AmerisourceBergen Corporation F2Q08 (Qtr End 3/31/08) Earnings Call Transcript

AmerisourceBergen Corporation (NYSE:ABC)

F2Q08 Earnings Call

April 23, 2008 11:00 am ET

Executives

Michael N. Kilpatric- Vice President of Corporate and Investor Relations

R. David Yost-President and Chief Executive Officer

Michael D. DiCandilo-Executive Vice President and Chief Financial Officer

Analysts

Lisa Gill-J.P. Morgan

Robert Willoughby-Banc of America Securities

Larry Marsh-Lehman Brothers

Charles Boorady-Citigroup

Tom Gallucci-Merrill Lynch

Randall Stanicky-Goldman Sachs

Ricky Goldwasser-UBS Warburg

Glen Santangelo Credit Suisse First Boston

David Veal-Morgan Stanley

Operator

Ladies and gentlemen, thank you for standing by and welcome to the AmerisourceBergen Second Fiscal Quarter Earnings Conference Call. (Operator Instructions) At this time I would like to turn the call over to your host Mr. Mike Kilpatrick. Please go ahead sir.

Michael Kilpatric

Good morning everybody and welcome to AmerisourceBergen conference call covering 2008 second quarter results. I’m Mike Kilpatrick Vice President of Corporate and Investor Relations and joining me today are David Yost, AmerisourceBergen President and CEO and Michael DiCandilo, Executive Vice President, and Chief Financial Officer. During the conference call today we will make some forward-looking statements about our business prospects and financial expectations. We remind you that there are many risk factors that could cause our actual results to differ materially from our current expectations. For discussion of some key risk factors we refer to you our SEC filing including our 10-K report for fiscal 2007. Also, AmerisourceBergen assumes no obligation to update the matters discussed in this conference call and this call cannot be taped without the express permission of the company. As always those connected by telephone will have an opportunity to ask questions after our opening comments.

Here is Dave Yost, AmerisourceBergen CEO, and President to begin our remarks.

David Yost

Good morning and thank you for joining us. Our Pharmaceutical Distribution Segment delivered excellent results in our second fiscal quarter ending in March. I will address separately our other segment, which contained our PharMerica Long-Term Care operation last year, but not this year and our PMIS Workers Compensation business in both years, but first the highlights in Pharmaceutical Distribution. In the Pharmaceutical Distribution Segment total revenues were $17.8 billion, up 9% for the quarter. Bulk revenues decreased significantly to 552 million, as some of that revenue was captured in operating revenue, making total revenues an irrelevant number and as Mike will detail, we are now making total revenue our revenue guidance and analysis metric. This was our largest operating and total revenue quarter in our history. Our operating margin on total revenue in the RX Distribution Segment expanded a very strong 9 basis points to 134 basis points to revenue, reflecting a gross margin expansion due to a robust manufacture pricing and generic environment and decreases in our operating expenses as a percent to revenue. Net of our Bellco acquisition, we spent less absolute expense dollars running our core drug company t his quarter versus last year, with a strong revenue increase. Consolidated diluted EPS was up 21%. Excluding the impact of PharMerica Long-Term Care the previous year, the EPS was up 26%. We generated $192 million in cash for the quarter with good asset management by driving our inventory and receivables days down. We delivered strong return committed capital and return on invested capital, all in all an excellence performance. At AmerisourceBergen we continue to focus on the basics, increasing revenues, controlling costs, managing our inventory and receivables.

You’ll recall that in January we announced our intention to pursue the sale of PMSI, our Workers Compensation business and speculate that if the sale process were to produce an acceptable price, PMSI would be listed as discontinued operations beginning in the March quarter. After reviewing final bids from interested parties, we have decided to discontinue the sale process of PMSI since the final bids did not reflect our valuation of PMSI’s potential. Although we had significant interest and strong first and second round bids, we saw final bids decrease significantly following the collapse of Bear Stearns and further tightening of credit markets. We continue to think that PMSI can be a strong contributor to ABC and we’ll devote our efforts to achieving that end. The disappointing financial results of PMSI this quarter reflects in part the distraction of the sale process and we look to PMSI to be on track in the September quarter and into FY09. As I mentioned last quarter, PMSI has an outstanding management team and a dedicated team of about 800 associates that has historically delivered fine results in the face of changing markets and increased competition and we expect a return of that tradition.

It is important to keep PMSI’s contribution to our earnings in perspective. When PMSI was hitting on all cylinders, they accounted for 5% of our earnings and today PMSI is in the 2% range. The total performance in the other segment is complicated by the fact that last year’s numbers for the quarter include the contribution of PharMerica Long-Term care operation which was spun on a tax free basis to ABC shareholders in July and immediately combined with Kindred’s long-term care assets and then taken public. The PharMerica operating results are not allowed to be classified as discontinued operations due to our long-term pharmaceutical supply contract with the new company.

Now turning to some industry issues. First market growth. IMS reported last month their assessment that the market grew the 4% range for calendar year 2007 and a forecast total market growth in the 3 to 6% per year range for the next three calendar years with calendar ’08 in the 2 to 3% range. Since the slowing in historic growth is strongly influenced by the impact of generics and because we have a strong market share in the fast growing specialty business, we continue to be confident in our ability to deliver strong financial performance in the forecasted market environment.

Regarding the California Pedigree, California Board Pharmacy has voted to delay the implementation of a required pedigree on all products to July 1, 2011.Though AmerisourceBergen would have been prepared to implement the regulations as proposed, we are delighted about the delay so the issue can be addressed on a national level and a more costly patchwork of unique state regulations can be avoided. This week national legislation was introduced in congress which provides a planned national approach to the pedigree issue.

Regarding AMP or average manufactured price, due to the losses filed by NCPA and NECDS highlighted the flaws to the calculation of AMP as currently proposed; the implementation of AMP has been delayed. The court case will probably not be resolved until late this calendar year at the earliest. There is also a legislative effort in process to correct the deficiencies, but my guess is that will also stretch into our next fiscal year. ABC as well as others in the industry have been actively involved in this issue, but essentially there is nothing to report.

Regarding the manufacture-pricing environment, we are not seeing anything anywhere, including Washington to lead us to believe that the brand manufactured pricing will be any different this year from recent history. We expect brand manufacturers to increase prices in the 5% range for the entire year. Price increases continue to be strongest in our March quarter and that was true again this year with our March quarter price increases slightly ahead of the pace we experienced last year. Of course fee for service with brand name manufacturers mitigates the fact of price increases that we had noted on a previous occasion.

Regarding the customer pricing environment, I would continue to describe the current environment as competitive but stable. There are not a lot of single customer, multi-billion dollar whole sale opportunities in the market, which itself speaks to market stability in a total market approaching 300 billion in size. Individual skirmishes tend to be somewhat anecdotal, but we are not seeing any broad-based irrational pricing in the market.

On top of the revenues, it is important to address our anemia business, the erythropoiesis-stimulating agents or ESAs and the impact these products are having on AmerisourceBergen, particularly our specialty group. Sales of ESAs in oncology were down 45% in the March quarter versus the previous year and accounted for 2% of total revenue. March quarter oncology ESA sales were down about 7% from the December quarter. You will recall that it was in March 2007 the FDA issued their black box warning on ESAs. We previously expected oncology ESA revenues to stabilize in our June quarter. We now think we could experience added pressure from ESAs for the balance of the year. Again, it is important to note that oncology ESAs are 2% of total revenues.

Revenues this quarter in our specialty group were also affected by the $800 million of annual OTN revenues lost in November of this fiscal year due to its purchase by a competitor. Though ABSG, our specialty group, is clearly weathering some headwinds, it is important to recall the very strong historic performance delivered by this unit and the key strategic space this unit holds. With our $12 billion of revenues, we are the largest distributor by far of specialty Rx products and services to the specialty physician market, exactly the territory where new and innovative products will undoubtedly enter the market. Finally discussing revenues, I’m going to address generics. As we have noted frequently, generics provide us great opportunity to provide value both up and down the supply channel for the manufacturers we aggregate demand across our customer base and provide daily delivery to our geographically diverse customer base within our prime vendor distribution model. For our customers we search the market for the best generic value including price, quality of product, reliability of supply and continuity of color, shape, and size of pill. Our generic business continues to grow faster than the market. We continue to increase generic penetration among existing customers as well as add new customers as our pro-generics is one of our programs that differentiate ABC from our competitors. Generics as a percent of revenue dollars are in the low double digits to our retail business and growing nicely. To the extent that the total pharmaceutical distribution market growth rate has been impacted by total generic penetration, reflects opportunity for distributors like AmerisourceBergen and particularly AmerisourceBergen with our strong customer base of independence, regional change, food/drug combos and clinics that rely upon us for their generics decisions.

I recently met with the advisory board of our Good Neighbor Pharmacies who continue to be very optimistic about their businesses and the role they will continue to play in health care. GNP now numbers about 2,900 stores and we look to be at our ’08 goal of 3000 stores by fiscal year end. Our good neighbor preferred provider network has over 5000 stores.

On the M&A front, we were actively engaged in the bidding process of the regional wholesaler that was recently purchased by a competitor. The continued interest of our peers in this space continues to validate our strategy. Our October $162 million acquisition Bellco Drug, our largest acquisition ever, continues to meet or exceed our expectations on all key metrics. We will continue to invest in the future and our ability to meet the future needs of our customers. This includes a business transformation program, a part of which is a new ERP system for the drug company corporate office and an expense plus capitalized cost to be spread over the next three to five years, which is included in our CapEx guidance. We continue to be on schedule and on budget on this program and have our systems integrator on board.

Mike will provide some additional color on our narrowed EPS guidance, but I would like to emphasize that our revised guidance continues within the original range and reflects a narrowing of the range at the top end, reflecting, primarily reduced PMSI expectations as well as slowed market growth and continued pressure on anemia product sales and oncology. Within the second half, we expect the September quarter to be stronger than the June quarter.

Before I turn the floor over to Mike, I want to emphasize my enthusiasm for our industry and the role that ABC plays in it. The fundamentals of our industry continue to be very, very strong. Our FY08 features a streamlined organizational structure, the largest acquisition in our history and the right segments to capitalize on generic opportunities and new specialty products entering the market. We continue to execute on the basis of revenue generation, quest control and asset management while continuing to provide outstanding service and programs to our customers, key differentiators for AmerisourceBergen. We look forward to continuing our history of strong operational and financial performance.

Now here’s Mike for some added color.

Michael DiCandilo

Thanks Dave and good morning everyone. We are very pleased with our excellent second quarter and first half of fiscal 2008 results. As our Pharmaceutical Distribution performance was strong once again in every financial category. We have a number of items to discuss today that impact our consolidated results and forecast including PMSI, our switch from operating to total revenue guidance, our modifications to our fiscal 208 guidance and the inclusion of our former LTC business results in our prior year numbers, all of which I will detail.

First, I would like to remind everyone that our March or second fiscal quarter has traditionally been our strongest quarter from an earnings and margin perspective due to the relatively higher number of brand name manufacturer price increases during the March quarter and this year was no exception. Certainly our fee-for-service agreements have somewhat mitigated the variability of the quarterly contribution from price increases; however the 20% or so of our brand name business that is still subject to the timing of manufacturer price increases continues to benefit the March quarter more than any other.

Now moving to revenue classification. Historically on our income statement we have provided breakouts for both operating revenue and both deliveries to customer warehouses. Our margin analysis has focused on operating revenues as both deliveries gross profit and expense were both negligible as the majority of this revenue represented direct shipment from the manufacturer to our customers warehouses. As a result of our contract extension and expansion with our largest customer earlier this year, we began in the March quarter to transition a significant amount of business previously conducted on a bulk delivery or direct basis, to being serviced out of our distribution centers on an operating revenue basis. Over $700 million or 5% of our 13% operating revenue growth this quarter and a significant decline in both delivery revenue, resulted from this transition. Our on going bulk delivery business is expected to be in the $1.8 billion range annually and because of its insignificance to our total revenue, we will begin to discuss our operating ratios and give revenue and margin guidance on a total revenue basis only. As a results, our annual revenue guidance is now a range of 7 to 9% total revenue growth rather than the 7 to 9% range of operating revenue growth and our operating margin expansion guidance in the low single digit basis point range still holds, only it is on a total revenue base measure.

Now moving to our consolidated results. Total revenue increased 8% to $17.8 billion driven by 9% growth in pharmaceutical distribution which included a 3% boost from the Bellco acquisition. Consolidated operating income was up 75 as Pharmaceutical Distribution EBIT grew a robust 16% and more than off set the $15 million EBIT decline in our other segment. Seven million of the other segment decline relates to our former PharMerica Long-Term Care business, which is once again, included in our prior year numbers, causing an apples to oranges comparison to fiscal ’08. Special items were negligible in both the current and prior year March quarters. Net interest expense of just under $19 million in the quarter was up 89% over the prior year as expected due to reductions in interest income as average cash balances were significantly less than last year at this time due to our share repurchase activity. Our effective tax rate for the quarter was 38.9% up from last year as expected, reflecting less tax-free investment income. We continue to expect the effective tax rate to be slightly north of 38% for the full year. Diluted EPS in the quarter of $0.82 was up $0.14 or 21% compared to the prior year quarter and excluding PharMerica Long-Term Care’s $0.03 contribution in the prior year was up $0.17 or 26%. This increase was driven by the $0.16% increase in Pharmaceutical Distribution operating income and the significant reduction in average outstanding shares net of the impact of the increase in interest expense. Average diluted shares outstanding were 163.3 million, down nearly 29 million shares or 15% from the prior year, reflecting our share repurchase activity over the last 12 months.

Now moving to the pharmaceutical distribution segment where our performance in the quarter was outstanding. Total revenue was up 9% driven by the drug company which increased 8% and Bellco, which contributed 3% of the top-line growth. The specialty group was essentially flat, up less than 1% as expected due to the anemia drug situation in the OTN acquisition earlier this fiscal year. Anemia drugs used in oncology represented 2% of total revenues in the quarter and were down 45% from the prior year quarter. The drug company growth was driven by our institutional customers, including significant growth from our largest PBM customer, where we have expanded our relationship during the current year. Retail customer revenue was flat compared to last year’s quarter.

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

Gross profit increased 10% during the quarter and gross profit margins expanded by 5 basis points driven by strong brand name drug price appreciation and increased generic drug contributions. As we noted last quarter, a large brand name manufacturer, which raised prices in December 2006 and did not raise prices in the December 2007 quarter, was expected to raise prices during the March quarter and that did happen, contributing to our strong results. Generic results benefitted from increased customer compliance as well as a couple of new introductions during the quarter.

We had LIFO charge of $9.6 million in the quarter compared to $1.6 million last year, reflecting the strong brand name price increases during the March quarter. We currently expect a charge in the $15 million range for the year.

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

Operating income was up 16% with operating margins expanding in the quarter to 134 basis points, up 9 basis points versus the prior year. After six-month segment operating income is up 8% with margins expanding by 2 basis points.

Now turning to our other segment formerly known as PharMerica. Again, the current year results include only PMSI and the prior year includes both PMSI and long-term care. As I previously mentioned, long-term care contributed just under $7 million of operating income to the segments operating earnings in the prior year’s second fiscal quarter. As Dave mentioned earlier, we have terminated our sale process with PMSI and are focused on more closely aligning them with ABC and continuing to make progress with their turn- around plan that we have spoken about the last couple of quarters. Unfortunately our progress is reflected in the financials, has been slower than we expected, which is reflected in this quarter’s numbers where revenues have declined by 8% to $105 million and operating profit declined by $7.8 million to $800,000. This reduction resulted in both declines in gross profit due to competition and reductions in reimbursement as well as increases in expenses where we continue development on our customer facing IT initiatives.

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

Now let’s turn to our consolidated cash flows on the balance sheet. We generated cash from operations of $193 million for the March quarter and $92 million for the first six months of fiscal 2008. We continue to expect our cash generation to be back ended for the year and have maintained our free cash flow estimate of 450 to $525 million. We had capital expenditures of $28 million during the quarter and $55 million for the six months on pace with our annual $125 million guidance. We continue to have a strong focus on asset management and our success in this area is reflected in our working capital statistics as inventory days on hand during the quarter were 25 days down nearly 3 days compared to March of ‘07 and DSOs were down 1 day to 19 days and DPOs were flat year to year.

From a share repurchase perspective we bought $84 million of our shares during the March quarter and have now bought back $395 million of our shares in the first six months of fiscal 2008. We have $302 million remaining under our share repurchase program and based on our first half activity and expected cash flow in the second half of 2008, it is likely that we will use a substantial amount of the remaining $302 million authorization in the second half of the fiscal year and exceed our 2008 share repurchase target of 400 to $500 million.

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

Now moving to our fiscal 2008 guidance, our revised annual dilute EPS guidance is $2.77 to $2.87 for the year within our original range and reflects a narrowing of the range by low end to top end. This top end reduction primarily reflects reduced PMSI expectations, declines in anemia drug revenues below our original expectations and slowing market growth. Said another way, with our GAAP diluted EPS of $1.48 for the first six months, we would expect diluted EPS in the range of $1.29 to $1.39 over the second half of our fiscal year with the September quarter expected to be higher than the June quarter due to the anticipated timing of certain manufacturer price increases.

This updated EPS guidance reflects our total revenue guidance of 7 to 8% and Pharmaceutical Distribution Segment operating margin expansion in the low single digit basis point range. Our increased share repurchase assumption should result in even fewer average outstanding shares than previously expected for the year, now down 12 to 13% , the benefit of which will be offset in part by higher net interest expense.

Now let me take a minute to express some high level thoughts about fiscal ’09 in light of the recent reduction in market revenue growth estimates by IMS. Keep in mind that we have not yet started our detailed bottom up planning process for fiscal ’09, which we will commence shortly.

Our long-term EPS growth target of 15% reflects market revenue growth, margin expansion in the single digit basis point range annually and free cash flow approximating net income. As we have said to many of you in the past, we are very comfortable with this target when market revenue growth is in the mid to high single digits. To the extent market growth is below this range, in the low single digits, it becomes more difficult to meet the mid teens EPS target although if the lower market revenue growth is due primarily to brand to generic conversions, we can certainly offset some of the slower revenue growth with increased margin expansion. As it pertains to fiscal 2009, if IMS is near term revenue growth guidance of 2 to 3% proves to be accurate, we can certainly see a clear pathway to low double digit EPS growth in fiscal ’09; however, mid-teens EPS growth would be more challenging. As usual, we will give detailed guidance for fiscal ’09 when we release our fiscal ’08 earnings in the fall of this year.

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

Now, I’ll turn it over to Mike Kilpatric for Q&A.

Michael Kilpatric

Thank you, Mike. We’ll now open the call to questions. I would ask you to limit yourself to one question with a follow up and if there’s time you can ask additional questions after others have had a chance. Go ahead Tony.

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Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We will take our first question in queue from Lisa Gill with J.P. Morgan. Please go ahead.

Lisa Gill-J.P. Morgan

Thanks very much and good morning.

Michael Kilpatric

Hi, Lisa.

Lisa Gill-J.P. Morgan

Just looking at the change in relationship with your largest client moving from bulk over to operating, Dave I think you said it added roughly $700 million to operating sales in the quarter, so if we think about this going forward are you really lowering your gross rate from just a pure operating to operating stand point to more like the, call it 2 to 4% range, or am I looking at that incorrectly? Then secondly can you just give us some color as to why it is that you moved from a bulk relationship to operating, are you providing additional services for that client, or is there some other reason?

David Yost

Let me take the second part first Lisa and then you and Mike can chime in on the first one. But, the really big additional service we provide when we move revenues from bulk to operating is daily delivery. When you think of bulk revenues, what they are is, think of it as pallets and merchandise, both merchandise that never go into inventory and that go to the customer in one big fell swoop. But when we move to operating +revenues, that inventory, the inventory is coming out of our warehouses on a daily basis, so the customer can replace his inventory and have his demands on a daily basis. So the added value that we’re providing the customer when we move from bulk to operating revenue is that he’s drawing on our inventory and the full breadth of inventory on a daily basis. It really allows the customer, any customer, to link up his production, his filling the prescriptions without having to maintain as big an inventory, without having the size of the inventory, which can be substantial for very large customers and kind of where you put it, but also having to deal with the inventory turn. So, it is a value added service and it relates to getting that inventory on a daily basis.

Lisa Gill-J.P. Morgan

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

David Yost

Right, Lisa, I mean it’s value add to the customers, value add to us and we would expect to get compensated and do get compensated for, you know, value that we bring to our customers.

Lisa Gill-J.P. Morgan

Then Mike, any thoughts on how we should be thinking about the growth rate, the underlying growth rate if you x out what’s happening here in the shift from bulk to operating?

Michael Kilpatric

Yes, Lisa, I mean we started with operating revenue guidance of 7 to 9 and you can see that our operating revenue was up 13% for the quarter and you know x the 5% contribution from the shift, we would have continued to be in the 7 to 9% range; so I think the way to look at this is we simply have had a shift. The operating revenue is going to be above the 7 to 9%, but on a total revenue basis with bulk coming down, in total we are going to be at 7 to 9. There has been no reduction of the operating revenue guidance. It’s actually higher.

Lisa Gill-J.P. Morgan

Okay, great, then just one follow-up question to that. As we think about what IMS is talking about and their talking about 2 to 3% and perhaps a lot of that is coming from generics. Can you just remind us all what the correlation has been to what ABC versus IMS has said in the past?

Michael Kilpatric

Well traditionally we’ve grown faster than the IMS numbers, Lisa and that’s a function of a couple things, but the biggest single thing is that we’re very strong in the specialty group; you recall the specialty group has grown like 2x the market. Our specialty group right now has a couple of headwinds, one of them is the loss of OTN which was purchased by one of our competitors in November, that was an $800 million dollar account and they’ve got some headwinds on the anemia products sales to oncology which is about 2% of our total revenue. But, after that, they’re growing in double digits and doing well, so that helps us grow faster than the market, that’s one thing. Secondly, we’ve had some institutional customers and other customers who have grown faster than market, so traditionally we’ve out performed the market in the last several years.

Lisa Gill-J.P. Morgan

Great and thanks very much and allowing me to squeeze in that extra one.

Michael Kilpatric

Okay.

Operator

Thank you. Our next question in queue will come from the line of Robert Willoughby with Banc of America Securities. Please go ahead.

Robert Willoughby-Banc of America Securities

All right, actually a couple of related issues. If the Pharm industry, Dave, is growing at the levels you suggest are possible next year, would there be any real need for incremental working capital for you or can we model some flat to down assumption. Then if you look at reduced capital needs, or certainly capital needs not growing, you’ve been a leader with boosting the dividends here over the past couple of years, but the yields are still ridiculously low given the capital requirements of your business now. So when do we see kind of a more meaningful shareholder benefit put in place?

David Yost

Well first of all Bob, I want to be sure that we’re not confirming the IMS numbers. What we’re just trying to do is we’re just trying to kind of postulate if the market were to grow in that range, how we would be able to postulate our own growth. In terms of our dividend Bob, what we have traditionally done is we have traditionally reviewed that on an annual basis at our year-end board of directors meeting in November and we’ve done that the last several years and I would expect that to be a normal agenda item for that November meeting. Mike, why don’t you talk about working capital?

Michael DiCandilo

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

Robert Willoughby-Banc of America Securities

Yes and [indiscernible] that isn’t the market currently dramatically different, it’s a new business model in the fee for service world that takes a great deal less capital and you’ve got visibility there on, why is the traditional, annual check on the dividend normal, why is this not semi-annual? I mean isn’t there an opportunity to do that much more? And, I don’t think you’re giving credit for the share repurchases.

David Yost

Well that’s a fair call out Bob and you know traditionally we’ve done it annually and we could review it more than that, but traditionally we do it on an annual basis and you’d probably not see our board doing it more than that. The important call out though I think you’ve made is an excellent one and that is that the efficiency of the whole working capital model. I want to tell you when you look at the working capital as a percent to revenues and how it’s come down in the last few years, it is extraordinary without question and currently we’re using that money of course to buy a lot of shares back. But good call.

Robert Willoughby-Banc of America Securities

Thanks.

Operator

Thank you. Our next question in the queue will come from the line of Larry Marsh with Lehman Brothers. Please go ahead.

Larry Marsh-Lehman Brothers

Well thanks and good morning. Thanks for updating us on the industry and a good drug update. I guess Dave, my question really is to drill down this PMSI process which I think is just a very disappointing outcome to say the least. I guess my question is you’re calling out a turn around that you’re going to drive yourselves, so in any organization when you’re subjected to being for sale and losing customers, it’s a challenging environment. Obviously that reflected in gross margin, you down what 27% on a gross margin basis in the quarter. So as you sort of think about looking out for the next two years, what gives you any real confidence that Mark and his team, you know he’s been there for several years, is going to be able to drive this turn around? I know you talked about it at the analyst day Mike, the 7 to 9% kind of the sustainable margin in this business and yet we’re below 1% here and losing customers. Where do we see the improvement besides this idea that technology is going to get us there and what gives you confidence and the board confidence that Mark is the guy that’s going to do it for you?

David Yost

Well Larry, thanks, I mean they’re all good questions and I think you’re completely correct; it is a challenging environment for the team. The one caveat I would give you is we would be or PMSI would be in a turn around situation regardless of ownership. Part of the appeal to others in the sale process was going to be this turn around plan as well. So, it’s something we’ve got to go through and that business has to go through regardless. I think we’ve got a very strong management in place, as we’ve said in the past this is a management team that took over kind of late in 2006 with some downward pressure on the business and I think some of the customer losses that started the downturn were already in place before this team took over and Mark Holyfield and Mark Augustan our chief financial officer for that business unit have put together a pretty strong turn around plan which included building out an IT infrastructure as we separated from PharMerica and making the customer experience more interactive and easier and certainly they have made great progress in building that infrastructure. Certainly the sales process was a distraction and probably delayed some of the benefits, but I think as a team it’s very focused on pushing forward, making sure their focusing on the right product lines within that business and part of this whole turn around will be more closely integrating this business with ABC and getting some benefit with things like shared services and getting some integration with some of our other business units, particularly with this pharmacy services business which is very closely aligned with ABC.

Michael Kilpatric

Yes Larry I’ll just chime on here a little bit and say one of my key tasks, clearly is to make sure I’ve got the right leadership in all the right spots in AmerisourceBergen, that’s one of the things I get charged with on the board and get paid for and I will tell you, I think we’ve got it in PMSI. You pointed out it’s a pretty challenging environment to go through a merger sale process and I can tell you we know that as well as anybody. It wasn’t that long ago that we were going through a merger process and I’ve been through it three times in my career and I will tell you that that team has weathered the storm quite well, the distraction quite well. They had held onto most of their key customers and I think they’re in good shape and we’ll be flat in the progress and we’ll be reporting it to you and you’ll be seeing how that progress progresses over the next several months, but I would say with the clear focus now on the turn around, the clear focus now on what they’re about, I would be very disappointed if we don’t see some big changes there.

Larry Marsh-Lehman Brothers

Okay great and just I wanted just one quick clarification for Mr. DiCandilo. You call out the oncology volume in your specialty business being down 45% are you saying what your anemia volume was x oncology in your business?

Michael DiCandilo

Yes, the numbers we reflected in our prepared comments Larry was the anemia drugs for oncology uses were 2% of total revenues down 45%. In total anemia drugs are a little over 5% of our total revenues with the other 3.5% or so concentrated on the dialysis business which has not been affected nearly to the extent and pretty much not at all compared to the anemia uses for oncology.

Michael Kilpatric

We thought that if we focused on the oncology issue Larry, that’s kind of where the controversy is and the institutional use has not been dramatically affected.

Larry Marsh-Lehman Brothers

Okay, thank you.

Operator

Thank you. Our next question will come from Charles Boorady with Citi. Please go ahead.

Charles Boorady-Citigroup

Thanks, good morning. My first question is with the reclassification of the bulk from the large customer. Are there any other accounting or financial implications with that move, for example with accounting for inventories or anything else like that?

David Yost

No , no financial implications Charles, I mean simply we’re working off a different measure and I think one way I think would be helpful for people to keep in perspective, we talk about the pharmaceutical distribution operating margin expansion being in the low single digit basis points. You know previously when you were looking at operating revenues for fiscal ’07, that operating margin was 120 basis points. If you computed that off of total revenues, it would be 112 basis points. So, I think when people look at last year to this year and they should be looking at the 112 basis points as the base measure from which we expect to have single digit basis point

market expansion.

Charles Boorady-Citigroup

Great, I appreciate your responses to the questions on uses of capital. You’re generating a lot of cash, which is great and one of our competitors has been more aggressive, if that’s the right way to describe it in acquiring, including independence, which as you mentioned is a good validation of your business mix and your model and also OTN which is a good validation of your specialty strategy, but I wonder whether those are acquisitions that you contemplated and whether you think your decision to buy your own stock back, seeing it is being undervalued, was an appropriate thing to prioritize over making acquisitions that could have been strategically beneficial, especially in light of an expected slowing organic top line.

David Yost

Good question Charles, I mean the first thing I’d point out is we’ve made the biggest acquisition we’ve ever made in our history this fiscal year, you know just about seven months ago when we bought Bellco. You know Bellco was a traditional wholesale or had the added benefit of having a large dialysis business and a generic telemarketing business that we liked very much, but it was a traditional wholesaler, you know very strong in the New York market which is a very strong independent market, so the answer to your question is yes, we actively are involved in the process. We looked at Ed Mcquiry [ph] and that was simply, that was bought by one of our competitors, announced within the last 30 days. We had a bid, we were very much involved in the process, and our bid was not the high bid. You know we looked it up at the OTN, actively involved in the OTN process, business we know very well with our large specialty business had some great operating synergies, and again we were out bid. So, I think the answer to your questions Charles is we are very much involved in the process, we will continue to be much disciplined in our use of capital and we will compare that to buying our own stock back. I sometime laugh when I talk about, internally when I talk about buying our stock back is we know the guys who run it, it’s a business we know very very well, you know you’re not taking any chances. But, we’ll continue to be involved in the process. We look at a lot of opportunities, we have a very active business development program, and we’ll continue to be engaged.

Charles Boorady-Citigroup

All right, thanks.

David Yost

You bet.

Operator

Thank you. Our next question will come from the line of Tom Gallucci with Merrill Lynch. Please go ahead.

Tom Gallucci-Merrill Lynch

Good morning, I just wanted to ask about two things. First, you mentioned generics a few different times in the remarks here and penetration in the client base being up; so I was wondering on top of the generics, one how are you going about in succeeding in terms of getting that penetration up in existing customers, what types of things can you do there and are you seeing an different ability to profit on generics? Then the second question would be on the anemia related drug category, you’ve lowered the expectations a bit. What have you factored in there for incremental degradation from private payer’s changing their guidelines or is that mostly just based on, on sort of what you’re seeing stemming from the Medicare changes?

David Yost

Well Tom let me start off with the generic penetration. I mean we’re doing several things with, first of all we’re doing a lot better job of monitoring it. You know now with our customers we provide them additional incentives so that we’re getting the total market basket of their purchases and not having us supply the health and beauty and over the counter product and missing the generics. We’ve got a telemarketing operation now, which we picked up in Bellco about seven months and we’re continuing to emphasize it with our sales force. Mike and I ended our day yesterday with talking; addressing a group of about 150 sales people on the West coast and generic was a key issue for us. So, I think it’s a function of focus Tom, it’s a function of proper incentive and it’s a function of new programs and you’re putting all those together and we’re getting some great traction. You know in addition it’s a lot higher profile with our customers than it was two or three years ago and I think the customers are realizing that kind of cherry picking other peoples programs probably doesn’t make a whole lot of sense and their better off dealing with a prime vendor model which has made themselves available in the past. So, it will continue to be a focused force Tom and a big differentiator.

Michael Kilpatric

Tom, as far as anemia drugs and again I’ll reiterate the base line, there 2% of our business today; From today’s baseline, obviously ODAC the panel has come down with certain recommendations to restrict further usage and the estimates that I’ve seen in the market place have been from a 20 to 40% further reduction in anemia drug use for oncology and our expectations are in that range for further decline.

Tom Gallucci-Merrill Lynch

Then just the profitability or are they building to make money on generics, has that changed at all in the last year?

Michael Kilpatric

Not at all, you know we’ve done very very well.

David Yost

You know we’ve done well Tom and part of the reason is, the customer base that we service on generics is really hard to reach without a distributor like AmerisourceBergen and it’s geographically diverse, it’s the independence and regional change of the clinics and the like so… you know we’ve got a good spot in the distribution channel for that and I will tell you I think generics will continue to be a differentiator for us and enhance our profits as we go forward

Tom Gallucci-Merrill Lynch

Okay, thanks.

David Yost

You bet.

Operator

Thank you. Your next question will come from the line of Randall Stanicky with Goldman Sachs. Please go ahead.

Randall Stanicky-Goldman Sachs

Great, thanks for the question. Actually, just speaking on the generics topic, just two related questions; first there has been obviously some news full of rumors, but all we have is exclusivity when a couple weeks ago and obviously the FDA’s subsequent appeal. Can you just clarify whether your guidance assumes Teva’s exclusivity or are you factoring, at this point, a competitive launch on that product?

David Yost

Yes, we’re expecting Teva to continue with exclusivity in the fourth quarter and that’s with built in. I think I’ll remind everyone that, you know on single drug is going to make that big of a difference to a single quarter, certainly as we’ve said in the past our suite to five for generics is during the six month exclusivity period and typically where there’s more than, where there’s two people battling it out for market share. That’s our sweet spot, but again, it’s one element with a lot of moving parts in a quarter and it is not going to make or break us.

Randall Stanicky-Goldman Sachs

Sure and actually on that topic, you know one of those battling it out spots certainly is Protonix where it’s right now a three generic market. You guys sit in a pretty good position to see what a pretty unclear market outlook for that product. Do you have any color, or visibility or expectations as you look at the rest of the year for that market in terms of what you’re seeing on the generic side?

David Yost

Well we really don’t and we’ve been really careful about talking about specific products. But, I will tell you when you’ve got three suppliers, multiple suppliers like that works out very well for us and that was a nice sweetener. For the March quarter we look for risk at all to be a nice sweetener for us and in the fourth quarter. So it’s one of the things that makes this business very very attractive is you’re not betting on a specific product and you’re not betting on a specific manufacturer, you’re really kind of a winner no matter how it comes out and with our diverse customer mix it makes it very very attractive.

Randall Stanicky-Goldman Sachs

Great, okay thanks guys.

David Yost

You bet.

Operator

Thank you. Our next question will come from the line of Ricky Goldwasser with UBS. Please go ahead.

Ricky Goldwasser-UBS Warburg

Yes, good morning, thank you for taking the questions, a couple of follow-ups. First of all just to clarify on Randall’s question on Respiderol. Are you, does your guidance assume it comes to market or are you just probability adjusting because there is still some uncertainty on whether the FDA will indeed appeal? Then secondly, as far as fiscal year ’08 guidance, first if you can quantify what is the percentage back of the $0.08 adjustment that you made to the upper end of the guidance range, what is the impact of CMSI in oncology versus market growth and then when you talk about pricing station, 5% for the entire year, is this 5% for calendar year ’08 or for fiscal year ’08?

Michael Kilpatric

Hi Ricky, this is Mike. I’ll try to answer all those questions. If I miss something I’m sure Dave will say something here. First with risk, our expectation is that it’s going to come to market in the fourth quarter and as I said, it’s one product and it’s not going to make or break, from our perspective, our quarter. I think the second question was with the lowering of the top end of our range by $0.08, what was the relative contribution of the three factors that we mentioned. I would say that PMSI was more than half of that, probably in the $0.04 to $0.05 range with probably $0.02 to $0.03 market growth and $0.01 to $0.02 from the reduced anemia drug expectations. I think your final question was our 5% price appreciation was that for the calendar year or the fiscal year that is a fiscal year expectation.

Ricky Goldwasser-UBS Warburg

Well just following up on that, if we see the same trend as we saw back in ’04 where an election year during the June quarter, I’m sorry, during the September quarter manufacturers didn’t take, or took the increases at the broader proofed it to the November post day election, then we might see some push over from fiscal year, from the September quarter to December quarter in terms of EPS impact?

Michael Kilpatric

Well again, I think we have to keep in mind the difference between this election in 2008 and 2004’s. Back in 2004 we did not have fee for service in place and fee for service mitigates largely the impact of price increases except for those couple customers and significant supplier customers that we have still have variability in our inventory management agreements. So we would be much more concerned about whether one of those particular manufacturers had a price increase or didn’t have a price increase rather than the general market slowing down in the September quarter because if the general market slows down from a price appreciation perspective in the September quarter, number one we’ve got an offset with fee for service, number two it probably has some impact on our LIFO charge expectation for the year, which would probably be less.

Michael DiCandilo

Thanks Ricky.

Ricky Goldwasser-UBS Warburg

Thank you.

Operator

Thank you. We’ll take the next question in queue from Glen Santangelo with Credit Suisse. Please go ahead.

Glen Santangelo Credit Suisse First Boston

Yes, David, Mike thanks. I just wanted to follow up on the guidance question. I mean it seems like you’ve lowered the top end of your range here by $0.08 and Mike, I think if I heard you correctly, you’re sort of attributing almost a nickel of that to PMSI and another $0.01 to $0.02 from anemia, so really with respect to your base business, what are you saying? The only impact you’re seeing from a decelerating market is a penny or two, is that the right way the right way to think about it? Then I just have a follow up question on generics.

Michael DiCandilo

Yes, it’s a couple of pennies, Glen. I think if you look at our original guidance for the year is, our drug distribution revenue guidance was based upon mid single digit revenue growth and obviously, IMS has just come out for the entire calendar year of ’07 and said the revenue growth was just under 4% for ’07 and the expectation for calendar year ’08 was 2 to 3%, so you kind of put those numbers together which overlap our fiscal year and we’re probably a percentage point down from what our original expectation was.

David Yost

I think Glen; I mean I think you’ve got it. Absent PMSI and anemia headwinds, which we tried to quantify and still has some uncertainty to it, our base business is doing very very well and continues to hail on all cylinders.

Glen Santangelo Credit Suisse First Boston

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

David Yost

I think it’s pretty much business as usual Glen. We’re continuing to have great opportunities in generics and it’s a good call out in that as the top line is impacted by generics, it gives us the opportunity to have margin expansion as we go forward and that’s why as we look at it ’09 for example, we’re not giving hard guidance there, we’re just trying to give people some comfort. The fact that, even if the market does slow down, we can grow our EPS faster than that and part of that is margin expansion and part of that is coming from generics so, very good call out.

Michael Kilpatric

We have time for one more question.

Operator

Thank you and that question will come from the line of David Veal with Morgan Stanley. Please go ahead.

David Veal-Morgan Stanley

Hey, just when you think about the 4% market growth last year, it’s becoming increasingly obvious that the US pharmaceutical market is becoming more mature. When you think strategically are there other verticals that would be of interest or is there a potential avenue for overseas expansion?

David Yost

Well it’s a good question, Dave and you know we continue to monitor that. As far as overseas right now, and we watch it very very closely, not a lot of interest right now because they’re struggling with this whole issue of importation and parallel trade between countries and that’s got some of the manufacturers a little jittery and the whole distribution model I think is going through a change within Europe. You know we moved into Canada a couple years ago, we’re very happy with that expansion and we’re keeping our eyes on the other markets, but at this point, nobody else, you know no other markets have great appeal to us, good call out. We continue to look for other products that our customers could possibly use, maybe their buying from someone else, so that’s another opportunity for us.

David Veal-Morgan Stanley

Thanks.

David Yost

You bet.

Michael Kilpatric

Thank you all very much for joining us today. For those who want to hear more about the AmerisourceBergen story we are at a number of healthcare conferences through out May and June, so we will be around for those opportunities. With that said, I’d like to turn it over to Dave for some final comments.

David Yost

Thanks Mike, I would like to just say again, thank you for joining us. We’re very happy with our second fiscal quarter and we think we ended the quarter on a very positive note. We had strong revenues, we had expanded gross margins, we had decreased costs, we had expanded operating margins, strong asset management, and good cash generation, so lots and lots to like about AmerisourceBergen and lots and lots to like about our industry, and we look forward to reporting our continued successes with you. Thank you very much.

Operator

Thank you. Ladies and gentlemen this conference will be available for replay after 1:00 eastern time today through April 30, 2008 at midnight. You may access the ATT teleconference replay system at any time by dialing 320-365-3844 and entering the access code of 917886. Again that telephone number is 320-365-3844 using the access code of 917886.That does conclude our conference for today. Thank you for your participation.

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