Jul 24, 2008
Executives
Michael Kilpatric - Vice President, Corporate & Investor Relations R. David Yost - President and Chief Executive Officer Michael D.
DiCandilo - Executive Vice President and Chief Financial Officer
Analysts
Larry Marsh - Lehman Brothers Lisa Gill - J. P.
Morgan Robert Willoughby - Banc of America Securities Charles Boorady - Citigroup Colleen Lang - Merrill Lynch Alex Beckwith - Goldman Sachs Ricky Goldwasser - UBS Glen Santangelo - Credit Suisse
Operator
Welcome to the ABC third quarter conference call (Operator Instructions) I would not like to turn the conference over to our host, Michael Kilpatrick.
Michael Kilpatric
Welcome to AmerisourceBergen conference call covering fiscal 2008 third quarter results. I am Mike Kilpatric, Vice President of Corporate and Investor Relations and joining me today are David Yost, AmerisourceBergen’s President and CEO and Mike DiCandilo, Executive Vice President, Chief Financial Officer an COO of AmerisourceBergen Drug Corporation.
During the conference call today we will make some forward-looking statements about our business prospects and financial expectations. We remind you that there are many risk factors that could cause our actual results to differ materially from our current expectations.
For a discussion of some key risk factors we refer you to our SEC filings, including our 10-k report for fiscal 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’s President and CEO to begin our remarks.
David Yost
We delivered excellent performance across our pharmaceutical distribution businesses this quarter, our third fiscal quarter. Total revenues were a record and up year-over-year double digits.
We demonstrated excellent expense control. Our operating margin expanded again this quarter and we have excellent asset management.
Our other segment now includes only PharMerica long-term care results from last fiscal year as we have an agreement to sell our PMSI workers compensation business. As a result, we have reclassified PMSI to discontinue the operations and taken a large non-cash impairment charge based on the sale price.
We were very disappointed with PMSIs performance this quarter, which was below our internal expectations and after reevaluating all alternatives, decided it was best to sell the business and focus on our core pharmaceutical distribution and related services businesses. PMSI remains a viable business with opportunities ahead that are not core for us.
The pharmaceutical distribution business continues to be very strong with excellent fundamentals. Those of you who have followed us for a while have heard me refer to the ABC circle of life.
The older people get the more drugs they take and the more drugs they take the older they get. Sound fundamentals as far out as anyone can see.
Total revenue in our pharmaceutical distribution segment was $18 billion our largest revenue quarter ever. Revenues were up a strong 11% including about a 3% benefit from the acquisition of Bellco which we made last October.
Expenses were down as a percent of revenue by 10 basis points with substantially all are dollar increase for the quarter compared to the previous year due to the acquisition. Our operating margin in the pharmaceutical distribution segment expanded by a very strong 10 basis points’ we generated $131 million of cash.
Consolidated diluted EPS from continuing operations was $0.70 and excluding the impact of special items in both fiscal years and PharMerica, EPS from continuing operations was up by a very robust 30%. There is a lot to like about the quarter.
At AmerisourceBergen we continue to focus and execute on the basics; increasing profitable revenues, controlling costs, managing our inventory receivables. With all the reported data and industry discussion about a retail pharmaceutical market that appears to be growing slower than it’s historic growth I want to briefly share with you some of the actions AmerisourceBergen is doing to continue to adapt and succeed in any environment.
First, as I have discussed, over the past year, we have been streamlining the organization and moving to an operating company model and away from a wholly company organizational structure. This has allowed us to remove expense, flatten the organization and better position us to quickly respond to the marketplace.
Second we have started an internal campaign called CE2 which stands for customer efficiency and cost effectiveness. The customer is always our primary focus and customer efficiency means doing what the customer wants and needs, doing it well and doing it in the most efficient manner possible.
It means focusing on programs and offerings that are valued by the customer and adding new programs that enhance value. For example, we announced our new Good Neighbor Pharmacy premier program at a recent trade show.
The new offering includes business coaching for community pharmacies which pilot tests show significantly increases the pharmacies profitability and efficiency. The program was received very enthusiastically.
Cost effectiveness is our internal focus on cost. That doesn’t mean we’re going to arbitrarily slash costs.
What it does mean is that we have to be very cost effective in everything we do. For example, we need to be responsive to our customers needs for HBC merchandise, but that doesn’t mean we need to stock 70 SKUs of one brand of toothpaste.
The focus must continually be on what is the most cost effective for us and our customer. Our CE2 program, which we rolled out in May and is already getting traction, is about rethinking everything we do to be sure that it adds value to the customer and that we’re doing it in the most cost effective matter.
It’s a logical extension of our culture which is customer focused and operationally and productively oriented and is critical to thriving in any environment. Now for some general industry observations, I would continue to describe customer pricing environment as I have through out this fiscal year as stable but competitive.
On the manufacturers side I would also describe the environment as stable and also similar to what we have seen in the recent past. Price appreciation has been north of our 5% expectations so far this year in branded pharmaceuticals, the impact mitigated, of course, by fee for service agreements.
The average manufacturer price A&P issue has had a very positive turn. A&P, you will recall, will be used to set the ceiling for reimbursement for Medicaid generic prescriptions.
A&P implementation is currently delayed by a lawsuit filed by NCPA at NECDS. Independent of the lawsuit A&P implementation will be delayed until September 2009 by legislation passed by both the house and senate and passed again into law by overriding a presidential veto.
The new timeline will provide an opportunity to correct the deficiencies in the calculation of A&P. The new law also suspends the Medicare DME competitive bidding program for one year and creates a 14-day prompt pay requirement for Part D PDPs.
This is all good news for retail pharmacy. It will also prevent the 10.6 position pay cut.
This is very good news for our physician customers of our specialty group. ABC actively joined NCPA, NECBS and COA, the Community Oncologists Alliance, and many others in this process.
Next I would to hit a few company specific topics, some under appreciated in my opinion. I would first call attention to the fact that we have relatively low account concentrations with only one account commanding more than 10% of our revenues.
Our specialty business, AmerisourceBergen’s Specialty Group continues to differentiate ABC among our peers and continues to deliver strong performance with revenues over $12 billion on an annual basis, including $9 billion in oncology sales to physicians. I had the opportunity to meet with many of our large practice oncologists last month and continue to be impressed with the integral role these physicians play in the delivery of health care.
ABSG has the widest array of value added services in the specialty market by far, reinforced by the physicians I met. We continue to be convinced that many of the new pharmaceutical therapies will be specialized products and we’re well positioned to capture this emerging market.
Generics, we continue to get good traction with our generic program in part because of our customer base weighted towards regional chains, food-drug combos, independence, and alternate sites that rely upon us for their generic offering. While in general we are uncomfortable talking about specific products, the risperidone launch the first of this month was very successful and met expectations we established at the beginning of the fiscal year.
Our packaging group continued to be an integral part of our total offering of ABC and this quarter received recognition from a major manufacturer, this time receiving Merck’s 2007 outstanding operational award for contract formulation and packaging. Next I want to mention the strength and critical healthcare role played by Community Pharmacy.
Mike and I just returned from our trade show with over 1,300 stores and 4.500 people, the largest gathering of community pharmacists in the industry. Community Pharmacy has demonstrated incredible resiliency in the three decades I have been in the industry and I do not look for that to change.
The mood among the group was very upbeat, particularly given the recent legislative victory. We now have over 3,000 stores and our Good Neighbor Pharmacy Program and as noted in the press release are rolling out a new franchise program within G&P called G&P premier.
With fuel costs continuing to be in the news, I want to take a moment to put them into perspective for ABC. Our total delivery costs run about 15 to 20 basis points as a percent of our total revenues.
These total costs include the people, equipment and fuel necessary to deliver our product. Substantially all of our deliveries outsource, generally on a contracted basis, so there is some delay to us on the impact of fuel increase and so far we have actively managed our delivery costs as part of our CE2 program mentioned previously.
In rough times if gasoline were to increase $1.00 per gallon it could affect our total cost in a couple of basis point range, clearly manageable within our total cost structure. So, there is a lot to like about our quarter and more good things to like as we move forward.
With one quarter left in our fiscal year and with our strong performance to date, we have raised our EPS guidance from continuing operation for the year, to a range of $2.81 to $2.89 with no contribution from PMSI and a $0.03 per share special charge. We would expect our yearly total revenues for FY08 to be up 7% to 9% over the previous year and would expect to be in the low end of the range.
We expect our operating margin to expand in the low to middle single-digit basis points for the fiscal year, an improvement over our previous guidance of low single-basis points. Looking ahead to FY09, which starts October 1 for us, our plan in process is in full gear and includes very detailed bottoms up input and on site reviews at each of our regional locations.
We will provide FYO guidance when we release FY08 year-end results on October 30; however at this stage of planning, I remain confident that our growth rate for FY09 EPS from continuing operations will be in the low double-digit range as we shared last quarter. We continue to be very excited about our industry and the role ABC plays in that industry.
Here’s Mike to drill down some specifics.
Michael DiCandilo
We had another very strong quarter for our pharmaceutical distribution business including solid revenue growth, operating margin expansion, and significant benefits from our deployment of capital. Our year-to-date nine month results are excellent as well and we are on track to meet every one of the financial targets we set out at the beginning of the year.
Our continued resiliency and ability to adapt to any type of environment continues to give us great confidence as we look to the fourth quarter of fiscal 2008 and fiscal 2009. My comments are going to focus on results from continuing operations as Dave detailed our dissatisfaction with PMSIs performance this quarter which led to our decision to exit this business.
The non-cash write down of PMSIs net assets fair market value is reflected in discontinued operations this quarter and our income statements reflect a reclassification of current and prior year PMSI results to two discontinued operations as well. Our results from continuing operations in the prior year continue to include our long-term care business, which was spun off last July, the impact of which I will detail.
Now moving to our consolidated results: total revenue increased 10% in the quarter to $18 billion, driven by the 11% increase in pharmaceutical distribution which included a 3% benefit from our Bellco acquisition. For the nine months our total revenue increased 75 well above market, reflecting strong intrinsic growth complimented by our acquisition strategy.
Consolidated operating income was $198 million down 3% from last year on an unadjusted basis, but after excluding special items both years and long-term cares operating income of $6 million in the prior year quarter, operating income was up a robust 22% on an apples to apples basis. Current year special items included in operating expenses were employee severance and other special costs of $7.9 million primarily relating to the company’s CE2 cost effectiveness program compared to $3.5 million of special expense items in the prior year.
Prior year special items also included a $32 million benefit from brand manufacturing and I trust litigation settlements included in gross profit, which did not repeat this year. Net interest expense of just under $16 million was up significantly 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 37.6% up from last years 34.8% but slightly below our expectations as we benefited from certain adjustments. Our normalized effective rate continues to be slightly over 38%.
Diluted EPS from continuing operations in the quarter was $0.70 and excluding the $0.03 of special charges was a very strong $0.73 in the quarter. This compares to $0.67 on a GAAP basis last year and $0.56 on an adjusted basis last year, excluding special items and the long-term care contribution resulting in a very strong 30% increase in dilute EPS from continuing operations in the quarter.
For the nine months GAAP diluted EPS from continuing operations was $2.16 per share, up 13% from last year and excluding special items and long-term care was up a robust 24%. The quarterly increase in EPS was driven by outstanding operating performance in pharmaceutical distribution which had a 22% increase in operating income and the significant reduction in average outstanding shares net of the impact of the increase in interest expense.
Average diluted shares outstanding for the quarter were $161 million, down $27 million or 14% from the prior year, reflecting our share repurchase activity over the last 12 months. Drilling down to pharmaceutical distribution segment where our performance in the quarter was once again outstanding.
Total revenue was up 11% driven by the drug company, which increased 8% and Bellco which contributed 3% of the top line growth. The specialty group grew a stronger than expected 4% in spite of the OTN acquisition by a competitor earlier in the year and anemia drug challenges as it’s non-oncology distributions businesses grew in double-digits and its oncology distribution business top line increased 2%.
For ABC in total anemia drugs used in oncology represented 2% of total revenues in the quarter and were down 28% from the prior year quarter, but were up sequentially from Q2. The drug company growth was once again driven by our institutional customers including significant growth from our largest PBM customer.
Gross profit increased 11% for the quarter and 8% for the nine months. The quarterly increase was driven by solid price appreciation including certain select generic price increases as well as a steady increase in contributions from our pro generics program.
This more than offset an increase in our LIFO charge and an $8 million write down of certain pharmacy dispensing equipment inventory. We had a LIFO charge in the quarter of $5 million compared to a credit of $1.7 million in the prior year quarter.
For the nine months our LIFO charge was $18 million compared to $7 million in the prior year. As usual, we will true up our LIFO calculation in the September quarter, which has historically resulted in significant adjustments.
Operating expenses as a percent of revenue in the quarter were 163 basis points, down an impressive 10 basis points as our continued organizational streamlining through our CE2 cost effectiveness program continues to moderate expense growth. Substantially all of the dollar expense growth in the quarter is a result of our Bellco acquisition.
Operating expenses in the quarter benefited by a $4 million reduction to equity compensation expense as a result of our organizational streamlining. As a reminder, prior year quarter expenses were also benefited by $6 million net relating primarily to incentive compensation adjustments last June.
This disciplined expense performance is even more impressive when considering it has occurred despite incremental costs related to the company’s business transformation program. Business transformation, you may remember, is our ERP enabled program designed to improve our end-to-end business processes.
Operating income in the quarter of $205 million increased an impressive 22% versus last year. Operating margins expanded by 10 basis points in the quarter to 114 basis points, primarily due to the expense leverage I just mentioned.
For the nine months operating income was up 12% and the operating margin was 119 basis points, increasing 4 basis points from last year. All in all it ahs been an excellent nine months for the segment and again speaks to our ability to adapt to the changing environment while continuing to meet our goals.
Now lets turn to our consolidate cash flows and the balance sheet. We generated cash from operations of $131 million for the June quarter and $223 million for the nine months.
We continued to expect to beat our cash flow of $450 to $525 million for the year. As we have stated all year, we would expect a strong finish from a cash perspective, including a net working capital reduction in the fourth quarter.
We had capital expenditures of $26 million for the quarter and $81 million for the nine months. Our fourth quarter CapEx will be heavier than normal due to a large software purchase, but we still expect CapEx to be in the $125 million range for the year.
We continue to be very disciplined in the working capital management arena as is our hallmark and our success is reflected in our working capital statistics s average inventory days on hand during the quarter were an industry lowest 24 days, down 2 days compared to June of ’07. DSOs were down one day to 19 days.
From a share repurchase perspective we bought back $159 million of our shares during the third quarter and have now bought back $554 million for the year, exceeding our target of $400 to $500 million. We have $144 million remaining under our share repurchase program and expect to spend a majority of this amount in the September quarter.
As usual the board will consider dividend increases and/or a new share repurchase program this fall. Our debt to total capital ratio at the end of June was 31% in line with our 30% to 35% target range.
We expanded our liquidity during the quarter by increasing our availability under our receivable securitization facility by $475 million to $975 million, increasing our financial flex ability. Our ability to execute this amendment in a tough credit market is a reflection of our strong credit profile and the markets confidence in our financial strength.
Now moving to our guidance for fiscal 2008: our updated GAAP diluted EPS guidance from continuing operations is a range from $2.81 to $2.89 an increase from the prior quarter and includes $0.03 of special charges and reflects zero contribution from PMSI, which again has been reclassified to discontinued operations so in effect we have increased the midpoint of our annual range by $0.06 without any of the anticipated $0.04 to $0.05 contribution from PMSI. This guidance implies a range of $0.65 to $0.73 per diluted share for the fourth quarter.
It continues to assume 7% to 9% total revenue growth for the year, most likely at the low end, with the fourth quarter expected to be slightly below the annual range as we start to feel the impact of the shift of some of our low margin Walgreens business to a competitor in July. The guidance also includes the positive impact of a GSK price increase which occurred in July meeting our expectations.
So, we are in a great position to finish out our fiscal year with above market revenue growth, operating margin expansion in the low to mid-single digit basis point range and a significant reduction in outstanding shares all contributing to grow EPS from continuing operations at least 20% after factoring out prior year contributions from long-term care and special items in both years. PMSI is behind us and we remain confident in our ability to grow EPS in the low double-digits in fiscal 2009 even in a low market growth environment through our demonstrated ability to control costs, benefit from increased generics, while continuing to generate significant cash, which can be used to grow our business through acquisitions like we did with Bellco or reduce our outstanding shares.
Operator
(Operator Instructions) Your first question comes from Larry Marsh with Lehman Brothers.
Larry Marsh - Lehman Brothers
Dave I never thought I’d say this but a hearty congratulations on selling PMSI for whatever price. I know you had said you didn’t want that to fester.
I just want to make sure I’m clear, tell me again, when do you hope to close the transaction and are there any specific conditions that are necessary to get it done?
David Yost
Yes we hope to have it closed by the end of this fiscal quarter, by the end of September and no unusual conditions.
Larry Marsh - Lehman Brothers
And at that time you would be able to determine whether you will get the extra $10 million or not?
David Yost
The extra is a really earn out, that will be based upon performance so it will be awhile before we would have that.
Larry Marsh - Lehman Brothers
A bigger picture question would be you had another top line quarter and that’s been a hallmark this year for you guys and you’re communicating comfort at the lower end of the revenue range, which in my numbers suggests a sequential reduction of revenues of $1.5 billion or so from Q3. I know you call that the new relationship with Walgreens that will pull some of that business away, but I mean that is the difference between Q3 and Q4 as we think about it, because that’s a bigger number than I was thinking.
David Yost
Yes it sounds like your GAAP is higher than we had anticipated. You know we did have 10% growth in total this quarter.
We are anticipating slightly below the low end of our annual range which is 7% so probably in the 6% to 7% arena in the fourth quarter and that difference is solely the impact of some of the bulk Walgreens business that is going to be transferring to a competitor.
Larry Marsh - Lehman Brothers
Right, okay I’m still thinking of the operating versus gross and I know you’re talking about revenues as a gross number. So that’s not quite as big as we thought.
Then just I know last quarter, David I’m curious to get your view, I know you had sort of talked about some of the take down on top of the arranged last quarter, PMSI and then the headwinds the slower market growth and then the anemia sort of issues. As you step forward it sounds like you are a bit more bullish on the pricing environment of the drug and this year not necessarily changing your view of top line.
It also sounds like you are a bit more comfortable about current trends in anemia. Am I hearing that right and is there anything else that would cause you to think about a little bit more confidence in those two data points from what you talked about in April?
David Yost
You’re hearing me right, the only caution I would have is ORAC you know the Oncologic Rouge Advisory Committee has not yet ruled, so we’re kind of waiting to hear — the FDA has ruled on their recommendation, so that could have an impact, so the ESA is a little, continues to be uncertain as we go forward. But other than that, I think you described it well and we continue to be impressed by the optimism of the retailers that we just saw in our trade show which I mentioned in my remarks.
Michael DiCandilo
Larry from a manufacturer pricing environment, it has been strong and it has been strong particularly for those suppliers who we do not have fee for service agreements with, which benefited both this quarter with a small price increase from Pfizer and some generic price increases and we also had great confidence with the fourth quarter with GSK having the price increase that we had anticipated.
Larry Marsh - Lehman Brothers
I know one of the other hallmarks that you recently reiterated to me and others is no out of the box acquisitions. So here you are, you’ve got a clean operating company versus the holding company structure.
You’re generating lots of cash, you’re buying back stock and you’re looking opportunistically for acquisitions. When you talk about Bellco are there other assets as you see it out there like Bellco still that you think you can pull off in the next couple of years?
Is that a realistic expectation?
David Yost
Well there is still some out there that we’ve got our eye on and that would be the kind of acquisition that we would be comfortable with. We are very comfortable making acquisitions.
The biggest one we’ve made is this fiscal year which was Bellco, $162 million. We spent over $1 billion in acquisitions in the last six, seven years, so we’re constantly looking for acquisitions but they would be in our sweet spot and again not going far a field from an acquisition that would not have some kind of manager or operating efficiencies or synergies associated with AmerisourceBergen.
Operator
Your next question comes from Lisa Gill with J. P.
Morgan.
Lisa Gill - J. P. Morgan
On McKesson’s [ph] conference call yesterday they had talked about some of the manufacturing relationships adding to gross profit in the quarter and I was just wondering, are you seeing something similar, are you seeing that on the fee for service side as you’re adding more services that you’re actually getting better rates with the manufacturers? Maybe if you could give us some more color there.
Then secondly, as we think about generics and we think about generic trends, can you maybe just talk about your customer purchasing patterns? Do primarily your customers buy all their generics from you, do you still view this as an opportunity to get generic penetration from your customers?
David Yost
First in terms of the manufacturer relationships, I would say our manufacturer relationships are very, very strong. We just got back from our trade show.
Mike and I both had an opportunity to interface with a lot of manufacturers so I would say our manufacturer relationships are very, very strong. We’re happy with the next generation of fee for service agreements that we’re executing right now, so we’re very, very positive on how we are, our relationship with the manufacturers.
In terms of generics, I will tell you as a general rule we like to capture all of the generic business that our customers have; we’re not doing that. I think we’re doing better at that then we were this time last year, but that continues to be an opportunity for us.
We track that very, very closely. We just got back from our trade show, again and that was one of the key issues we had with our sales force, to focus on that, so I would say yes we are doing better and yes we still have some more opportunities here.
Lisa Gill - J. P. Morgan
Do you want to quantify what the opportunity is by any chance?
David Yost
It’s really customer by customer, so I’m not comfortable assessing it, but we clearly have some more work to do and the good thing about the generics is we have to keep raising the bar. What was good generic concentration with a customer a year ago is not good today, because new generics come out on the marketplace, so we constantly have to challenge ourselves to keep raising the bar on what the generic percentage of purchases should be with us with each of our customers.
Lisa Gill - J. P. Morgan
I was also just wondering if you could follow up on a comment you made early on, Dave, on general industry, talking about retail and the slowing market growth. Are you actually seeing prescription trends slowing with your customers?
I know that as we look forward we have the Walgreens rolling off, but are you starting to see a slowing trend as far as people that are picking up their prescriptions on a retail side?
David Yost
What I was reacting to was the industry numbers that IMS and others have reported about the increase of prescriptions year-over-year and I would just have a couple of cautions about the prescriptions. The first is that one prescription for a 30-day generic versus a 90-day brand is a huge difference in dollars so again, as a general rule we have not been as sensitive to prescriptions as others who have observed he industry, that’s the first thing.
The second thing I would note is that many of our customers have other parts of their business that we clearly participate in DME is a good example, diabetes shops, and the like outside of prescriptions, so what we were just trying to note with that is that even if the retail market is somewhat slower than it’s been historically, we can adapt to that very well as our customers appear to be doing as well.
Operator
Your next question comes from Robert Willoughby - Banc of America Securities.
Robert Willoughby - Banc of America Securities
Mike, just realistically, how much lower can you pull those inventory days and secondarily is there a new level where you feel comfortable bringing the cash balances down to?
Michael DiCandilo
Yes, you know our inventory performance has really been outstanding as I mentioned. I think we’re well below what others in the industry are and it’s really a tribute to our supply chain group which looks to bring every dollar out.
I mean there still are some dollars we are carrying in our inventories that we are required to under some of our fee for service agreements with our manufacturers that we think we could do without and we will continue to have conversations with certain manufacturers about bringing those inventories down or potentially being compensated higher if we’re asked to carry those inventories at a higher level. I think we’ve done a pretty good job.
There is probably a day or two days that we could bring those down further, depending upon some of those further negotiations. As far as the cash balances, I think I’ve said historically that we can very comfortably operate with a couple hundred million dollars in maintenance cash running through our system, so we still have some room to bring the cash balances down.
We do have fluctuations through out the month and I think that’s one thing people have to understand is we do have some intra period volatility as well and that’s why we do things like making sure we’ve got plenty of ample liquidity as well. I think we’ve done just an excellent job in managing our working capital overall, our inventories, our receivables, and as we look forward, we continue to generate free cash in line with our net income as we look to the future.
Robert Willoughby - Banc of America Securities
The inventory for your specialty business is that on a consignment basis primarily or do you take title to that?
Michael DiCandilo
No it’s primarily on an owned basis and dynamics very much like the drug company. Because of the high price of some of the products they carry, we turn it probably just a bit quicker than we do the overall broad inventory, but it is owned.
Operator
Your next question comes from Charles Boorady with Citigroup.
Charles Boorady - Citigroup
First on the ESA growth that you talked about, what was the driver of that? Do you know if it reflected growth in the customer end markets or was it a result of winning new customers?
David Yost
We’ve been pretty good at picking up new customer. We continue to do a good job of that and that’s really based on our full service offerings and I made reference in my comments about our large practices and we’ve been able to attract some new large practices because of the services we provide to them, so we’re picking up some new customers as well and we’ve got some utilization changes within our customers.
Michael DiCandilo
Yes, just ESAs and in general just to reiterate, we were down from last year in the quarter about 28% and again it’s about 2% of our business. We were up sequentially from the second quarter of ’08.
Charles Boorady - Citigroup
Understood, I was just curious about that sequential improvement and what drove that, if it was a customer end market demand seasonality or it sounds like you’re winning new customers.
Michael DiCandilo
I think it’s a little bit of new business but as Dave said earlier, we were also helped by the fact that he FDA has not yet ruled on the ODAC recommendations.
David Yost
We’re kind of waiting to see what happens there.
Charles Boorady - Citigroup
I see and unrelated to that what would you attribute the high price increases to by manufacturers this year and do you think it’s sustainable into next year or is there something unusual going on this year?
David Yost
The truth of the matter is we’re really not qualified to judge what causes them to raise their prices. I would say that it’s how they fund their research and as the increasing demands of research, more sophisticated, taking more dollars, there is going to be probably some more demands there so, the truth of the matter is I don’t think we’re really qualified to judge.
We’re just kind of observing. The first part of this year it’s been just a little stronger than we anticipated.
Nine months doesn’t make a year, but it’s been a little stronger than we originally thought.
Charles Boorady - Citigroup
As you look at low double-digits EPS growth for ’09 are you contemplating a similar magnitude of price increases by manufacturers?
David Yost
We are, we don’t see the environment changing dramatically from the 5% or so that we anticipated this year and has been the trend recently.
Charles Boorady - Citigroup
I’m curious what your take is on the competitive environment for M&A. It was not that long ago, maybe a year ago, you were talking about the financial buyers really bidding up the price of assets to levels that you thought didn’t pencil and then once they had a tougher time accessing capital there was a strategic buyer that you commented had paid an amount that you thought didn’t pencil.
Are you still seeing prices for deals being higher than what you think, are they intrinsically worth or are valuations down to where you think you’re seeing more attractive opportunities on the M&A front?
David Yost
I think it kind of remains to be seen. It’s almost anecdotal, one at a time.
The ones that we look at are ones that have operating or management synergies for us, so we would think we would have an advantage over the financial buyers. I think the financial buyers will probably be a little less aggressive then they have in the past which will probably bode very well for us and with the cash position that we’ve got we’re in a good position to act.
We are inclined to move that direction and again the biggest move we made we made this year and I will tell you it has worked out very, very well for us. We are very happy with the Bellco acquisition.
Charles Boorady - Citigroup
When I look at operating expenses for this quarter is it the right jumping off point to project going forward or is there still some overhead related to the planned sale that would be reduced?
David Yost
Yes the operating expense this quarter would exclude any impact at all from PMSI or the sale process. We have historically had a bit of a step up between Q3 and Q4 historically for a couple of reasons the biggest of which we hold our annual trade show in July which is a significant expense for the company, so you will see some trend up between 3Q and 4Q in expenses which are well within our guidance.
Operator
Your next question comes from Colleen Lang from Merrill Lynch.
Colleen Lang - Merrill Lynch
Just going back to brand price inflation, I guess it’s going a bit ahead of expectations and we were wondering, at this point, is the percent of profits from inflation larger than the 2q0% to 25% we’ve heard about previously or is it still in that range?
David Yost
I think the answer is no. The inflation has been very much within our expectations particularly for the couple of accounts that we have that are not on fee for service.
You know occasionally we do get surprised, like I mentioned earlier we had some positive news from some generic, certain generic items that gave us a little bit of a boost this quarter, but I think overall it’s been pretty much as planned. Obviously we’ve got volatility this quarter from quarter with the companies that are not under fee for service agreements and we continue to work under that atmosphere, but I think as we look through nine months and we forecast through for the 12 months I think appreciation is very much in line with our expectations.
Colleen Lang - Merrill Lynch
On the expense side, can you talk in a little more detail what the biggest areas of savings are?
Michael DiCandilo
It’s really been across the board, but the one thing, it has not just been focused on the lower end of the pay scale, it has been across the board, vice presidents as well as pickers and packers. We have looked at literally everything we do from delivery to how we handle receipt of merchandise and it’s a basis point business and we manage the business that way and I will tell you under our CD2 program there has not been a single rock we haven’t turned over, so it’s really part of an operating philosophy and I think that’s essential in a business that works on as tight as margins as we do.
Operator
Your next question comes from Alex Beckwith with Goldman Sachs.
Alex Beckwith - Goldman Sachs
What are you assuming for the use of the PMSI proceeds?
David Yost
We’re talking about a $40 million proceeds from the sales. I think we’ll use it for general purpose.
Certainly we have shown in the past where we’ve had extra cash we’ve tended to increase our share repurchases and I think that’s a good possibility.
Alex Beckwith - Goldman Sachs
Is it safe to say that whatever it is it will be a fiscal 2009 event?
David Yost
Yes, we expect to close by the end of this fiscal year so any benefit will flow through in ‘0-9.
Alex Beckwith - Goldman Sachs
Within specialty have you seen any change in the industry competitive dynamics following McKesson’s acquisition of OTM?
David Yost
We really haven’t. I think that McKesson brought some stability to the market.
Before you had an acquisition that was controlled by private equity and probably trying to pump up revenues at the expense of other things so I think having McKesson in the market is a positive issue. I haven’t really seen you know a big impact so far.
Operator
Your next question comes from Ricky Goldwasser with UBS.
Ricky Goldwasser - UBS
Regarding Protonix, some of the other channel participants said that they have a supply that’s going to last them for the full year. Can you just comment if you still have Protonix in the channel and is it included in the guidance revision?
Then on the GSK price increase, should we assume that the increase that took place a few days ago makes you, is there any extracted into guidance and if GSK is going to rise prices again in August or September or is that just going to be upside to two numbers?
David Yost
First of all, talking about Protonix, I will tell you we’re really uncomfortable talking about specific products and where our inventory levels are and so forth just because we think it’s a pretty dangerous precedent to start. In terms of GSK, the GSK price increase met our expectations in terms of timing of what we had anticipated when we started the fiscal year and what we’ve tried to do is we’ve tried to communicate that so it would not be a surprise.
Michael DiCandilo
That’s one of the reasons we had a range for the fourth quarter and depending upon the magnitude of any further action it most likely will be within the range of earnings that we’ve provided for the fourth quarter.
Ricky Goldwasser - UBS
So even if they have any additional pricing action that’s already factored into the high end of guidance range?
Michael DiCandilo
Yes base upon their historical practice, yes.
Ricky Goldwasser - UBS
Can you discuss some of the strategies that you have in place to increase compliance with you customers on the generic side as it seems like this is one of the biggest growth opportunities for you in the next couple of years.
David Yost
We’ll be a little careful we don’t get to granular here, our competitors may be listening, but clearly what we need to do is we need to continue to have our sales force properly incentivized, we need to provide rebates as incentive to our customers, so we’re doing those kinds of things; monitoring very closely customer by customer, item by item, so again the good news is that I think we have got the right tools in place, we have got opportunities. As a result of having the trade show, we just had our sales force en mass and this was one of the key issues to really make sure they continue to focus on generics, capture the new launches that come down the road and so forth.
I think we’re pretty well positioned versus our competitors and I think that the opportunity for us is not, I don’t think our competitors or any other large wholesalers are getting that business from our customers, it’s going direct, and so our opportunity there is to capture that direct business that’s going around us and our whole prime vendor model really plays to that, where the customer is best served by buying everything from us, focusing on selling and letting us worry about buying.
Operator
Your last question comes from Glen Santangelo with Credit Suisse.
Glen Santangelo - Credit Suisse
I just had one follow up question on the distribution operating margins. It seems like relative to what you thought in the beginning of the year.
It seems like relative to what you thought in the beginning of the year things are certainly shaking out ahead of expectations; you’ve now officially raised your guidance here. What is kind of driving that higher margin relative to what you maybe thought just a quarter or two quarters ago?
Is it really the patent expiration schedule, the exclusivities on these drugs or is it more price increases coming in greater than what you thought or could it be rebates? How would you kind of think about that?
David Yost
I will tell you if I had to focus on one thing it’s our expense management. We streamlined the organization, started early in the fiscal year, we have kept it going and I’ll tell you what we have really been relentless on expenses.
You saw our expenses year-over-year down ten basis points, that’s a really big deal for us. If is obviously a multi-faceted issue, but if I had to focus on one thing I would focus on our expense control.
Glen Santangelo - Credit Suisse
And do you think you have more room to go there?
David Yost
I do. I will tell you, it is kind of one of the things that it’s never good enough for the boss, but we continue to have opportunities there and I think the CE2 program which we’ve launched, I will tell you it’s not just a program it’s an operative philosophy.
I do think we can do better and we will do better. Mike and I are going to be out next week, as we look at our FY09 plans and the whole issue of expenses will be a key focus for us.
Michael Kilpatric
Thank you everybody for joining us on the call today. Now I’d like to turn it over to Dave Yost for some final remarks.
David Yost
I’d just like to close by thanking you for joining us and just reiterate that we continue to focus on executing the basics at AmerisourceBergen, increasing our profitable revenues, controlling our costs, managing our receivables and our inventory. A good performance this quarter, we had strong revenues, we controlled out expenses, we expanded our operating margin, generated good cash, and robust EPS increase.
I think all of that demonstrates our strength and our resiliency. We look forward to sharing with you our full fiscal year results which will be on October 30.
Thank you very much.