces, because of the tenure distribution contract, and the marketplace is accepting that this is a new groundbreaking opportunity for them and for us as well.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

But Steve, is there any way, I mean, even just to quantify this in any way, is it greater than 50% buy for generics from you today on the independent pharmacy side? Is it 90%? Just trying to quantify what that incremental opportunity would be going forward.

Steven H. Collis

So we service thousands of stores on some basis. We have about 4,500 in the Good Neighbor Pharmacy. Those customers are the ones that we really like to focus on. In fact, we've got some data, we have a couple of customers that are celebrating 29 years with us. They will be calling out on Friday [indiscernible] . So those customers tend to be very compliant. I think we've seen some data that show that they're buying over 90% of their formulary products from us. We want to get all customers today, when we meet with any independent pharmacy that's an AmerisourceBergen customer, we try to get them to be in the Good Neighbor Pharmacy program. I believe, and I believe Tom will prove me right, our Good Neighbor Pharmacy is only going to be greater enhanced. The actual program is going to be stronger. So if you're an independent pharmacy and you believe that ABC is a good partner, I think that there's a lot of logic to you being more compliant rather than less, and more interested in becoming a part of ABC and a greater customer than you have had in the past. And that's going to be our message. And honestly, I haven't heard anyone that dispels that notion that I've had. In fact, it's being understood. It's very logical and compelling, frankly.

Barbara A. Brungess

Thanks, Lisa.

Operator

Due to time constraints, our last question will come from the line of Mr. John Ransom of Raymond James.

John W. Ransom - Raymond James & Associates, Inc., Research Division

As we think about your Specialty business, the way it's -- the current run rate, can you help us understand the relative contribution of Oncology versus the relative contribution of everything else, both in terms of revenue and profits, just to get some kind of idea of how much is growing versus how much is under pressure?

Steven H. Collis

John, I've just said, I know we got you under the wire, I think we do have to move you up next year, but it's -- you've always really been interested in our Specialty business, we appreciate that. And Tim, do you want to comment on the risk [ph] of contribution?

Tim G. Guttman

Yes, we don't -- John, I mean, I appreciate the question, but we really don't give specific operating income information. But from a revenue standpoint, when you look at, again, the businesses, the non-Oncology businesses, Oncology Supply, right, so non-Oncology Supply, they're probably about 60% of the revenue and Oncology Supply is about 40%.

John W. Ransom - Raymond James & Associates, Inc., Research Division

And would Oncology be higher or lower average margin in your Specialty?

Tim G. Guttman

I would say that Oncology is slightly higher. Again, those other businesses, those other businesses are higher volume, higher growth, but slightly, slightly lower margins.

John W. Ransom - Raymond James & Associates, Inc., Research Division

Okay. So it wouldn't be completely

off the reservation to think about half of the business growing and half of it being under pressure from a profit standpoint, something in that ballpark.

Steven H. Collis

Well, again, we were really -- we were flat, our second to third quarter in our Oncology Supply revenues. Again, some of the reasons we've got such good growth at our ASD and Besse divisions, which -- well, not Besse, but ASD in particular is that they are doing a lot of oral oncology drugs. So I think it's -- we've had this theme for a while that our Oncology business is really integrated throughout the company, including in our health systems, alternate site business and our ASD business would be 3 of the other beneficiaries of a strong oncology portfolio, they're just not always in our B [ph] drugs.

Tim G. Guttman

Yes, I mean I think that's -- I mean, that's the key point, right? We're down, when we talk about results versus last year, we're down. But the good news is, sequentially here, we've stabilized and we're pretty flat in terms of Oncology. So we think that's very encouraging.

John W. Ransom - Raymond James & Associates, Inc., Research Division

Just one other quick one. When we think about next year, I know you're not giving guidance, I know you talked about $0.20 from the Walgreen, does that include also the benefits of the JV? Or is that strictly the Walgreen wholesale contract as a standalone?

Steven H. Collis

No, it's both for 2014. But again, we expect that it will get better in 2015, and that's why we're fairly comfortable and...

John W. Ransom - Raymond James & Associates, Inc., Research Division

And I'm sorry if you said this, but you'll start doing the generic piece -- have you said -- what did you say, back half of the year, you'll start doing the generics? Have you nailed that down? I may have missed it.

Steven H. Collis

No, we haven't -- it's -- so we got the brand starting September 1. We expect to start on the generic distribution for calendar 2014. And then we really have the whole year to complete that. We'd hope to maybe go a bit quicker, but we have -- there's no hurry. Again, it's a 10-year contract so there's no hurry, and we'll go very steady. I'd tell you that just having visited a lot of the customers' stores, there's tremendous excitement about this program. It's going to be a great program for this cause so it's fully implemented.

John W. Ransom - Raymond James & Associates, Inc., Research Division

And when do you think you'll be -- your JV, when will all the heavy lifting on the contracting be done with the suppliers?

Steven H. Collis

Yes, I think you'll see come in during the course of fiscal year '14. We'll have a lot more guidance [indiscernible] . I think everything's on track. It's just -- it's complicated. We've got Peyton Howell hitting up our global supply chain business now, EG Finiche [ph], she's in Switzerland a lot. So I think we'll give you more color on it. But again, it's important that we have all these 3 buckets within the contract be profitable and important to our future success. So I think we need to really wrap up. So thanks, John.

Barbara A. Brungess

Thanks, John. And now, Steve, do you want to say a few closing remarks?

Steven H. Collis

Yes. So we appreciate a lot of interest, the terrific questions, and I think it help gives you good understanding of how well ABC is positioned for an exciting future. There's no doubt in my mind that it's very clear from this release that ABC executed superbly against our key initiatives in the quarter that we just reported. This next quarter is going to be truly a historic momentous quarter for us as we implement probably one of the largest contracts in the history of our industry. It's important then, as some of the questions have come up, that we will deliver superbly for all of our customers and we'll meet the high expectations that all of them have for us, including this new Walgreens contract. So thanks for your time and attention, and we'll be with you in a couple of months again. Thank you.

Barbara A. Brungess

Thanks, Steve. And before we go, I'd just like to highlight 2 of our upcoming events. We'll be attending the Morgan Stanley Healthcare Conference on September 9 in New York and the Robert Baird Health Care Conference on September 10, also in New York. That concludes our call for today. And now, I will turn it back to the operator.

Operator

And ladies and gentlemen, today's conference call will be available for replay from today, July 24, 2013, at 1:00 p.m. Eastern time until August 7, 2013, midnight of that day. You may access that conference by dialing 1 (800) 475-6701 and entering the access code 297735. If you happen to be in an international location, please dial (320) 365-3844 and the same access code of 297735.

That does conclude our conference call for today. On behalf of today's panelists, I'd like to thank you for your participation in today's AmerisourceBergen third quarter earnings call, and have a good day and you may now disconnect.

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