卡地納健康 (CAH) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Cardinal Health, Incorporated third-quarter 2012 earnings conference call.

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

Later, we will conduct a question-and-answer session with instructions to follow at that time.

(Operator Instructions)

As a reminder, this conference is being recorded.

I would now like to turn your conference over to your host today, Ms. Sally Curley, Senior Vice President of Investor Relations.

Ma'am, you may begin.

Thank you, Ben, and welcome to Cardinal Health's third-quarter fiscal 2012 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.

I would also like to remind you of a few upcoming investment conferences and events in which we will be webcasting, notably -- the 2012 Deutsche Bank 37th Annual Healthcare Conference on May 7 in Boston; the Bank of America Merrill Lynch 2012 Healthcare Conference on May 15 in Las Vegas; the Goldman Sachs 33rd Annual Global Healthcare Conference on June 5 in Rancho Palos Verdes, California; and the William Blair 32nd 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 of Cardinalhealth.com, but please make sure to visit the site often for updated information.

We look forward to seeing you at the upcoming events.

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

George?

Thanks, Sally.

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

I'm pleased to report another solid quarter and to have now completed nine months of excellent overall growth and progress in our areas of strategic focus in FY 2012.

Revenue for the third quarter was $26.9 billion, up 3% from the prior year.

Non-GAAP operating earnings increased by 6% to $524 million.

Our non-GAAP EPS grew 16% to $0.94 from last year's $0.81.

Our Pharmaceutical segment delivered 9% profit growth on a revenue gain of 3%.

The Medical segment achieved top-line growth of 8%, reinforcing our improved position in the market, but as we had expected, the segment recorded a year-over-year profit decline of 17%, primarily due to residual commodity cost pressures.

The team has shown great focus, offsetting much of this headwind with solid performance in the underlying business.

I would like to walk you through the performance highlights of each segment.

First, Pharmaceutical, revenue increases came from multiple classes of trade.

This growth outpaced the market in virtually every channel.

Our focus on creating value for the specific needs of each customer in this dynamic environment remains a top priority.

Our customer base remains strong and the mix continues to evolve along our strategic pathway.

Our non-bulk sales were up 7.6% versus prior year.

Profit was fueled by the continued strength of our generics activities and solid performance with our branded partners, whose needs continue to evolve with changing markets.

Our strong generic results reflect the continued focus on this important industry driver and the impact of new and recently launched products, a number of which launched in the prior quarter.

I want to take a few moments to comment on our nuclear activities, as this part of the industry has been going through some change.

We see distinct market dynamics at work in the two different nuclear product lines.

On the low energy side, our legacy business, demand remains soft.

Although we continue to provide market-leading products and services, and the supply of raw material to us has been reliable, the number of nuclear cardiac procedures is considerably below historical norms.

Part of this can be explained by general economic conditions and part is likely associated with payer and employer policies designed to continue the growth of medical procedures.

We have been making the necessary modifications to our business to adjust to what may be the new normal from a cardiac procedure perspective.

I should note here that demographics should, in the long-term, generate some upward pressure on demand.

As you know, our activities in the PET area are at a different stage of evolution.

We were excited to see the FDA approval of Lilly's Amyvid, a high-energy product used in PET scanning as a diagnostic product for patients being evaluated for Alzheimer's Disease.

We have been an innovator in this area, a partner in the development of this product, and we will be an important part of the team as a manufacturer and distributor of Amyvid from our specialized facilities.

From a business model perspective in nuclear, while I would love to have been able to synchronize the slowing of the legacy low-energy business with the growth coming from the new category of diagnostic products, we do recognize that Amyvid is the first product in a category of drugs, and because of this, will take some time to position and to build.

Nevertheless, we believe that PET, in particular, this new class of drugs, shows excellent promise for the future.

As a reminder, Amyvid is the first of the over 20 diagnostic products in which we are actively involved in clinical trials.

As you know, and have heard us say repeatedly, we believe a growing presence in specialty is very important to our strategic positioning.

Our emerging Specialty Solutions Group delivered an outstanding revenue growth in the quarter versus last year, driven by our provider distribution services.

Approximately $150 million in revenue growth was generated from new and existing distribution customers.

We also signed another $100 million in annualized distribution revenues, including several large oncology customers.

Having said this, we are still at a stage in Specialty where any bump in the road can have an impact on the Specialty numbers in the near term.

Unfortunately, we did have an issue with a customer in the P4 legacy operations that resulted in the loss of some of our business with them, primarily affecting margin, and Jeff will touch on this in his comments.

All in all, our Specialty Solutions Group is picking up customers, creating new products for providers and payers, and we have built an outstanding management team.

I'm very pleased with the momentum we are gaining, the innovation coming out of this team, and the promise of continued progress.

I would like to take a moment to comment on the overall pharmaceutical environment.

These past few months have been active in the pharmaceutical arena.

The dispute between Walgreen's and Express Scripts has had some impact on end markets.

The VA contract was awarded and Medco and Express Scripts consummated their transaction.

We are well positioned to compete and deliver value in this environment.

We have developed dedicated tools to support the needs of large, highly integrated customers, and feel good about those relationships, each of which, I might add, is unique.

At the same time, we have increased our range of options for the smaller chains, hospitals, and independent pharmacies that depend on us every day.

Finally, before I leave the Pharmaceutical segment, I want to provide an update on the DEA situation since we last spoke on February 3. At that time, we discussed our contingency planning, specifically transitioning the distribution of controlled substances from our Lakeland facility to our Jackson, Mississippi, facility and other distribution centers.

Since that time, we have put the plan in motion.

Litigation is continuing with our show cause hearing before a DEA administrative law judge, scheduled to begin on May 7. We have been investing and will continue to invest in people, tools, and systems designed to detect and prevent diversion of controlled drugs and I know our people are committed to this effort.

Turning to our Medical segment, we continue to show good revenue growth in a relatively flat medical market, a strong validation of our value proposition.

Sales grew by 8%, helped by growth across customer channels, as well as from the Futuremed acquisition in Canada.

Although system-wide physician office visits were down, we continue to see double-digit growth in our ambulatory channel, fueled by our business with surgery centers.

And, similarly, our work around preferred products produced double-digit growth rates, outpacing the balance of the portfolio.

We had a number of new product launches in the quarter, including the introduction of the DuraBlue sterilization wrap, a hydrogel coated version of our protective surgical glove, a plasma [solten] device, and flexible masks, all of which came out of our innovation teams.

And just a few comments on our MBT Go-Live.

We are now up and running.

Given the scale of this initiative and the complexity of the implementation, it has gone extremely well.

I'll share a few statistics to give you a better sense of this scale.

On a daily basis, our Medical segment processes an average of 5000 customer calls, 31,000 orders, and 35,000 invoices, and I might add, MBT had to revise millions of lines of code and billions of rows of data.

Even with all of this, we are barely off our previous customer service levels, less than 0.5% change.

We are most appreciative of our customers who have worked closely with us on this major initiative and particularly those who have had to endure some of the glitches that can occur in projects of this scale.

I also want to thank the thousands of employees who have worked tirelessly on this program, many putting off vacation and family time to ensure that every issue is addressed and that we deliver significant customer benefits from this investment.

We are now through most of the heavy lifting at MBT, we've absorbed some considerable commodity headwinds, and we've strengthened our value proposition.

We now anticipate that our Medical business will return to positive bottom-line growth in Q4 and into our fiscal 2013.

Finally, on Medical, as you know, we announced two weeks ago that Don Casey would be joining us to lead this important segment of our business and that Mike Lynch would be leading Cardinal Health.

I'll come back to Mike in a few minutes, but a few words on Don.

We're thrilled to get an executive of Don's experience, insight, and drive.

He brings to us more than two decades of strategic and operations work in healthcare, having touched virtually every area in the industry.

We welcome him and his family to Cardinal Health and look forward to introducing him to those of you who do not already know him.

In the past few quarters, I've taken just a few moments to comment on our work in China, which crosses segments and businesses, and I would like to do the same today.

I recently returned from a visit to China, where I had the opportunity to meet with local and national leaders and policy makers.

I came away from this trip confident that our team is focused on the right drivers of growth for Cardinal Health, but this visit also reinforced for me that we are well aligned with national priorities as spelled out in China's 12th five-year plan.

These priorities include improving the public health and access to affordable healthcare and the development of a vibrant service sector of the economy, which will play an important role in promoting domestic demand.

Jeff will provide commentary specific to our business in China when he comments.

In summary, I'm pleased by our performance this quarter and over the first nine months of our fiscal 2012.

And, based on the information we have today, we are raising the lower end of our guidance, resulting in a revised range of $3.15 to $3.20 for fiscal year 2012 non-GAAP EPS.

Finally, as I mentioned a few minutes ago, Mike Lynch will be leaving the Company after a distinguished 28-year career with Cardinal Health and its predecessor companies.

Mike's fingerprints can be found throughout our operations, through the strategies he developed and the people he mentored.

We wish Mike all the best as he moves forward and we thank him for his many contributions and his readiness to work with Don and the Medical team as they transition over the coming months.

And with that, I'll turn the call over to Jeff.

Thanks, George.

Good morning, everyone.

In my remarks today, I'll explain our financial trends and drivers in the third quarter.

Then I'll touch briefly on our outlook for the remainder of fiscal 2012.

Let's start with slide 4. During the quarter we grew our non-GAAP EPS by 16% to $0.94 per share, driven by 3% revenue and 6% non-GAAP operating earnings growth as well as favorability in our non-GAAP effective tax rate.

Interest and other expense came in $3 million favorable to last year, driven by changes in the value of our deferred compensation plan.

Our non-GAAP tax rate for the quarter was 35.6%, lower than prior year and our second quarter of this year.

This quarter's rate was favorably impacted by the mix of foreign and domestic earnings and net favorable discrete items of approximately $3 million.

This $3 million included two sizable and largely offsetting discrete items that I wanted to highlight.

First, approximately $45 million related to the final settlement of certain open audit years, which favorably affected the rate.

Second, we had a $44 million negative impact, triggered by settlement discussions for other open audit periods, and the resulting remeasurement of unrecognized tax benefits.

As a reminder, last year's Q3 rate was abnormally high, driven primarily by changes in Puerto Rican tax law.

Our share count in Q3 was about 349 million diluted average shares outstanding versus 353 million in the prior year's quarter.

I would like to point out that our fiscal '12 share count guidance is now approximately 350 million shares.

Favorability in our share count versus last year continued to be driven by the $300 million of share buybacks we completed in Q1.

As a reminder, we still have $450 million of share repurchase remaining under our Board authorization.

Let me pause here to reiterate our position regarding capital deployment.

You may want to reference slide 7 as I do so.

As we've consistently emphasized since redefining our employment strategy at the time of the CareFusion spend, our objective is to have a balanced approach that begins with maintaining and growing our differentiated dividend.

In fact, just yesterday, we announced Board approval of a 10.5% increase in our quarterly dividend to $0.2375 per share, or $0.95 annualized.

This dividend represents a cumulative 70% increase from the per share amount we were paying in fiscal 2009, prior to the CareFusion spend, and represents a current yield of about 2.2%.

Second, we ensured that we are investing appropriately in our capital expenditures to support and drive organic growth.

In this regard, we continue to expect to invest $250 million to $270 million in FY '12, with the majority of that in IT-related processes and systems.

Beyond this, we don't have a fixed formula.

Our goal is to ensure that we are positioning for sustainable competitive advantage and to create shareholder value.

Clearly, over the past 12 to 24 months, acquisitions have played a role in positioning us for sustained growth.

Over that time, we have also continued to buy back shares on an opportunistic basis.

Before shifting the discussion to segment results, let me comment on a few items from our consolidated cash flow on the balance sheet.

Our strong earnings performance, coupled with reductions in networking capital, led to excellent operating cash flow of nearly $900 million in Q3, bringing the year-to-date amount to approximately $1.3 billion.

We did have a few unique items affecting our working capital metrics in the quarter.

Day sales outstanding were higher this quarter versus last year, due primarily to certain issues related to our Medical Business Transformation Go-Live in early February.

While the MBT implementation was overall a definite success, as one would expect with an implementation of this size, we did encounter a few problems.

Specifically, there were some temporary back office issues, including invoicing, which we are still in the process of resolving.

This affected our quarter-end AR balance and, in turn, our DSOs.

Days inventory on hand was higher in the quarter due to the onboarding of a customer in pharma and the timing of this quarter end.

We ended Q3 with approximately $2.4 billion in cash, of which approximately $200 million is held overseas.

This cash balance does not include our investments in health maturity fixed income securities, which totaled approximately $90 million at quarter end.

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

Revenue in the segment increased 3%.

Overall growth with existing customers was the primary driver, but let me walk through a few more of the details.

As George said, non-bulk sales were up 7.6% for the quarter and reached 60% of total segment revenue.

We again experienced strong growth in our generic programs, up 18%.

And Specialty Solutions continues to add new distribution customers, growing revenues this quarter 59%.

Pharma segment profit margin rate increased by 10 basis points compared to the prior year's Q3, in part reflecting continued mix shifts with both customers and products.

In fact, we saw margin rate growth in virtually every one of our pharma distribution classes of trade.

We continue to see significant contribution from the ongoing success of our generics programs, including the favorable impact of recently launched generic products, with the equivalents to Lipitor, Zyprexa and Lexapro contributing strongly.

Generic inflation rates continue to be below historical norms, with inflation this quarter roughly in line with Q2 and the prior year's Q3.

While we do not believe the industry dynamics moderate generic deflation will necessarily change in the near term, we do expect the overall deflation rate on our portfolio of products to increase next quarter and into next year, as certain recently launched items pass their exclusivity period.

As you know, our nuclear business has had a rough stretch, as it continues to be challenged by the low-energy market softness that we described in our last two calls.

We continue to take actions within that business to mitigate the impact of this.

One of these initiatives did result in the inventory write-off we mentioned on last quarter's call.

This write-off lowered segment profit by $11 million, or approximately $0.02 per share in the quarter.

As George said, we did have some positive developments on the positron emission tomography side of the business recently with Eli Lilly's Amyvid, a PET diagnostic agent which we have previously highlighted, receiving FDA approval on April 6.

Regarding our DEA-related issues in Florida, as George mentioned, we have been transitioning distribution of controlled substances from our Lakeland, Florida, facility primarily to our Jackson, Mississippi, operation.

For the quarter, we did incur some incremental costs associated with the DEA issue, which totaled over $4 million.

This amount includes legal and other external fees and then was recorded in the Pharma segment.

Our expectations for any continued negative impact are reflected in our guidance.

In summary, the Pharma segment had another strong quarter, resulting in a 9% increase in segment profit to $446 million.

Now, turning to our Medical segment.

For the quarter, revenue increased by 8.2% to $2.4 billion.

Let me highlight a few items driving this result.

We saw another good increase in revenue from our preferred products, with 11% growth in the quarter.

As we've highlighted in the past, this is a key growth and margin expansion opportunity for us.

Our ambulatory channel, another important focus area for us, also had another strong quarter, with 11% revenue growth.

Cardinal Health Canada had a solid quarter with 16% revenue growth, including the contribution from the acquisition of Futuremed during the period.

Consistent with last quarter, I wanted to quantify a couple of unique items which contributed to our reported Medical revenue growth this quarter, although I will note that they had a relatively insignificant impact on segment profit growth.

First, as the ongoing effect of having transitioned our business with CareFusion to a traditional branded distribution model, a move that we highlighted in our Q3 earnings call last year, this change added 2 percentage points, or $46 million to revenue.

As we have now lapped this transition, this will be the last time I quantify its impact on Medical segment growth.

The second item was the impact of the refinement we have made in the way we report results for our international commercial operations, which I discussed in detail on our Q1 call.

This change contributed 1.9 percentage points to the Medical segment revenue growth rate in the quarter.

Now, turning to Medical segment profit, which as we expected, declined 17% to $89 million.

Consistent with the forecast we provided on last quarter's call, commodity prices negatively impacted our Q3 cost of products sold by $20 million versus last year.

For the full year, we are still expecting a headwind of slightly under $70 million.

On the issue of commodities, I want to remind everyone that, due to the four- to six-month lag between price movements and the corresponding impact on our cost of products sold, further changes in commodity price levels during this fiscal year will have more of an FY '13 than FY '12 impact.

On that note, let me comment on the -- on what the information we have available to us today says about the impact for next year.

Currently, we anticipate the commodity headwind that we've been facing, which has ranged from $60 million to $70 million in FY '11 and FY '12 to significantly lessen for FY '13.

Although the price of oil remains fairly volatile, based on today's information, we expect the gross headwind to be closer to $5 million to $15 million next year, $5 million to $15 million next year, although that will clearly fluctuate over time.

Also, as mentioned on last quarter's call, we saw approximately $8 million of incremental expense associated with the Medical Business Transformation launch, as we began to depreciate the assets and incurred additional spend associated with the national implementation.

We are currently forecasting a similar level of incremental expense in Q4.

Partially offsetting the effect of the negative items I just mentioned was the positive margin benefit of increased sales of our preferred products.

Now, I would like to follow up on George's comments regarding Cardinal Health China.

Our revenue in China was again strong and we continue to see outstanding growth from our local direct distribution business, which grew its revenue by 45% during the quarter.

As of the end of Q3, we've expanded to 10 distribution center sites in China and our service area covers more than 250 million people.

We remain excited about the opportunity we have in China to partner with brand pharmaceutical and medical device companies, and progress in this regard continues to gain momentum.

And we continue to move forward well in the new business areas we've initiated over the past [while], including consumer healthcare products for retail pharmacies, direct-to-patient specialty distribution, and medical device distribution.

Let's turn to slide 8, which I'll just summarize.

In total, GAAP results in the quarter include items that had a positive $0.01 per share net after-tax impact.

This compares to a negative $0.10 per share net impact in our GAAP results last year.

There are two unique items recorded in Q3 related to our Specialty business, which are excluded from our non-GAAP results.

The first is related to the P4 Healthcare earn-out contingency.

We updated our forecast for future EBITDA generation, which resulted in a decrease in the fair value of a total contingent consideration obligation, bringing the remaining earn-out liability from the P4 acquisition to [$23] million.

You will see this appears in approximately $55 million, or $0.10 per share gain in acquisition-related costs.

The reduction in our forecast and corresponding earn-out liability is largely driven by the revenue loss from a significant customer of the P4 Healthcare legacy business, which, given the nature of the services business, has a relatively high margin impact.

Separately, the other item related to Specialty is tied to our decision to rebrand our Specialty business as Cardinal Health Specialty Solutions, and largely discontinue use of the P4 trade name.

This resulted in a $16 million write-off recorded in the impairments line.

And again, to be clear, neither of these two unique items related to Specialty, which net to a positive $0.07 per share, are reflected in our non-GAAP results, or our Pharma segment numbers we've been discussing.

Keeping in mind that we have about eight weeks left in our fiscal year, our FY '12 guidance range takes into account some key factors that could still change, including generic launch values, generic deflation, and branded price increases.

And to be clear, our new guidance range of $3.15 to $3.20 assumes we do not have a LIFO charge in Q4.

I'll also point out that we made some minor changes to our full-year assumptions of share count, interest and other, and amortization of acquisition-related intangible assets as shown on slide 11.

Note that we have left our full-year tax rate assumption unchanged, despite the lower rate we had in Q3.

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

(Operator Instructions)

Ricky Goldwasser, Morgan Stanley.

And congratulations on a very good quarter.

Thank you.

You know, George, thank you for the update on the fourth quarter, but if we can look ahead for fiscal year '13, can you provide us any guidance for fiscal year '13 on generics and what's your expectation for total revenue growth for the year?

Yes, good morning, Ricky.

At this point, we're not prepared to guide.

We're still working through our planning process.

I can give you some color on what we see on generics going forward and hopefully that will be of some help.

I'll start with this.

We expect our generic business to grow.

I would probably say that the number and value of generic launches in our fiscal '13 is probably lower than in our fiscal '12 and as Jeff mentioned, some of the products that launched, say, in the last four to five months, will lose their exclusivity, so we'll expect to see some deflation on those products.

But it's sort of an extraordinary time in the industry.

We're probably looking at the potential of total system-wide generic penetration exceeding 80% sometime next year, which is clearly a sort of mind boggling number.

And so, this will help fuel, and the work that we're doing in our program in general, we think will help fuel continued growth.

But that's probably the general color I could give you at this stage.

Ricky, I think there might have been a second question there about revenue growth for next year, which I assume was overall growth.

And again, we're still going through our planning process, so I don't want to be too specific here.

I think we all recognize that FY '13 is going to be an interesting year in respect to revenue, just due to the sheer volume of large branded products that have and will come off patent in this fiscal year.

And the reality is that could very well result in flat to negative revenue growth in Pharma and the overall Company next year, although as you know, that could actually be good for our gross margins.

That's our early thinking, but there's still a lot of things to play out over the next couple months.

Okay.

Thank you.

So from our regard, we should think of flattish to negative growth, but continued margin expansion, as generic compliance increases, is that fair?

Again, I don't want to get too specific on margin, but I would say if you look at the impact of the products going off patent, there's two impacts.

Just looking at those in isolation, they will tend to dampen revenue and I think an assumption of flattish to slightly down is probably reasonable and they generally will be positive to our gross margin rates, yes.

Great.

Thank you.

You're welcome.

Tom Gallucci, Lazard Capital Markets.

Good morning, everybody.

Thanks for the details.

You know, there's obviously been a lot of talk in the marketplace around customers and turnover, renewals and potential customers that are coming up for renewal.

So I was wondering if you can make any comments on maybe your top five or so customers that, and their status and how you're sort of thinking about renewals or contracts over the next year or so.

Yes.

Good morning, Tom.

It's George.

I'll start with this one.

Again, we are generally providing somewhat limited information on specific customers, but some of this, I think, is fairly available out there in the public domain.

So I can comment on a few of the contract renewals and just general timing.

So couple things to say.

We have renewed a couple that you may know with K-Mart and Kroger have been renewed in terms of long-term contracts that extend beyond FY '15.

That's always helpful to us in terms of long-term stability and we'll continue to work closely with these customers.

I think you all know from other calls that the status of the Express Scripts contract, we've extended that current agreement until the end of September and are in the process of responding to an RFP, which is there to include the entire Express plus Medco business.

There's not much we can say obviously about that in terms of the outcome, other than to say we've been a very solid and I think outstanding supplier to Express Scripts and would look forward to continuing that relationship.

Both CVS and Walgreen contracts run through the summer of 2013, so it's still over a year away.

Not much to say about that other than obviously two very important customers and outstanding relationships for us.

One which we've been getting questions about and since we've had enough questions we probably should comment on, which is that we did pick up Safeway.

We've been asked this, and I thought we should confirm that for most of your agreements.

We really are excited about this.

We view this not just as a new customer, but as a terrific partnership going forward.

That probably gives you the, some color on the contracts that we would typically make some comments on.

Okay, that's helpful.

Just two quick follow-ups.

Do you have any idea about the timing of when you might hear on the Express situation?

And since you did confirm Safeway, is there any color you can provide us on the dynamics around that contract change?

No.

For the first of the two parts of the question, I don't think I can provide specifics on when we'll hear regarding the RFP on Express Scripts.

It's possible we could hear by the time we speak with you again for our year-end numbers, but no certainty at this point.

The second part, I'm sorry, on Safeway, yes, there's not much color I can provide for you here.

Obviously, each agreement that we have with our partners is obviously quite proprietary and as I said earlier, they are quite specific and distinct.

I can say that it's a broad-based agreement and it covers branded lines and generic lines and we're excited to be working with them.

Thank you.

You're welcome.

(Operator Instructions)

Jeff Elliott, Robert Baird.

Yes, good morning.

Thanks for the question.

Just a quick housekeeping question here.

Can we get the profitability split between bulk and direct store delivery?

Sure.

Thanks, Jeff.

This is Jeff.

The bulk rate for Q3 was 59 basis points and the non-bulk rate was 2.64%.

Let's put that into a little bit of context.

As we said before, we don't think looking at these particular margins on a quarterly basis necessarily tells a complete or accurate story.

We think the most appropriate comparison is over multiple quarters, so that kind of smooths out quarterly blips, et cetera, that often occur.

So in that vein, let me give you the year-to-date figures.

Year-to-date bulk margins are 40 basis points and non-bulk are 2.52%.

And for comparison to last year, last year's rates in that same period were 35 basis points and 2.40% respectively.

Great.

Thank you.

You're welcome.

Larry Marsh, Barclays.

Great.

Thanks, and good morning.

I guess I would like to maybe get you to frame kind of where you sit on MBT.

Obviously as you said, George, you're live.

The process is in motion.

You spent some incremental funds this quarter, which ended up with a result of what was better than I was thinking for this quarter.

But as you think about this full year and next year, how should we frame the overall costs associated with investment in MBT versus benefit this year, next year, and how do we think of that as a go-forward basis?

And then as we sort of think about next year, is there -- you know, with the I guess medical device tax to into effect this year, how do we think about impact in our models?

Thanks.

Good morning, Larry.

And why don't I let Jeff touch base on this.

So kind of talking a little bit as I got the MBT question, because I'm recalling John Ransom's accusation of me giving an essay question, but I answered a math question last time, so let me try to be a little bit more mathey with my response this time, John, if you're out there.

And I will, now that we've completed the go-live.

I do want to provide a few more details regarding both the expense impact and future benefits.

First of all, let me talk about fiscal '12.

For the year, we'll incur $32 million of expense related to both project implementation expense and depreciation.

And it's about equally divided between the two.

On the benefits side in FY '12, as we've said before, there are very few benefits realized this year.

We're really focused right now on cleaning up any remaining problems and ensuring customer satisfaction.

And that will continue to be our focus for the next couple months.

Now, beginning in fiscal 2013, and start on the expense side here, we have a full year of depreciation which kicks in.

And that's worth about $34 million next year.

Because MBT is really replacing systems that are quite old, there isn't much in the way of elimination of depreciation expense for the systems being replaced.

Then there will also be a relatively modest amount of ongoing annual cost to sustain the system and do enhancements.

Now, on the benefit side, we do expect the income statement benefits to begin in 2013 and ramp up over time.

Bottom line, though, is we expect the financial benefits resulting from MBT next year to exceed the ongoing annual expense in the system.

So in summary, the project will be net accretive for fiscal 2013 and beyond.

We also expect that net benefit to increase over time, as we fully utilize all the benefits of a new system.

That pretty much answers the MBT question.

On med device tax, as you all know, the medical device tax currently is scheduled to kickoff on January 1, 2013, assuming that medical, healthcare reform continues as scheduled.

You should know that there still is considerable debate around the exact final regulations as it relates to the medical device tax, but based on our current interpretation of those regulations and our current product mix, we estimate the half year impact next year to be somewhere in the range of $13 million to $23 million.

And I know that's a wide range, but the size of that range is really being driven by different assumptions regarding which of our offerings this tax will be applied to.

And until we get some further definition in that regard, we'll be looking at that sort of range again, $13 million to $23 million for the half year of impact.

Now, I should also point out that this is a gross impact, that's before any mitigating action that business takes to minimize its impact on us.

And I guess just a final point of clarity, from an accounting perspective, this tax will appear as SG&A on our income statement.

Right.

Just a quick follow-up then on that point, I mean, to extend it to tax, it raises price to your customers, so I guess you're suggesting you don't anticipate any ability to offset that with raising price to your customers, and then, maybe just a follow-up then on medical with Don coming on board.

George, you may have covered this, but when do you hope to have him in a position to kind of comment on his initial views and perspectives of where he wants to take the business here once he's on board fully?

First, just a quick comment on the question that, the hypothesis you gave Jeff in terms of our ability to mitigate the tax, first of all, as you probably know, there's also still considerable discussion around medical device tax.

I won't go into a long treatise as to whether our products of the nature that we sell, competitive should be casted out, and there's still some action around there.

As it relates to our ability to mitigate, I don't think we should preclude any option for us.

Jeff is trying to give you the growth impact and obviously it will be for Don and team to think about what strategies we can deploy to make sure that that is fairly -- if we have to experience it that it's fairly distributed across those in the channel.

And that's one that we need to consider.

Don is on board.

He is up to speed and I suspect will not be shy about giving you his perspective on where we are, obviously just getting into the business now and we're glad he's on board working closely with Mike.

I'm hoping that probably by the time we get a chance to talk with you all in August, he's probably going to feel a lot more comfortable with life with Cardinal Health and with the business, we'll have gone through a planning process that actually be an extremely fast learning experience in terms of the nature of Cardinal Health and what we're doing.

So, that's it.

Okay.

Very good.

Thanks.

You're welcome.

David Larsen, Leerink Swann.

Hi.

In terms of the DEA situation, I mean, several years ago, there was some impact on your sales.

And I think what I'm hearing is there's really -- sales have been going very well and there has not been any negative impact due to the current situation, is that correct?

I would just say that at this point, our customers have been tremendously supportive and we've I think put in very effective contingency plans and we're doing everything to make sure that customers are served.

So that I would say.

Okay, great.

And then there's a Defense Department contract I think that should be ramping up in May for the Medical segment.

Is that still on track for a May start?

Yes, it is.

That process is still expected to continue this month.

As a reminder, we initially had expected that to start transitioning in February, but at the request of the DOD, due to a systems implementation they were making, it got deferred to May.

So it will be a gradual ramp up as we bring on the various elements of that, but that timing you described is still accurate for the beginning of that ramp up.

Okay, great.

Thanks.

You're welcome.

Lisa Gill, JPMorgan.

Thanks very much.

Good morning.

George, I was wondering if you could maybe just give us some comments around pricing that you're seeing on the generic side.

I think Watson last week on their conference call, or earlier this week, noted that they would expect roughly four to six generic manufacturers for Lipitor post 180 days of exclusivity, but we're expecting price to drop pretty substantially.

What do you see and what are your thoughts on, as we have the outlook for generics over the next several months, as some of these bigger drugs now lose their exclusivity period?

Right.

Good morning, Lisa.

Good question, it's hard obviously to know exactly what it's going to look like at the expiration of that exclusivity.

But I think we probably have the same perspective in terms of the number of players that we're seeing on that particular drug.

So here's what I would say in terms of the overall environment.

You almost have to look at this in three buckets.

You have the products that are sitting in exclusive periods, that will go through the binary change when competition ensues.

And then you have this enormous basket of thousands of products.

And then you have some individual products that occasionally inflate.

And I would say in general in that middle bucket, we're not seeing any particularly noteworthy change in the pricing environment.

It looks quite as it did last quarter.

Obviously, we will see some of these big products that go from being alone or alone with generics, to four or five or six players.

I think once we get into that range, then it would be reasonable to assume some fairly significant deflation.

Okay, and then just as my follow-up, I wanted to clarify that I heard a couple things correctly.

On the nuclear, did you talk about an $11 million write-off in the quarter around nuclear?

And then secondly, on DEA, did you say that that cost roughly $4 million in the quarter, so if we think about the next quarter, should we anticipate that there will be another roughly $4 million cost associated with DEA?

Yes, first of all, on the nuclear issue, yes.

You did hear correctly.

That was an $11 million inventory write-off.

As you may recall from last quarter's call, Lisa, it sort of foreshadowed that that was a possibility.

As we were taking actions to mitigate some of the demand softness that we've been experiencing, a result of one of those initiatives was a write-off of so many inventory that we had, and that was exactly that.

I think I had sized it as $0.02 to $0.03.

So when I talked about it last quarter, it ended up being $0.02 of the $11 million that I described.

And Lisa, regarding the DOD costs, yes, they were slightly over $4 million this quarter.

I'm not going to try to forecast exactly what they may be next quarter, other than to say that I think any reasonable range of possibilities is reflected in our guidance.

Yes, I probably would add to that, just recognize we're in the middle of some -- it's been a relatively tense legal period, so some of that, of course, is associated with just the work around the legal.

Operational numbers are smaller.

So--

I wouldn't expect a dramatically different number than what we experienced in Q4, in Q3 at this.

So I mean, would I characterize this correctly, in the fact that these costs would be more one-time in your numbers, that the margins in the quarter are actually probably slightly better than what you would have anticipated?

I mean, I know you knew about nuclear, but core business is even slightly better than what you printed today, is that the right way to think about it?

There's always unique events in every quarter, right?

But, yes, the $11 million was reflected in the Pharma segment.

So you could argue absent that, margins would have been better.

And the roughly $4 million in DEA costs was also reflected in the Pharma segments.

Now, whether that's one-time or not, I guess we'll see as we go forward, depending on the ultimate resolution of that.

So, yes, there were a couple of somewhat unique items.

Okay, great.

In the Pharma segment.

Okay.

Appreciate the color.

Thank you.

You're welcome.

Robert Jones, Goldman Sachs.

Yes.

Thanks for the questions.

Actually, just had a big picture question on the Medical side.

Outside of the expected commodity headwind, that business continues to perform well.

Your largest competitor in the acute care space has been talking about a shifting in leverage towards the customer, particularly as these larger IDMs get larger.

I was hoping maybe you could just weigh in on what you're seeing from that customer base and has there been any notable pressure as a result of the consolidation that has been going on at your customer base?

Well, just good morning, Robert.

I would start with certainly confirming that notion that there has been consolidation among the customer base.

There's no question that we're seeing hospitals either under a lot of pressure or anticipating significant pressure going forward, and they are finding and looking for ways to create value.

That can create some pricing pressure for sure.

It also for us creates an opportunity for us to be able to deliver a message around how to create value for them.

Price is one element in the way you create value.

We have a broad portfolio of products and services that we can bring to bear to the market, particularly a highly integrated IDM and so our message to them is really about our ability to create value for you, in an environment that has quite a number of pressures.

Would never dispute that there's pressure.

It comes from large customers, but I would also say that in some ways, this enables us to articulate our value proposition about how we can create value for them.

That's helpful.

And I guess just my follow-up, moving over to P4, which I guess I should refer to it as Specialty Solutions now, outside of the write-down of the earn-out liability, which sounds like it was largely linked to just one loss, I was wondering, George, maybe if you could just take a step back and maybe just share your experiences in Specialty today, maybe versus what you thought originally.

And maybe just talk to some of the challenges that exist in that business relative to maybe where you guys were when you first entered with P4.

Sure.

It's a good question, and one that probably deserves a larger answer than we could provide on this call.

But let me give you a quick overview.

We felt strongly that moving to Specialty strategically was very important to us.

We recognized in that acquisition that we were buying a business that essentially had three, sort of three legs to the stool basically, three components to the strategy, one which is biggest activities would provide tools to oncologists and other specialty practices.

That has now expanded.

A second part of the stool that is really supporting the payer community with products and services.

The third, which is an area in which we had this loss of business, was really in what I call marketing services to biopharma.

Here's what we've seen.

We are really pleased with the progress in our tools to support the provider community.

Those tools now include a much more robust position in the distribution of Specialty and you can see that's an area where we've had particular focus and particular growth.

And we also, if you remember, it was an area in which we got off to a pretty slow start.

Really pleased to see that momentum.

I think our work with the payer community, particularly around -- is actually very interesting and I think is quite innovative in that area.

As you look at the biopharmaceutical services we feel it's not a large customer base.

And so in this case, where we lost some business from a customer, we could actually feel it, because it's a relatively high margin business.

So that's sort of how I'll describe where we are.

I'm really pleased at the evolution of the team.

We've got some just terrific talent in that group.

I think the kinds of innovative approaches that we're taking to the market, recognizing that this is a world undergoing a lot of changes, is pretty exciting to us.

So it's been a little bit of a mixed bag.

And I hope we've been pretty transparent about which parts have been going well, which parts have been more challenging and the progress.

But I'm really looking forward to the future with that business.

Great.

Thanks for all the details.

You're welcome.

John Kreger, William Blair.

Thanks very much.

Just a quick follow-up to Bob's question on Specialty.

George, would you be willing, given the puts and takes, just to size that business if we think about '13 and beyond?

No, I'm sorry, John, at this point, we've got to keep this in the perspective of the segment and these report in as part of the Pharmaceutical segment.

As I said in the overall mix, this is still a relatively small business.

Got it.

And then a similar question, it sounds like the top line growth in Specialty improved sequentially.

How about the profit growth in the business?

How is that doing?

Well, I think again, the profit growth in this particular case was hampered significantly by the loss of the time margin, sort of consulting marketing services part of the business.

If you think about '13, can we assume that profit growth and revenue growth in Specialty should be pretty comparable?

You know, as we continue to ramp -- this is Jeff, by the way, John.

Thanks for the question.

As we continue to ramp up the distribution business, I think we feel very good about the revenue outlook for Specialty.

However, I think due to the loss of this unique customer, probably the margin dollars will be somewhat challenged for the next 12 months or so, as we work to replace that business and as the other parts of the business continue to grow.

Great.

Thanks much.

You're welcome.

Stephen Valiquette, UBS.

Thanks.

Good morning, George and Jeff.

Apologize for the voice here.

I'm a little bit sick today.

But just in relation to the DEA, I'm assuming there's some additional operational costs you're incurring to use the backup facility in Mississippi.

So I'm wondering, is that material and quantifiable, or is that just really so tiny, it doesn't matter?

Just trying to get a little more color on that.

Thanks.

Yes, Steve.

Sorry you're not feeling well.

This is Jeff.

The incremental operational cost was included in the $4 million of incremental costs that I described earlier.

That $4 million is composed of legal fees, other outside consulting fees, additional compliance costs, and incremental transportation costs.

So it's a portion of that $4 million.

Okay.

I thought that was just legal.

Got it.

All right.

Thanks.

Okay.

Glen Santangelo, Credit Suisse.

Okay thanks.

And good morning, guys.

I just wanted to ask about the 4Q, the implied 4Q guidance.

If you're kind of telling us that you swallowed an incremental 3 pennies this quarter in the DEA and in the nuclear business, it kind of makes results obviously look that much better than if you look at the sequential decline in earnings power you're now expecting in 4Q, it just kind of doesn't make sense.

So I'm kind of curious outside of the obvious, some of the key generics losing their exclusivities.

Is there anything in particular that you want to call out for 4Q that will be a headwind that maybe we're not thinking about?

Yes, thanks, Glen.

I'm looking forward to the day when someone actually gets your name right when they introduce you.

You and me both.

You know, first of all, let's put things in perspective.

Based on the range of guidance that we've given for the year, you know, that implies that EPS growth rate in Q4, somewhere between low to mid teens to low 20s.

And -- which I would still describe as a pretty robust rate of growth.

I would also say that traditionally, Q3 -- in terms of sequential dollars, Q3 has always been our strongest quarter traditionally.

And that remains the case.

So one would naturally expect Q4 to be sequentially lower.

And then on the one-timers you described, I would agree that nuclear was somewhat unique to Q3, but I wouldn't describe the DEA issue necessarily as being unique to Q3.

Most of those costs are continuing this quarter up until today, and absent some sort of resolution, will continue.

But, just stepping back and sort of talking about what are some of the major drivers of what would drive a sequential decline in dollars from Q3 to Q4, and again, some of this is quite typical.

For example, by margin decline, I would describe that as sort of our typical seasonal pattern that we see most years.

I also expect the tax rate to return to a nor normalized level in Q4.

The Q3 rate was somewhat low for the reasons I described.

You know, third issue is the one you referenced.

With Lipitor, Zyprexa coming off exclusivity, we do expect those to start deflating and that should have an impact on some of our generic dollars.

And then the final issue we've talked about is the impact is the Specialty loss of business with one customer.

That happened during Q3.

We'll feel the full impact of that in Q4.

Those are the things I would point to.

But again, I would come back to the point that our guidance implies teens to low 20s growth in EPS.

Okay, and Jeff, maybe if I could just ask one follow-up then.

Obviously reported a couple quarters in a row here of decent upside, but yet the quarters didn't have any share repurchase in it the past two quarters.

So, what's your thought there given the remaining $450 million on the authorization?

I mean, when do you expect to start to get active on that front again?

Yes, I think it's a great question.

But as you know, we would never telegraph exactly if and when we were going to be repurchasing shares.

But I will say, it's always an option, right.

We do have that $450 million left.

We do intend to be opportunistic about it, and depending on market conditions and us having an available window to purchase, et cetera, I think it's an option at any point.

Okay.

So there's no debt maturities or there's no reason you're taking your leverage down or anything along those lines.

You're just kind of waiting to be opportunistic?

No, correct.

We have no intention of changing our debt level at this point, or reducing our debt level at this point.

Let me put it that way.

So, no, it's really just a matter of being opportunistic and flexible.

Okay.

Thank you.

Thanks.

Charles Rhyee, Cowen & Company.

Thanks.

Most of my questions have been answered.

Just maybe a couple of clarifications.

Jeff, you kind of said on the Medical, when we think about the expenses versus benefits, you said for fiscal '13, we're going to have the full depreciation, plus the ongoing annual costs, but you said the benefit should exceed the annual costs.

But is that to say that it doesn't exceed both that and the depreciation?

No, when I was referring to annual costs, I was including depreciation in that.

Okay.

So still our net benefit in '13 is positive.

Correct.

Okay, and then in terms of the commodity headwind, you said $5 million to $15 million, right?

That's correct.

Okay.

As we think about the distribution though through the year, is it fair to think that we're looking at sort of a net benefit in the first half of '13, but that maybe turns a little bit more to headwind in the back half of '13 and then we net out $5 million to $15 million headwind.

I don't want to get too specific at this point until we work through our final budget.

And quite honestly, it's really only the first three months or so that we have really good visibility into it, so we're basing the rest of year off of forward range, et cetera, right now.

So I don't want to get too specific about the seasonal pattern at this point.

I think I would just leave it at the overall annual impact of $5 million to $15 million.

And probably as we get to August, we'll give a little bit more detail in terms of quarterly pattern in that regard.

Okay, and then maybe the last question, just going back to P4 here, so the contract that you guys lost, can you talk about what occurred that made the contract move here or that P4 lost it, and does the marketing, sort of the consulting side of the business, remain important to the Specialty strategy?

Yes, Charles, so again, I'm not going to be able to share it.

We didn't actually -- we lost business with a customer, so we didn't lose a customer.

We lost business with a customer.

It just happened to be high margin business and as I said, it's sort of, we're at that stage where you can feel this kind of bump.

I would say right now that the marketing services are still a part of the strategy.

I think Meg and team continue to really look at the areas of greatest potential for us.

We are, in some ways, we have a disadvantage in being a little bit of a smaller business.

And we have the advantage of being a smaller business, which is that we can do a lot of course correction and forward-looking thinking about how to evolve this business.

So, just remember that we've actually picked up a fair amount of new business in Specialty, but the margin impact of the loss of this part of this customer's business was meaningful.

Okay.

That's helpful.

Thanks a lot, guys.

Okay.

Thanks, Charles.

John Ransom, Raymond James.

Good morning.

Well, Glen stole my clever question about 4Q.

My other question is, if we step back and look at the business, and I'm talking about the distribution business, over say the intermediate term, let's say we're in a world where 85% of the drugs have gone generic and that calendar slows down and we're in a deflation cycle.

In your mind, George, what does the profit picture look like for the business intermediate term?

Or are we just kind of stuck in a profit deflation cycle and you've got to be clever with using your capital and continue to diversify around other businesses?

Hi John, first of all, good morning.

I wouldn't say we're stuck in a profit deflation cycle.

We will see cyclical pricing on generics, which certainly affect the business.

But by and large, our generic business through the cycle is growing.

The profit that comes from that business is meaningful, continues to be meaningful, and so much of this has to do with the way we run the program.

It has to do with our ability to penetrate accounts, our sourcing models, our ability to use scale.

And so, yes, so I wouldn't translate the, necessarily the deflation of the products as they come out of exclusivity to a long-term sense of stagnation.

That's not the way I see it.

Okay.

Thank you.

You're welcome.

Thank you.

And with no further questions in queue, I would like to turn the conference back over to George Barrett for any closing remarks.

Thank you all for joining us this morning.

We're excited to have reported another solid quarter and we look forward to talking with you again in the coming weeks, and certainly we'll see you over the coming meetings that Sally referenced.

Thanks.

Ladies and gentlemen, thank you for your participation in today's conference.

This does conclude the program and you may all disconnect.

Have a great rest of the day.