卡地納健康 (CAH) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter 2010 Cardinal Health earnings conference call.

At this time, all participants are in listen-only mode.

(Operator Instructions).

I would now like to turn the call over to your host for today, Ms.

Sally Curley, Senior Vice President of Investor Relations.

Please proceed.

Today, we will be making forward-looking statements.

The matters addressed in these statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected or implied.

Please refer to our SEC filings in the forward-looking statements slide at the beginning of the presentation found on our Investor page of the Cardinal Health website for a description of those risks and uncertainties.

In addition, we will reference non-GAAP financial measures.

Information about these is included at the end of the slides.

A transcript of today's call is also posted on our investor website.

Before I turn the call over to Chairman and CEO, George Barrett, I would like to remind you of the few upcoming investor conferences in which we will be participating, notably the Bank of America conference on Tuesday, May 11; the Citigroup conference on Wednesday, May 26; and the Sanford Bernstein conference on Thursday, June 3.

The details of these and other events are or will be posted on the IR site of our website, so please make sure to visit that often for updated information.

Finally, as always, I would like to ask you to please limit your questions to one with one follow-up in order to allow for others to also ask questions.

Now, I'd like to turn the call over to George Barrett.

George?

Thanks, Sally.

Good morning, everyone, and thanks for joining us on our third-quarter call.

Let me start the by saying that I'm very pleased with our performance during the March quarter and our continued momentum throughout the first nine months of fiscal 2010.

We continue to execute well on our strategic priorities as we reposition our business.

This is resulting in stronger bonds with our customers, better financial performance, and growing enthusiasm from our employees around our overall mission and greater optimism for the future.

For Q3, revenue was $24.3 billion, up 1% over the prior period.

Non-GAAP EPS was $0.61, down 8%, while non-GAAP operating earnings decreased by 7% over the prior Q3 results.

Our overall operating performance was better than we originally expected.

I'm pleased with the progress we're making to deliver sustainable growth and value to both our customers and to our shareholders.

As a company, our results reflect solid performance in both segments, driven by several key highlights, significant ongoing improvement in our generic business.

Of particular note is a further increase in generic penetration rate or what we refer to as "share of wallet"; continued solid performance under our branded manufacture agreement; strong performance in nuclear, particularly given the ongoing global supply shortages; solid growth in our Medical segment's preferred products; and excellent revenue and profit growth in Canada from new suppliers and products.

We've also been very successful with our working capital improvement and had another very strong quarter of operating cash flow.

Now, let me comment on each segment separately, starting with Pharmaceuticals.

Continuing its strong momentum in Q3, our Pharma segment delivered strong performance and improving margins.

Segment sales increased slightly versus the prior-year period.

The sales growth was in line with our expectations, dampened by the previously disclosed loss of two customers in the first half of this fiscal year.

Segment profit improved, increasing 7% in the quarter versus Q3 of fiscal 2009.

This was driven primarily by an increase in overall margin rates due to excellent performance in our generic initiatives, continued solid performance under our branded manufacture agreement, and disciplined expense management within the segment as a whole.

As I mentioned earlier, we continue to see good progress in our Generics program, both on the sales and sourcing side.

We have developed a highly attractive offering for our customers, and they are responding enthusiastically.

Last June, we set a target for ourselves to increase our Generic penetration rate by 10%.

We have already exceeded that annual improvement goal, and our customer loyalty scores further validate that we are on the right path.

We saw a healthy 10% increase in overall generic sales this quarter, driven by continued progress in our retail independent customer base.

Generic sales to our Medicine Shoppe customers in the first nine months of the fiscal year have exceeded full-year 2009 generic sales.

We believe that improving sales effectiveness is key to further increasing "share of wallet" with our existing customers, as well as capturing more new business.

Our Sales College, launched earlier this year, takes a best practices approach to building these capabilities.

It provides comprehensive on-boarding training for all new sales reps as well as ongoing training for all reps and managers in an integrated curriculum model, positioning us to serve our customers with an even higher degree of satisfaction.

Additionally, several months ago, we began a purposeful cross-selling effort in the ambulatory care channel with our Medical segment sales force.

While still early, this effort is beginning to deliver benefits to both our customers and to Cardinal Health.

It has been an unusual stretch for our nuclear business and I'd like to take a little extra time today to discuss this part of our Pharmaceutical segment.

I am extremely proud of what this team has done to manage an incredibly difficult raw material shortage.

While supply constraints had an impact on overall volume, the team continues to take care of our customers and deliver solid bottom-line growth.

In response to the supply shortage, the nuclear team engaged several of our own Six Sigma operational excellence black belts to maximize the available product through just-in-time delivery -- working closely with our customers to adjust patient schedules and calibrate delivery times to help meet the needs of the most critical patients first.

And, where appropriate, customers have substituted a different imaging modality using Thallium, a compound that we also supply.

Our people have been working around the clock to compensate for this these extraordinary circumstances.

And our customer loyalty scores, already at a high level, have actually increased during this difficult time, a testament to the trusted advisor role that our team has earned with their customers.

But that's not the end of the story.

In the category of "you can't make this stuff up," the volcanic eruption in Iceland further hindered the availability of raw material, as suppliers of European-processed Moly-99 were unable to ship to US manufacturers of technetium generators.

Our current expectations regarding supply is that the production from the Petten reactor in the Netherlands and the Chalk River reactor in Canada will normalize no earlier than late August-early September timeframe.

The impact of the volcanic eruption and our expectations of nuclear generator supply are reflected in our forecast for Q4.

In the quarter, we also achieved strong results in our small but growing positron emissions tomography business through continued sales growth, clinical trial support and operational efficiencies.

This is an exciting area, as PET imaging agents are being developed to detect and treat diseases such as Alzheimer's and other neurological and aging-related diseases.

We play a key role in supporting these clinical trial efforts and are well positioned for future growth in this space through the manufacturing, dispensing and distribution of these and other products.

And just a reminder that the technetium generator supply issue does not affect the PET business.

Turning to the Medical segment, the quarter came in about as we expected.

Revenue grew a respectable 7%, largely based on strong performance from our business in Canada, growth in both ambulatory care and lab; and increased sales of our self-manufactured products.

While segment profit was down 16% compared to last year's strong third quarter, it was up sequentially from Q2, as we forecasted on last quarter's call.

An unusual year-over-year comparison in the cost of goods sold created a tough comparison versus the prior period.

Further influencing our results in the Medical segment were higher expenses in the period, primarily driven by year-over-year comparison in performance compensation accruals and by our Medical Business Transformation investment.

Apart from this investment, we continue to quietly manage our core expenses.

We are closely watching hospital admissions and procedures, as this does influence demand for our products.

There were clear signs that consumers have been cautious with their medical spending with both inpatient and outpatient volumes down slightly.

This, along with the weak flu season, did somewhat dampen our hospital supply business in the third quarter.

We will monitor these factors carefully and are hopeful that job growth data and other signs of some economic recovery will begin to translate into higher utilization.

We are extremely focused on improving the hospital channel and continue to build up our preferred product categories, including self-manufactured and private label products.

Progress during the quarter in our private label initiative included the launch of new OR and nursing products.

In the first nine months of the year, our portfolio of private label products has grown at double the rate of the rest of our hospital supply business.

We believe that these "preferred product" programs will create benefits for our customers and have a positive impact on our margins.

We've recently realigned our resources, within the entire Medical segment, around customer channels and product categories in order to leverage our collective capabilities in manufacturing, distribution and sourcing in order to bring a higher level of value and service to our customers.

Canada had another excellent quarter, posting both revenue and profit growth well in excess of 20%.

New products and supplier agreements, with some upside from foreign exchange, fueled this outstanding growth.

Ambulatory care and lab also continued to perform well this quarter, although showed slower revenue growth due to lower flu volumes.

Work on our Medical Business Transformation continues to meet our timeline and budget expectations.

We completed the design stage and are now in the build stage of this important project to enhance our technology platform and processes -- in short, further reducing supply-chain costs while making it easier for our customers and suppliers to do business with us.

As is true with the segments, at the Cardinal Health enterprise level, we continue to focus on tight expense controls and the prudent use of capital.

We continue to manage our balance sheet carefully with a strong emphasis on reducing working capital.

I am particularly proud that we were able to continue to reduce inventory days while keeping our service level rates high.

Operating cash flow was very robust, buoyed by our business performance and working capital focus.

Given this performance, the cash we have on hand and the additional cash we expect to generate from the sale of CareFusion stock, many of you have asked how we intend to deploy our capital going forward.

With the exception of our policy on, and our commitment to, a solid dividend, we do not bring a fixed formula to our capital deployment strategy.

Our goal is twofold - 1)-- to ensure that we are well-positioned for sustainable competitive advantage; and 2) to create shareholder value.

The investments we are making are focused on those two things.

To the extent that we need to complement our internal capabilities or scale with an external moved to achieve our goals, we will explore acquisitions.

In this mix, we will consider other strategies such as share repurchases.

Based on our performance during the first nine months of this year and our visibility into what is effectively the remaining 60 days of the fiscal year, we are increasing and narrowing our non-GAAP earnings per share guidance for fiscal 2010 to a range of $2.15 to $2.20.

The implication is that our fiscal 2010 fourth quarter will be weaker than last year's fourth quarter.

This is as we expected, and Jeff will walk you through our assumptions around the remainder of the year in a moment.

Consistent with the comments I made in the first and second quarters, we came into this transition year with clarity about what we needed to do to put the company on the path toward sustainable long-term growth, what we expected to face on that journey in fiscal 2010 and a determination to get the work done.

Our renewal as a company has progressed at a more accelerated pace than we originally anticipated.

I'm delighted that, coming out of fiscal 2010, we expect earnings growth of a larger and more stable base than we originally anticipated.

Although we don't typically provide annual guidance at the end of the third quarter, this has been an unusual year and we would like to provide investors with our early thoughts on fiscal 2011 on this call.

Given the data we have at this stage and the progress in our underlying business performance, our initial outlook for fiscal 2011 non-GAAP EPS is expected to be in the range of $2.35 to $2.45.

On our fourth-quarter call, after we have finalized our annual budget, we will provide more detail.

Jeff will walk you through our core assumptions for the remainder of fiscal 2010 and for our preliminary view of fiscal 2011.

Before I turn the call over to Jeff, I'd like to make a few comments on healthcare reform.

As you are well aware, since we last spoke on our second-quarter call in January, this historical legislation has been passed.

It is important to note that the Patient Protection and Affordable Care Act marks the beginning of healthcare reform, not the end.

With more than 2700 pages of legislation to interpret and implement, there will be a long administrative, regulatory and legal process as the appropriate agencies work through the details of implementation.

This will be a very interactive and iterative process in which Cardinal Health plans to participate.

While there is much work to be done, we are well-positioned to address healthcare reform's two main goals, coverage and cost.

Clearly, adding more than 30 million new patients will put greater demand on the US healthcare system, a system already under stress.

This additional pressure will increase the relevance of our capabilities to improve the cost-effectiveness, quality and safety for our customers' operations, allowing them to focus on patient care.

Finally, let me end by saying that I feel very good about our performance in the quarter and our rate of progress to this point.

Our organization is tightly aligned around our strategic priorities, intently focused on execution, and our people are passionate about continuing to improve the customer experience.

With that, I will hand the call over to Jeff to provide more details on the quarter.

Jeff?

Morning, everyone, and thanks for joining us.

It's a pleasure to be reporting out to you today on our results because I'm very proud of the organizational execution and financial performance we have delivered in the third quarter and fiscal year to date.

George has provided an overview of our Q3 results and key drivers.

Let me build on those, as well as touch on our revised FY '10 guidance and a preliminary fiscal '11 outlook.

To begin, as you may recall, before the start of this year, we identified a few key financial metrics that we needed to focus on to win, specifically margin expansion and working capital improvements.

Driven by a number of the performance initiatives that George has already referenced, we have made some great progress in both of these areas.

First, we are pleased that, for the second quarter in a row, consolidated gross margin rates have increased year-on-year.

In Q3, this rate increased 5 basis points, versus last year, to 4.15%.

And non-bulk profit margins within our Pharma segment were 2.24% versus 2.05% in Q3 of FY '09.

Second, regarding working capital, we've continued to see the hard work of our people pay dividends.

Both year-on-year and sequentially, inventory declined by two days, largely due to the efforts of our operating teams and our lean Six Sigma programs.

At the same time, our accounts receivables days outstanding improved versus last year.

These initiatives, combined with our earnings performance, helped to generate $879 million of operating cash flow in Q3, bringing our year-to-date operating cash flow to just over $1.8 billion.

Due to the timing of payments, our cumulative operating cash flow for the full year will likely be below this, in the range of $1.5 billion or so, but it still represents a significant number and is much higher than we projected coming into the year.

To summarize, we're making great progress with our performance initiatives, and it's beginning to consistently show in our key metrics.

Although we will always see some quarterly fluctuations in margin rate trends and working capital levels due to the nature of our business and external factors, we feel we have the actions in place to continue to move these in the right direction over time.

Now, let me add a few more details regarding our Q3 performance, starting with the segments.

As George said, we are pleased with the business progress and financial results in Pharma.

Revenue increased by 0.5%, split almost equally between non-bulk and bulk customers.

The ending of our relationship with two significant customers in the first half of the year dampened sales growth by approximately 150 basis points.

These are the same two low-margin accounts we had referenced in previous calls.

Certain of our large customers also grew their orders less than market in the third quarter, which further impacted the growth rate.

Moving to Pharma margins in the quarter, we saw strong performance under our branded agreements, particularly related to branded inflation from our price-contingent vendors, as well as their generic programs.

This benefit was partially offset by the continued Medicine Shoppe and Pfizer DSA transitions and previously referenced contractor pricings, which are largely flowing through as anticipated.

In the Medical segment, profit declined 16% versus last year to $108 million, primarily due to an unusual year-on-year comparison in the cost of goods sold, the year-on-year impact of performance-based employee compensation, and increased investment spend associated with the Medical Business Transformation.

The decline was partially offset by revenue growth from our Canadian, lab and ambulatory businesses and our portfolio of preferred products.

Segment profit increased sequentially by $5 million, despite less benefit from commodity price changes and the absence of a significant Q3 flu season.

In fact, after a much higher than usual positive impact from the flu in the first half of fiscal '10, that trend pretty much reversed itself in Q3.

Let me now cover a few items at the consolidated level.

Non-GAAP operating expense is up over 9% from last year, largely driven by funding our performance-based employee compensation programs that did not occur during the prior-year period, and to a lesser extent investment spend on key initiatives.

If you exclude those drivers, our core SG&A is down year-on-year, reflecting the continued tight focus we have in this area.

Let me spend a few more moments on this compensation issue, given its significance to our expense line this quarter.

As I'm sure you recall, last year in late Q2 and Q3, we were in the midst of the global financial crisis.

At that time, we had not yet spun off our CareFusion capital equipment businesses.

The economic crisis had begun having a very negative impact on hospital capital equipment orders, significantly impacting our CareFusion business.

As we recognized this downturn in our full-year financial forecast for FY '09, we also brought down our management bonus accruals across the entire company commensurately.

This particularly impacted Q3 '09.

This year, our bonus accruals have increased based on strong performance versus target.

The net year-on-year impact of those accruals moving in opposite directions is reflected in our SG&A growth this quarter.

Compounding this increase is the decision we made heading into FY '10 to tie more of our employee-related expenses to company financial performance, and hence make more variable.

Specifically, we replaced a portion of our 401(k) benefit that was a fixed employer contribution with a variable contribution linked to financial performance.

Again, better-than-planned performance this year resulted in higher accruals for this expense in Q3.

Moving on, our non-GAAP tax rate for the quarter was 38.2% versus 37.3% last year.

The higher rate in the current quarter was attributable to changes in income mix and a few discrete items.

On the balance sheet, we finished the quarter with over $2.6 billion of cash, approximately $400 million of which is overseas.

Now, let me turn to Slide 7 and take a moment to walk you through the items that accounted for the difference in our GAAP and non-GAAP EPS numbers.

All of these figures that I will review are on an after-tax basis.

The biggest item in this category is a $23 million gain from sales of 5.4 million shares of CareFusion stock in the quarter.

This accounted for approximately $0.06.

The next item is the impairments and loss on sale of assets of approximately $0.04.

The majority of this relates to the closure of a facility, as well as well as final tax true-ups related to a divestiture.

The other three items -- restructuring and severance, litigation charges, and other spinoff costs -- netted to approximately $0.01.

The net of all these items result in a GAAP EPS of $0.62, versus non-GAAP of $0.61.

Now, turning to Slide 8, an update on the status of our CareFusion stake.

As mentioned earlier, during Q3, we sold 5.4 million shares to generate $136 million in proceeds and a gain of $23 million.

We've accrued no tax on the proceeds of this sale.

After these sales, we now hold 30.5 million shares of CareFusion stock, which had a value of $805 million at March 31.

During Q3, we had a pretax, unrealized gain in this remaining ownership of $43 million, which does not have an earnings impact until shares are actually sold and capital gains or losses are recognized.

As we've said in the past, in order to maintain the tax-free nature of the spinoff, we need to divest of the remaining shares within five years from the spinoff date.

We intend to complete this by the end of fiscal '11 and are continuing to assess the best method and timing to do this based on market conditions and other factors.

Also during the quarter, we signed a definitive agreement for the sale of Martindale in the UK and are expecting to close this by the end of fiscal 2010.

This, along with the sale of Specialty Scripts, the closing of which we announced earlier, completes the portfolio rationalization activity that we projected for this year.

Now, let's review our revised FY '10 outlook.

Let me begin with some framing comments about how we now view the full year from a forecast perspective, particularly given our relatively strong financial results in the first three quarters.

Clearly, our performance thus far has been better than we anticipated heading into the year.

This has been driven by two major categories of items.

First, we have had very good execution against our key initiatives this year, including our medical supply chain strategy, generics programs, and our progress in retail independence, and strong performance in nuclear despite supply shortage issues.

We've also benefited from certain external factors including generic launches that happened at a higher level than we had planned, lower deflation on certain generic products, accelerated compensation from our branded vendors relative to price increases, and the higher demand for certain MedSurg products resulting from a stronger and earlier flu season in the first half of the year.

For the full year, although we will get some net benefit from those factors, we are assuming that they will largely normalize in the fourth quarter.

So in total, the sum of these items has added up to solid performance for the first nine months of this fiscal year.

This is reflected in our increased guidance of $2.15 to $2.20.

Implicit in this is that Q4 will be down from last year, based upon several factors which I'll attempt to walk through.

Our Pharmaceutical segment assumptions for Q4 include the following.

The headwinds of the Pfizer DSA and Medicine Shoppe transitions continue to play out as anticipated.

The earlier-than-anticipated branded price inflation realized in the first three quarters is not expected to continue in the fourth quarter.

In fact, we had originally expected price increases from a major branded contingent vendor in Q4, which we no longer anticipate.

The negative year-on-year impact of generic launches in deflation was not as significant in the first three quarters as we anticipated, again due to several unplanned launches and lower deflation of certain products launched.

However, we are not projecting any significant, high-value generic launches in Q4.

Finally, let me comment on the financial impact of the nuclear generator supply situation, which George covered in some detail.

The supply shortage had an unfavorable EPS impact of $0.01 to $0.02 in Q3.

And based on what we're seeing so far, will have at least $0.02 impact in Q4.

Turning to our Medical segment, the first three quarters results show revenue growth to be above overall market trends, driven by our mix shift, strong growth in Canada, ambulatory and lab, an exceptional flu season in Q1 and Q2, and the one-time revenue recognition benefit from that CareFusion spin.

In Q4, we expect that segment revenue growth may moderate somewhat, given the absence of a few of these unique items and a slightly cautious view of the market due to some softness in utilization we saw during part of Q3.

In the first half of 2010, this segment also saw greater benefit from commodity raw material prices and higher flu-related sales than we had originally projected.

These did not continue in Q3.

In fact, oil prices moved higher over the past six to nine months, and as you recall, there's a lag effect regarding the impact of these movements in our income statement.

These factors make for a harder second-half comparison.

That all said, after a tough compare in Q3, we do expect the Medical segment to return to year-on-year profit growth in Q4.

On Slide 10, we provided our corporate assumptions for fiscal 2010, which are identical to what we've shared previously.

The only comment I will make in this area is that we expect that our full-year tax rate will likely be north of 37%, which implies a fourth-quarter rate that could be 4 percentage points or so higher than last year's unusually low Q4 rate.

Taking all of these items into account and based on our performance during the first three quarters of this year, as George had mentioned, we are increasing and narrowing our non-GAAP earnings per share guidance for FY '10 to $2.15 to $2.20.

Now, let's turn to slides 12 to 14 and look at our preliminary FY '11 guidance.

As George mentioned, we thought it made sense to provide you all with an earlier look at next year, given the somewhat unique circumstances of 2010.

Our initial thoughts for a fiscal 2011 non-GAAP earnings-per-share range are between $2.35 and $2.45.

Implicit in this is our expectation for relatively modest revenue growth on a consolidated basis.

Now, that said, let's spend a few moments going through some of the segment-specific assumptions in more detail.

On Slide 13, you can see the Pharmaceutical segment assumptions.

Let me hit on a few highlights.

Importantly, our FY '11 guidance assumes the renewal of all existing major customer contracts.

Brand inflation is projected to be on a comparable level to FY '10.

We do not anticipate a significant change from FY '10 related to the year-on-year comparison of generic launches and price deflation.

We do, however, expect continued benefit from our generic sourcing programs.

As we did heading into this year, we have risk-adjusted a basket of potential at-risk launches in FY '11 to come up with our forecast.

In the nuclear business, we expect the Moly supply shortage to moderate during the first half of next year, but nuclear will likely face a tough first half due to the supply shortage.

Now, let's turn to Slide 14 and our assumptions for the Medical segment.

We expect to benefit from increased preferred product sales and customer mix shifts to hire-margin classes such as ambulatory care.

We do project a negative impact from rising commodity prices that we saw over the last several quarters, as their increased cost flow through our P&L during FY '11.

We do not anticipate the extraordinary demand from the pandemic flu season that we experienced in the first half of this year.

Our Medical Transformation initiative expense will continue at a similar level to FY '10 as we continue to position our Medical segment for long-term growth.

We're also making some further strategic moves in the Medical segment related to sourcing and category management, which drive long-term benefit.

In addition to the segment-specific items noted, I want to highlight that we will continue to take additional broad-based actions to improve the cost and capital profile of our businesses.

As you would expect, we will be providing an updated look with additional details at our Q4 call.

But we hope this preliminary look at FY '11 is helpful.

Let me conclude with some final remarks on healthcare reform, building on what George commented on earlier.

At this point, it is difficult to accurately quantify the impact that some elements of the reform package will have on volumes or margins, although we are optimistic that increased access will provide an overall benefit to us in the medium to longer term.

However, there are two areas that are a bit easier to quantify.

First, with regard to the cost of our employee benefits, we expect the ongoing impact to be relatively minimal, and we will be taking no charge for postretirement healthcare, as we do not have a company-funded retiree healthcare program.

With regard to the 2.3% tax on sales by med device manufacturers, we expect this fee, which is scheduled to take affect on January 1, 2013, will have some impact on us.

The final language as to the classes of devices to include in this tax application was a little more inclusive than we would have liked.

To size this for you, based on today's book of business and absent any actions we may take to mitigate or share the impact, the hit to our MedSurg manufacturing business would be about $20 million to $25 million annually.

With that, I will turn it over to the operator to begin our Q&A.

(Operator Instructions).

Tom Gallucci, Lazard Capital.

Good morning.

Thanks for the color.

I was wondering first -- some of the upside that you mentioned in the quarter in the Drug segment, some strong inflation, generics, etc., you've done a pretty good job in the last couple of quarters at identifying sort of the relative magnitude of the upside from unexpected aspects of those areas.

Can you provide any more clarity on that front for the third quarter?

Yes, Tom, it's Jeff.

Thanks for the question.

Good morning.

Yes, at our Q2 call, I mentioned that the year-to-date breakdown between what I would say are external factors and internal performance factors was in the range of 75/25 or thereabouts.

Now, as I also said at the time, it's always hard to come to a definitive break between those two because, clearly, as we improve our internal performance, our ability to capitalize on external changes increases, so it's a bit of a gray line.

But I would say that rough breakdown that I talked about in Q2 probably still applies to Q3 and the overall year-to-date.

Okay.

Then George, just as a follow-up, you mentioned real strong performance in terms of your rising generic compliance or penetration rates.

Can you sort of frame for us where you are as you think about how much more room there is to go, given you've done so well in the last year?

Yes, it's been very encouraging progress on this account.

You know, I think there is still room to go, Tom.

I don't know how -- I can't give you a complete quantification.

I can tell you that we are significantly north of what we had set as a target, but I still think we experienced some leakage and we are working very hard to continue to close any gap in our compliance rate.

So, I think there's still room to go, but certainly I am pleased at the progress we are making.

Glen Santangelo, Credit Suisse.

Thanks for taking my question.

George, I wanted to kind of talk to you about your investment spending that you made in 2010.

Basically, if we go back to analyst day last year, you laid out a whole bunch of initiatives in terms of investment spending that was required that negatively impacted your margin in fiscal '10.

Could you maybe quantify that for us as you kind of look back, maybe how much you spent, maybe how much that impacted your margins?

Then as we look out to this initial fiscal '11 guidance that you're giving us, could you give us a sense for maybe how the investment spending in fiscal '11 might compare to fiscal '10, so we could maybe think about what a more normalized margin run rate would look like?

Sure, Glen.

Let me just start in sort of the qualitative sense, and then I'm going to turn it over to Jeff.

But yes, we really set out a game plan with some of these investments very well articulated upfront to ourselves in terms of what we want to do.

Then we also knew there were some key initiatives and pilots that were being considered inside the business units.

I would say we are making good progress on both counts.

What I'll do is turn it over to Jeff.

I think he can give you a little bit more of a sense of breakdown, particularly as it relates to the largest of the investments that we have made.

Sure, thanks, Glen, for the question.

Let me break it down into a few different areas.

Starting with the Med segment, there were two major transformational initiatives going on this year that we invested in.

One was our overall Med Transformation which is a multi-year pretty significant overhaul of our processes and systems related to our Med supply and manufacturing business.

Incrementally this year, we're going to spend about $25 million more on that program than we did last year, and last year's spend was relatively minimal.

The spend next year will be about the same, so there won't be a positive benefit from it next year, but it will be pretty much neutral in terms of the year-on-year spend.

The other major transformation within the Med segment was in our ambulatory space, particularly related to customer-facing IT systems and ordering platforms.

The bulk of that investment has happened already.

There will be a little bit still as we finish up next year, but I would actually expect that to be a net positive next year, both due to lessened investment but also because we are reaping the benefits of that transformation that we've done over the past year and a half.

On the Pharma side, the biggest investment we've made this year has to do with our ordering systems that we put in our customers' pharmacies.

We are in the midst of rolling that out to our customers across the US.

There was significant spend related to that this year.

I would expect the spend next year to be about equivalent for that implementation, so again, neutral impact from FY '10 to FY '11.

Then there is always a certain amount of investment spend that we sort of hold at corporate to fund certain initiatives and strategic imperatives over the course of the year.

That was a negative variance from FY '10 to FY '11, in the range -- I'm sorry, from FY '09 ' FY '10 in the range of I would say $15 million or so.

I would say it will be largely neutral going into next year.

So hopefully that helps.

Lisa Gill, JPMorgan.

Thanks and good morning.

Jeff, I just had a couple of follow-up questions around the guidance for next year.

In your initial guidance, are you making any assumptions around share repurchase in that number?

Yes, Lisa, all I'll say on that for now is that, at a minimum, we assume that we will do share repurchases equal to the amount required to offset the dilution from equity share issues as under our management programs.

Then the fee for med tech that you talked about for $20 million to $25 million, is that also included in your expectations that you initially gave us?

Yes, Lisa, actually, that does not begin implementation until January 1, 2013, so that would not impact FY '11 at all.

Okay, great.

Then just lastly, obviously you are sitting on $2.6 billion of cash.

Do you have thoughts around acquisition opportunities?

Clearly, you are trying to work more in the ambulatory care area, George.

Do you see opportunities to make acquisitions there?

Do you think that it's better to build it out internally?

Yes, Lisa, you know, again, I probably would revert a little bit back to the general comments that I made.

We are really trying to do this without a fixed model.

We have a balanced view of this.

Certainly, our goal is to create a competitive advantage for ourselves and to make sure that we are generating shareholder return.

So we will look at every way to do that, and so if that can be done organically, obviously we would pursue it and pursue it aggressively.

To the extent we think building out a capability in one of our target areas requires some kind of external mover that we could turbocharge the effect, then we would certainly look at those things.

So just generally speaking around acquisitions, is there anything that you see right now that you think is interesting and you think would be additive to your well-positioning of the company going forward?

Yes, it's a good question and of course it's hard for me to answer.

You're not going to answer it!

(laughter).

Alright, but I always have to try, George!

Thank you.

Steven Valiquette, UBS.

First question here -- I may have missed this but I know you guys are giving some updates on the dollar amount of generic profits, where I think we left off at down $75 million the end of last quarter for this fiscal year.

I wonder if there is a further update on that.

That's question one.

Then question two is kind of actually really the same question for fiscal '11, where you say generic launches and deflation comparable to fiscal '11.

I want to make sure that means flat as opposed to comparable guidance where you are saying it's going to be down, you know, try to clarify that as well for the initial view for next year.

Jeff, why don't you start and then I will provide a little color commentary to that.

Sure, great questions, Steve.

In answer to your first one, yes, on the last call, we said that the total impact from both fewer generic launches this year and generic inflation from products that launched last year was the net impact was going to be about down $75 million year-on-year.

Based on what we saw in Q3, where we saw a few more launches than we had been anticipating and a little less deflation on a few products than we had been anticipating, we now view that number for the full year to be closer to around down to $50 million.

To clarify my comments regarding next year -- and I'm glad you asked that because it probably needs clarifying -- what I meant is the net impact from generic launches and deflation next year from a dollar standpoint is about neutral, so flat to this year.

Steve, just a bit of extra color -- part of the interesting phenomenon, as you know, having covered the generic industry, is that we have taken a sort of risk-adjusted approach to modeling.

That's something we articulated about a year ago.

What happens of course is, when you get launches at risk or settlements, of course those don't come out risk-adjusted.

They are binary; they either happen or they don't happen.

It's been a year in which we've had quite a number of launches at risk as well as some settlements.

That's a phenomenon that we deal with and of course we will deal with every year.

Yes, you're right.

That definitely makes it challenging, trust me, from our end as well.

So I appreciate the color, though.

Thanks.

Garen Sarafian, Citigroup.

Thanks for taking the question.

On the Pharma side, your generics programs seem to have been very successful thus far and exceeding your goals, so without sharing your secret sauce, what types of activities have really led to your success?

Well, it's a bit of a question of integrating the pieces; there is no one part.

It starts with focus and making sure that everybody understands the goal of growing this part of the business, growing share of wallet, and expanding our generic presence.

We've done a lot of sales training, as I mentioned during my prepared comments.

We are making sure that our incentive systems are aligned to drive the right behaviors.

We have tried to create programs for our customers that are really flexible and tailored to their unique needs, because every one of our customers is different and has different needs, and making sure that we are monitoring, measuring this important factor all of the time, then linking it to a proper kind of sourcing model.

So I think it's the integration of those pieces, and we are making some good progress there.

Moving on to your Canadian operations, you highlighted another strong quarter.

Can you elaborate on what's driving this growth and if you could quantify year-over-year growth in revenue and earnings on a constant dollar basis?

Let me start, but then I get to turn it to Jeff, our resident Canadian, who will be stoked to answer that question (laughter).

So our Canadian business has done a terrific job.

They have been able to bring in new customers as well as expand their business with existing customers who see their extraordinary distribution and service support as a way of penetrating the market.

But Jeff, any more color on that?

Yes, Garen, I think, on the sort of currency adjusted revenue growth rate year-to-date, I would peg it at about midteens.

So even when you back out the currency benefit, they've had a very, very strong year, which I'm always very proud of.

(laughter)

The last quarter, I think it was in excess of 20%.

Was that also a constant dollar basis last quarter?

I would say about 20%.

There was probably, again, probably 5 percentage points or so of currency benefit.

Was included in the 20%?

Yes.

Got it.

Then just one quick follow-up on fiscal '11 guidance.

You mentioned hospital admissions as it impacts your Medical segment.

Your early guidance, what does it assume in hospital admissions for next year?

I'm sorry, we didn't quite get your question.

Could you repeat it?

Sure.

Just on your early fiscal year '11 guidance, what does it assume regarding hospital admissions?

Does it assume any sort of a pickup due to the economy picking up, or is it what you are seeing now?

I think we are assuming that we will track the market again, so we are not modeling in, at this point, a pickup related to the economy.

We are of course somewhat encouraged by what we've seen in recent weeks or days in the broad economy, but still taking a cautious outlook.

Got it, thanks.

Charles Rhyee, Oppenheimer.

Thanks for taking the question.

Maybe for Jeff, I think you talked about it.

I might've missed some of the items.

You talked about some of the things helping fiscal 3Q that you said might normalize in the fourth quarter.

Can you just kind of repeat some of those things, and does that relate to also the things that are impacting the 4Q margins?

Yes, I would say the biggest one, Charles, is the contingent branded inflation that we saw some fairly significant increases from the branded vendors that still fall into our contingent category of fees in Q3.

Quite honestly, in Q4, we are expecting very, very little of that.

In fact, one of our largest contingent vendors that typically would do a fairly significant price increase in Q4 -- our expectations are that price increase will not happen.

So again, our income from brand inflation from contingent vendors is a very conservative view of Q4.

That both is responsible for the largest step down from Q3 to Q4 in terms of Pharma income.

It's also the largest driver of the decline from last year to this year.

But there's a few other factors in Q4 as well.

You know, clearly we still face the headwinds related to the Pfizer DSA transition which ultimately impacted Q3, but the impact in Q4 is slightly higher.

You know, we expect fewer generic launches this year versus last year.

As you may recall, Adderall launched in Q4 of last year, which was a fairly significant value generic launch for us.

We don't see anything of even comparable size in our Q4.

Then, as we indicated, our nuclear supply shortage continues to be quite severe.

That impacted us for part of Q3; it's going to impact us for the entire Q4.

It has turned out to be a pretty big challenge for us.

So those would be the big factors.

Again, the other thing I would point out is that our tax rate in Q4 will be about 4 percentage points higher than it was in Q4 of last year.

If I can follow up there, so when we look at sort of overall brand price inflation in the market, you're saying that sort of diverges from the brand price inflation that you see from your specific vendors, and then the contingent vendor pricing from the one vendor you're talking about not happening in 4Q.

Would you expect that to happen then in September quarter or later?

I think there are two questions there.

In answer to the first one, yes, we actually attract two types of branded inflation.

There's just the general market inflation, which tracks very closely to what you would see in the published reports, which I think, by most published reports this year, have been in the high single digits.

But more importantly, from sort of a quarterly swing factor perspective, we also track the brand inflation from our contingent vendors.

That does differ from the overall market, and this year has been more in the mid single digits, as we've commented on before.

But we think most of that happened in the first three quarters of the year, which is why we are not projecting much in Q4.

Regarding whether we will see those price increases happen next year, don't know.

We always assume a certain level of contingent branded price increase in each year.

Exactly the timing of those and which ones will happen at which rate, again we sort of look at it largely as an overall portfolio, so it's hard to say which specific ones will happen in Q1 or not.

Larry Marsh, Barclays Capital.

Thanks and good morning.

Congrats on good, continued good progress.

I will really bore you and ask you another question on Q4.

It sounds like, if we sort of think about your midpoint, you are taking down the fourth-quarter number maybe $0.05 versus consensus.

I know you don't guide to quarters.

But it sounds like you're calling out maybe a couple of cents from this manufacturer not raising prices in the fourth quarter, and I would assume that just gets pushed out to Q1, maybe an incremental $0.01 from nuclear.

It sounds like Medical will be back up.

but I'm still struggling a little bit to understand the other couple of cents.

Could you just run it through the numbers?

It looks like your drug business would be down 25% year-over-year to kind of get there.

Any additional clarification, Jeff?

I just want to start and then I am going to turn it to Jeff, because I do think there are sort of natural fluctuations to the orders.

We don't guide by quarter, and that's actually a very good reason for it.

Right now, I would say, again, the characteristics of the business continue today as they did two months ago.

These are largely the mechanics of our business.

The one thing I would probably call out is just that we are going through this nuclear shortage but actually have done very well in light of it.

While we will suffer a little bit from that comp in Q4 on nuclear, this is largely the mechanics of business flowing through.

But I want to just turn it to Jeff at that point.

Sure.

I fully understand your question, Larry.

Let me just build on what George said.

First of all, I wouldn't view it as us taking down Q4; I would view it as us taking up the year and recognizing that there were shifts between quarters and probably some of the stuff we were expecting in Q4 before happened in Q3.

But let me be a little bit more specific regarding some of the year-on-year negative drivers in Q4.

First of all, the headwinds from the Pfizer DSA and MSI transitions that we have been talking about all year probably hit us to the largest degree in Q4, given past timing of Pfizer price increases.

That's worth $0.03 to $0.04 of negative impact, year-on-year.

Other brand inflation that we think sort of got shifted, primarily earlier, that's in the $0.04 range.

Lack of generic launches is $0.01 to $0.02, again versus last year.

The impact of the nuclear supply shortage, as I said, was at least $0.02, so I will put that in the $0.02 to $0.03 range.

The tax rate increase is worth about $0.03.

Then we will probably be accruing at higher performance compensation rates as well in Q4, which could be worth another $0.03 or so.

So, I think, if you add those up, you can quickly get to the difference between growth and the negative growth we will be anticipating.

The final thing I will point out -- and obviously you know this, Larry, but just for -- just to state it -- our Q4 is traditionally always lower than our Q3, due to just the nature of our business.

Right, okay.

Obviously, I am sort of looking at it sequentially, too, but some of that obviously impacts the quarter.

So thanks for the clarification.

Secondly then, just the same sort of question for fiscal '11.

Again, I think it's smart to get out ahead of the Street, you know, to give a number here, so thank you for doing that.

But just, again, looking at that, just in my model if I am assuming Medical grows some next year -- I think you've been bullish about that business -- I would sort of assume drug is going to be flat.

Without pinpointing you, I guess would you be disappointed if you went through fiscal '11 and your drug business was flat in profits?

Yes, Larry, let me first jump in.

We're glad to be able to give some early look at our expectations for '11.

You know, we will, as you would expect, at the end of Q4 when we've completed our final budgets, we will provide greater detail on the segments.

Right now, I'm actually feeling good about where we are as a business.

I'm feeling good about 2011, but I think, at this point, it is probably too early to be giving any direction on the segments.

But again, I will suffice to say the things we've done during the course of this year to help position us have been productive and probably a little faster than we might have otherwise modeled.

There is a little bit of color in the slides that we gave you on some of the let's say assumptions in our general thinking about next year, but I think I will come out of 2010 feeling pretty good about where we're going to be going in 2011.

But we will provide some greater detail when we get to that at the end of Q4.

Okay, very clear.

Just a final thing I guess following up on another question.

I know you don't talk about what you're going to do with your capital, but I would think, if we sat here six months from now and had a conversation and the cash was still on the balance sheet, would you come and say "Look, we want to be prudent, but I'm a little disappointed we haven't been able to put it to work"?

Or, is it just we are just going to wait for the right things?

Let me -- again, I'm going to probably sort of sum up a little bit as a general comment but I will say this -- it's certainly not our goal to trap cash.

That is not necessarily productive for our shareholders, and we want to make sure we are putting cash to work effectively in any number of forms, including investment in the right things internally.

So I won't give any more color than that, other than that we take a -- we're going to take a very balanced look at this without a pre-existing formula.

From that, we will say it as we go.

Very good, very fair.

Thanks.

The next question, operator?

Bob Willoughby, Banc of America.

George or Jeff, our take from some of the ambulatory care providers was that demand for services was somewhat soft.

How are you guys characterizing your experience there, your gains?

Is this a market share grab, or is the market actually doing a bit better than thought?

Then secondarily, any success with some of that formulary approach to managing the SKUs for the MedSurg supply business?

Let me start with the first one.

You know, I think what we track is really procedures, outpatient procedures, elective procedures, admissions and discharges.

I would say the data has been generally a bit soft, as you are hearing.

We've been growing largely -- again we were a relatively small position, so partly we are growing through focus and the kind of IT investments that we've talked about in making the experience with ambulatory centers more effective.

So I think we're -- you know, it's some share movement.

I would say the market is certainly experiencing a little bit of the softness that you've described.

As it relates to our formulary approach, this is really -- we've just really begun to build out our capabilities and to reorganize around both the right channels and the right business categories.

The early efforts, particularly as we see it through private-label work, is showing good results.

But I would say it's early days, so I don't want to get ahead of us, but we're really excited about this as a model for serving customers in the way they need to be served and creating value for them.

We think that will provide margin expansion for us as well.

Thank you.

Robert Jones, Goldman Sachs.

Good morning.

Thanks for the questions.

In thinking about the Medical Transformation initiative, I was wondering if you could give us a little bit of a sense of the improvement in margins that you are expecting in fiscal 2011 versus fiscal 2010.

Maybe just qualitatively, is fiscal 2011 when you expect to see the meaningful impact from this initiative?

Excellent question, Bob.

No, I would say we start seeing material benefit towards the end of 2012 and then pretty significant benefit in 2013.

You know, we are identifying some early wins along the way, which we will try to accelerate and capture as quickly as possible, but I think, in terms of meaningful impact on our working capital and our margins, we are really looking late fiscal '12 and then fiscal '13.

It's probably too early to quantify that at this point.

No, that's helpful.

Then I just had one on the redesigned sourcing initiative.

I was just curious if there's been any fallout from some of the generic manufacturers that might not have been on the preferred list.

As we think about -- you mentioned at-risk launches and such.

As we think about particularly some product opportunities going forward, is there any risk of the nonpreferred manufacturers having these products and how those products would come through Cardinal?

Yes, a great question.

No, we are really pleased with the way this program is rolling out.

First, let me remind you that we continue to do business with the entire mix of generic suppliers.

As it relates to our preferred program where we've begun to narrow or have been able to narrow that group, we did this with I would say a relatively thoughtful strategic perspective by product, not just by company.

So thinking about which products we're going to launch, where exclusivities would lie, who is involved in the mix, who had what capabilities, who was specializing in which areas.

So I don't think there's been any fallout.

Again, I would also remind you that we've got I would say strong relationships with a lot of the suppliers.

So some of those companies that might have not been the number one player were in a backup position.

There have been some disruptions to the market this year, and some of those players have been available to us to step up.

So, we are pleased with the way that's unfolding and think we are on the right path.

That makes sense.

Thanks for the question.

Operator, we're at the bottom of the hour, but I think we're going to go take the folks that are currently in queue.

Richard Close, Jefferies.

Thanks for squeezing us in here.

George, you talked about essentially your target 10% improvement on the generics and that you have exceeded that this year.

Can you quantify the amount you exceeded that by, and then what your thoughts are for fiscal '11 in terms of additional improvement?

Well, I don't think I'm prepared to set a goal.

We will internally, and that's part of our final budgeting process.

I'm always a little reluctant to give exact numbers.

I would tell you that we have substantially exceeded that growth target.

So exact rate is probably not something I'm uncomfortable describing at this point, but we are very pleased with the rate.

I would say, through nine months, we are well past the target.

Okay.

Jeff, I was curious.

You guys have talked about the bulk margin over the last couple of quarters, and I think it was 22 basis points in the December quarter.

Any thoughts on where that shook out in this quarter?

Or maybe I missed that.

I'm sorry.

Jeff, you can actually just give --

That's a good question.

The bulk rate for Q3 was 48 basis points, which was about 2 basis points lower than the same quarter last year.

Okay, great.

Thank you very much.

Ricky Goldwasser, Morgan Stanley.

Good morning.

I have a couple of follow-up questions.

First of all, Jeff, on the interest expense line, are you still expecting interest expense to be $110 million for the year?

I think that implies a pretty significant step up from third-quarter levels.

I think it's in that range, Ricky, you know $110 million to $115 million, perhaps.

That would imply a fairly comparable level to what we saw in Q3.

I think you have to back out, though, the benefit of the CareFusion sale in the Q3 numbers.

You may be comparing the GAAP numbers because there's a significant -- that $23 million gain that we recognized appears in interest and other.

So when I refer to that $110 million level, I am excluding the CareFusion gains we've realized this year.

Okay.

Then on the fiscal year '11, what are the generic compliance assumptions you're making for '11?

Are you assuming pretty much steady-state, or are you assuming additional progress?

Then, I know that you mentioned that the guidance also factors in contract renewals.

I think the big contracts are Kmart and Kroger.

If you can just remind us what the timing for these contracts are and when should we be hearing about them?

Ricky, let me start but I want to make sure -- I didn't quite hear a word in your question about generics, so would you repeat that one?

Then I will come back to the contract renewals.

Sure.

On the generic compliance, basically what are your assumptions for fiscal year '11?

Are you assuming steady-state or are you factoring in improved compliance rate?

Got it, thank you, now I understand.

So, while I won't give you targets at this point, we haven't even finalized them internally, and I will say that we are assuming some ongoing improvement of generic compliance or generic penetration rate.

As it relates to the second, these are both spring and I think June dates on the renewals.

I can tell you definitively that one of them is in final contract negotiations today, and we feel good about our progress on all of those conversations.

Okay, thank you.

John Kreger, William Blair.

Good morning.

Thanks for taking the question.

This is [Ravi Fadah] in for John.

Can you quantify your growth with independents this quarter and perhaps how much of the $1 billion in business that you lost last year that you've won back at this point?

Yes, Ravi, we had a relatively modest growth.

We really followed the market, which is the 1% range this period.

So, I think the noteworthy success for us was the growth of our generics inside the independent.

The total growth of independent was just following the market at this point.

This is a great question; people ask it all the time.

I wish I knew how to answer, how you describe what we recovered from the loss business during the challenges of 18 months ago.

And the problem is you can't do a one-for-one comparison because, in a sense, there is always some churn.

So we are picking up business.

We don't know for sure whether or not it's exactly the business you lost, partly because we were doing business with most of those players but they significantly reduced business during that stretch.

So, I don't know how to answer the question about how much exactly from the amount -- loss of pickup.

We can just give you a general sense of growth, and we will continue to grow this business.

Helene Wolk, Sanford Bernstein.

Good morning and thanks for taking the question.

First, a question about revenue -- I just want to understand or get some more color around the revenue growth in the quarter and the outlook for the balance of the year in '11 around sort of what you are seeing or hearing relative to some of the customers underperforming the market.

Sure, yes, so let me start by saying, as you know and you've touched on, we do have a couple of large customers.

To some extent revenue, our growth is linked to the performance of any of those customers.

I am not really all that comfortable characterizing their business -- that's really for them to do -- other than to say that it was a couple of these major customers who are enormous suppliers.

We are doing the bulk of -- the vast majority of their business.

And so to some extent, we track how they do.

Beyond that -- and I will turn it to Jeff to sort of just give you the general thinking about the revenue assumption here.

Sure.

First, just to build a little bit on what George has said about what happened in Q3, given the very large nature of some of our customers, particularly on the bulk side, you can sometimes get a fairly significant swing in a quarter just because of timing of orders.

It may not necessarily track their demand but they may place a very large order on December 29 and that may shift something from Q3 to Q2.

So with our very large customers, it's always hard to read too much into the timing of their orders.

Regarding our view going forward, I would say, within the Pharma side, we are generally going to track the market, although recognizing that those two large customer losses or terminations that we had early this year still haven't lapsed, so we will still feel the effect from that going into Q2 of next year.

But if you sort of adjust for that, we expect to generally attract the market.

Exactly how close we will track the market will depend on how our customers perform in terms of market share versus the broader market.

On the MedSurg side, again, we had a few unusual events this year that, for the first three quarters, tended to abnormally elevate our revenue growth.

Again, we had the recognition of revenue related to the CareFusion spin in Q1.

We had an extraordinary flu season in Q1 and Q2.

Those events clearly won't repeat in Q4 and probably into next year.

So I would say, generally, we expect to track the market in the markets we participate in.

I would say we have a somewhat cautious view for the next couple of quarters until we see exactly where the economy settles out, etc., but I would say in general we see modest growth for the coming periods.

Great, and then just a question on the generics guidance around what you are expecting for fiscal '11, just sort of trying to understand whether the removal of product -- how does that respond to either Eloxatin, Protonix, whatever transpires here, if it's impacted or forecasted into your assumptions.

It's George.

You can assume that whatever has happened and is in the public domain -- and there are a few that I know you're referring to -- that is assumed into our preliminary outlook here.

So yes, it has been some interesting stuff in the last two weeks and it's all essentially built into this assumption.

Great, thank you.

Operator, I think we have time for one more question.

Before we do that, operator, I believe I wanted to mention one other revenue-related item that I neglected to in my answer.

Clearly, in the supply situation, nuclear is having an impact on their revenues as well, which would fall into the Pharma segment.

That had some impact in Q3, will clearly impact Q4, and very likely most of Q1 until the supply situation stabilizes heading into Q2.

John Ransom, Raymond James.

As we think about branded inflation, you will be fully transferred to fee-for-service by fiscal '12.

Is there going to be less -- it sounds like there's still a fair amount of quarter-to-quarter volatility, on branded inflation.

How much will the getting Pfizer to a fee-for-service model and move into '12 -- how much will that reduce the volatility?

John, good morning.

Yes, first of all, I don't want to say that it will be completely converted over on our entire book of business by 2012.

It is possible, but that's not something I could tell you; it's not, at this point, clear.

There's no question that, every time one of the major players converts, it does smooth out the nature of our business.

As you know, today it is still a relatively small part but it can, from quarter to quarter, show up.

We do think that volatility that comes from that mechanism of compensation will diminish the volatility.

That's a good question.

John, just to build on that, the sort of annual portion of our branded buy margin that is now contingent-based is less than 20% after the Pfizer transition.

It seems like a small amount, but as George says, when that 20% occurs quarter-by-quarter, it can have significant quarterly swings, which is also why it's sometimes difficult to predict exactly how it should play out.

Yes, because I don't think we really stress-tested fee-for-service in a lower-inflation environment, and I'm a little concerned there may be more volatility than some people expect.

The second -- I'm sorry, go ahead.

Yes, John, I actually don't think so.

I think what's been noteworthy is that we had one player convert from one system to another.

The other thing that's been noteworthy is I would say price increases used to be relatively predictable and timing and so in a sense we could provide greater color on that.

I think all of you learned to have the expectation.

Actually, what's happened with the few players that do this, it's just been a little bit less predictable in the last 12 months, and that's probably just part of a phenomenon in the system.

Just one follow-up -- we are certainly seeing, at the retail pharmacy levels, more stress on pharmacy margins, particularly generic margins and yet your generic economics continue to be pretty good.

Are you getting any pushback at all?

Then secondly, are you getting any pushback at all from the branded -- or the generic guys on some of your fee-for-service as you would renew some of those agreements?

Well, let me again describe it generally.

Look, the generics market is of course a competitive market, so -- and we expect it to be that way.

We've just I think done a better job of making our offering attractive and making sure that we are doing the right things on the sourcing side to make us an attractive partner with a generic company.

So, I would certainly not say suddenly it's not a competitive market.

Of course it's a competitive market, so we live with that every day.

On the branded relationships, we feel good that we've got strong and pretty deep relationships with our branded suppliers, and so we've continued to have very productive conversations.

We feel very clear and we hope we articulate well to our branded partners how we create value for them in being their partner and getting products into the system.

So I feel relatively good about that.

But everybody feels the pressure.

It's part of the system today and we just assume that going forward.

Okay.

Well, thanks to all of you.

I know this has been a little bit longer of a call but we wanted to make sure we gave everyone time to ask questions.

So, I will just end by reiterating how encouraged we are by our performance in the quarter and through the first nine months.

We do remain focused on executing on our strategic priorities and continuing to improve the customer experience.

We are pleased that is showing up in some of our progress.

So we look forward to providing more detail on our initial guidance for fiscal 2011 on our fourth-quarter call.

We look forward to talking with you then.

Thanks for your time today.

This concludes the presentation for today, ladies and gentlemen.

You may now disconnect.

Have a wonderful day.