卡地納健康 (CAH) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the third-quarter 2011 Cardinal Health Incorporated earnings conference call.

My name is Luann, and I will be your coordinator for today.

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

Later, we will conduct a question-and-answer session.

(Operator Instructions).

As a reminder, today's conference is being recorded for replay purposes.

Now, I would like to turn the conference over to your host for today, Ms.

Sally Curley, Senior Vice President, Investor Relations.

Ms.

Curley, please proceed.

Thank you Luann and welcome to Cardinal Health's third-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, which can be found on the investor page of our website, for a description of those 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 investor conferences and events in which we will be webcasting.

Notably the Deutsche Bank 36th Annual Healthcare Conference on May 2 in Boston.

The Banc of America-Merrill Lynch 2011 Healthcare Conference on May 10 in Las Vegas.

The Sanford Bernstein 27th Annual Strategic Decisions Conference on June 1 in New York.

The Goldman Sachs 32nd Annual Global Healthcare Conference on June 7 in California.

And the William Blair 31st Annual Growth Stock Conference on June 14 in Chicago.

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 that updated information.

We look forward to seeing some of you at these upcoming events.

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

George?

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

I'm very pleased with our performance this quarter, which continued the momentum we built in the first half of fiscal 2011.

We reported revenues for the third quarter of $26.1 billion, up 7% over the prior-year period, and a non-GAAP EPS number of $0.75, up 23%.

This excellent overall performance is led by our pharmaceuticals segment, fueled by our pharmaceutical distribution business, and boosted by the contribution from acquisitions we completed earlier in the fiscal year.

These 3 strategic investments, P4 giving us a presence in oncology and specialty pharmaceutical services, Kinray dramatically increasing our footprint in community pharmacy, and Yong Yu establishing a new platform for growth in China, one of the largest healthcare markets in the world, are already creating value for us.

Our emphasis on execution, margin expansion and disciplined management of working capital is continuing to bear fruit.

We have further enhanced the customer experience, and strengthened our competitive position across all of our businesses, and in new areas that help us position for future growth.

Based on our performance in the first 3 quarters of fiscal 2011, we are increasing our full-year fiscal 2011 guidance and now expect our non-GAAP earnings to be in the range of $2.61 to $2.67.

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 excellent performance in the third quarter.

Revenue increased by 7%, and segment profit increased by 25% versus prior year.

Including strong results from our pharmaceutical distribution business, and the contribution from P4, Kinray and Yong Yu.

Let me take a moment to discuss our Kinray and Yong Yu acquisitions.

In both cases, their integration has progressed swiftly and seamlessly.

Customer retention at Kinray is very high.

In fact, since the acquisition, we have slightly increased our overall base in the New York Metropolitan area.

And, as we have said in the past, we continue to support these customers using the same service model and the same sales and customer service team with which they are familiar.

Similarly, the Yong Yu integration is going exceedingly well.

Yong Yu's overall growth in the third quarter versus its performance in the same period last year is strong, largely driven by the local direct distribution business, a key area of focus for us.

In addition to the growth potential in distribution, we continue to be excited about the opportunities to offer many of the products and services we have developed in the US to providers in China.

Healthcare providers in both countries face similar challenges.

Increasing access, driving efficiencies in their supply chain, reducing costs, and improving quality.

And we can help.

As you know, Jeff is leading our China Advisory Council, and he will provide some additional color on Yong Yu in his remarks.

US pharmaceutical distribution did extremely well in the quarter, driven by excellent performance in our generic programs, solid performance under our branded manufacturer agreements, and strong sales in our retail base.

Sales under our SOURCE generic program increased by 32%, with overall generic sales up by 23%.

Thus far, our fiscal 2011 has been an outstanding year for generics, both in terms of our base generic performance, as well as the number and value of new launches.

Let me say that we expect our fiscal 2012 to be relatively comparable to fiscal 2011, in terms of newly and recently launched generic value.

All in all, we are increasingly well-positioned to drive value in our generic program, and to satisfy the growing demand for generic drugs in fiscal 2012 and beyond.

We continue to build out our specialty platforms, further enhancing our tools to help providers manage their practices more efficiently, expanding our bio-pharma relationships, and extending their release of our P4 Pathways programs with both providers and payors, and we are making good progress in each of these areas.

We are particularly pleased with the rate of adaption in our Pathways programs, and the quality of the next generation of our EOB-One practice management software.

While uptake in specialty distribution will take some time, we have recently signed a number of new agreements with providers and manufacturers, and look forward to the potential here.

And our nuclear business continues to work hard on the confidence campaign we initiated at the beginning of this fiscal year, to rebuild demand and eliminate lingering concerns around supply constraints.

In each of the past 3 months, we have seen a steady sequential increase in procedure volume, an encouraging sign, although demand has not returned to pre-shortage levels.

In the Positron Emission Tomography, or PET space, we continue to work with our pharmaceutical and research partners on what is now 25 new compounds in various stages of development, to provide even more accurate diagnosis and effective treatment of disease.

To support our expanding work with innovators and the science of molecular imaging and technology, and to accelerate the commercialization process of these new imaging agents, we will be launching a state-of-the-art facility called the Center for the Advancement of Molecular Imaging in Phoenix in June.

This facility will house our scientists, engineers and researchers who will focus on enabling our partners in the accelerated development of novel new radio-pharmaceuticals.

Turning to medical, this segment saw a revenue increase of 5% in the quarter, primarily from higher sales to existing customers.

The medical teams continued to compete well, and to improve our win-loss ratio.

Providers throughout the country are looking for ways to be able to compete and thrive in a health system undergoing significant change.

Through some of our recent wins, we see signs that our ability to provide broad categories of products across multiple channels is a source of competitive advantage, and we believe that our value proposition is increasingly resonant with customers.

We were recently awarded a 20-month contract with the US Department of Defense for the distribution of medical supplies.

As was announced by the DOD, the contract also has an option for 2 additional 20-month contract periods, for a total of 5 years.

We expect to see the positive incremental impact of this win in the back half of 2012.

Segment profit in the medical segment decreased slightly, by less than 1%, versus the prior-year period, but was up sequentially versus the second quarter.

This is solid performance, given the continued impact from commodity price increases.

As we indicated last quarter, the full fiscal 2011 impact from commodity prices on our cost of goods is likely to be approximately $60 million.

Of course, we continue to work to find ways to mitigate this impact through our sourcing, product design and with our customers, as well as through careful management of expenses.

As you are well aware, oil, latex and cotton prices have remained high in recent months, and we do expect that we will have to wrestle with his headwind for some time into the next fiscal year.

Our preferred products continue to be an important part of our category management strategy.

We launched new private brand products in 2 important categories in the quarter, and signed a number of new commercialization agreements with national brand suppliers.

We should note, however, that surgical procedure volumes remain somewhat sluggish and this dampened segment revenue and profit growth in the quarter.

The ambulatory care and lab channels performed very well, outpacing industry growth in their respective channels and each posting double-digit revenue growth in the quarter.

In summary, we had a terrific quarter, and I'm very confident in our ability to execute going forward.

Our people continue to demonstrate their commitment our customers and to high-performance.

On one final note, I would like to publicly thank Jon Borschow for his service with Cardinal Health.

As many of you know, Jon is the founder of our Puerto Rico business, which we acquired in 2008.

After building a successful business from the ground up, and then personally overseeing its integration into Cardinal Health, Jon has decided to retire in June of this year.

I want to take the opportunity on behalf of all of Cardinal Health to thank him for his incredible passion, his business insights, and his customer focus.

We have greatly enjoyed working with Jon and know that General Manager Debbie Weitzman, who has been working closely with John for a number of years, will do a fantastic job building upon the strong company he founded.

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

Thanks George, and hello, everyone.

It's great to be discussing another very strong quarter of results.

I'll begin my remarks today by expanding on some financial trends and drivers in the third quarter, then try to add more color around our updated fiscal 2011 guidance, including some of our key expectations from a corporate and segment standpoint.

I will conclude my remarks by providing a few preliminary fiscal 2012 assumptions for certain corporate items for which we have some visibility.

Consistent with our general practice of allowing the timing of giving guidance with our internal project process, we will provide guidance for fiscal 2012 on our Q4 call.

Let's start with slide 4.

During the quarter, we grew our non-GAAP EPS by 23% to $0.75, leveraging 7% of revenue and 21% non-GAAP operating earnings growth.

Notably, the $26.1 billion of revenue recognized in Q3 represents an all-time high for Cardinal Health, since the Company's inception, including the periods pre-spin, when we were still reporting the CareFusion businesses in our results.

Once again, we are reporting strong progress in our goal to expand margins.

With both gross margin rate and non-GAAP operating margin rate increasing versus Q3 of last year, up 31 basis point and 20 basis points respectively.

Although non-GAAP operating expenses were up 11.5%, this was largely driven by the expenses added to the net impact of acquisitions and divestitures.

Now I will comment in a little more detail on the impact of our acquisitions on the quarter's results.

Over time, as the recent acquisitions become more integrated into our overall business, they will become increasingly difficult for us to break out the impact of the specific deals.

However, since this is the first full quarter in which we have had a collective benefit of Yong Yu, Kinray, and P4, I do want to try to give you some kind of idea of the combined impact on our financials.

If you exclude the impact of these 3 acquisitions for the quarter, on a consolidated non-GAAP basis, revenue grew 2%, SG&A would have been up less than 2%, and operating earnings increased 16%.

Interest and other expense came in better than our expectations and last year, driven by favorability realized in interest rate, foreign exchange and gains on a deferred compensation plan.

As I stated before, we generally do not try to predict continuation of these items when we prepare our internal forecasts.

On last quarter's call, I mentioned that we expected our non-GAAP tax rate in the back half of the year to be higher than the full-year rate, due to the impact of certain discrete items.

Consistent with these comments, our non-GAAP tax for this quarter was 40.5%, above last year's rate of 38.2%.

The unfavorable discrete items in the quarter net to approximately $50 million on a non-GAAP basis.

These include a tax law change in Puerto Rico, which reduced the value of the deferred tax asset, and the impact of unfavorable changes in state items.

Note that we are still maintaining our previous non-GAAP tax rate guidance of approximately 37% for the full year.

Finally, we continue to benefit from the $450 million in share repurchases we executed last summer.

With our share count at about 353 million diluted average shares outstanding versus 362 million in last year's Q3.

Before pressing to discussions of segment results let me comment on the consolidated cash flow in the balance sheet.

We had excellent operating cash flow in Q3, at over $900 million, bringing the total year-to-date to $1.3 billion.

This outstanding result was primarily driven by our strong earnings performance, as well as further working capital improvements.

I will point out that Q3 is typically our strongest quarter for operating cash flow, and it was particularly so this year.

Let me also add that quarterly cash flow is a highly volatile number, and very difficult to predict actually.

That all said, I don't anticipate near that kind of cash generation in Q4.

Overall, we are very pleased with where we are from a cash perspective.

Clearly, our ongoing focus on working capital excellence continues to pay dividends, resulting in a 0.6 day reduction versus last year.

The variation within certain components of net working capital days is largely driven by our recent acquisitions and timing, but the net result clearly highlights our continued disciplined asset management.

We ended the quarter with $2 billion in cash, of which $205 million is held overseas.

As a reminder, this cash balance does not include our investments in held to maturity fixed income securities, as they are classified as other assets on the balance sheet.

At quarter-end these investments, with maturities less than 2 years, totaled $153 million.

One final note on the balance sheet.

During the quarter we repaid $220 million of long-term debt and maturity, bringing our long-term obligations to $2.4 billion.

This pay-down was funded by the $500 million of debt that we opportunistically issued last December.

Now let's move to Q3 segment performance, referring primarily to slides 5 and 6, and starting with the Pharma segment.

Revenue in this segment increased 7.3% with the acquisitions we completed earlier in the fiscal year contributing 5.6 percentage points to this growth rate.

Sales to non-bulk customers grew 21% in the quarter, while sales to bulk customers declined 7%.

This decline in bulk sales is attributable to a shift in shipments to certain national chain customers from bulk and non-bulk, as well as the impact of certain branded products converting to generics.

It is worth noting that sales to non-bulk customers now comprise 57% of total segment sales.

Within the category of non-bulk growth, I want to point out that revenues from retail independents continued to grow at a rate above the market, in this important class of trade, even when excluding the sizable impact of the Kinray acquisition.

Let me also add a few comments about growth in our China business, whose results are captured in our Pharma segment.

Revenue for the Yong Yu business grew 25% in Q3, versus its performance as a separate company in the same time period last year.

Eric and his team are doing a great job of driving the business forward.

Growth was particularly high in our local direct distribution business, an area where we are focusing our efforts to expand geographic breadth and penetration.

As George said, I just returned from a visit to China, where we are focused on reviewing strategic initiatives in the fiscal year 2012 budget.

My excitement level about our potential in this market seems only to grow each time I visit, both in the base business, but also as we explore possible opportunities in additional areas like nuclear pharmacy, lab distribution, and supporting the growth of retail pharmacy.

Now turning back to the overall Pharma segment.

Pharma profit margin rate increased by 23 basis points, compared to the prior year's Q3, driven by an increase in non-bulk margins, and a continued mix shift towards non-bulk.

In addition to the ongoing success of our generics sales and sourcing programs, we also saw a continued benefit from new and recently-launched generic items during the quarter, as well as an overall generic deflation rate that continues to be below historical norms.

Dollar performance under our branded manufacturer agreements was also a positive driver.

Net-net, the Pharma segment again had an excellent quarter, which resulted in an increase in segment profit of 25% or $384 million.

I will note that the acquisition has contributed 5.7 percentage points of the segment profit growth in the quarter.

Now turning to our medical segments.

Revenue for the segment increased by 5.1% to $2.2 billion, driven by increased sales to existing customers.

As the volume from recent customer wins phases in, they're beginning to offset our customer losses from prior periods.

By Q4, that impact will be a distinct net positive.

Our ambulatory business, a continuing focus for us, grew its revenue by 13% during the quarter.

We also saw strong growth in our lab business, which grew nearly 12% over the prior-year quarter.

Medical segment profit declined 0.6% to $107 million, as volume growth was offset by the negative impact of commodity price increases on the cost of products sold.

Specifically, commodity prices impacted our current period cost of goods sold by $12 million versus last year.

This commodity headwind reduced segment profit by 11 percentage points versus last year.

Flu had a negligible year-on-year earnings impact on the quarter.

I also mentioned that inpatient surgery procedures continue to be somewhat sluggish, which disproportionately impacts our higher-margin preferred products, including our pre-source kits.

We remain very focused on cost containment across the medical segment, as we continue to work to offset some of the external environmental factors we have faced in recent periods.

Overall, despite continuing headwinds for our medical business, we continue to show good progress in the underlying performance, and believe we are well-positioned for longer term growth.

Now let me turn to slide 7, and although I won't go through schedule in detail, I will mention that GAAP results include items that had a negative $0.04 per share net after-tax impact.

One additional comment.

You may notice the schedule shows a loss of a sale of CareFusion share taking place in the third quarter, despite the fact that we had sold all of our stake in CareFusion in prior periods.

Let me explain.

Upon finalizing the fiscal 2010 federal income tax return in the third quarter, we adjusted the value of certain deferred income tax accounts, related to CareFusion increasing our cost basis.

This resulted in a $3 million reduction of our previously-recognized gain on the sale of CareFusion shares.

Now let's turn our discussion to our updated fiscal 2011 guidance, starting with slide 9.

As George mentioned, based on our strong fiscal year-to-date performance, we are increasing our full-year guidance range for non-GAAP EPS to $2.61 to $2.67, from the previous range of $2.54 to $2.60.

This increase in guidance range reflects our strong performance in generics, and better contribution from the recent acquisitions than we previously noted on our Q2 call.

There's a possibility that we may have to take a LIFO charge in our pharma side in Q4, which is the primary explanation for why we are providing the breadth of earnings range that we are at this stage in the year.

Our overall revenue guidance remains at low single digit growth.

Slide 10 outlines some of our key corporate expectations for the year.

The only change, shown in red, from our previous assumptions shared on our February call, is that we are now expecting interest and other to net to approximately $80 million, which incorporates the benefits we saw in Q3.

I'd like now spend a couple of minutes going through some of the specific segment assumptions in more detail, starting with a few items related to the Pharma business on slide 11.

Expectation for brand inflation is that the rate will be similar to, or perhaps slightly higher than what we saw in fiscal 2010.

We continue to expect a positive earnings effect from generic launches versus FY 2010, and as earlier, the possibility of a LIFO charge in Q4 which we've incorporated into our guidance range.

Turning to slide 12 and the medical segment, our guidance continues to include an expectation of approximately $60 million of full-year negative impact on cost of goods sold, due to commodity price movements.

Thus far in fiscal 2011, we have realized about $45 million of negative impact.

As you may recall, the $60 million figure is the same that we indicated to you back in February during our Q2 call.

Although there has been significant commodity price volatility since, given the lag time we have, as input costs flow through our channel, we actually had a pretty good level of visibility at that time, through much of the remainder of the year.

Our medical business transformation is now in the testing phase and on track for national implementation in calendar 2012, with a phased rollout scheduled to begin in the fall of this calendar year.

As we said before, this is a significant business transformation, designed to further enable our channel and category management strategy, and enhance the customer experience.

We continue to expect meaningful contribution of margins in this effort in fiscal 2013.

Finally, I want to note a change that will impact the optics of our P&L for medical going forward.

As we have been saying for some time, we are transitioning our distribution model with CareFusion, from a net service fee-based arrangement to a traditional branded distribution agreement, which will increase our reported revenue by approximately $50 million to $60 million beginning in Q4.

Although this transition will have a significant impact on margin dollars, it will have the effect of somewhat depressing our segment profit margin rate going forward, in the range of approximately 25 basis points.

Before we begin moving to Q&A, about it would be helpful to provide a few preliminary corporate assumptions for fiscal 2012 on this call.

Although we are not at a point in the budget process where we can provide operating assumptions, we have relatively good visibility in the items shown on slide 14 at this point, so we thought we would share our thinking here.

Starting with non-GAAP effective tax rate, we are expecting a rate of between 37% and 37.5% for the full year.

Note that this rate may continue to fluctuate quarterly due to unique items affecting certain periods.

Next, we expect our diluted weighted average shares outstanding to be between 353 million and 354 million in fiscal 2012.

You will note that this is an increase from our forecast at fiscal 2011, when we had averaged slightly above 352 million shares.

Although this forecast for fiscal 2012 assumes $250 million of gross share repurchases, consistent with the amounts we repurchased in fiscal 2011, there are certain assumptions that counteract this, such as the impact of share price on both the number of shares repurchased, and also the dilution calculation and exercising of options.

For interest and other net, we anticipate a range of $100 million to $110 million for the year.

This forecast generally assumes certain items that benefitted us in fiscal 2011, such as interest rate swaps, foreign exchange, and deferred compensation, do not necessarily repeat in fiscal 2012.

We estimate approximately $250 million in capital expenditures next year, with a continued focus on the medical business transformation project, and customer-facing IT investments.

To sum up my remarks, let me say that I am again very pleased with the overall performance in the quarter and the results we have delivered year-to-date, positioning us very well for the future.

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

(Operator Instructions).

And your first question comes from the line of Ricky Goldwasser of Morgan Stanley.

Please proceed.

Ricky?

Hello?

Hello, Ricky.

Hi, good morning.

Good morning.

So, congratulations on a good quarter.

Thank you.

I have one question, just a clarification, and another follow-up.

So George, you said today, and you said in the past that 2012 should be comparable to 2011 in terms of the generic volumes.

So just to clarify, you are referring to your fiscal 2012 versus fiscal 2011 or are you referring to calendar year?

Ricky, hi.

I don't know if you're on a mobile, but we're having a really difficult time picking you up, would you try that one more time?

Sure, can you hear me now?

Better.

Just to clarify George, on your comments on the generic year, that 2012 should be comparable to 2011.

Just to clarify, are you referring to Cardinal's fiscal year 2012 versus fiscal year 2011 or are you speaking to calendar years?

Yes, thanks Ricky.

We're just talking about our fiscal year expectations, yes.

Okay, great.

And then, obviously great performance on the generic side.

Yesterday, one of the smaller distributors lowered their guidance for the year, citing difficult generic comparison.

So the question here is do you think that you are gaining share from the smaller distributors, and is the shortage in supply that we are hearing about in the marketplace helping you, not just from pricing perspective but also from product allocation perspective?

Great, Ricky.

Let me say it's very difficult to comment on other companies' characterizations.

So it's hard to do that.

I'll comment as best I can on ours.

I think in general, our programs are performing very well.

Our penetration continues to be strong.

Our customers are doing well, the demand for generics continues to be robust.

I think our service levels and our broad base of distribution covering all of the retail channels, and remember we're also in hospitals and clinics.

So we have got a very broad base of distribution.

The flow of new products was reasonably robust and in general, I think obviously the addition of Kinray also added somewhat to our overall generic business, although they're not really yet fully on our SOURCE program.

Those are sort of all the areas that contributed to it.

I'm not sure that the supply issues necessarily alter the dynamics of share around the industry.

I probably would not point to that.

And your next question comes from the line of Tom Gallucci of Lazard Capital Markets, please proceed.

Good morning guys, this is Andrea Alfonso for Tom.

The first question is on commodities.

A while back, you had suggested a rough rule of thumb for the earnings impact on the Company for every $1 that oil rises.

Is there still a simple formula to follow here?

And if so, how do you think about it?

Thanks Andrea, that's a great question, and one that I expect I'll get into a lot over the coming days, just given the prevalence of discussion about commodities and commodity inflation that's impacting a lot of companies these days.

So let me try to answer that by starting very broadly, and then getting a little more specific.

I think the rule of thumb that we used to have, it probably isn't as simple as that anymore.

Our overall exposure has continued to grow, the number of commodities we're exposed to has continued to grow, and quite frankly, the number of commodities that are showing price volatility has changed.

A year ago, we didn't talk a lot about cotton or even latex.

Now those are some of the most volatile commodity prices that are out there.

Again, this might be a little longer answer to your question, but I thought it was important to give you the full picture.

So to be clear, our current estimate of total gross exposure to commodities, and this includes both direct and indirect exposures.

This is an estimate for next year, so fiscal 2012, is somewhere between $500 million and $600 million.

Okay?

Again I want to reiterate that our total gross exposure, and is probably the broadest definition possible, since it includes the raw material inputs we buy directly, as well as those products that we source where we have or indirect exposure to cost input movements.

It also has been a gross number, so it reflects none of our hedging programs, or programs that we're undertaking to mitigate our exposure.

Again, that amount of $500 million to $600 million also reflects the entire range of commodities, not only items like oil and oil-based resins, but things like cotton and latex and corrugates and other materials.

So again, that would be our total exposure from a cost of goods standpoint.

One other thing I want to point out is that it's not as simple as sort of applying one commodity price movement to that total bucket and then coming up with a rule of thumb, because a lot of these commodities aren't correlated, and they, in fact, move in opposite directions at the same time.

So I guess that would be the first answer to your question.

The other question that I'm sure will come up, that is related to this, that I would just get out there is what, if you look at that total basket of exposure, what's the potential headwind for next year?

Now I'll probably give you a partial answer to that, because we are still only 9.5 months or 10 months into fiscal year 2011 so there's a lot of fiscal year 2011 and obviously fiscal year 2012 to play out, and lots of things could change.

But because there's a lagging effect related to commodity price movements and our cost of goods sold, we do have some limited visibility on the commodity impact of fiscal 2012.

But again, I would point out that it still very early, prices are volatile, and our planned mitigation actions aren't fully worked through yet, and we will be going through those, continue to go through those as over the couple months as we do our planning.

But an early estimate, based on today's spot rates and forward curves would imply an increment an incremental headwind next year in about in the same range as the one we experienced in fiscal 2011.

But again I point out, it's early, and we will have a better view of our commodity headwind and mitigation strategies as we provide guidance on our Q4 earnings call.

So again, long answer to your question, but I think that the situation has gotten more complex, so there's no sort of simple algorithm that we can probably point to.

But hopefully, that gives you a little bit of directional input.

Great, I appreciate all of the color.

And I guess, just to transition to George's earlier comment about his expectation for fiscal 2012 to be comparable to fiscal 2011 in terms of generic value.

Just to clarify, is any aspect of that due to Cardinal just making internal progress as far as generics in 2011 over and above market dynamics, such that in fiscal 2012, the internal progress slows down a bit so it normalizes things for you?

Yes, let me clarify, because I wanted sure we don't confuse two different issues.

So what I was referring to is our fiscal year-over-year launched and newly-launched value.

So we're not talking about the base of our program, we're just talking about the flow of new and what we would call recently-launched products.

So this is just a snapshot of what we see in the launch landscape, as we look forward 12 to 15 months.

As you know, a lot can change and that does change often, because you can't perfectly have visibility on litigation and challenges, etcetera.

I would say, having said that, 2011 has been a very, very strong year for us.

That's good news.

It's been strong for us, both on the core activities and our level of effectiveness with our program, as well as a good year of launches, and I would say also, as it relates to inflation, deflation has been a relatively strong year with less inflation than we've seen in the prior-year.

And your next question comes line of Garen Sarafian of Citigroup, please proceed.

Good morning.

One is a clarification question.

George, you had mentioned that you had started to sign some new agreements with specialty manufacturers, but it would take some time.

Can you just elaborate on that a little bit, as to the progress that you've made, and sort of maybe some sort of a baseball analogy, what inning you're into become, for this process to work itself out, and when we could expect Cardinal to have a full specialty capability in terms of distribution?

Sure.

Yes.

Thanks.

We're probably still early stages, I don't know that I'd say we're in the second or third inning.

From the standpoint of building out capabilities, we're actually in reasonably good shape.

What I said to you before is that for us, a building of the special distribution depends on building that right presence in the community of oncology and other specialty areas.

So we've just really begun to do that in recent months, and we've just begun to sign our early agreements.

So we expected that the distribution aspect would grow gradually.

And we really are in the early stages.

I will say that this is going a bit slower than I would like.

You probably know, I'm not a very patient person.

The flipside is that other aspects of our specialty business, particularly the Pathways program, have probably taken hold a little bit quicker than we expected.

So I would say that we are in the early stages in specialty distribution, it's hard to time that for you.

But the better we build our positioning and the provider community, the greater our ability to secure deals on distribution.

Sounds like it's more of at least a 2013 type of a story.

It's hard to time for you.

The good news is that we are relatively small and so the ability to move the needle for us might be a little quicker.

So I'm not going to try to time that for you.

I'm hopeful that will make some good progress during the next six to 12 months.

But again, this is going to be a building process, and we are prepared to see that through.

Got it.

Regarding generics, you had another impressive quarter of year-over-year growth in your SOURCE generics program.

Still trying to grasp, what's behind that?

Was that impacted just proportionally by Kinray or were there new customers, just greater share?

What was it?

Yes, it's an interesting question because really Kinray is not part of that SOURCE number at this point.

We are just beginning to integrate that, we haven't really done that yet.

So the SOURCE growth is really a broad-based growth.

We have seen in almost every channel for us.

It's been with that solid generic penetration rate, and interestingly, there's been a fair amount of supply disruptions, so in spite of the supply disruption in the system, we have done pretty well.

I think our teams are just very focused, I think our program is good, our offering is flexible, our customers understand the value proposition, and I think we've done a reasonably good job of driving it.

I think we've also done a good job of working collaboratively with our suppliers upstream.

To create the right value proposition for them.

So I think it is really an alignment of all of the components.

As I said before, about generics, it's not just one piece, you have everything working right from the sourcing to the selling to the incentive systems, and I think we've probably got things leading up increasingly in the right

And your next question comes from the line of Ross Muken of Deutsche Bank, please proceed.

Good morning, this is Mike in for Ross.

Congratulations again on the quarter.

Thank you.

Just want to dig into Kinray a little bit.

You said that the integration is going very well.

Obviously, Kinray is a big contribution during the quarter.

Kinray brings their community and independent expertise.

Can you talk about the lessons you've already learned from Kinray in terms of applying that to your legacy independent community base?

Yes, thanks, that's a good question.

We've really enjoyed getting to know the folks at Kinray.

There's a lot of things we do very similarly.

But in many ways, the New York market is actually quite unique, and it's always been in retail pharmacy.

And so there are learnings about different approaches to the model that we gained from them.

But we also recognize that some of the things that we do and that they do in New York are so specific to the characteristics of that market.

So I think we are a good learning company, as well as a good teaching company when we acquire, and we work very hard at making sure that the flow of information and learning growth in both directions.

And I think we will continue to learn from each other.

It would be hard to call out one specific thing.

But I do think that there are plenty of us to teach one another.

Great, and then obviously the end of 2010 was a busy year for you guys in the M&A side, and you talked about integration going along well.

At this point, how do you feel in terms of readiness for further acquisitions, and if so, what areas are you focused, or is integration still going to be the near-term focus?

Let me start by saying that execution on our recent acquisitions remains for us a very high priority.

Let me be very clear about that.

Having said that, I think our organization is capable.

And I think from a talent management standpoint, we are really thrilled about the team and the depth that we have been building.

And our goal over the long-term is to position ourselves for long-term and sustainable competitive advantage, and of course we will always continue to look for opportunities to do that, both organically and externally.

But again, I should say that focus on execution on our acquisitions is very important to us right now.

And your next question comes from the line of Steve Valiquette of UBS.

Please proceed.

Steve you there?

Yes sorry -- toggling between a couple of different calls, here.

This may have come up, and I apologize.

I want to get a sense for the current environment for generic drug supply shortages, more from a manufacturer's side that could be driving better pricing on generics, this has come up obviously last quarter as well.

Just generally, how would you characterize the current environment in the March quarter into April, let's say, versus 12 months ago?

Just sort of generally speaking, supply disruption is helping you on generic pricing, is it better or worse or about the same, versus a year ago?

Let me first answer the question independent of the question of pricing.

Because I think it's really noteworthy.

I would say the level of supply disruption is higher today than it was 12 months ago.

I'm not sure it's changed particularly over the last three or four months, I would say the last six, seven months have been quite lumpy out there.

Certainly, if I compared it to a year ago, I would say the there's been more disruptions across the spectrum in the generic supply system.

It probably is one of the explanations, and we've talked about this before, for some of the moderating deflation.

That in some products, simply got fewer competitors because companies have struggled, there have been some compliance issues around heightened scrutiny on many companies.

So I think I would probably say that it's higher than it was one year ago.

Next question.

And your next question comes from the line of Lisa Gill of JPMorgan, please proceed.

Good morning and thank you, and let me just say good quarter, and as you know, we've been concerned about commodity pricing, so thank you very much for the detail today.

Just a couple of quick follow-ups here.

George, have you been able to pass along any of the increase in commodity pricing to your customers?

And as Jeff talked about the lag around commodity pricing, and $60 million being the headwind next year, is there some expectation that either hedging or passing that along to the customer will help to mitigate some of what we are seeing right now?

Yes, Lisa, let me start, and I'll give you a bit of a generalized answer because it's really very specific to the conditions.

Certainly, during the course of this year, we have been evaluating and in some places implementing, how and when it's appropriate to pass these costs along to our customers.

These are often delicate discussions, they involve trade-offs, and so we look at this, but we look at this quite carefully.

As you also know, there are also contracts in this part of our business.

So there are forward-looking obligations.

But we have worked closely with customers in some cases.

We have been asking them to share some of the burden with us.

In some cases, we had to offer additional services to them to help mitigate the impact for them.

So we are really working very carefully on ways, essentially for the whole supply chain to mitigate the cost of this.

So that's probably the best answer I can give you, and Jeff I don't know if you want to add to that?

Let me brief you on hedging.

We hedge about 50% to 75% of our exposure to diesel fuel, we've also begun hedging our exposure to cotton over the last quarter.

We continually look for other ways of financially hedging our exposure.

Although, as you know, that's always somewhat difficult, because you have to find the right correlation between the financial derivatives and your underlying exposure in order to get hedge treatment.

Some of our exposures are indirect, either because we are looking at the root of the commodities, or because we are not directly buying the right inputs, it's not always to get those hedge accounting treatment that allows you to lessen the volatility in your income statement, but again we continue to expand our hedging efforts and are looking for more opportunities there.

We also take the approach that we need to continually adjust to our cost level in the organization, and sometimes that means reducing other costs.

As I mentioned in my prepared remarks, the medical segment continues to be very focused on cost containment to ensure that we are minimizing our overall cost structure, not just cost of goods sold, to the extent that we can.

And then just as my second question, when I look at the preliminary numbers to think about for 2012 that you put out, Jeff, I noticed that share count will be going up in 2012.

Can you maybe just reiterate for us, I know there's been questions today about acquisitions, what your capital deployment strategy is?

Is there not plans for share repurchases as we look into 2012, or is there something else that is driving that share increase as we go into next year?

No, thanks for the question.

First of all, we currently we have a $750 million share programs offers by our Board, it was authorized last November.

Currently it is untapped, we have the full amount available.

The assumption in next year's numbers is that we use $250 million of that authorization to buy back shares, which is similar, exactly the same amount of gross repurchases that we did in fiscal 2011.

So we looked at that in isolation, you'd say our share count should be going down, however, when we estimate our share count, we're also taking into account things like assumed timing of repurchase, and perhaps even more importantly, what our share price is going to be, and given the recent escalation in share price, and our projections for that in the future, we then run that through our option dilution model, our option exercise model, and one of the reasons we're seeing a fairly high offset to our repo next year is that we have a fair number of option tranches with strike prices in the low-40s to mid-40s.

So as we start to pass those strike prices, we go over a cliff, and you begin having the potential for option exercises, which affects our base share count, and this is a dilutive impact when you do the option dilution calculation, which affects our diluted shares outstanding.

So that's really what's driving the offset to the assumed share purchased next year.

And your next question comes from the line of Larry Marsh of Barclays Capital.

Please proceed.

Thanks, and good morning George and Jeff.

So maybe just a follow-up and a second question there.

Just around, you're thinking about 2012.

Guess the good news is you're assuming your shares are going up, but what's the size of the potential option impact, the treasury stock method, just start to think about what could be offset to potential share repurchases?

You can easily have a several million dollar dilutive impact, either from options being exercised or the dilutive impact from passing those strike rates over the course of the year.

Right, okay.

Follow-up question then is really around the medical business.

I think the good news in the quarter, your $60 million estimated impact that you communicated last quarter is consistent with what you had said this quarter, which obviously said you were proactive and thinking conservative, and thinking about commodity costs.

And you are communicating potential headwinds of another $0.10 for next year.

I know the big picture, George you talked about medical business or medical transformation initiative, is a platform that you think can be nicely more profitable for a combination of factors.

You've had to fight through the headwind this year, you're communicating getting another headwind next year.

When do you think we will see the nice ramp in margins with Mike and his team, and what gets us there?

Yes, so let me just give you first a general observation, Larry, which is again, our medical group has really been battling two kinds of headwinds in the last eight to 12 months, obviously the commodity issue we have talked about.

But also, a relatively sluggish procedure volume, particularly in hospital surgical procedures, which is a significant driver for us.

It's actually a margin driver as well, because a lot of our preferred products are used in the OR.

So if you actually strip those away in a sense, underlying performance has actually been encouraging.

I'm really pleased at what's happening, both in terms of our market position, the kind of account wins we have had, the focus on category, and what I think is our ability to create value for our customers through our tools, ranging from the black belts that we deploy in our operations to the deferred products programs.

So those are all, to me, margin expanders.

And I think what's been happening in some ways is that some of the good work has actually been masked by some of those headwinds.

So it's hard to time all this, because again, because of the commodity aspect that we look at a little bit of these procedure issues that are tied to the economy.

But my general sense is that we are feeling momentum now, actually.

I would say the state of confidence in our group is high.

And I think we just got to keep at our strategy, the medical trends I think we'll start to, in fact that's probably more in 2013 than in 2012, but those are all about driving margin, and we actually feel fairly good about where we're positioned, and the team is on it, and they're hungry.

And your next question comes line of Robert Willoughby of Banc of America-Merrill Lynch, please proceed.

Can you just comment on the D&A run rate, is the current experience what we should carry forward?

And secondarily, you commented somewhat on the share base for next year.

Can you remind us what your long-term dividend payout goals are?

Will we make some progress towards getting there next year?

Hi Bob, it's Jeff.

I mentioned in the last call that our anticipation for intangible amortization next year was somewhere in the $85 million to $95 million range.

We're still finishing the valuation for two of our acquisitions.

So I don't have any new information to apply to that.

It will get finalized in the next month or so.

We will be able to give a more firm number when we do the guidance for next year.

So I would say that $85 million to $95 million number for amortization next year is probably as good as any.

Which is a slight increase from this year, as you would expect from the full-year impact of the acquisitions come in.

In terms of depreciation run rate, I would actually expect depreciation to go up next year, reflecting in part the medical transformation going live, and we will begin to depreciate that capital that we put in that program starting next year.

In terms of the dividends, obviously that's up to our Board.

Ultimately they decide, and will communicate when and if that decision is made.

But our longer-term goal of growing the dividend at or above the longer term earnings growth rate over time, it's still our expectation.

And your next question comes from the line of Eric Coldwell of Baird.

Please proceed.

I was hoping we could dig into the ambulatory segment growth, I think you quoted 13%.

What are the drivers of that growth?

Penetration versus share, volume pricing, impact of health systems, consolidating medical groups and physician practices?

If you could give us some sense of what the real market growth is, and what is driving or 13% performance?

So the question?

We are encouraged by the growth here.

This as you know, has been an area of some focus for us.

There are a couple of things happening.

One obviously, we have deployed more resources into this group, believing that this is a very natural linkage to our care strategy.

Particularly as IDNs begin to expand their footprint into the ambulatory settings.

Partly the focus is about deployment of our teams and about resources.

It's somewhat about our offering, which I think has been -- we have done a better job with some of the work we have done.

The customer-facing IT investments have really been about making us a more natural player in that market.

So I think we have done well.

They have done particularly well in surgery centers, where we have, I think, some natural opportunities particularly in the kitting area.

So I think that's largely been what's going on there.

There's probably also an element of this connection, as you said, to the IDN.

You have these large integrated systems which are increasingly expanding their footprint beyond the acute care box towards the ambulatory setting.

And that's probably a gravitational pull that is a natural affinity for our business and for our strategy and for a lot of our capabilities.

That's great.

My second question relates to conversations we've had recently with supply-chain managers and health systems.

We get the sense that some are looking to really revisit how they contract with vendors, looking to put in place long-term co-terminus contracts, where for example, they would look at Cardinal's nuclear, pharma, lab, med surge, pharmacy consulting businesses, etcetera in total as a corporate relationship, and move them all to one contracting process, perhaps with an extended renewal date, say three, five, seven years down the road.

Are you seeing a big shift in how the supply chain managers within health systems are looking at your business in total, and if so, what the impact of that might be?

Right.

Look I don't want to overstate this, because it's important.

But I do think that -- We believe that there is value in doing that.

Many health systems today, given the environment around them, are looking for new ways to create value and to approach their business.

This really is an area that plays to our strength.

We reach completely across categories of products and drugs and also across channels.

And I think the ability to bring this suite of those tools to a large system can be a value creator.

We are seeing some of that but I don't want to overstate it, as if it's a massive change.

But I do think it's something that we're seeing.

We think it will continue, and we think that plays to our strength.

Jeff, I think, wanted to clarify something from the last one.

I was going to add onto your answer to the prior question from Eric, and that is, as we look at ambulatory, as you may know, our ambulatory growth from surgery centers and physicians offices, we look at both in total and separately for those subsets.

I would say both of those it did very well, showing strong growth in Q3, which indicates that we are growing well above market in both of those subsets, which is very important.

Luann, in the interest of time, I think we have time for probably two more questions from the queue, and any other questions, we will be more than happy to take after the call.

That's fine.

The next question does come from John Kreger of William Blair.

Hi good morning, this is Robbie Fatta in for John Kreger, thanks for taking the question.

I'll make it quick.

On the generic side, given the supply disruptions that you've talked about, and the impact of the complexity of some of the new drugs are going to be losing protection in the next year, what are your expectations for generic deflation in fiscal 2012?

That's hard to answer, Robbie, we have generally not guided on a deflation rate.

It is really the composite of so many forces, some of which we have no control over, as you know.

If a certain product is in exclusive or semi-exclusive status and it stays there for three more months then we model, then deflation will be less than we expected.

So it is very difficult to give you a forward-looking model on deflation rates.

What we can say, is that certainly over the last nine months or so, and again, that's an inexact timetable, we have seen a lower rate of deflation.

Some of the conditions that I think are causing that, we continue to see.

But I don't know that I can give you a guidance on a deflation rate.

Okay great, thank you.

You're welcome.

And your next question comes from the line of Robert Jones of Goldman Sachs.

Good morning, this is Radell Walker in for Robert Jones.

I just had a quick question on the CareFusion transition.

Just a clarification.

I think you said that we can expect a $50 million to $60 million quarterly impact from that going forward.

I was just wondering, could you just walk us back through that on the revenue and the margin side?

From the transition?

Sure.

Perhaps it would be helpful we go into a little more detail on this.

Because some people are a little bit confused on exactly what's happening here.

Absolutely, thanks.

At the time of the spin, we put in what was a temporary arrangement with CareFusion, particularly around, or primarily around our businesses in the Chicago area that had been linked for some time going back to the Allegiance days really.

Because we needed some time for CareFusion to get its own independent systems up and running, we put in place a temporary arrangement where effectively we managed most of their distribution for them, and then charged a fee.

So it was purely a 3PL relationship for that particular business, which primarily affects their V.

Mueller and respiratory products.

The plan was always, eventually they would get their own systems up and running which they did this quarter actually.

And once they did that, we agreed that we would move from that service fee-based arrangement, where we just got a service fee for the products that we handled, to a more traditional branded distribution agreement, where we actually took ownership of the products, recognize the revenue, and then realized a margin on that revenue that went down to our bottom-line.

That transition is happening now, and will begin to affect us economically in Q4 of this year, and then going forward.

Now really it's more of a P&L optics issue, because the bottom line impact is about the same for us, before and after the transition.

But because we are now recognizing the revenue, it has the impact of boosting our revenue, and reducing our margin.

That's where we get to that $50 million to $60 million incremental revenue figure per quarter, starting in Q4, and also the dilutive effect on our margins, our segment profit margins of about 25 basis points, so hopefully that helps.

I think that was the end of the questions.

You have no further questions.

At this time, I will turn the call back over to Mr.

Barrett for your closing remarks.

Thank you, Luann.

Let me close by saying that we feel very positive about our performance in this quarter, and about our trajectory going forward, and I want to thank all of you for joining us on today's call.

And have a good day.

Ladies and gentlemen, that concludes today's presentation.

You may now disconnect, and have a good day.