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Executives

Dave Yost - President & Chief Executive Officer

Mike DiCandilo - Executive Vice President, Chief Financial Officer

Mike Kilpatrick - Vice President Corporate & Investor Relations

Analyst

Eric Coldwell - Baird

Glen Santangelo - Credit Suisse

Tom Gallucci - Lazard Capital

Larry Marsh - Barclays Capital

Lisa Gill - JP Morgan

Charles Boorady - Citi

[Stephen Ballicud] - UBS

Helene Wolk - Sanford Bernstein

Richard Close - Jefferies & Co.

Robert Willoughby - Banc of America

AmerisourceBergen Corporation. (ABC) F4Q09 Earnings Call November 3, 2009 11:00 PM ET

Operator

Welcome to AmerisourceBergen fourth quarter earnings conference call. Thank you for standing by. At this time all participants are in a listen only mode. (Operator Instructions)

Now we’ll turn the meeting over to Mr. Mike Kilpatrick, you may begin sir.

Mike Kilpatrick

Good morning everybody and welcome to AmerisourceBergen’s conference call covering fiscal 2009 fourth quarter and year end results. I’m Mike Kilpatrick, Vice President Corporate and Investor Relations and joining me today are David Yost, AmerisourceBergen President and Chief Executive Officer; and Michael DiCandilo, Executive Vice President, Chief Financial Officer.

During the conference call today, we will make some forward-looking statements about our business prospects and financial expectations. We remind you that there are many risk factors that could cause our actual results to differ materially from our current expectations. For discussion of some key risk factors, we refer you to our SEC filings including our 10-K report for fiscal 2008.

Also, AmerisourceBergen assume no obligation to update the matters discussed in this conference call and this call cannot be taped without the expressed permission of the company. As always, those connected by telephone live have an opportunity to ask questions after our opening remarks and here is Dave Yost, AmerisourceBergen’s President and CEO to begin our remarks.

Dave Yost

Good morning and thank you for joining us. As you probably know from our press release this morning AmerisourceBergen delivered a strong fourth quarter in a series of strong quarters and a strong year in a series of strong years which speaks to the resiliency of our industry and consistent performance within that industry. We enter our new fiscal year which began October 1, with great positive momentum.

Mike will provide the financial details on the quarter and year, but I will hit the high points. Revenues for the quarter were a record $18.7 billion up 9% over the same quarter last year. Again, this quarter our dollars of operating expense were lower than last year and operating margin continued to expand. We reduced receivable days and generated cash.

Diluted earnings per share from continuing operations were 44% on a GAAP basis, up a robust 22% over last year and we had a tough comparison since our EPS was up 18% in the September quarter last year lots to like about this quarter. The highlights of the year are more of the same. Revenues with the right customers, good expense control, operating margin expansion, strong asset management, robust cash generation and a diluted EPS from continuing operations increase of 17%.

You will recall we raised our EPS guidance during the year and then exceeded that raised guidance and during the year we split the stock and increased our dividend twice. This is the fourth consecutive year that we have increased our operating margin by 5, 6 or 7 basis points per year and the fourth consecutive year we have increased our EPS by at least 14%.

We generated well over $600 million to free cash flow and had over $1 billion of cash on our balance sheet at the end of September, reflecting our continuous actual management of our two key financial assets of receivables and inventory. Since the merger that created AmerisourceBergen in 2001, we have a compounded EPS growth from continuing operations of 16%, very consistent performance demonstrating our resiliency and the resiliency of the industry.

So the sound bite for ABC would be consistent performance in a resilient industry with positive momentum going into FY10 driven by a great customer mix featuring generic and specialty. A couple of comments on the industry, first healthcare reform, we continue to be engaged in the process.

The final outcome of course remains to be seen, but we are encouraged by the fact that pharmaceuticals are being viewed as part of the solution to controlling total healthcare expenditures and anything that increases the number of prescriptions that are dispensed should be good for our industry and ABC. Emphasis on generics and biosimilars will be particularly good for ABC given our customer mix.

Second, on the topic of industry growth, we have stated previously that the forecast of negative total industry growth for this calendar year seemed overly pessimistic and that low single digit growth seemed more realistic. With just two months to go in the calendar year, our instincts would seemed validated. IMS has recently revised their estimate of U.S. market growth to 4.5% to 5.5% for calendar 2009 and 3% to 5% for calendar 2010, which seems more a lot more realistic to us.

Third, the pricing environment, I would continue to describe the pricing environment as competitive, but stable with few billion dollars pieces of business in the wholesale drug business in play in the next 12 months or so. Now little closer to home for ABC, during the quarter, we announced that Steve Collis, formerly head of our Specialty Group would be transferring to our drug company as its President.

Many of you know Steve from our previous Investor Days or Company Presentations at Investor Conferences. Steve is a proven performer of course, having started our specialty business and growing it to over a $15 billion revenue business with a wide array of value added services. Mike Mullen has taken over the leadership responsibilities at Specialty. Mike is a Specialty Group veteran having performed well in a series of jobs in our Specialty Group, with escalating responsibility.

Both Steve and Mike will report directly to me and both plan to be presenters at our Investor Day on December 15. Our Packaging Group, supply chain management, IT and business transformation will continue to report to Mike DiCandilo. Our business transformation process our ERP centered drug company initiative continues on schedule and on budget with testing scheduled to begin in our second fiscal quarter that begins in January and back office implementation beginning towards the end of our fiscal years.

Our 9% revenue increase for the quarter to a record $18.7 billion reflected both the strength of the market and good performance in literally all segments of our business. Generics continue to be a key component of our value added offering at ABC and during the quarter generics grew in the mid teens.

In our traditional drug company, each of our customer segments of independent retail chains hospital and alternate site had strong revenue growth with both hospitals and independent delivering double digit revenue increases reflecting strong and balanced growth.

We continued to enjoy increasing generic penetration in hospitals and alternate sites as well as retail. Our Good Neighbor Pharmacy franchised like program for independents and regional chains crossed the 3, 700 store mark and our G&P performance network, a third party access program continues at well over 5,000 participating stores.

Our Specialty Group continued its strong performance. Revenues and earnings were a record for the quarter with revenues now at $16 billion run rate. Our Specialty Group benefited from a good mix of product and value added services and the successful launch of generic and lexicon earlier than originally expected.

Our Specialty Group continues to be extremely well positioned with the broadest offering of value added services in the industry. Our Oncology business features a strongest position interface in the industry. Our third party logistics and reimbursement counseling businesses continued to do extremely well. We have a robust plasma and vaccine business and had a good flu season this year.

Our reimbursement counseling business is gearing up for the calendar year end transition season and will employ some 1, 300 people by calendar end. Our clinical services unit features a pool of over 400 registered nurses. The depth and strength of our product and service offering within our Specialty Group continues to deliver attractive margins.

Our Packaging Group had a challenging year, due to a large part to delayed product launches, whereas well positioned for FY10 was a robust pipeline. It’s important to note, that the ABC customer base features very low concentration with only one customer representing more than 10% of our revenues and the next largest less than 5%. We have no billion dollars customer contracts up for renewal this year. Substantially all of our customers except the one large mail order customer buy generics from us.

Let me take just a moment and focus on cost control and receivable management at ABC and give our people in the field the credit they deserve for delivering that performance while maintaining superior customer service that helps drive our revenue growth. In FY’09 our total operating expense dollars were lower than FY’08 and FY’08 was lower than FY’07 net of the two acquisitions we made.

This cost control was delivered while our physical workload was actually increasing and our just completed quarter for example our total costs were down 2% year-over-year while our invoice lines our actual unit of work increased in double digits. Our invoice lines are increasing faster than our revenues in part because our product mix is reflecting an increased proportion of lower priced generics.

We have been able to drive down our cost in spite of this increasing workload in part because of the investments we have made previously in automation and in part because of the quality of our field management and workforce. Cost control is an important element of the D&A at ABC and positions us well for the future. On the receivable front, our day sales outstanding were down this quarter versus last year in an environment that could easily be described as challenging.

I think our receivables performance speaks volumes about the quality of our customer relationships and the quality of our customers. With our large cash position at our fiscal year end let me reiterate our position on acquisitions although none are contemplated in our guidance, we have said on a number of vacation that we are accepted to acquisitions and spent over 1 billion in a last seven years on acquisitions.

Our largest at 162 million being our most recent we have said that the $200 million or so acquisition in our basic business of pharmaceutical distribution or related business would appeal to us and we would consider something larger if it made sense. We are in an excellent position for acquisitions both financially and organizationally.

Now, looking ahead to our fiscal 2010 which began October 1, Mike will hit the details but here is the summary. We expect revenues to grow well ahead of the market in our first half due to new customer wins last year and to grow with the market after we begin to anniversary that new business in March. We expect flat to low single digit operating margin expansion.

We expect to continue our share repurchase program in the $350 million range. We expect to grow our EPS from continuing operations in the 8% to 14% range and that of course is on top of the 17% we delivered this year. So the dead net here is we expect to deliver the kind of consistent performance that has been characteristic of ABC since our 2001 inception. We have begun FY’10 with great momentum in a great industry. I have been in the industry for more than a third of a century and I’m as excited as I have ever been about our industry and ABC’s prospects within that industry.

Here is Mike.

Mike DiCandilo

Thanks, Dave and welcome to all of you who have joined us this morning. It is very gratifying to have such a tremendous end to what was already a fantastic year, especially when you consider the macroeconomic environment over the last 12 months and we certainly have strong momentum as we enter fiscal 2010.

Before I get to our quarterly results followed by next year’s guidance, I would like to take a moment to reflect on our 2009 performance against our original guidance for the year. As a reminder our financial model is based on revenue growth, operating margin expansion and significant cash generation and we met or exceeded all of our financial targets in these areas that we set in the beginning of the year.

Our revenue growth guidance for fiscal 2009 was a range of 1% to 3% and we finished solidly in the middle of the range while new customer wins during the year have positioned us for strong growth in fiscal 2010. We expect to have FY’09 operating margin expansion in the low to mid single digit basis points range and we finish the year with operating margin expansion of five basis points. This margin expansion was driven by both gross margin expansion and expense reduction.

From a gross margin perspective our diverse customer base enabled us to capitalize on strong generic market growth and our higher margin specialty business delivered once again. At the same time we reduced our expense margin by decreasing total expense dollars while focusing on our future with significant investment in our ERP enabled business transformation program.

Our free cash flow of $638 million far exceeded our forecasted range of $460 million to $535 million and we use that strong cash flow to enhance our total shareholder return by increasing our dividend twice during the fiscal year and by repurchasing $450 million of our stock, well above our targeted $350 million of share repurchases in fiscal 2009.

All of these factors contributed to drive our GAAP diluted EPS from continuing operations to $1.69 well above our original adjusted guidance of range of $1.54 to $1.63 per share. Also very importantly in these challenging economic times, we continue to improve our all ready strong balance sheet. We achieved a ratings upgrade from S&P ended the year with great financial flexibility. Again, truly and exceptional year and we thank all of our associates to work very hard to make it happen by delivering superior customer service everyday.

Now moving to our quarterly results, total revenue increased 9% in the quarter to a quarterly record of $18.7 billion. The drug company grew its top line 10% in the quarter and the specialty group grew 8%. New business in the drug company including the new CPA Retail Buying Group and the expanded relationship with HPG Group in the hospital segment contributed 6% of the drug company growth and 5% of the total company growth. The majority of this new business, anniversaries in the March 2010 timeframe and as a result revenue growth in the first two quarter of fiscal 2010 should continue to benefit from this new business.

The specialty group hit a new milestone in the quarter exceeding $4 billion in revenue for the first time and its 8% top line growth was driven by ASD, our nephrology products in flu distribution business and oncology supply, our oncology distribution business. The specialty group exceeded $15.5 billion in revenue for the full year as be expected and continues to have unparalleled offerings in physician distribution, in specialty services that make us the market leader in this fast growing space.

Gross profit for the total company increased 2% in the quarter despite a very tough comparison to last year’s quarter, which benefited from a significant Glaxo price increase and a $12 million favorable settlement with the supplier. In the current quarter, we continued to benefit from improving product mix as higher margin generics grew in the mid teens percentage range including and increasing contribution from generic oncologics in the specialty group.

The margin contribution from generics more than offset the non-recurring profit items, the faster growth of our largest customers and the Kaiser reprising, which was effective July the 1. We had a LIFO credit in the quarter of $5.7 million, compared to a charge of $3.4 million in the prior year quarter. This credit was primarily due to having a higher mix of deflationary generics in our ending inventory as a result of our strong generic growth. For the year, our LIFO charge was $15 million compared to a charge of $21 million last year.

From an operating expense standpoint, expense dollars in the quarter were down nearly $11 million from last year and as a percentage of revenue were down an impressive 21 basis points as we managed the additional volume from the 9% revenue increase at a very low incremental cost through our automated distribution facilities. In addition to our normal cost discipline we also benefited from a normalized bad debt expense from last year’s quarter and a reduction in asset write-downs in other special items.

In total for the year operating expense dollars declined from 2008, which is impressive considering the significant amount of new business we added in the second half of 2009 in the increase in investment spending for our business transformation project where we incurred incremental expenses of $14 million compared to last year.

The increase in gross profit combined with the operating expense decrease led to an impressive 11% increase in operating expense in the quarter with operating margin expansion of two basis points. For the fiscal year our operating margin of 123 basis points expanded by five basis points compared to fiscal 2008.

Moving below operating income, net interest expense of just under $15 million in the quarter increased 11% compared to the prior year due to a decline in interest income of $2.4 million resulting from significantly lower yields on invested cash compared to last year even though we had significantly more average invested cash on hand in the September 2009 quarter than we did last year.

As I mentioned last quarter we expected our fiscal 2009 effects the tax rate to be approximately 38% and we came in just under that rate at 37.9% from the quarter and for the fiscal year. On a GAAP diluted EPS from continuing operations of $0.44 in the quarter significantly exceeded our expectations and was $0.08 or 22% higher in the prior year.

EPS growth was well above the 13% growth and income from continuing operations due to the reduction and average outstanding diluted shares as a result of our share repurchase activity over the last 12 months. Average diluted shares outstanding in the quarter were just under $296 million; down nearly 7% were the prior year quarter.

Now, let’s turn to our cash flow in the balance sheet where we continue to demonstrate stellar performance. Cash generated from operations in the September quarter was $353 million, bringing our full year cash from operations to $784 million. Our free cash flow which we define as operating cash flow less capital expenditures was $638 million for the year, well above our guidance of a range of $460 to $535 million primarily due to better than expected working capital management, primarily in receivables.

Consistent with last year we had an average of 25 days of inventory on hand in fiscal 2009 and 18.1 days DSOs were down more than a half day from last year. Average day’s payable outstanding, were flat with the prior year. Our ending inventory and related accounts payable balances increased by more than our 9% quarterly revenue growth compared to last year due to $400 million inventory buys in September, primarily generics and blood products.

Our gross debt to total debt and capital ratio at the end of September was 30.2% within our target range of 30% to 35%. Our better than expected cash generation during the fourth quarter allowed us to repurchase significantly more stock than originally expected as we purchased $177 million of our stock in the quarter bringing our annual total to $450 million, a $100 million above our targeted range.

Including share repurchases and dividends we returned approximately 80% of our free cash flow to shareholders in fiscal 2009. Our cash balance at September 30 was just over $1 billion and after factoring out or normal maintenances cash levels and working capital timing we have approximately one half of that amount available for deployment leaving us with great financial flexibility as we enter 2010.

Now turning to next year’s guidance, our fiscal 2010 guidance for diluted earnings per share is a range of a $1.82 to $1.92, an increase of 8% to 14% over our fiscal 2009 diluted EPS from continuing operations of $1.69. The assumptions behind this guidance include revenue growth of 5% to 7%. Operating margins are expected to range from flat to expansion in the low single digit basis point range and we expect free cash flow in the range of $500 to $575 million.

The guidance assumes share repurchases in the $350 million range depending, of course, on market conditions and board approval. The guidance also assumes we will have higher interest expense in 2010 versus 2009 anticipating that we will take advantage of low long term interest rates and term out amounts outstanding under our revolving credit facility.

In addition, we expect our effective tax rate to be 38.4% slightly higher than the 37.9% in 2009 which benefited from certain net adjustments. Capital expenditures which were $146 million in fiscal ‘09 are expected to be relatively similar in fiscal ‘10 at about $140 million. Average outstanding diluted shares are expected to be down between 5% and 6% reflecting our anticipated share repurchase activity net of stock option exercises.

To drill down a little more on our revenue and margin assumptions the revenue growth assumption expects both the drug company and specialty to grow between 5% and 7%. The specialty growth reflects mid to high single digit market growth less a 2% top line impact from generics in that space. Again as a result of our new customers total company revenue growth will be significantly higher in the first half of 2010 than in the second half where our top line growth should approximate market growth.

Flat to low single digit operating margin expansion reflects 1% to 3%, expense dollar growth which includes increased ERP spending. It also includes the impact for nine months of the Kaiser reprising and normal competitive pressures on gross margins. Before turning the call back to Mike Kilpatrick for Q-and-A, I would like to finish by saying that we are very proud of our performance in fiscal 2009 as once again we showed great resiliency in the face of a challenging market.

As Dave mentioned our GAAP EPS from continuing operations has grown at an average compounded rate of 16% since the merger in 2001 and we have significant momentum as we enter 2010. That momentum combined with our cost and working capital discipline positions us very well for another strong year in 2010 even as we continue to invest in our future.

Here is Mike Kilpatrick.

Mike Kilpatrick

Thank you, Mike. We will now open the call to questions and I would ask you to limit your questions and follow ups so everyone has an opportunity this afternoon. Cathy, go ahead.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Eric Coldwell from Baird.

Eric Coldwell - Baird

First Dave, I think you are marking a milestone this quarter so congratulations on, I believe, 50 quarters now.

Dave Yost

Thank you very much for noticing, thank you very much that’s good.

Eric Coldwell - Baird

The question is on specialty on great on in the quarter. A couple mentioned about the higher margin and the mix of services there. I think you might make its weight until December, but I am hoping to kind of get validation of what you guided through this years which was operating margin of around 1.6% in the segment and more importantly what drivers there might be to actually maintain or grow that operating margin into fiscal ‘10 or maybe generics would be one driver but I am looking for other opportunities perhaps in the services business? Thanks so much.

Dave Yost

I don’t want you to think Mike is talked about delivering the strong results and getting have a have a little trouble with his throat, I try it kick it off, but I would say one of the issues for sure Eric in the specialty business is the opportunity in generics. We had actual product, which I mentioned earlier was an issue for the specialty business.

I think demonstrates the fact that generics within specialty do provide opportunities going forward. Sometime that’s over look to going forward. We also have a very, very strong specialty services business and this quarter did particularly well. So our things are well positioned for us going forward. We continue to be very excited about the specialty business.

Mike DiCandilo

Eric, we will breakout the margins as we usually do in December. I’d like to stay away from that a little bit now, but I think you will see an up tick in the specialty margin.

Eric Coldwell - Baird

That’s great. Thanks so much.

Mike DiCandilo

Thanks.

Mike Kilpatrick

Next question please.

Operator

Our next question is from Glen Santangelo of Credit Suisse.

Glen Santangelo - Credit Suisse

Yes, thanks for taking my question. I just wanted to explore the revenue guidance a little bit. I was expected 5% to 7% and if I look at the first half given the new contract wins you should be significantly above that. Are you just kind of curious? Are you taking a little bit more of a conservative cut in the guidance in the June and September quarters next year or does that include some of the run off from loans? I’m not sure if there’s an update on that situation or the timing around that, any kind of clarity would be helpful. Thanks.

Mike DiCandilo

Yes. Glen, this is Mike. Let me comment on that and Dave can jump in. What we expect obviously, we had 9% this quarter and there’s no reason why we shouldn’t continue at that pace until we start to anniversary some of our new business wins and we start to anniversary those wins in the March timeframe, so the first half of next year should look very similar to the fourth quarter of this year.

As I mentioned 5% of our 9% revenue growth came from that new business. So as we anniversary that, the second half of next year will pretty much grow at the market rates and again take 5% off the 9%, that’s in the 4% or so range. So our expectation is that we will continue to service the launch business throughout the full year of 2010 and that’s not a factor in that guidance.

Dave Yost

Nothing new to report on loans Glen, we continue to do business with them, service them, happy with the relationship. We expect to continue that through our fiscal ‘10 and that’s included in our guidance.

Glen Santangelo - Credit Suisse

Okay, thank you very much.

Mike Kilpatrick

Next question please, Cathy.

Operator

Next question is Tom Gallucci of Lazard Capital.

Tom Gallucci - Lazard Capital

Good morning. Two quick questions; I guess first, Mike as you think about the range for next year in terms of the earnings, what do you think sort of the bigger wild cards are variables are in terms of the top end versus bottom end and then the second thing, I think you mentioned a strong flu season, would you care to frame in some respect whether it is top line or bottom line what the impact is this year?

Mike DiCandilo

Okay, Tom, I’ll start with the earnings range and I’ll turn to flu over to Dave. Certainly, I think our progress in generics is a big factor in the range of next year. The better we do, the higher we will be in that range. Certainly, we’ve got the revenue momentum and we feel very confident from that perspective. I think some of the other variables. One of the things I mentioned is that we were going to have higher interest expense next year than we did this year. We expect it to be $10 million to $20 million higher.

I think the variable there is, when we go to market to term out some of that short term financing into long term financing and how much we’ve raise. So I think that’s certainly one of the variables, obviously timing of share repurchase could be a variable as well and right now we contemplate doing that fairly evenly over the year, but of course, that can always change.

Dave Yost

Tom, if you look at our third quarter versus our fourth quarter, our revenues are up about $300 million or so sequentially with the majority of that coming from new business. So it’s really hard for us to make the case that the flu is the dominant factor in our September quarter. To the extent that it provides a strong in quarters going forward, it’s upside, but I would not isolate that as a big factor for us.

Tom Gallucci - Lazard Capital

Thank you.

Mike Kilpatrick

Next question please.

Operator

Next question is from Larry Marsh with Barclays Capital.

Larry Marsh - Barclays Capital

Thanks, good morning. Congratulations on the quarter. Dave on the pronunciation of that generic launch, you better remind me. So I wanted to follow-up on two points. One is a little bit discussion of the ERP expansion or timing here. It seems like you had a bit increase in CapEx in the fourth quarter. I think Mike you talked a little bit about 14 million of incremental expenses. Could you elaborate little about total sort of investment in the ERP in the next couple years and how much of that will show up on the income statement and compare it to this year?

Mike DiCandilo

Sure, Larry. Let me just pricing, our ERP project is really kind of cover three fiscal years, ‘9, ‘10 and ‘11. 2009 our guidance was that we are going spend roughly $100 million was about a third of that being expense and we were pretty much right on those targets. In 2010 really a key year in the product as Dave said we started our testing in January and we start our training and implement the back office piece towards the tail end of the fiscal year, because of that our spending is going to increase a bit.

I would expect it to be in the $110 to $120 million range with slightly over a third of that being expense in 2010. As we move towards 2011, we really move to our distribution center and customer implementations and because of that, the total amount of spending is going to drop fairly dramatically between from 2010 to 2011, maybe 50% to 60% of what we spend in 2010.

However, you are probably going to have a much higher percentage of that be expense versus capital due to the nature of the work we are doing in that we are going to be in the training and implementation phase of the projects. So, expense should be slightly up in 2010 as is the capital. The capital is going to roughly a little bit more than half our total 140 total capital expenditures and as we move to 2011, total cost down, but the expense should be pretty similar to 2010.

Dave Yost

That’s included in our guidance.

Larry Marsh - Barclays Capital

The benefit I guess is what holding line on SG&A and continues to be more efficient company that how think of the offsets on the expense lines?

Dave Yost

Yes, I think you look at the same way we are getting the benefit, today handling incremental volume and our warehouses through our automated at facilities at a very low incremental cost. I think, our goal is to have that same dynamic for really our back office infrastructure as well. In addition, giving our customers great flexibility and making it really easy for them to do business with us which is really our goal.

Larry Marsh - Barclays Capital

Very good and just one quick follow up then. I think Mike you talked a little bit about more investment opportunities in blood products and plasma. This particular quarter, is there something unique in the market there that is more encouraging are just that typical seasonal?

Mike DiCandilo

Yes, I was talking about our inventories were up about $400 million at the end of the quarter. It was generics and blood products, probably more generics, Larry. We had a manufacturer shutdown for a period of time and we had to load up on their products and we had some opportunities with in addition to that, our blood inventories are up some mainly because our volumes are up, ASD had a very strong quarter as I mentioned in the prepared remarks and really were just adding inventory for them to meet some of the demand there.

Larry Marsh - Barclays Capital

Thank you.

Mike Kilpatrick

Thanks Larry. Next question please.

Operator

Our next question comes from Lisa Gill with JP Morgan.

Lisa Gill - JP Morgan

Dave I think you made a comment at the beginning of your prepared comments around customers buying generics from you, that the majority of our customers buy generics. Can you maybe just talk about what the future opportunities are for generic penetration rates?

I know you don’t want to get into specifics that how much opportunity is there are is just the opportunity around the number of drugs that are going generic in the next couple of year first and then secondly can you just your thoughts around it branded drug price inflation now that we now it Kaiser is moving to that the fee for service agreement. How should we be thinking about that as we move into 2010?

Dave Yost

I’ll take the first part, Lisa and Mike can comment on the inflation. Well, to answer your question, Lisa, it is really both. We expect to get additional penetration with our customers and sign up new customers who buy generics from us, but the point I was just trying to make is our customer base with the exception of one large mail order facility that looks to us for their generics and so we have a great opportunity to increase our generic sales as products come off of patent.

As we lookout over the next years, we lookout over our next fiscal year, we see some great products coming off, very balanced, quarter-by-quarter. So that continues to provide great opportunities for us and the other thing that occurred, this quarter we’ll continue to have benefit of that next quarter or so is the issue of Loxitane.

The Generic Loxitane, which is the specialty product and because of our very role in specialty, we participate somewhat disproportionately in that. So I’d make the case that our customer base and role in specialty allows us to have very strong generic opportunities as we look out over the next couple quarters.

Lisa Gill - JP Morgan

Can I just ask a follow-up? When we think about the penetration rate that we have today, can you even just ballpark that for me? I mean do you have more than 50% of that Generic Loxitane or more than 80% or is that a smaller number where you are just continuing to work at and giving them to buy more generics from Amerisource?

Mike DiCandilo

Lisa, this is Mike. I think from a retailer perspective we’re getting a very large percentage of their generic buys today. I think where we have had great growth this year and had great opportunity going forward continues to be in the alternate site segment. We have done very well with nursing homes, providers as an example and other non-traditional institutions and I would say our penetration there is maybe 50% to 60% versus retail, where we have the large majority of that business.

In addition, obviously we’ve started doing business on the oral solid generic side with Novation and we see that as an increasing trend as we go forward as well. I think the GPOs are really starting to recognize that. Our expertise and our scale in the generic area can add great value to their hospitals. I think the difference there is we’re getting most of that generic business today. We’re just doing a lesser percentage on our own proprietary program and we expect to increase that percentage that we do from our proprietary program as we go forward.

Dave Yost

I don’t want to make this answer too long, Lisa, but I just the one thing I will say is we track generic penetration very, very closely by customer and track it very, very closely. We have our sales people properly and centralized for collecting our generic business. So it’s a very high profile issue for us. I’m going to be address in our sale force, as Mile will be in the next couple of weeks and I will tell you is one of the key issues I’ve got. So we’re watching the generics very, very well and think we’re doing a good job there. We just don’t want to lose…

Mike DiCandilo

I think your other question Lisa, was around price inflation and the impact of the Kaiser change on that. First off, as we measure it for our fiscal year, brand names, drug inflation again was north of 8% consistent with what it was last year. Our expectations going into 10 would be some moderation of that and probably the 5% to 6% range.

As far as our impact to our profitability, it’s actually a very little, because as most of you know with fee for service, about 85% of our business or so is not subject to variations and manufactured price increases and that percentage is only going to go up January 1 with the Kaiser contract.

I think the impact of Kaiser to us for the year is very little even though we only have nine months of the fee for service contract in fiscal 2010. We think the dollar profits will be pretty consistent with what we experienced in fiscal ‘ 09. If anything, most of our profits historically have been recognized in our second and third fiscal quarters and you’ll have some spreading of that next year to the fourth quarter as well.

Lisa Gill - JP Morgan

Okay, great. Thank you very much for the comments.

Mike Kilpatrick

Thanks, Lisa. Next caller please.

Operator

Next question is from Charles Boorady of Citi.

Charles Boorady - Citi

Thanks, good morning. How you would characterize the total business for independent pharmacies right now. They have weathered the economic storm seen bad debt and become a prom I know you have kept a tight led on that in the past and if they are still concerned about implementation of A&P or other industry trends that are challenging their business?

Dave Yost

I would characterize it Charles as very update I mean we just got back recently from the national community pharmacies association NCPA and some get a little bit of a probs to store wavered, because you get your most successful retailers attending, but I will tell you the mood was very, very up beat. We think as you implied that they have gotten through the worst here of some of their financial challenges and they are very well positioned going forward. So, we continue to think this is a very strong sector for us and for the industry.

Charles Boorady – Citi

In terms of future trends for them and how that might impact your business. For example, the patent clip as more drugs generic, does that level the playing field anymore for the independent versus the chains, any other trends that you picked up that event and talking you customers that lead you to expect a change in their total of business going forward?

Dave Yost

I would say the generics are clearly a level playing field and talk it might tip it a little bit in the independence direction, because it makes the interface with that patient, as you explain the differences very, very important and of course we’re delivering to the independents generic pricing that is very, very competitive, allows them to be very, very competitive in the marketplace. So, we see the independents future as bright. As I have said in a number of occasions I have been in this industry for a long, long time and people have been worried about the strength of independence and very resilient and we talk about AmerisourceBergen being resilient. So are the independents and we think the trends going to continue.

Charles Boorady – Citi

You just a clarify in your prepared remarks you commented on a few large billion dollars contracts up for renewal. I think later you said that none of yours are up for renewal and more if you can characterize what kind of accounts those are retailers or are those with manufacturers on the specialty side and what you built into your guidance in terms of your chances of winning some of those accounts?

Dave Yost

We have no billion dollars piece of business, Charles. That was the most important point I wanted to make and the other point I wanted to make there are few in the industry. The implication is it is somewhat stable going forward. What typically happens on the billion dollar accounts it has been clearly true for us as well.

As they don’t quite for bit anyway they get renegotiated and part of that is because the forward integration that the current supplier usually with a billion dollars customer. the point out was making there we don’t have any of our business at risk any large pieces of our business for any risk in the industry appears to be relatively stable in the next months in terms of the large contracts coming up.

Charles Boorady – Citi

Fair to says none of those assumed in your guidance that you gave us for next year.

Dave Yost

Absolutely right. We don’t anticipate any large movement of big customers in our guidance.

Charles Boorady – Citi

Great thank you.

Mike Kilpatrick

Next question please.

Operator

Next question is from [Stephen Ballicud] with UBS.

Stephen Ballicud - UBS

A couple of quick one I know we discussed generics quite a bit. How would you specifically compare the generic industry pipeline outlook for fiscal ‘10 compared versus what we had in fiscal ‘09, the same greater or smaller base fiscal ‘10 versus fiscal ‘09 based on what you see right now?

Dave Yost

For us it matches up pretty nicely fiscal ‘10, fiscal ‘09 and even by quarter-by-quarter, it is not dramatically different. You can never tell when somebody will go to risk and so those are kind of hard to forecast but we don’t see any dramatic differences year-over-year and even quarter-over-quarter.

Stephen Ballicud - UBS

Just real quick, fiscal ‘10 distribution revenue guidance of 5% to 7% growth and I may have missed it, did you give a breakdown of how much you expect for growth between direct store delivery versus bulk within distribution?

Mike DiCandilo

First off, bulk is a very, very small proportion of our business. So, we don’t break it out. Again, it is 5 % to 7% for both drug and specialty and the bulk which is a small part within that drug number.

Mike Kilpatrick

Next question please.

Operator

Next question is from Helene Wolk - Sanford Bernstein.

Helene Wolk - Sanford Bernstein

I just have a question about the operating expense guidance and how does it reconcile the 1% to 3% growth relative to what you just accomplished in terms of fiscal ‘09 and given the increase in ERP spending, I can’t quite get better.

Mike DiCandilo

The guidance that I gave, Helene, was 1% to 3% over the current year and again, remember, that’s on revenue growth of 5% to 7%. So we continue to have operating margin expansion from that expense leverage. This year we were down some, but that was with an average 2% revenue growth and of that 1% to 3%, a good piece of that, up to about half of that could come from our increased ERP spending, which is up $10 million to $20 million in total and as I said, a little bit more than a third will be expensed this year versus a third last year. So you’re looking at a piece of that being from the ERP, good piece.

Dave Yost

Again, it’s important to note that our unit of work is going up faster than revenues as I mentioned in my prepared remarks, because we’re doing more and more business with generics. You have more items per dollars. So our cost control is really the money that we’ve spent on our automation and your cost controls out are really paying off and we’re getting good leverage from that as we go forward.

Helene Wolk - Sanford Bernstein

Just a corollary to that, in terms of what we’re hearing from generic manufacturers around, so pricing stability and even perhaps supply availability, any impact on your business or increased penetration in terms of expectations around supply?

Dave Yost

Supply as a general rule supplies has not been an issue. They’ve been some recalls and the like they will cause problems, but as a general rule we’ve been able to get adequate supply from our customers and I think part of that is because of the large base of business that we have, the customers that we have who look to us for their generic supply. I think the manufacturers look to us as a very strong partner here. So we have not had any problems apart from those in the market that resulted from recalls.

Mike DiCandilo

I think there’s certainly been a couple of a well public sized case of certain generic manufacturers having issues. In our business we’ve been able to have continuous supply through the use of the supplier that is we do partner with and from a pricing standpoint in some of those cases it has caused prices to raise a little bit, but our general expectation is not for significant price increases on the generic side going forward.

Helene Wolk - Sanford Bernstein

Thank you.

Mike Kilpatrick

Thank you. Next caller please.

Operator

Next question from Richard Close, Jefferies & Co.

Richard Close - Jefferies & Co.

Yes, thank you, just a follow on the discussion of Kaiser switching to a fee for service. Mike, you’d touched on this a little bit, but maybe if you can give us a little more granularity here. The second quarter, I think the street estimate is for $0.51, typically your seasonally strongest if I’m not mistaken and can you walk us through, I know you don’t give quarterly guidance. You just walk us through, should we see a little bit more a smoothing on a quarterly progression, maybe not such a large gap up in the March quarter in terms of the earnings per share?

Mike DiCandilo

Richard, there will be as I mentioned some smoothing between the second, third and fourth quarter. I don’t think it’s going to be real significant or real noticeable. Certainly the up tick from 1Q to 2Q that we have had historically will still be there. It will moderate a little bit, but it’s not going to be a dramatic change in our trend between Q1 and Q2.

Richard Close - Jefferies & Co.

Okay, and then with respect to follow-up on generic discussion and talking about first half greater growth than the second half in overall revenues. I assume with respect to generics we’re talking double digit growth if not higher in the first half because of the new customers, and then maybe moderate into the mid single digits in the second half in generics. Is that the way we should be thinking about it?

Mike DiCandilo

I think we expect the generic growth to be above the total growth and that pertains for both the first half where the total is higher than as well as it does for the second half where we’re more in line with market.

Richard Close - Jefferies & Co.

Okay, thank you very much.

Mike Kilpatrick

We’ll take one more call please.

Operator

Our next question is from Robert Willoughby - Banc of America.

Robert Willoughby – Banc of America

No question it actually so I yield to the next guy.

Mike Kilpatrick

Dave, you want to give some closing remarks, please.

Dave Yost

Just to wrap up, let me again thank you for joining us. We delivered a strong quarter, a strong year in a series of strong quarters and strong years in an industry that has remained strong in a turbulent economy, very consistent growth in a resilient industry as we mentioned a couple of times we have grown EPS years from continuing operations at a 16% compounded annual growth rate. We have great momentum going into our new fiscal year and we look forward to a more detailed update with you at our annual investor conference which is scheduled for December 15 in New York City. Thank you very much.

Mike Kilpatrick

That concludes our call. Thank you all for joining us today.

Operator

Thank you. This concludes AmerisourceBergen call for today, audio replay can be found by dialing toll free at 1-800-839-4519 or 203-396-3587. Thank you for participating.

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Source: AmerisourceBergen Corp. F4Q09 (Qtr End 30/09/09) Earnings Call Transcript
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