Overview

The following discussion should be read in conjunction with the Consolidated Financial Statements and notes thereto contained herein.

We are a pharmaceutical services company serving the United States, Canada, and selected global markets. We provide drug distribution and related healthcare services and solutions to our pharmacy, physician, and manufacturer customers. We are organized based upon the products and services we provide to our customers. Our operations are comprised of the Pharmaceutical Distribution Reportable segment and Other.

As of September 30, 2012, we committed to a plan to divest AndersonBrecon (a business unit within AmerisourceBergen Consulting Services); therefore, its operations are classified as discontinued operations for all periods presented. All historical information provided herein has been retroactively adjusted to conform to our current presentation.

The Pharmaceutical Distribution reportable segment is comprised of two operating segments, which include the operations of AmerisourceBergen Drug Corporation ("ABDC") and AmerisourceBergen Specialty Group ("ABSG"). Servicing healthcare providers in the pharmaceutical supply channel, the Pharmaceutical Distribution segment's operations provide drug distribution and related services designed to reduce healthcare costs and improve patient outcomes.

ABDC distributes a comprehensive offering of brand-name pharmaceuticals (including specialty pharmaceutical products) and generic pharmaceuticals, over-the-counter healthcare products, home healthcare supplies and equipment, and related services to a wide variety of healthcare providers, including acute care hospitals and health systems, independent and chain retail pharmacies, mail order pharmacies, medical clinics, long-term care and other alternate site pharmacies, and other customers. ABDC also provides pharmacy management, staffing and other consulting services; scalable automated pharmacy dispensing equipment; medication and supply dispensing cabinets; and supply management software to a variety of retail and institutional healthcare providers. Additionally, ABDC delivers packaging solutions to institutional and retail healthcare providers.

ABSG, through a number of operating businesses, provides pharmaceutical distribution and other services primarily to physicians who specialize in a variety of disease states, especially oncology, and to other healthcare providers, including dialysis clinics. ABSG also distributes plasma and other blood products, injectible pharmaceuticals and vaccines. Additionally, ABSG provides third party logistics and outcomes research, and other services for biotechnology and other pharmaceutical manufacturers.

Our use of the term "specialty" and "specialty pharmaceutical products" refers to drugs used to treat complex diseases, such as cancer, diabetes, and multiple sclerosis. Specialty pharmaceutical products are part of complex treatment regimens for serious conditions and diseases that generally require ongoing clinical monitoring. We believe the terms "specialty" and "specialty pharmaceutical products" are used consistently by industry participants and our competitors. However, we cannot be certain that other distributors of specialty products define these and other similar terms in exactly the same manner as we do.

Other consists of the AmerisourceBergen Consulting Services ("ABCS") operating segment and the recently acquired World Courier Group, Inc. ("World Courier") operating segment. The results of operations of our ABCS and World Courier operating segments are not significant enough to require separate reportable segment disclosure, and, therefore, have been included in "Other" for the purpose of our reportable segment presentation.

ABCS, through a number of operating businesses, provides commercialization support services including reimbursement support programs, outcomes research, contract field staffing, patient assistance and copay assistance programs, adherence programs, risk mitigation services, and other market access programs to pharmaceutical and biotechnology manufacturers. World Courier, which operates in over 50 countries, is a leading global specialty transportation and logistics provider for the biopharmaceutical industry.

Acquisitions

In November 2011, we acquired TheraCom, LLC ("TheraCom"), a subsidiary of CVS Caremark Corporation, for a purchase price of $257.2 million, net of a working capital adjustment. TheraCom is a leading provider of commercialization support services to the biotechnology and pharmaceutical industry, specifically providing reimbursement and patient access support services. TheraCom's capabilities complement those of the Lash Group, a business unit within ABCS, and significantly increase the size and scope of its consulting services. TheraCom's annualized revenues are approximately $700 million, the majority of which are provided by the specialized distribution component of the integrated reimbursement support services for certain unique prescription products.

In April 2012, we acquired World Courier Group, Inc. ("World Courier") for a purchase price of $518.0 million, net of a working capital adjustment. World Courier is a leading global specialty transportation and logistics provider for the biopharmaceutical industry. World Courier further strengthens our service offerings to global pharmaceutical manufacturers and provides an established platform for the introduction of our specialty services outside North America. It operates in over 50 countries and has approximately 2,500 employees.

Results of Operations

Year ended September 30, 2012 compared with Year ended September 30, 2011

     Revenue

                                             Fiscal year ended
                                               September 30,
          (dollars in thousands)            2012           2011        Change
          Pharmaceutical Distribution   $ 78,349,334   $ 79,753,118      -1.8%
          Other                            1,324,744        302,012     338.6%
          Intersegment eliminations         (184,482 )      (51,286 )   259.7%

          Revenue                       $ 79,489,596   $ 80,003,844      -0.6%

Revenue of $79.5 billion in fiscal 2012 decreased 0.6% from the prior fiscal year as ABDC's revenue declined 3%, and was partially offset by the 6% revenue increase of ABSG. Additionally, our recent acquisitions, with TheraCom and World Courier being the largest contributors, added 1% to our revenue growth in the fiscal year ended September 30, 2012.

We currently expect our revenue in fiscal 2013 to increase between 6% and 9%. Our expected growth rate reflects our new three-year contract with Express Scripts, Inc. ("Express Scripts") that is effective as of October 1, 2012, to supply primarily brand-name pharmaceuticals. Annual sales to Express Scripts in fiscal 2013 under this contract are estimated to be $18.5 billion. In early April 2012, our largest customer, Medco Health Solutions, Inc. ("Medco"), merged with Express Scripts, which is the surviving corporation. Medco accounted for 17% of our revenue in fiscal 2012. In addition, fiscal 2013 will include a full year's operating results of our fiscal 2012 acquisitions of TheraCom and World Courier. Our future revenue growth will continue to be affected by various factors such as industry growth trends, including the likely increase in the number of generic drugs that will be available over the next few years as a result of the expiration of certain drug patents held by brand-name pharmaceutical manufacturers, general economic conditions in the United States, competition within the industry, customer consolidation, changes in pharmaceutical manufacturer pricing and distribution policies and practices, increased downward pressure on government and other third party reimbursement rates to our customers, and changes in Federal government rules and regulations.

ABDC's revenue decreased 3% from the prior fiscal year. The decline in ABDC's revenue was primarily due to the increase in use of lower priced generics, a reduction in chain customer revenue primarily due to the previously announced loss of one of our larger retail customers, the former Long's Drugs, which was acquired by a customer of one of our competitors and did not renew its contract prior to September 30, 2011, and lower sales to its largest customer. The decrease in revenue was partially offset by an increase in brand-name pharmaceutical prices.

ABSG's revenue of $16.4 billion in fiscal 2012 increased 6% from the prior fiscal year primarily due to growth in its third-party logistics business and growth in its vaccine and physician office distribution business, which has benefited from sales of a new ophthalmology drug. ABSG's revenue growth was partially offset by a decline in sales of certain specialty oncology drugs. The majority of ABSG's revenue is generated from the distribution of pharmaceuticals to physicians who specialize in a variety of disease states, especially oncology. ABSG's business may be adversely impacted in the future by changes in medical guidelines and the Medicare reimbursement rates for certain pharmaceuticals, especially oncology drugs administered by physicians and anemia drugs. Since ABSG provides a number of services to or through physicians, any changes affecting this service channel could result in slower growth or reduced revenues.

During fiscal 2012, 72% of Pharmaceutical Distribution revenue was from sales to institutional customers and 28% was from sales to retail customers; this compared to a customer mix in fiscal 2011 of 70% institutional and 30% retail. Sales to institutional customers remained flat in the current fiscal year and sales to retail customers decreased 7% from the prior fiscal year.

Other revenue increased $1,022.7 million from the prior fiscal year primarily due to the $959.9 million contribution from our TheraCom and World Courier acquisitions.

Gross Profit

Gross profit in fiscal 2012 increased $167.5 million from the prior fiscal year due to the contributions made by our recent acquisitions (primarily World Courier and TheraCom), the solid growth and profitability of our non-specialty generic programs, and brand price increases, all of which were offset, in part, by the reduced contribution from the sales of certain specialty oncology drugs, and by competitive pressures on customer margins. As expected, in fiscal 2012, the gross profit contributions from the sales of Oxaliplatin, Gemcitabine, and Docetaxel (all generic oncology drugs) were approximately $132 million lower than the prior fiscal year. We had no sales of Oxaliplatin in our current fiscal year until mid-August 2012 and; therefore, gross profit on the sale of Oxaliplatin was significantly lower than in fiscal 2011. In fiscal 2012, the gross profit decline from the above-mentioned three specialty generic drugs was partially offset by the gross profit contribution from over 30 ABDC brand to generic product conversions. In the current fiscal year, we recognized a gain of $14.8 million from antitrust litigation settlements with pharmaceutical manufacturers. This compared to a recognized gain of $2.1 million from antitrust litigation settlements with pharmaceutical manufacturers in the prior fiscal year. These gains were recorded as reductions to cost of goods sold. We are unable to estimate future gains, if any, that we will recognize as a result of antitrust settlements (see Note 13 of the Notes to Consolidated Financial Statements). Additionally, in fiscal 2011, our gross profit was impacted by a non-recurring $12 million benefit in connection with a customer being acquired by a third party.

As a percentage of revenue, our gross profit margin of 3.36% in fiscal 2012 increased 23 basis points from the prior fiscal year. The gross profit margin increase was due to the gross profit contributions of our recent acquisitions, primarily World Courier and TheraCom, and the solid growth and profitability of our non-specialty generic programs, both of which were offset by the decline in gross profit relating to the above mentioned specialty oncology generic drugs. Additionally, the gain on antitrust litigation settlements, as noted above, contributed 2 basis points to our gross profit margin in fiscal 2012.

Our cost of goods sold includes a last-in, first-out ("LIFO") provision that is affected by changes in inventory quantities, product mix, and manufacturer pricing practices, which may be impacted by market and other external influences. We recorded a LIFO charge of $0.7 million and $34.7 million in fiscal 2012 and 2011, respectively. Our LIFO charge in fiscal 2012 was lower than the prior fiscal year charge due to higher brand inventory sales prior to the end of our fiscal year.

Operating Expenses

                                                   Fiscal year ended
                                                     September 30,
    (dollars in thousands)                        2012          2011        Change
    Distribution, selling and administrative   $ 1,229,495   $ 1,179,234        4.3%
    Depreciation and amortization                  141,054       105,482       33.7%
    Employee severance, litigation and other        45,821        23,567       94.4%
    Intangible asset impairments                         -         6,506     -100.0%

    Total operating expenses                   $ 1,416,370   $ 1,314,789        7.7%

Distribution, selling and administrative expense in fiscal 2012 increased 4.3% due to the operating costs of our recently acquired companies and was partially offset by a reduction in consulting expenses within our Pharmaceutical Distribution segment and a decrease in our bad debt expense.

Depreciation expense increased from the prior fiscal year primarily due to the implementation of our new ERP system. Amortization expense increased from the prior fiscal year primarily due to the newly acquired intangible assets resulting from the TheraCom and World Courier acquisitions.

In fiscal 2012, we introduced a number of initiatives, some of which were made possible as a result of efficiencies gained through our ERP implementation, to improve our operating efficiency across many of our businesses and certain administrative functions. In connection with these initiatives, we recorded $34.7 million of severance and other related costs and through September 30, 2012, 47 employees have been severed. Other costs include an estimated $10.3 million liability to exit our participation in a multi-employer pension plan resulting from a planned ABDC distribution facility closure in fiscal 2013. In addition, we incurred $11.1 million of acquisition costs related to business combinations.

In fiscal 2011, we introduced our Energiz program, which encompasses a number of initiatives to maximize salesforce productivity, improve customer contractual compliance, and drive efficiency by linking our information technology capabilities more effectively with our operations. Employee severance, litigation and other for fiscal 2011 included severance costs of $4.4 million related to our Energiz program, a $16.0 million charge related to the preliminary settlement of a Qui Tam matter (as described in Note 12 "Legal Matters and Contingencies" of the Notes to the Consolidated Financial Statements), and $3.2 million of acquisition costs related to business combinations.

We incurred a $6.5 million charge related to intangible asset impairments in fiscal 2011.

As a percentage of revenue, operating expenses were 1.78% in fiscal 2012, up 14 basis points from the prior fiscal year. This was primarily due to our recent acquisitions. For the Pharmaceutical Distribution segment, as a percentage of revenue, operating expenses were down 4 basis points from the prior fiscal year.

Operating Income

                                                   Fiscal year ended
                                                     September 30,
    (dollars in thousands)                        2012          2011        Change
    Pharmaceutical Distribution                $ 1,226,430   $ 1,181,959       3.8%
    Other                                           72,119        28,414     153.8%
    Employee severance, litigation and other       (45,821 )     (23,567 )    94.4%

    Operating income                           $ 1,252,728   $ 1,186,806       5.6%

Segment operating income is evaluated before employee severance, litigation and other.

Pharmaceutical Distribution operating income increased $44.5 million from the prior fiscal year due to the decrease in its operating expenses, offset in part by a decrease in its gross profit. Other operating income increased $43.7 million from the prior fiscal year primarily due to the $24.6 million of contributions made by our recent acquisitions, primarily World Courier and TheraCom. We expect our operating income margin to decline in fiscal 2013 due to our new Express Scripts contract, which significantly increases our mix of lower-margin brand business, the loss of a large food/drug combo customer, the negative impact of certain customer contract renewals, and a lower number of brand to generic conversions expected in fiscal 2013.

The net impact of the gain on antitrust litigation settlements, the costs relating to employee severance, litigation and other, and the asset impairments was to decrease operating income as a percentage of revenue by 4 basis points in both fiscal 2012 and 2011.

Other income of $5.8 million in fiscal 2012 and $4.6 million in fiscal 2011 primarily related to a gain resulting from payments received in excess of amounts accrued on a note receivable relating to a prior business disposition.

Interest expense, interest income, and the respective weighted average interest rates in fiscal 2012 and 2011 were as follows (in thousands):

                                       2012                            2011
                                       Weighted Average                Weighted Average
                            Amount      Interest Rate       Amount      Interest Rate
   Interest expense        $ 97,225                4.76%   $ 78,870                5.31%
   Interest income           (1,801 )              0.22%     (2,181 )              0.19%

   Interest expense, net   $ 95,424                        $ 76,689

Interest expense increased from the prior fiscal year due to an increase of $494.4 million in average borrowings, primarily due to the November 2011 issuance of our new $500 million 31/2% senior notes due 2021. In addition, interest costs capitalized related to our Business Transformation project of $0.5 million and $3.4 million in fiscal 2012 and 2011, respectively had the effect of reducing interest expense for those periods. Our average invested cash was $1.5 billion during both fiscal 2012 and 2011. Despite the similar levels of average cash, interest income was lower in our current fiscal year due to an increase in the amount of cash held in non-interest bearing cash accounts. Cash held in these accounts partially offset bank fees.

Our interest expense in future periods may vary significantly depending upon changes in net borrowings, interest rates, amendments to our current borrowing facilities, and strategic decisions to deploy our invested cash. We currently expect our interest expense to be lower in fiscal 2013 since we repaid our $392 million of 55/8% senior notes in September 2012.

Income taxes in fiscal 2012 reflect an effective tax rate of 39.1%, compared to 37.6% in the prior fiscal year. The increase is primarily the result of a valuation allowance recorded on deferred tax assets primarily relating to our Canadian drug distribution operations. We expect that our ongoing effective tax rate will be approximately 39%.

Income from continuing operations of $708.2 in fiscal 2012 increased 2% from the prior fiscal year due to the increase in operating income and was offset in part by the increases in interest expense and income taxes. Diluted earnings per share from continuing operations of $2.76 in fiscal 2012 increased 10% from $2.51 per share in the prior fiscal year. The difference between diluted earnings per share growth and the increase in income from continuing operations was primarily due to the 8% reduction in weighted average common shares outstanding, primarily from purchases of our common stock in connection with our stock repurchase program (see Liquidity and Capital Resources), net of the impact of stock option exercises.

Income from discontinued operations, net of income taxes, of $10.8 million and $10.7 million, represents the income of AndersonBrecon in both fiscal 2012 and 2011, respectively.

Year ended September 30, 2011 compared with Year ended September 30, 2010

     Revenue

                                             Fiscal year ended
                                               September 30,
          (dollars in thousands)            2011           2010       Change
          Pharmaceutical Distribution   $ 79,753,118   $ 77,552,936      2.8%
          Other                              302,012        261,705     15.4%
          Intersegment eliminations          (51,286 )      (38,181 )   34.3%

          Revenue                       $ 80,003,844   $ 77,776,460      2.9%

Revenue of $80.0 billion in fiscal 2011 increased 2.9% from the prior fiscal year. The increase in revenue was due to the 5% growth of ABDC, offset in part by the 3% revenue decline of ABSG.

ABDC's revenue increased 5% from fiscal 2010 due to overall pharmaceutical market growth, and the above market growth of a few of our largest customers, primarily our institutional customers.

ABSG's revenue of $15.5 billion in fiscal 2011 decreased by 3% from fiscal 2010 primarily due to the September 2010 discontinuance of its contract with a third party logistics customer that transitioned to a direct manufacturer distribution model. ABSG's revenue decline in fiscal 2011 was also attributable to a decline in sales to dialysis providers, and a shift in product mix to more generic pharmaceuticals.

During both fiscal 2011 and 2010, 70% of revenue was from sales to institutional customers and 30% was from sales to retail customers. Sales to institutional customers increased 4% in fiscal 2011 and sales to retail customers increased 1% in fiscal 2011.

Other revenue increased $40.3 million from fiscal 2010 primarily due to the strong performance of the Lash Group, which provides commercialization support services to pharmaceutical and biotechnology manufacturers.

Gross Profit

Gross profit of $2.5 billion in fiscal 2011 increased $176.5 million or 7.6% from fiscal 2010. This increase was greater than our revenue growth in large part due to the impact of certain specialty generic product introductions (launches), the continued strong growth and profitability of our non-specialty generic programs and increased contributions from our fee-for-service agreements with pharmaceutical manufacturers. All of the above was offset, in part, by normal competitive pressures on customer margins. Oxaliplatin, Gemcitabine, and Docetaxel (all generic oncology drugs) were launched in the quarters ended September 30, 2009, December 31, 2010 and March 31, 2011, respectively. The gross profit benefit achieved collectively from all three generic oncology drugs in fiscal 2011 was higher than the benefit achieved from Oxaliplatin alone in fiscal 2010 by approximately $96 million. Sales of Oxaliplatin, the largest contributor of the three specialty generic drugs, benefited our gross profit by approximately $106 million and $117 million in fiscal 2011 and 2010, respectively. Beginning in our fourth quarter ended September 30, 2011, the gross profit contributions from the sales Gemcitabine and Docetaxel began to moderate as additional pharmaceutical manufacturers offered these products for sale and as third party reimbursement rates to our customers declined. In fiscal 2011, we recognized a gain of $2.1 million from antitrust litigation settlements with pharmaceutical manufacturers. This compared to a recognized gain of $20.7 million from antitrust litigation settlements with pharmaceutical manufacturers in fiscal 2010. These gains were recorded as reductions to cost of goods sold. Lastly, in fiscal 2010, we completed a reconciliation with one of our generic suppliers relating to rebate incentives owed to us. Our gross profit benefited by approximately $12 million in fiscal 2010 as a result of having completed this reconciliation.

As a percentage of revenue, our gross profit margin of 3.13% in fiscal 2011 improved by 14 basis points from fiscal 2010 due to the above-mentioned generic oncology drug launches, the strong growth and profitability of our non-specialty generic programs and increased contributions from fee-for-service agreements with pharmaceutical manufacturers. These factors more than offset the above market growth of some of our largest customers, who benefit from our best pricing, and normal competitive pressures on customer margins. Additionally, the gain on antitrust litigation settlements, as noted above, contributed 3 basis points to our gross margin in fiscal 2010.

We recorded a LIFO charge of $34.7 million and $30.2 million in fiscal 2011 and 2010, respectively.

Operating Expenses

                                                   Fiscal year ended
                                                     September 30,
    (dollars in thousands)                        2011          2010        Change
    Distribution, selling and administrative   $ 1,179,234   $ 1,150,833       2.5%
    Depreciation and amortization                  105,482        83,572      26.2%
    Employee severance, litigation and other        23,567        (4,482 )
    Intangible asset impairments                     6,506         3,200     103.3%

    Total operating expenses                   $ 1,314,789   $ 1,233,123       6.6%

In fiscal 2011, we started to incur significant costs to support our new ERP system as we began the transition of our legacy information systems to our new ERP system. Additionally, in fiscal 2011, ABDC implemented its Energiz program, which encompasses a number of initiatives to maximize salesforce productivity, improve customer contractual compliance, and drive efficiency by linking our information technology capabilities more effectively with our operations.

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