卡地納健康 (CAH) 2011 Q2 法說會逐字稿

Good day ladies and gentlemen.

Welcome to the second-quarter 2011 Cardinal Health Incorporated earnings conference call.

I will be your coordinator for today.

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

We will facilitate a question-and-answer session towards the end of the conference.

(Operator Instructions).

I would now like to turn a presentation over to your host for today's call, Ms.

Sally Curley, Senior Vice President, Investor Relations.

Please proceed, ma'am.

Thank you and welcome to Cardinal Health's second-quarter fiscal 2011 conference call.

Today, we will be making forward-looking statements.

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

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

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

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

Before I turn the call over to Chairman and CEO George Barrett, I would like to remind you of a few upcoming investment conferences and events in which we will be webcasting, notably the UBS 21st Annual Global Healthcare Services Conference on Feb.

7 at 11.30 a.m.

EST at the Grand Hyatt in New York.

The Citi 2011 Global Health Care Conference on March 1 at 8.30 a.m.

at the New York Hilton, and Barclays Capital Global Healthcare Conference on March 16 at 9 A.M.

at the Loews Hotel in Miami.

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

We look forward to seeing you at the upcoming events.

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

Good morning everyone.

Thank you for joining us on our second-quarter call.

I am really pleased with our operating performance during the second quarter and throughout the first half of fiscal 2011.

We recorded revenues for the second quarter of $25.4 billion, up 2% over the prior-year period, and a non-GAAP EPS number of $0.69, up 21%.

Our operating performance in the quarter was driven by excellent results in our Pharmaceutical segment, and we continued our disciplined management of expenses and working capital.

We also continued to strengthen our core businesses and position our company to deliver sustained growth.

Based on our performance in the first half of fiscal 2011, execution on our recent acquisitions, and our best assessment of the current environment, we are increasing our full-year fiscal 2011 guidance and now expect our non-GAAP earnings to be in the range of $2.54 to $2.60.

Jeff will walk you through our core assumptions during his remarks.

Now let me provide some color on each segment separately.

Our Pharma segment continued its momentum in the second quarter.

Revenue increased by 2% versus prior year, primarily driven by a 6% growth in sales to non-bulk customers.

Segment profit increased 11% on strong generic growth as well as excellent performance within our Specialty Solutions business.

We continue to solidify our relationships with our national retail chain customers, highlighted by the early renewal of our contract with Walgreens that now extends through our fiscal 2013.

Since our last quarterly earnings call, we also completed two acquisitions which we expect will contribute to earnings in the second half of our fiscal year and both of which will have important strategic implications -- Kinray, which increases our retail independent pharmacy base by 40%, adding balance to our customer mix and better positioning us for the emerging opportunities in generic drugs, and Yong Yu, which gives us a well-established and growing distribution player in China and provides us with a platform in one of the world's largest and fastest growing healthcare markets.

The acquisition of Kinray gives us a strong position in New York and the surrounding states and adds more than 2000 retail independent customers.

We have continued to serve them using the high-touch service model they have come to expect.

We've kept Kinray's New York distribution facility and have supported these customers with the same sales and customer service team with which they are familiar.

I can report that these new customers have been supportive and that we have retained all primary Kinray customers to date.

The Yong Yu transition has gone equally well.

Our teams are engaged and we are learning quickly from each other.

We see the opportunity for growth driven by powerful and healthy organic forces, population size, per capita income growth, industry consolidation, and a national policy which supports and is investing in access to healthcare for all citizens.

Aspects of the distribution model vary somewhat from our U.S.

system but we share critical value drivers -- logistics expertise, management of working capital, and operational excellence, all fundamental for us.

Further, we are encouraged by the dialogues we are having with our upstream branded pharmaceutical supplier partners as well as medical device companies about their commitment to China and the opportunities to work together.

Both Yong Yu and Kinray represent strategic investments that help position us well for today and for tomorrow.

We are excited about their potential, and we have now turned our attention to the execution of our plan to integrate these moves and to create value for our customers, our supplier partners, and our shareholders.

In the U.S., we continue to enjoy tremendous success with the generic programs we've put in place.

The team is executing exceptionally well in generic launches and in our comprehensive SOURCE program.

SOURCE revenue was up 31% in the second quarter versus the second quarter of last year.

Let me take a moment to touch on the so-called generic wave, as we continue to get questions on this.

As you know, the actual timing and profitability of generic launches is dependent on many factors, including patent litigation, settlement considerations, exclusivity issues, technical complexity of the drug, the regulatory process, and the therapeutic indication.

For many of those same reasons, the actual value of a generic launch does not always follow the value of the branded product.

As we have been saying for some time, we expect the flow of yearly generic value through this wave to be less dramatic in its upward and its downward trajectory than many observers were predicting.

In fact, our own expectations for the period between 2011 and 2013 have been shifting somewhat in this general direction.

As we now look ahead, we see a smoothing of the wave with our fiscal 2011 creating better generic opportunities, fiscal 2012 projecting largely as a model, and fiscal 2013 looking better than we originally forecasted.

The net effect is that the change in generic launch value from our fiscal 2011 to 2012 and the change from 2012 to 2013 will be more moderated, but the overall area under the curve is larger.

More broadly, we've continued to grow our independent -- retail independent business, and improve customer retention.

Our churn rate in this space continued at the very low level we saw in the first quarter and is the lowest we have seen since we began measuring churn many years ago.

We continue to expand our offers to support branded products through their lifecycle with a particular emphasis on educational programs such as point of dispense communications to help ensure patient compliance to medication prescriptions.

I am also very pleased with the progress we are making in our Specialty Solutions business since our acquisition of P4 back in July.

All lines of business in this group are showing positive momentum.

Our P4 Pathways program, a key component of our value proposition which brings together payors and practices, is gaining momentum.

We signed three new agreements in the quarter, and we are executing well for Highmark, a new customer that we announced in November, with more than 50% of their community oncologists now enrolled in our Pathways program.

During the quarter, we also launched specialty distribution and our specialty GPO called VitalSource.

Our nuclear and pharmacy services business performed very well in the quarter, posting double-digit profit growth versus the prior-year quarter.

Raw material supplies are stable and at normal levels.

However, demand has not yet returned to pre-shortage levels.

The confidence campaign we initiated to rebuild demand and eliminate any lingering concerns around supply constraints is in full swing and began to yield positive results in the second quarter.

For positron emission tomography, or the PET imaging modality, we had strong performance in non-cardiovascular indications and expanded our support of clinical trials for PET biotracers.

We are now working on clinical trials for 24 new compounds that support the more accurate diagnosis and treatment of disease.

Based on one of those trials, Avid, recently acquired by Lilly, received positive input from an FDA advisory panel review last month for florbetapir, their biotracer for Alzheimer's.

This bodes well for molecular imaging and the pipeline of products that are currently being developed to help detect neurological disorders.

We are looking forward to working with Lilly to commercialize, both manufacture and dispense this important diagnostic tool once it is FDA approved.

Turning to Medical, this segment saw a revenue decline of 1% in the quarter, primarily driven by previously disclosed customer losses from fiscal 2010 and the tough compare to a strong flu season in the prior quarter.

Segment profit was essentially flat for the second quarter.

The negative impact of commodity price increases was mitigated by cost reduction.

I like the way our medical teams are competing.

Our win/loss ratio has improved and the scale has slowly tipped in favor of wins.

These new customers will begin to have a positive impact on revenue in the back half of the year.

Our preferred products, central to our category management strategy, are growing faster than the rest of our product portfolio.

We continue to build out product categories with Cardinal Health branded products as well as select national brands.

For example, in the quarter, we launched a new Cardinal Health branded patient hygiene line in the quarter with 50 new products, and that is seeing good sales momentum.

We experienced a lighter-than-normal flu season in the first half of fiscal 2011 versus last year.

That had a negative impact on our Canadian and lab businesses in the second quarter.

Recent CDC reports indicate that flu activity is increasing and we anticipate a more normalized level for the balance of the flu season.

Our ambulatory care business performed well in the second quarter with revenue growth of 6.8%.

The cross-selling effort we established with our Pharma segment in the second quarter of last year is beginning to contribute to the ambulatory business.

We continue to be excited about our ability to grow our ambulatory footprint.

We have invested in tools which improve the customer interface and make it easier for them to access our broad product line and our service offerings.

We are well positioned to serve the post-acute-care segment as care delivery models evolve and different forms of coordinated care emerge.

We saw a slight improvement in surgical procedure volume at the end of calendar 2010.

While this is encouraging, we continue to model this rather conservatively for the balance of the fiscal year, given the disproportionate impact that procedure volume has on our Presource kitting business and our preferred product portfolio.

Our medical business transformation is on track for national implementation in calendar 2012.

We continue to expect a contribution of margins from this effort in fiscal 2013 due to reduced complexity and improved sales.

This is a business transformation, not simply an IT project.

It enables our channel and category management strategy and overall will make it easier for our customers to do business with Cardinal Health.

In summary, we had another good quarter and very solid first half, and expect continued strong performance in the second half of fiscal 2011.

Although we continue to plan with a cautious eye given the slow pace of economic recovery, we have a strong financial and operational foundation upon which to build.

We've made strategic investments to help position us for growth in the short, medium and long term.

We're extremely focused on executing against our plans in order to deliver value on a sustainable basis to our customers and to our shareholders.

As the business behind healthcare, we are well positioned to play a significant role in this fast-changing landscape.

While healthcare reform will require some retuning, we continue to believe that care in the future will be more accessible, better coordinated, safer, and more evidence-based whether this comes through legislative change or market forces.

As we continue to focus on our strategic priorities, financial discipline and meticulous execution, I'm increasingly excited about that future and confident in our ability to perform.

Before I hand the call over to Jeff, I would like to thank our employees who have been dealing with the impact of the ferocious storm system that has been paralyzing much of the country this week.

They have been working incredibly hard, many of them virtually around-the-clock, to get medical supplies and pharmaceuticals to our customers.

I'd like to take this opportunity to acknowledge their efforts.

With that, let me turn the call over to Jeff.

Thanks George.

Hello everyone.

I'm happy to be discussing another strong quarter of results and continued progress across our businesses.

I'll begin my remarks today by expanding on some financial trends and drivers in the second quarter, and then try to add more color around our updated fiscal '11 guidance, including some of our key expectations from a corporate and segment standpoint.

Let's start with Slide 4.

During the quarter, we grew our non-GAAP EPS by 21% to $0.69, leveraging 2% revenue and 5.5% non-GAAP operating earnings growth.

Both gross margin rate and non-GAAP operating margin rate expanded versus Q2 of last year, up 8 basis points and 5 basis points respectfully.

Non-GAAP operating expenses were up a little under 3%, really driven by the expenses added due to the net impact of acquisitions and divestitures, partially offset by cost reductions, including the year-on-year impact of certain compensation items.

I should note that we expect our total operating expenses to be noticeably higher in the second half of the year as we fully absorb the recent acquisitions.

Interest and other expense was favorable to our expectations and last year, driven by favorability realized in interest rate swaps, our deferred competition program, and foreign exchange, all of which, for forecast purposes, we do not assume to continue in the back half of the year.

As a reminder, the deferred compensation gain of $3 million recorded in Q2 within Other Income is offset one-for-one by an expense recorded to the operating expenses line.

I've mentioned previously that our non-GAAP tax rate may fluctuate quarterly due to unique items affecting certain periods.

This was the case in Q2.

Our tax rate this quarter was 32.8%, below our expectations for the full year and last year's rate of 38.5%.

This abnormally low rate is attributable to discrete items in the quarter which net to an approximately $17 million benefit.

It includes favorable settlements of prior-year state tax audits which allowed us to release reserves for state tax contingencies.

They also include a reduction in a deferred tax valuation allowance related to new legislation in Puerto Rico.

Despite the favorability during the quarter, you will note that we are maintaining our previous non-GAAP tax rate guidance of approximately 37% for the full year, as we expect a few discrete items to increase the tax rate during the second half.

I'll touch on these items in more detail in a few minutes.

Finally, we continue to benefit from the $450 million in share repurchases we executed last summer with our share count at about $351 million diluted average shares outstanding versus $361 million in last year's Q2.

Before shifting the discussion to the segment results, I'd like to make a few comments related to the asset management figures shown on this slide.

First, our operating cash flow of $144 million in the quarter may look light when compared to the prior year, but it's important to keep in mind that last year's Q2 figure reflects net working capital reductions that generated nearly $400 million of operating cash flow for that period.

Although we continue to be very focused on balance sheet efficiency with a goal of further reducing our net working capital days, as we've indicated in the past, we don't necessarily expect as dramatic an improvement as we saw last fiscal year.

Also note while there is some volatility within the components of net working capital days due to our recently completed acquisitions and the impact of customer buying patterns in the prior year, I am pleased to report that net working capital days are down 0.4 days versus last year.

Before I move onto segment performance, let me touch briefly on Slide 5, which has been inserted to update you on the relative composition of our business segments based on the most recent information.

As you may recall, in fiscal 2010, our Pharma segment made up approximate two-thirds of segment profit.

For fiscal 2011, that number is closer to 75%, given the contribution of the P4, Yong Yu and Kinray acquisitions, all of which are reported within the Pharma segment, as well as reflecting strong performance across the Pharma business.

Now let's move to Q2 segment performance, referring primarily to Slides 6 and 7 and starting with the Pharma segment.

Revenue in this segment increased 2% driven by a 6% increase in sales to non-bulk customers.

Sales to bulk customers declined 2%, attributable to a shift in shipments to certain national chain customers from bulk to non-bulk, as well as the impact of certain branded products converting to generics.

Within the category of non-bulk, I also want to point out that revenues from retail independents continue to grow at a rate above the market in this important class of trade.

The Pharma segment profit margin rate increased by 11 basis points compared to the prior year's Q2, driven by an increase in non-bulk margins and a continued mix shift towards non-bulk customers.

In addition to the continued success of our generic sales and sourcing programs, we also saw greater-than-expected benefit from new generic launches during the quarter as well as an overall generic deflation rate that was below historic norms.

Excellent performance in Specialty Solutions was also a positive driver.

P4 had a good Q2 across multiple lines of business with the three new Pathways agreements we announced at our December analyst day contributing to the performance, as well as strong results from P4's data analytics services.

Our Nuclear and Pharmacy Services business performed well in the quarter, showing year-over-year double-digit profit growth.

Although demand for technetium-based products has yet to rebound to pre-shortage levels, volume was stronger than we expected in late November and December.

Importantly, our PET business continues to show strong growth.

Net-net, the Pharma segment had an excellent quarter which resulted in an increase in segment profit of 11% to $289 million.

Now, turning to our Medical segment, revenue for this segment declined by 1% to $2.2 billion.

We are still lapping some previously disclosed customer losses from fiscal 2010 and the benefit from several new customer wins is just beginning to layer in.

Importantly, we expect sales volume from our wins to begin to fully offset and then outweigh our losses in the second half of the year.

Also, similar to Q1, the tough compare against an early and strong flu season in fiscal 2010 negatively impacted Q2 sales growth by $22 million.

Our ambulatory business, a continuing focus for us, grew its revenue by nearly 7% during the quarter.

Medical segment profit remained relatively flat at $102 million as cost reductions offset the combined year-on-year impact of headwinds due to commodity prices and the flu.

Specifically, commodity prices impacted our current-period cost of goods sold by about $18 million versus last year.

The flu comparison was worth approximately $4 million.

Combined, these two items negatively impacted segment profit growth by approximately 21 percentage points.

I'd also like to mention that surgery procedures are down on a year-over-year basis, which impacts our highest margin operating room products, although there were some positive trends in this regard towards the latter part of the quarter.

Sequentially, segment profit dollars and margin percent improved considerably versus Q1 of this year.

Overall, despite some headwinds our Medical business has faced in the first half of the year, we continue to gain momentum and believe we are well-positioned for long-term growth.

Let me turn to Slide 8.

Although I won't go through this schedule in detail, I will highlight the item that accounted for the largest difference between our GAAP and non-GAAP EPS numbers in Q2, approximately $16 million in after-tax acquisition related costs.

Consistent with our usual practice, these costs have been excluded from our non-GAAP earnings.

The remaining items, such as litigation charges and other costs related to the CareFusion spinoff amounted to approximately a $0.03 reduction.

Last year, we saw a net after-tax benefit from one-time or unusual items of $23 million, or $0.07, driven by a $20 million after-tax gain from sales of CareFusion stock and $16 million of after-tax income from an insurance recovery.

These positive and unique items from last year significantly impact the year-on-year GAAP earnings comparison.

Now let's briefly shift our discussion to our cash and liquidity position.

Several significant items which impacted it are listed on Slide 9.

We ended the quarter with $1.3 billion in cash, of which $148 million is held overseas.

There was no balance outstanding on any of our available short-term credit facilities.

We maintain this strong liquidity position in spite of more than $1.7 billion in total outflows related to our acquisitions of Kinray and Yong Yu.

Also note that our cash position was enhanced by the $500 million of debt we opportunistically issued in December, a portion of which we plan to use to repay a $220 million debt maturity in February.

One final item of note -- during the quarter, we also invested in held-to-maturity fixed income debt securities with maturity dates ranging from seven months to two years.

These items have a cost basis of $139 million as of the end of Q2 and are classified as other assets on the balance sheet.

In other words, they are not included within cash and equivalents.

Now let's turn our discussion to FY '11 guidance, starting with Slide 11.

As George mentioned, given the solid underlying performance of our businesses in the first half of the year, as well as the anticipated contribution from the recent acquisitions, we are increasing our full-year guidance range for non-GAAP EPS to $2.54 to $2.60 from the previous range of $2.38 to $2.48.

Our overall revenue guidance remains at low single-digit growth, although it's higher than our previous expectations due to the inclusion of Kinray and Yong Yu into our most recent forecast.

Slide 12 outlines some of our key corporate expectations for the year.

Let me start by focusing on the items in red, which represent changes from our previous assumptions shared on our October call.

We now expect interest expense and other to net to $90 million, reflecting some of the benefits we saw in the first half of the year as well as the impact from our recent debt issuance.

We are increasing our capital expenditures forecast to approximately $290 million due to our recent acquisitions and organic investments we are making to enhance our strategic position and spur future growth.

Finally, let me revisit our FY '11 effective tax rate guidance of approximately 37%.

While there's always some inherent difficulty in forecasting discrete items that affect our tax rate, we are confirming our prior guidance given state tax legislation that has already passed in Q3 and other pending state or foreign tax law changes that are likely to be passed which would increase our tax rate for the second half of the year.

Now, let's spend a few minutes going through some of the segment-specific assumptions in more detail, starting with just a few items related to the Pharma business on Slide 13.

Given the strong first half of the year from a generic launch standpoint, we now expect a positive earnings effect from generic launches versus fiscal '10.

It is possible we may have a minimal LIFO charge related to recent acquisitions, but our forecast assumes that to be $10 million or less at this point.

Integration of our Healthcare Solutions, or P4 acquisition, remains on track.

Finally, we expect the Kinray and Yong Yu acquisitions collectively to contribute $0.02 to $0.03 in fiscal 2011.

Turning to Slide 14 and the Medical segment, our guidance now includes an increased negative impact on cost of goods sold from commodity price movements, given the sustained and more elevated prices for oil, latex and cotton.

You may recall on our August 2010 call I mentioned that we expected this impact will be more than $40 million.

Our guidance now includes an expectation of closer to $60 million for the full year.

Thus far in the first half of fiscal '11, we have realized about $33 million of that negative impact.

Finally, as we lap difficult comparisons through both flu and previous customer losses, we expect the Medical segment to benefit in the second half of the year, aided by significant new hospital system customer wins.

To sum up my remarks, let me say that I am very pleased with the overall performance in the quarter, and we expect to continue this momentum in the second half of the year.

We feel good about fiscal 2011 laying a solid foundation for our fiscal 2012.

With that, let me turn it over to our operator to begin the Q&A session.

Operator?

(Operator Instructions).

Ross Muken, Deutsche Bank.

Good morning guys and congrats on a great quarter.

In terms of, George, your comments early on regarding the generic cycle that we are about to enter towards the end of this calendar year, you suggested sort of the smoothing out effect.

In terms of the different puts and takes or what has changed bigger-picture in terms of variables in your model that has led sort of to this conclusion, what are the sort of key points you're looking at?

Because from obviously our side of things, we thought we've understood sort of the trajectory for some time, so I'm curious as to the sort of changing assumptions.

Yes, let me try to answer it, although I'm not sure our assumptions frankly have changed all that much.

But I think partly I would argue that the wave has already started.

Even if you look back, '10 was larger than most people thought.

One of the things that I have been saying for some time is that predicting the timing of launches can be difficult, and you know this well.

That can tie to all of the complexities associated not only with patent law, but also with the technology and the complexity associated with many of the drugs that are being launched during this period.

So, you have this shifting tide a little bit as it relates to when a product is going to be launched.

So by and large, what we've seen is that '10 was larger than we would have originally modeled.

'11 has been stronger, '12 is about as we modeled it.

Again, these are our fiscal years for us and for our product line.

And '13 looks a bit better than we had seen.

So it's more of a rounded shape, and it's really driven by those dynamics.

Sometimes, it's very difficult to predict, as you go out years, and particularly by quarter, when a product is going to launch.

So it's real good dynamics.

I mentioned, complexity, patent issues, and even the nature of the drug.

What is a small branded drug can turn out to be a significant generic opportunity.

What is a very large branded drug can turn out to be a relatively small and highly competitive generic opportunity.

So we just have to take all of this into account.

I know many of you do that, and that's, I guess that's a summary.

Great.

Maybe Jeff, quickly in terms of the Medical business, you sort of outlined the inflation on commodity prices and what that's doing to the business.

To what degree, or how long does it typically take to start to maybe recapture some price there on certain products where you're able to pass it through, or, as a whole, is that not something historically you've been very successful with?

Good question.

I'm not going to comment specifically on customer pricing, but I will say, whenever we have increases in the cost of our goods, we look for opportunities to either mitigate those costs, pass them on or pass them back.

And that happens right away, and we are continually in a state of looking for ways to reduce our exposure or minimize the impact.

So, I wouldn't say it's necessarily in reaction to any particular increase.

It's sort of an ongoing part of how we try to manage the business and reduce the overall volatility of the business.

Glen Santangelo, Credit Suisse.

George, I just had a couple of quick questions on generics.

First, your SOURCE generics program was up 31% this quarter.

What really drives that?

Was it just generic launches that happened within the last six months, or was it now that you're selling some generics to some customers that you historically were not?

So I'm just trying to figure out how does that number get to be so big?

Yes, it's really a combination of both.

We were always thrilled at the opportunity to launch a new drug.

But we actually got very solid contribution from existing products.

We have talked a little bit about this, both expanding to new customers but also doing better with each customer.

And so I would say, net/net, it's a really positive combination of those two factors; it's not just about new launches.

Is there any type of customer that is coming back to you that used (technical difficulty) that's now saying, hey, you know what, why don't I just buy from you guys?

Yes.

I would say it's probably less of people sort of shifting their basic strategy than are performing better for each account.

The other thing I probably should note also that's a dynamic -- and I think Jeff mentioned this -- is that the deflation rate also was a little bit less than we've seen.

I would describe that largely as more event-driven than necessarily systemic, but we certainly saw -- and what I mean by that is a product, let's say, that had exclusivity that we modeled to lose exclusivity or to be competitive with a certain number of competitors and that dynamic was different.

So deflation rate was a little bit lower, contribution with existing customers, expansion at some new customers, particularly in the independent retail side, and the value of new launches.

And that was my follow-up question, is the comments around that generic price deflation.

Basically, one of your primary competitors earlier in the week on their call sort of suggested that they are actually starting to see even some levels of inflation on generics.

Maybe I misheard that comment, but I'm just curious if you can give us an update in terms what you're seeing in terms of generic pricing.

You just suggested that maybe what happened this quarter was more event-driven.

But has there been any change from the historical trend in terms of generic pricing?

Yes, I don't -- but I think event-driven, I don't want to make it specifically about the quarter.

I think it's a more long-lasting issue.

But really what I'm describing, the primary drivers are how you see big products moving from a less competitive to a more competitive stage, and also what happens when you have disruptions in the market.

We've had that in a lot of categories, particularly in injectable drugs, and that has created less deflation and as one of our competitors mentioned, we've seen a couple of cases of inflation.

But I am not necessarily going to describe this as a sort of broad-based systemic trend, but rather it seems to be tied to certain dynamics.

Now again, it's not that there may not be some broader trends, but I'm not sure the data is completely there yet to make that statement.

But it certainly is driven by shortages that we've seen, some market disruptions, and certainly some exclusivity dynamics.

Thanks.

Maybe if I could ask the last question and then I'll hop off.

You sort of said in your prepared remarks that, in December, you started to see an uptick in surgeries, and maybe admissions have gotten a little bit better.

Do you think that's people trying to beat deductible resets or has that really continued into January, maybe there's something a little bit more cyclical going on?

Yes, it's hard to answer yet.

I think we'd probably -- again, we're going to take a cautious view on this going forward.

We are encouraged certainly to see the uptick, but I think it's probably too early to say this is a trend, and it's probably too early to be able to completely attribute cause.

Our hope is that some general recovery in the economy is having people feeling more optimistic and we're ready to do the things that they might have done a couple of years ago from a utilization standpoint.

But we'll continue to model with a bit of a cautious eye right now.

Thanks very much.

Tom Gallucci, Lazard Capital Markets.

Good morning, this is Colleen Lang on for Tom.

Jeff, just a quick housekeeping item -- I was wondering, could you give us the bulk and non-bulk margins in the quarter?

I had a funny feeling I was going to get that question.

So, the rate for Pharma sales to non-bulk customers was 2.16% for the quarter, which was up 18 basis points versus last year's Q2.

However, as I said previously, the quarter-by-quarter comparison for these margin rates is really less relevant than a longer-term trend comparison.

So let me try to give you some of the longer-term information.

Year-to-date, the rates for the first two quarters of the year, the rate for non-bulk is 2.17%, which is 29 basis points favorable the first half of fiscal '10, and 24 basis points favorable to the full-year rate we experienced for fiscal 2010.

For bulk customers, the year-to-date rate is 28 basis points, which is about 12 basis points favorable to the first half of fiscal '10, and 1 basis points favorable to the full-year rate for fiscal '10.

Great.

Then you have the $750 million share repurchase program.

Do you have any buybacks assumed in your guidance or how should we think about cash flow deployment here?

Yes, as we said previously, our guidance for fiscal 2011 assumed $250 million of gross repurchases.

We've completed that for the year, so our guidance does not assume any additional repurchases this year.

Okay, thanks.

Robert Jones, Goldman Sachs.

Thanks for taking the questions.

George, on the retail independent front, even before Kinray, you guys had talked about making progress in growing this customer base ahead of the market.

You made comments on that again today.

I guess maybe could you talk a little about what's driving this above-market growth?

Then beyond that, as it stands today with Kinray, can you maybe give us a sense of where you think your market share is of the overall retail independent market?

Yes, I'll start by saying I probably will not provide market share at this point.

I would tell you that our market share in the New York metropolitan and extended area was quite, quite small, so we are really pleased to be able to have increased that.

But let me go back now to your first part of your question.

A lot of this is about a dedicated focus to growing this business, that we've really been really plugging away at for nearly two years to really rebuild our organization, the training of our salespeople, the actual organizational design.

The service offerings that we provide to independent retailers is really, really quite substantial.

So, I think it's been about focus.

It's been about very tailored programs, almost strategies of one as we like to call it, for each of these customers, because think of each one of these community pharmacies as its own business.

So we've done a lot of things.

We put together I think I've mentioned our sales college where we have our salespeople in for training, great execution there and training on generics.

So, I think our programs are really among the industry leaders.

With that extra dedicated focus from our team and our leadership, I think we've been able to really create value for those customers.

That's helpful.

Then just one quick one on Specialty Solutions.

In the press release and in your prepared remarks, you mentioned excellent performance from this business.

Can you give us a sense of how you measure success in this business long-term?

Is it really just the signing of some of the deals we've seen lately with the Blues and AmeriHealth, or is it, at some point, really measuring this on how deep of a participation you have in the actual distribution channel?

Well, it's a number of things.

Certainly over any period, it's about contribution to our earnings.

That business is already beginning to do that, and we're pleased with that.

Part of it for us is building out a presence in the community to allow it to compete in markets where we just didn't have standing in the past.

I think our positioning in oncology, a little bit of increased position in some therapeutic areas, is beginning to happen.

And so in a sense the covered lives associated with some of these Pathways programs is really a little bit of a surrogate marker to know that we are actually beginning to play and play effectively.

We are beginning to pick up some interest in our distribution and we signed, I think as you think you heard us say in November, our first customers during this past quarter.

So distribution will be part of our expectation, and we are at early stages there certainly, but expect that to be something we'll measure and we intend to compete effectively in.

Ricky Goldwasser, Morgan Stanley.

Good morning.

A couple of follow-up questions here.

First, on the bulk margins, Jeff, I think you mentioned they were 20 basis points but they were up about 12 basis points versus the first half of '10.

It seems that is despite the fact that you had some contract renewals between that period and now.

So can you talk a little bit about the initiatives that you have in place that help drive the expansion in bulk margins despite the price hits that you're seeing on the renewals?

Yes.

I'm not going to comment specifically on the pricing on the renewals.

I will say a lot of the quarter-to-quarter variance that we get in bulk is due to timing, timing of orders, timing of branded price increases in a particular quarter.

I would say quite honestly that there are not a lot of specific initiatives that we undertake to influence the bulk rate other than what we do in our normal business to begin with, which is to maximize sales and maximize the efficiency of our operations, etc.

But I wouldn't say we had a particular focus on the bulk business.

Most of our initiatives from a sales and operational perspective are focused on the non-bulk part of the business where we have the greatest day-to-day influence.

To the extent they carry over to bulk, great, but I wouldn't necessarily say there are some specific initiatives to point to there.

Ricky, again, just to qualify to make sure -- to jump on here.

Obviously, the bulk part of our business is important to us but, again, I think Jeff is talking about the specific efficiency initiatives and programs that we have really across both our bulk and our non-bulk businesses.

Okay.

Then of the 6% increase in the non-bulk revenue contribution, can you give us color on what was the Kinray contribution?

Kinray contribution for the quarter was very little.

We had basically a week of sales, so it was roughly immaterial to our financials.

Larry Marsh, Barclays Capital.

Thanks and good morning George and Jeff.

George, thanks for your education efforts to make us a bit learned on some of your pieces of business.

Maybe if I could elaborate a little bit on how we should be thinking about your SOURCE and your non-SOURCE generics programs.

I know that, in the past, you sometimes talked about overall revenue growth in generics.

I don't know you had that for the quarter.

I know you don't talk about how much of your total book of generics is SOURCE.

But could you describe how much growth -- how would you describe the profitability between the two businesses, and how much you're thinking about increasing your total penetration of your generic business to SOURCE over the next couple of years?

Let me start.

It's a really good question and then I'm actually going to turn it to Jeff who can probably provide a little bit of the detail on it.

But the SOURCE program is, for us, is our preferred generic program.

It's a very high priority for us.

This is the business in which we offer customers the opportunity to essentially have us be their generic arm.

We source the products with the suppliers, and we provide sort of a what we think is a differentiated value proposition downstream to those customers.

Those tend to be more profitable, on average, than the other components for our generic mix, but we certainly have other generic business.

There's product that we sell on contract.

There's product that we sell to hospitals.

There's product that we sell to warehousing and non retail chains that may be on some different kind of contract.

So we do have some components of our generic business that are not the preferred program.

But I would say a good proportion of our business is the preferred program.

It's a high priority for us and we are really pleased with the progress there.

Did you give us a total revenue growth for generics this quarter?

This is Jeff.

Overall, revenue growth for generics was 13%

Great.

Along with that, it sounds like, anecdotally, with Kinray now about 1.5 months under your belt, you're feeling good about initial indications of customer retention.

I was curious of any other data points around what I think is a great asset.

How quickly does that customer base, is that customer base able to switch into SOURCE?

Well, it's a really good question.

I think the integration in a case like this is actually relatively straightforward because remember that we are not changing the distribution platform.

We are keeping largely the model that these customers have been used to working with.

So in a way, the integration is rather straightforward.

The part that you're describing, which is integration of generics, is already happening, but that certainly didn't happen in that first week.

But we think that should be a great opportunity for those customers and a good opportunity for us.

Helene Wolk, Sanford Bernstein.

This is Andrew [Weisskahl] in for Helene.

I just had a quick question about your Medical Distribution segment.

It seems that you guys were able to cut a lot of costs in the quarter to overcome the pretty material commodity headwind.

So I was just wondering how to think about the cost going forward essentially.

Is this a permanently reduced level, or were these more one-time items?

I would say it's probably a combination of both.

We recognize that, in our business, in order to be part of the solution to the supply chain efficiency, that we need to be continually focused on the efficiency of our own organization and a complete supply chain.

So focusing on bringing down expenses and getting more efficient is an ongoing part of the business.

So, I am hopeful that the sorts of reductions that we took in the first half of this year will be a permanent part of our cost base going forward.

That's not to say there weren't a couple of specific things that we did in the quarter, but I would generally view most of our cost reduction initiatives that we undertake to be sort of a permanent part of our structure going forward.

By the way, I want to come back to a question that was asked earlier about bulk and non-bulk, because I know there's always a bit of confusion on this issue with respect to our large national chains.

I know some of you know this, but I just wanted to be clear that our sales to large national chains consists of both bulk and non-bulk sales in that to the extent we deliver directly to the pharmacies, those are considered non-bulk sales.

To the extent we deliver directly to their warehouses, those are considered bulk sales.

I just wanted to continue to provide that clarification for people.

A.J.

Rice, Susquehanna Financial Group.

Hello everybody.

Just a couple of quick questions.

On the guidance, it sounds like Kinray and Yong Yu combined are sort of $0.02 to $0.03 in the back half of the year.

Is that reflective of the run rate that they came on line for you guys with, or are you assuming any meaningful change in their business mix through synergies in that number?

Then is there any update for sort of a long-term -- I know it's still early, but have you refined in any way your thoughts about what they might contribute long-term?

Thanks for the question.

So let me try to address both of those.

First of all, I would say what we are seeing for the remainder of fiscal '11 from Yong Yu is primarily what they brought to the table.

For Kinray, I would say we are starting to see some of the synergies that we expected to bring to the table materializing in the second half of the year.

I would say a good bulk of what they are contributing is what they brought to the table.

By the way, related to acquisitions, just an update on intangibles because I've touched on that previously when we announced our three acquisitions in fiscal '11.

I expect the total amount of intangible amortization related to the three acquisitions next year to be somewhere in the $85 million to $95 million range for the full year, which is fairly consistent with the early preliminary guidance that we'd given you at the time we announced each of those acquisitions.

So again, I'll provide some input.

In terms of our expectations overall for the contribution, I would say what we've said previously is largely still the case for each of the three acquisitions.

Just maybe on -- you had complimented your own employees about how they manage through the weather.

I wonder -- it's a very short-term oriented question -- but have you factored any weather impact in your updated guidance?

Maybe give us a flavor for whether it's been any meaningful impact to you.

Yes, I would say the range of guidance that we have given would reflect in any financial variability related to the weather that we've seen.

It's too early to say regarding any specific impact.

I will say, as always, our team is doing a great job of responding.

I have to admit, from a personal standpoint, it always boggles my mind how good we are at citing through issues like this and meeting our customers' needs.

During times when much of the country is shut down, we still manage to get through, which is a huge testament to our people.

Yes, just a comment on that, within the last couple of weeks were really two different storms.

So it's very early to sort of judge exactly how we've come through this week.

But last week, we got the results.

The folks did an incredible job and we were tracking it, all of us, through the nights and I think our customers were hopefully appreciative of the work that our chains did.

George Hill, Citigroup.

Thanks for taking the question.

George, just to circle back your comments on generics and the flow of generics through 2011 through 2013, you talk about it being less dramatic in its upward and downward trajectory.

I'm wondering if we could dig into that a little bit.

When you talk about less dramatic in the impact, are we talking about how it impacts the revenue line, how it impacts the operating earnings line?

I guess just some more color about how you guys have thought about modeling that.

Sure.

Again, I'm going to be careful because we're not -- I wanted to try to help create a little bit of shape, and it's really about the shape of the curve.

By and large, what we're talking about is the margin impact for us.

So that, again, it's primarily the big movement here is more about I would say margin than revenue.

Okay.

Then just a quick follow-up on Kinray now that you guys have had that business in house a little bit longer.

Anything new that you guys have learned, any surprises we should know about?

No.

Actually, we are really -- you always hope it is as it appears to be when you do your work in the due diligence and you get to the finish line.

Our teams are feeling very good about the way it's playing out, and the team there in New York is doing a great job.

Our folks here are really pleased with the way it's unfolding.

Steven Valiquette, UBS.

Thanks.

Actually a question on the Medical segment.

You guys highlighted the significant new customer wins on the slide, so I guess two questions on that.

First, were there some additional wins over the past month or two over and above the ones that were discussed last fall?

And then also, generally speaking, are the wins tied to better penetration within GPOs, or are these separate exclusive customer wins?

Just any feel for that as well.

Thanks.

Just a quick perspective on it.

I think we've really clarified the value of our proposition as we started to roll out our category and our channel strategy.

I think the broad range of offerings that we can provide, every institution at this point is looking at a changed world; they are looking for companies that can offer solutions.

I believe that our team has done a great job in demonstrating that, and that's been, I think, part of the explanation.

I don't know, Jeff, if you want to add anything to it.

Yes, you know, we have talked previously about winning Baylor, about the expansion of our relationship with HPG, about winning a large research-based IDN.

Those are beginning to layer in really right now and will affect us in the second half of the year.

I would say, on top of those, we've had a couple of other notable wins as well that we haven't disclosed publicly, but I would say generally the track record over the past six months has been very positive.

Great, thanks.

Robert Willoughby, Bank of America.

Jeff, did you break out an actual organic growth number for the quarter, backing out the three deals?

Backing out the three deals?

No I didn't.

But I would say Kinray and Yong Yu had virtually no impact on the growth rate.

No, we haven't backed out for P4, probably because we look at P4 as part of the entire Specialty Solutions business within the Pharma segment, which includes our legacy business which actually performed quite well for the quarter.

But we haven't broken out the impact of P4 specifically.

Okay.

Just the working capital accounts, they have some seasonality to them obviously.

But what did acquisitions due to kind of receivables, payables, inventories?

Any insight on that front?

It negatively impacted working capital for the quarter for a couple of reasons, in part because we had the full balance sheet at the end of the quarter but not the full income statement for the period that we measure necessarily.

Secondly, as you would expect, Yong Yu has longer net working capital days than we would typically see in the U.S.

I would say for both of those reasons they negatively impacted the days, and I would expect there'll be a slight increase to our days going forward as well.

John Kreger, William Blair.

This is actually Robbie Fada in for John.

How should we think about additional acquisitions and how they factor into your expectations over the next few years?

Would you be more focused in the U.S.

or China?

If it's the U.S., which segment would you be more focused on?

It's George.

Let me start with the first and most important -- is we are sort of right now in a period where we really are quite focused on executing and making sure that we deliver value from our core business and some of those moves that we've made in the last six months.

So, it's very important to us and I want to emphasize it too.

I'd also say this.

We know that this is a dynamic environment; it certainly is in the US and outside.

I hope there is an organization that is mindful of those things, and is really committed to creating long-term and sustained value from our business model to our shareholders.

Over that stretch, to the extent that we see opportunities, whether those are here or perhaps in another market, we will certainly evaluate.

But again, I wouldn't steer you to one particular area.

I would say this.

We've tried to make sure that the moves that we make are close to home, in a business sense, and that whatever we do we can bring value to it.

That is a very important lens for us.

So again, that's probably as much shape as I can give you.

The only thing I would add with respect to China and Yong Yu is, right now, we're focused on integrating that business and growing them organically.

However, at the time we announced the deal, we recognized that, over time, doing certain smaller tuck-in acquisitions to gain greater regional presence in certain high-growth areas was probably something we were very much looking at, and I would say that remains the case.

At this time, I would like to turn the call over to Chairman and CEO, Mr.

George Barrett, for closing remarks.

Thanks.

Let me just close by saying we've had a very strong first half, and we certainly look forward to the future with optimism.

I want to thank all of you for joining us on today's call, and hope you have a good day.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Have a great day.