Cardinal Health Inc CAH
Q2 2012 Earnings Call Transcript
Transcript Call Date 02/02/2012

Operator: Good morning, ladies and gentlemen, and welcome to the Second Quarter 2012 Cardinal Health, Incorporate Earnings Conference Call. My name is Chris and I will be your conference moderator for today. Presently, all participants are in a listen-only mode. Later, we will facilitate a question-and-answer session.

As a reminder, this conference is being recorded for replay purposes.

At this time, I would now like to turn the conference over to your presenter for today, Ms. Sally Curley, Senior Vice President of Investor Relations. Ma'am you may proceed.

Sally J. Curley - SVP, IR: Thank you, and welcome to Cardinal Health's second quarter fiscal 2012 conference call. Today, we will be making forward-looking statements. The matters addressed in these statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected or implied. Please refer to 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'd also like to remind you of a few upcoming investment conferences and events in which we will be webcasting; notably, the UBS Global Healthcare Services Conference on February 8th, the Leerink Swann 2012 Global Healthcare Conference on February 16th, Citigroup 2012 Global Healthcare Conference on February 27th, the Cowen and Company 32nd Annual Health Care Conference on March 5th, the Raymond James 33rd Institutional Investors Conference on March 6th, and the Barclays Capital Global Healthcare Conference on March 14th. The details of these events are or will be posted on IR section of our website at cardinal.com. So, please make sure to visit the site often for updated information. We look forward to seeing you at one of these upcoming events.

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

George S. Barrett - Chairman and CEO: Thanks Sally. Good morning, everyone, and thanks to all of you for joining us on our second quarter call. We are now half way through our 2012 fiscal year, and I am pleased to report a solid second quarter performance. We continue to make excellent progress on activities that will benefit the near, mid and long term. Revenue for the second quarter was $27.1 billion, up 7% from the prior year. Non-GAAP operating earnings increased by 21% to $475 million. Our non-GAAP EPS grew 11% to $0.81 from last year's $0.73, which benefited from a lower than usual tax rate. The earnings improvement reflects continued margin expansion across our business. This continues to be a priority of ours and our margin improvement is a result of disciplined approach to product and customer mix as well as overall efficiency improvements.

Our Pharmaceutical segment continued its momentum and delivered a terrific performance, 30% profit growth on a revenue gain of 6%. The Medical segment achieved top line growth of 9% demonstrating good progress but as expected recorded a year-over-year profit decline of 18%, primarily due to residual commodity cost pressures. Overall, our growth initiatives continued to gain momentum and our recent acquisition are yielding results at or above target.

Now, let me provide some color on each segment's performance in the quarter. The 30% Pharmaceutical segment profit growth was driven primarily by our Pharmaceutical Distribution business. Strong generic performance, solid execution under our manufacturer agreements and contributions from the Kinray and Cardinal Health China acquisitions resulted in a 29 basis point margin expansion. To provide a bit more detail, our generic revenues grew by 17% versus the prior year. As you know, this quarter saw the generic launches of a number of major branded pharmaceuticals, in particular, the launches of the generic equivalents to Lipitor and Zyprexa occurred in the period with financial contributions largely as planned. Our generics team did an excellent job in preparing for what turned out to be a very complicated launch scenario and executed well for our customers. We've now lapped the earmark for Kinray in last year's acquisition in the retail independent pharmacy space and our integration is complete. We were very pleased with the performance this quarter and we continue to see the positive impact of Kinray on both our customer and product mix.

Innovation continues to be a high priority for organization. BarCode360 launch during this quarter is a great example. This barcode administration solution supports hospitals' medication safety initiatives by making it easier, timelier, and more cost-effective to order medications. It also ensures that more unit-dose medications can be scanned at the patient bedside.

Moving to nuclear, our team continues to do a terrific job serving our customers in this high touch business. That said, sluggish utilization in low energy cardiac imaging had negatively affected our top and bottom line in this space. However, we continue to see solid progress in positron emission tomography or PET sales.

As I noted last quarter, we are moving into more key U.S. markets with three new PET manufacturing facilities targeted to open this fiscal year, and we look forward with promise to the potential for several launches of new biomarkers for cancer and Alzheimer's from our biopharmaceutical partners.

The Specialty Solutions group delivered revenue increase of 37% for the quarter, driven by our provider distribution services. Over $100 million in revenue growth was generated from new and existing distribution customers. We also signed another $100 million in annualized distribution revenues including a new oncology customer cCARE, the California Cancer Associates for Research and Excellence, a rapidly expanding group in that state.

On the payor side, we remain very encouraged by key customer wins that will impact future growth, including a partnership with CareFirst BlueCross BlueShield to add rheumatoid to its P4 clinical pathways program. We are excited about our specialty model which work at the intersection of the biopharmaceutical companies, the payors and most important, the providers.

Turning to our Medical segment, solid revenue growth of 9% for the Medical segment was achieved primarily through increased sales to both new and existing customer. We believe this is a strong validation of our value proposition. Customers are seeking new ways to compete in a shifting healthcare landscape and we continue to create unique solutions to support them.

As noted earlier, the Medical segment operating profit declined as expected, negatively affected by the challenges of the anticipated higher year-over-year commodity costs and the investments in information systems associated with our Medical Business Transformation or MBT initiative. Our investment in MBT has moved to an important stage. The second quarter pilot went very well and we are ready for a national rollout in this current quarter.

We feel very confident that this effort will allow us to reduce complexity for our customers while enabling us to take cost and working capital out of the system.

The business fundamentals of the Medical segment remained solid and we were pleased with the strong contributions in the second quarter from our strategic focus areas. The growth of our preferred products, which includes both Cardinal Health branded and select national brands continues to outpace the restaurant of our product portfolio and make a positive impact on segment margin rates.

Cardinal Health branded product revenues grew at a double-digit rate during the quarter, driven by the strength of patient care, surgical, and kitting products and above planned new product launches. Our national brand portfolio also reported good results.

From a channel perspective, ambulatory care growth was again in double digits outpacing the market. We saw particularly strong results from our surgery center team.

Our Canadian Medical Surgical business had another strong quarter, with revenues increasing by close to 8%. Jeff will provide some additional color on Cardinal Health China, but let me just make a few comments here. The integration has done extremely well. We have opened two new state-of-the-art distribution centers in Shanghai and Beijing. We expect to complete about $90 million in acquisitions in China this fiscal year to enhance our geographic coverage and local direct distribution business. We are developing a platform in China not only for pharmaceutical partners but also for other global companies who seek to build the business in China for their medical products, lab equipment and other supplies, so the outlook is very encouraging.

Finally, it's always great to receive positive customer recognition for the work we do to serve them. In November, Gartner released their 2011 Healthcare Supply Chain Top 25, which is the survey process to identify organizations that enable high-quality patient care at optimal economic cost. I am pleased to report that Cardinal Health was rated number one in this survey. We were recognized as a Company that is working collaboratively toward common goals in care and cost improvement.

As we look to the back half of the year, we continue to watch several market and macroeconomic trends, which influenced our second half performance and our perspective on the full year. Jeff will elaborate on these factors during his remarks.

(Indiscernible) include relatively soft healthcare utilization rates and continued residual commodity cost pressures. Based on what we see today and our first half performance, we are tightening and slightly raising our non-GAAP EPS guidance range from $3.04 to $3.19 to a new range of $3.10 to $3.20.

In summary, I'm encouraged with the performance of our business these past six months and the progress we made on our strategic initiatives. Healthcare is an exciting place to be and one experiencing powerful forces. We're positioned well in this environment, and we will continue to innovate and adapt as these forces play out.

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

Jeff Henderson - CFO: Thanks, George, and hello everyone. I'm happy to be discussing another quarter of strong results. I'll begin my remarks today by expanding on some financial trends and drivers in the second quarter. And then I'll touch briefly on our updated fiscal 2012 guidance.

Let's start with Slide 4. During the quarter, we grew our non-GAAP EPS by 11% to $0.81 per share driven by 7% revenue and 21% non-GAAP operating earnings growth. Looking specifically at revenue, even if you exclude the year-on-year impact of the midyear fiscal 2011 acquisitions which contributed about 4.1 percentage points, underlying sales are growing well driven by increased volume from existing and net new customers for both segments. Although non-GAAP operating expenses were 6%, more than half of this growth represents expenses added through the aforementioned acquisitions, with a sizable portion of the remainder related to planned business system investments.

Consolidated gross margin and non-GAAP operating margin rates continue to increase year-on-year, up 19 and 21 basis points, respectively. Interest and other expenses came in $8 million higher than last year driven by changes in the value of our deferred compensation plan. Our non-GAAP tax rate for the quarter was 37.8% versus an abnormally low at 32% last year. Tax rate this quarter included unfavorable net discrete items of $5 million, driven by state tax items versus a net favorable $17 million in the prior year.

Finally, favorability in our share count versus last year was driven by the $300 million of share buybacks we completed in Q1. Our share count in Q2 was about 349 million diluted average shares outstanding versus 351 million in the prior year's quarter. I would like to point out that our FY '12 share count guidance remains at approximately 352 million shares. As a reminder, this higher share account forecast is driven by certain assumptions such as the impact of share price on the dilution calculation and exercising of options.

Now, let me comment on consolidated cash flow and the balance sheet. Operating cash flow for the quarter was a use of $114 million, driven by normal and anticipated year-end working capital demands and the impact of large customer ordering patterns. Year-to-date operating cash flow of approximately $400 million is still slightly ahead of where we were at this point the last year. Overall, our networking capital days end of the quarter at 8.8 days versus 8.4 in the prior year, driven by a slight variance in days payable.

We ended Q2 with approximately $1.8 billion in cash, of which approximately $300 million is held overseas. This cash balance does not include our investments in held-to-maturity fixed-income securities, which are classified as other assets on our balance sheet and totaled approximately $100 million at quarter end.

Now, let's move to Q2 segment performance referring primarily to Slides 5 and 6 and starting with the Pharma segment. Revenue in the segment increased 6.5% with the China and Kinray acquisitions we completed in the prior year's quarter contributing 4.4 percentage points to this growth rate. Let me walk through a few of the other drivers. In the Pharmaceutical Distribution business, growth in existing and new customers was a strong driver. Non-bulk sales specifically were up 14.8% for the quarter.

As George mentioned, our Specialty Solutions business continues to progress growing revenue in this quarter at 37%. Our nuclear business continues to be challenged by the lower energy market volume softness that we described last quarter. As you would expect, we are taking actions within this business in the areas of contracting strategies, network and sourcing efficiency, and expense management to mitigate the impact of this demand softness. It is possible that one of these initiatives may result in the inventory write-off or other impacts later this year, the majority of which will likely be in the third quarter. Any likely range for that expense is reflected in our guidance.

As George mentioned, we remain excited about growth opportunities on the positron emission tomography side of the business, where we grew our doses per day, one of the key performance indicators we track internally, by more than 8% compared to the prior year.

Pharma segment profit margin rate increased by a noteworthy 29 basis points compared to the prior year's Q2, in part reflecting a continued mix shift towards non-bulk. Further, we saw margin expansion in each of the (classified) trade that we track within the Pharma Distribution Business.

We continue to see significant contribution from the ongoing success of our generics programs, including the favorable impact of generic new item launches with both Zyprexa and Lipitor contributing strongly. As an aside related to generic deflation, we did benefit from inflation on a few specific generic products in Q2, which helped to moderate the overall deflation rate to a level that was better than our expectations for the quarter.

Performance under manufacturer agreements both brand and generic was a positive driver in the quarter. Some of this variance was driven by timing of price increases, including one that we view as a pull head from Q3 as well as sizeable increases for our few specific products that we view as somewhat atypical. We also continue to see strong contribution from the Kinray and China acquisitions. As we have now lapped both of these deals, this is the last time we plan to provide a breakout of the combined impact. But the benefit of segment profit in Q2 is estimated a little less than 13 percentage points in total from both acquisitions.

In summary, the Pharma segment had another excellent quarter, resulting in a 30% increase in segment profit to $394 million.

Now, turning our Medical segment. For the quarter, revenue increased by 9.4% to $2.4 billion driven by increased sales to customers across all channels.

Let me highlight a few items driving this result. Volume from net customer wins was again positive this quarter. We saw another good increase in revenue for our preferred products. As we have highlighted in the past, this is a key growth and margin expansion opportunity for us. Our ambulatory business, another important focus areas for us also had another strong quarter, with a 11% revenue growth.

Consistent with the last quarter, we also had a couple of unique items, which contributed to reported revenue growth that I want to quantify once again. First is the ongoing effect of having transitioned our business with CareFusion to traditional branded distribution model, a move that we highlighted in our Q3 earnings call last year. This change added 2 percentage points or $44 million to revenue.

Second item is the impact of the refinement we made in the way we report results for our international commercial operations, which I discussed in detail on last quarter's call. This change also contributed 2 percentage points to the Medical segment revenue growth rate in the quarter while having a relatively insignificant impact on segment profit growth.

Now turning to Medical segment profit, which as we expected heading into the quarter declined 18% to $85 million, driven by the negative impact of commodity prices. Specifically, commodity prices impacted our current period cost of products sold by $23 million versus last year. For the full year, we are still expecting a headwind of approximately $70 million, as favorable price movements in cotton and latex since the last call have largely been offset by unfavorable oil and oil derivative trends. The remaining negative impact in the second half we estimate approximately $20 million will be felt in Q3.

As a reminder, due to the lagging effect 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.

We saw approximately $5 million of negative impact from foreign currency movements this quarter, roughly the same amount we saw in Q1 and in line with our expectations. Additionally, we increased our investments in information systems which affected the year-over-year expense comparison in the quarter. In this regard, I'm pleased to report that we are nearing the national implementation of our Medical Business Transformation during Q3. As we said in the past, we expect meaningful margin accretion from this project beginning in fiscal 2013. But I'd like to remind you that since most of our attention in the coming months will be on ensuring a successful launch, we are not assuming much in fiscal '12 and segment results will be dampened in the back half of the year as we begin to depreciate these assets and incur incremental project spend associated with the national implementation.

Specifically, we expect over $15 million of negative expense impact versus prior year in the second half, with the majority of this in Q3 as we implement and ensure a smooth rollout post-launch. But again, we expect the benefits of this project to more than outweigh the depreciation expense next year. Partially offsetting the effect of these negative items was the positive margin benefit of increasing our sales of preferred products as well the impact of increased volume to existing and net new customers.

Given the masking impact of commodity costs this year we thought it'd be helpful to share some of the key metrics we track internally to measure progress in the Medical segment. Let's start with revenue growth and net customer wins. Even adjusting for unique items like the CareFusion switch and the international reporting change, core sales growth was in the mid single-digits in both the first and second quarter and is expected to be at that rate for the full year.

Net customer wins have been positive each quarter so far this year and again, are expected to be so for the full fiscal '12. One related point in this regard is that we've been informed that the transition to the expanded Department of Defense MedSurg contract that was awarded to us last year have been delayed by the Department of Defense until May due to their systems change pushing out any impact out of Q3.

Moving on to the growth of preferred products, sales of Cardinal Health branded products specifically grew 12% in Q2, and are expected to grow at least high single-digits for the year. And finally, ambulatory growth, despite reports of sluggish and choppy trends to physician office visits, our ambulatory business grew at 11% in Q2 and has been outgrowing the market for at least 10 quarters now. So, in summary, we are closely tracking the progress of our Medical strategy and remain excited about where the future is heading.

Now, I'd like to spend a few minutes discussing Cardinal Health China. Our revenue in China was again very strong, and in particular, we continue to see exceptional growth from our local direct distribution business, which grew its revenue by 37% during the quarter. By the end of Q3, we will have expanded to 10 distribution centers sites in China and our service area will cover more than 250 million people. We also continue to move forward in our evaluation and piloting of opportunities in other areas, such as consumer healthcare products for retail pharmacies, direct to patient specialty distribution, diagnostics and lab supplies, and medical device distribution. In summary, Cardinal Health China continues to perform well, and we are very optimistic about its future.

Let's turn to Slide 7 which I'll just summarize. In total, GAAP results in the quarter included items that had negative $0.05 per share net after-tax impact, primarily from the exclusion of $0.03 of amortization of acquisition-related intangible assets from our non-GAAP results. This compares to a negative $0.12 net impact in our GAAP results last year, mostly driven by $0.08 in acquisition-related costs.

Now, let me briefly comment on our fiscal 2012 full year outlook. Following our strong first half results, we are both tightening and raising our non-GAAP EPS guidance to a range of $3.10 to $3.20.

Our other assumptions on Slide 9 and 10 remain largely consistent with our prior guidance. This new range also encompasses our forecast for some key factors including generic launch timing and value, generic deflation, branded price increases, a LIFO charge which could be up to $25 million and any anticipated impact on our results from the Express Scripts and Walgreens situation.

While we generally don't provide quarterly guidance, I did want to make some directional comments about the shape of the second half of this fiscal year. Base on our $3.10 to $3.20 guidance range and our best estimate of timing of the events, we anticipate the Q3 EPS growth rate versus last year to be in the mid to high single digits. Keep in mind, that many of the drivers that result in this growth pattern were referenced by me earlier in my discussion. But I would be happy to answer any further questions on it during our Q&A.

To close, let me reiterate, this is a very solid quarter. I am very pleased with our first half results. We've continued to execute well across both our base business and on key strategic growth drivers. And we remain well-positioned to deliver value to our shareholders.

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

Transcript Call Date 02/02/2012

Operator: Glen Santangelo, Credit Suisse.

Glen Santangelo - Credit Suisse: I just had a couple of quick questions about the MBT, the business transformation. Jeff if I heard you correctly, you said that you expect to spend about 50 million in the back half of the year with the bulk of that kind of slated towards the 3rd quarter. I guess my question is, how has that number been trending over the past several quarters? Are you increasing the spending rate, or is that kind of about level with where it is? And then, should we assume that at the end of fiscal '12 that basically run rate is spending stops and we start to see the margin lift right in fiscal '13?

George S. Barrett - Chairman and CEO: Jeff, why don't you take that?

Jeff Henderson - CFO: So just to be clear that was 15.

Glen Santangelo - Credit Suisse: 15, okay.

Jeff Henderson - CFO: But, yeah, that is the higher run rate that what we saw in Q1 and Q2 of this year, and that's for two reasons. Number one, since we are going live with the national implementation this quarter, we begin depreciating the assets, so that begin flowing through our income statement. But on top of that, as we get towards the end of any project like this, you actually do incur a fair amount of expense as you've finalized the training and develop continuously plans for the go-live and ensure stabilization once you've rolled out the implementation. So the run rate that we will see in Q3 and Q4 will probably be the highest expense run rate that we've seen for the project and higher than Q1 and Q2. Now once we get through the end of this year, all the project limitations spend largely goes away. Clearly, we still have the ongoing depreciation, but the benefits that we expect to realize in the project really kick in beginning in Q1 and then ramp up. And as I said during my prepared remarks, they will more than offset any ongoing depreciation that we have from the implementation.

Glen Santangelo - Credit Suisse: If I could ask George one follow-up with respect to generic pricing. You seem suggest that there were a few generics. We actually saw price increases, which moderated the overall rated deflation. Could you just kind of maybe give us any type of quantification for that? And if you think the current, what's driving the current trend and the sustainability of the current trend?

George S. Barrett - Chairman and CEO: I won't be able to quantify this for you, but I can sort of just give you a little bit of color on it. I think the way you characterize it is right. We would say that generic deflation has been somewhat favorable and this is really largely by a subset of what is this enormous multi-thousand product portfolio of generic drugs. So what we saw we in this subset, in some product we saw lower deflation, in some products we actually saw price increases and that's really driving the shift. So, as to what causes it, it is sort of a good question and a hard one to answer. Some of this is probably a little bit event driven in that that's disruption of supply through parts of the system have had some impact on pricing. I think there is probably little doubt about that. The question is, is it sustainable? It's a hard one to know because it's hard to know exactly what behavior would be. What I would say is this that the characteristics that are driving some of the supply disruptions, some of the shortages, those continue to persist for the moment. So, on that I would say whether I would go and predict market behavior at this point, I'm not that comfortable doing that. But I would say that to the extent that some of this is driven a little bit by the supply disruptions and some of the shortages that that may persist.

Operator: Ross Muken, Deutsche Bank.

Ross Muken - Deutsche Bank: Obviously, we've got a lot of moving parts in the Medical business at the moment and Glen touched on some of the investment. I mean, George, relative to the plan you laid out 18 to 24 months ago for the reinvigoration of this business, where do you feel like you've sort of hit plan, where do you feel like you've overachieved, where do you feel like there is still quite a bit of room to go?

George S. Barrett - Chairman and CEO: Yeah. Good morning, Ross. So, here's what I'd say. If we go back two years ago and we look at the various components driving our business, the reorganization around category management, the focus on preferred product, the general efficiencies that we are going to be looking at as we reorganize our focus on growing our ambulatory setting, I would say, those are all encouraging signs. The part that we probably didn't model well was what would happen with oil prices and flood in Thailand that would affect our cotton prices this past year. So, again that's not in any way to make excuses, but those are the unplanned ones for us, but I would say in terms of the things that we control, I feel pretty good that the progress that we are making is solid. We measure them. We've got, I think, good lead indicators. Our market progress in terms of overall share and retention and wins feels good. So I think I'm encouraged that we are on the right path. I'd be very happy to see the commodity situation stabilize.

Ross Muken - Deutsche Bank: Maybe Jeff, was there anything in the guidance relative to sort of future, and I know you haven't enclosed it yet, and I know, it's relatively small, but I was just curious if there was any assumption on Medical from contribution there.

Jeff Henderson - CFO: Good question, Ross and there isn't. We don't reflect in our guidance any deals that haven't closed. So, there is nothing reflected for (future meds).

Operator: A.J. Rice, Susquehanna Financial.

A.J. Rice - Susquehanna Financial Group: Just on, obviously, you had some new customer wins in both segments that you've been commenting on for several quarter now. Can you just maybe step back and comment on the competitive landscape and where are you picking up those customer wins potentially?

George S. Barrett - Chairman and CEO: This is always a hard one to answer because we have got so many activities and businesses and markets. You know this is a – business by business it varies. I think our largest business in Pharmaceutical Distribution is as always a competitive market, but I think we're competing effectively. We've been able to, I think, bolster our share in the community pharmacy and the independent pharmacy space. We have had some encouraging signs in the chain world, in the retail chain world and I think we've done well in the institutional areas and hospitals and in ambulatory settings. So I think in general we feel a pretty encouraging sign across the board. Medical business is – again, these are all competitive businesses, but I think as you saw from our revenue numbers, the growth of 9% in our Medical that we're making some good progress there. So I would say generally speaking rather than be specific about any individual talent, I feel like we've got some sense of momentum and a pretty effective value proposition, a good market position throughout most of our businesses.

A.J. Rice - Susquehanna Financial Group: Then (indiscernible) other follow-up question. You guys did raise the point about trying to bake in some expectations around the Walgreens, Express dispute. Is there anything more? I know it is a sensitive topic, but is there anything more that you can say about how it's impacting your performance and how you think it might in the second half?

George S. Barrett - Chairman and CEO: Yeah, other than to say that our guidance sort of encapsulates all our thinking, as you can imagine, it's probably best for the parties to speak directly about how this issue may or may not have affected them. So I think it is better for us to just leave that one alone for the moment.

Operator: Thomas Gallucci, Lazard Capital Markets.

Thomas Gallucci - Lazard Capital Markets: Just first one was a clarification Jeff for a nuclear and that's sort of in the guidance, and I assume that's part of a little lower growth in the third quarter versus let's say the fourth quarter that you talked about?

Jeff Henderson - CFO: Tom, we lost you for a few seconds there during a question. Would you mind repeating it please?

Thomas Gallucci - Lazard Capital Markets: Just first one was a clarification on the nuclear. You said Jeff that there may be write-off in the quarter on inventory, and that's in the guidance and that's sort of also part of your commentary on the moderate EPS growth that you expect in the period?

Jeff Henderson - CFO: It's possibility that there could be a write-off as a result of some of the actions that we're taking Tom. Yes, that's reflected and likely range for that is reflected in our guidance. And yes, that's part of the Q3 specifics that I provide.

Thomas Gallucci - Lazard Capital Markets: You care to roughly size it if it would happen or not at this point?

Jeff Henderson - CFO: We are still working through and as I said, it's still a possibility for us not certain, but could it be $0A.02 to $0.03, yeah, but we're still working through exactly what it will look like, and if in fact it will occur, but if it does, it could be up to that sort of range.

Operator: Robert Jones, Goldman Sachs.

Robert Jones - Goldman Sachs: On the Medical side, I was wondering if you guys could comment a little bit on with respect to the trend of IDNs growing through acquisition of physician practices. You obviously have unique advantage point distributing both on the acute and the ambulatory side. Are you getting more requests from these IDNs to help distribute across these wider networks as they grow?

George S. Barrett - Chairman and CEO: Yeah, I'd say this, we have certainly seen a general trend toward IDNs looking to acquire or affiliate in some ways with physicians practices. Although as you probably know this varies a little bit specialty area. So, yeah, I think in general this plays to our historical strength in the IDN and this is probably helpful to us in many ways. Having said that, I would acknowledge that we still do hear from some physicians that they like to practice in the community setting and they believe that this is an excellent way to deliver care. So, we still see a robust community setting, but I think the general trend that you're describing is probably one that we would echo.

Robert Jones - Goldman Sachs: Then just a follow-up on a different topic. This morning Walgreens announced they will try to be acquiring some of the specialty pharmacy and mail service assets from BioScrip. Can you just remind us of your relationship with Walgreens on the mail and specialty sides?

George S. Barrett - Chairman and CEO: Yeah, so I think what I can say is we are a supplier (or we've ever) publicly disclosed is that we are a significant supplier to Walgreens and I think that's probably covered in our public documents and probably that's what we can say at this point.

Operator: Lisa Gill, JPMorgan.

Lisa Gill - JPMorgan: I think that Jeff you made a comment that direct store sales grew 14.8% in the quarter. Did I get that number correct, number one? Then number two, can you just help me understand what it looks like on a same store sales basis? If we look over especially this quarter, I think across the distribution channel all three drug distributors have grown faster than expected. So, can you maybe help us understand where that growth is coming if it's not coming from competitors?

Jeff Henderson - CFO: Sure Lisa. This is Jeff. Yeah, we said that non-bulk sales in the Pharma segment grew 14.8% in the quarter. I would say probably same store sales is lower single-digits. But on top of that, we have two significant wins that we have publicly announced previously and that was picking up both the Duane Reade and the (Longs) business. So, clearly, that helped the growth rate as well. I think the Kinray acquisition and the China acquisitions also contributed to that. Without Kinray, just to provide you some data, the non-bulk growth rate is about 8.3%.

Lisa Gill - JPMorgan: Then as a follow-up, maybe George, can you talk to us about capital deployment. I think, you mentioned today you have $300 million outside of the U.S., talking about $90 million additional acquisitions in China. But how should we think about capital deployment over the next 12 months?

George S. Barrett - Chairman and CEO: Yeah. Good morning Lisa. I'm not sure that we would probably alter our perspective on that versus what we've said fairly recently. We really are looking at this in a balanced way. You know that we continue to believe that the dividend is important part of our story to our shareholders and our value creation. We are always looking for the opportunity to strengthen our strategic positioning as a business and enhance the growth rates for our business, and to the extent that we fund those opportunities, we are always ready to deploy capital in that area. Having said that, other than those things that we've announced and our observations about China that we just made it'd be hard to give you any particular indication that there's anything particular to discuss. We've always said that we regard share buybacks as a part of the equation when we accumulate cash and that's the most effective way to deploy capital in our shareholders' interest, and of course, we have the investments and our own capital infrastructure of IT systems, everything else that we do to drive this core business. So, there's not much to share other than we probably take – I think we take a very balanced approach to looking at this, and we believe very shareholder friendly.

Jeff Henderson - CFO: Lisa, the only thing I'd add is that dividends have been and continue to be an important part of our capital deployment story going forward.

Operator: Ricky Goldwasser, Morgan Stanley.

Ricky Goldwasser - Morgan Stanley: My first question is around generics. Obviously generics drew a very impressive 17% this quarter. I think some of your competitors noted low single digit growth. Do you have a sense of what market growth was and also what percent of the generic growth is same store?

George S. Barrett - Chairman and CEO: I don't have the market growth rate in front of me and maybe as we are talking, someone will grab that for me, we are actually fairly encouraged by what's happening with our generic business. As you know, for the last couple of years, I think we are making good progress. That's both in terms of I think same store sales in effect or same company sales where we are doing better with each of our accounts. I think we've been more and more effective with each launch. I think that the distribution of our business and the mix of our business is actually favorable to the progress of our generic business and I think we are just doing a more effective job as a global sourcer of generic products. So we generally speaking have been able to outgrow the market and feel pretty encouraged by that.

Jeff Henderson - CFO: Ricky, on the market growth, our best estimates are that both script and probably dollars growth for generics were in the lower single digits value. Clearly, we did much better in that which I think continues to reflect the performance that we've had in improving our generics sales over the past couple of years. Obviously it also reflects the Kinray acquisition in the second quarter as well and again keep in mind that Kinray came into our books very late in the second quarter of fiscal '11.

Ricky Goldwasser - Morgan Stanley: And then just clarification on the Q3 guidance, it just seems based on the fact that you raised guidance for the year that this year you might have miss of the seasonality or between the March quarter and the June quarter. When I was just doing back of the envelop I get to around, as you said, high single digit growth for third quarter which would imply kind of like 20 plus range for the fourth quarter on a year-over-year basis. So can you just clarify that and is there anything that I am missing here and kind of like the headwinds versus tailwinds in the last two quarters of the year?

Jeff Henderson - CFO: As has been happening for the past couple of years, the seasonality in our business continues to decrease over time as more and more of our brand pharma contracts go to a DSA basis. Also, I think it's true in the Medical segment, as you know, traditionally Q3 in the Medical segment has been one of our strongest ones. Again, I think some of the seasonality in that business segment has decreased over the years as well. So I guess that's point number one. Point number two, I mentioned the potential write-off of the inventory in nuclear which – the majority of which would happen in happening. So obviously that would depress Q3 somewhat as well. We also as I referred to think there was a bit of pull ahead of price increases from Q3 to Q2 this year. So I mean those are some of the thing that I would highlight, Also keep in mind that the commodity impact in Q for Medical referenced to be about $20 million in Q3, but if you sort of force out the Q4 based on the $70 million for the full year that I gave you, you can see the Q4 number will be in a – is expected to be in the single digit $1 million range for commodity impacts. So, I mean, those are all the things that I think that are affecting the distribution between Q3 and Q4.

Operator: Larry Marsh, Barclays Capital.

Larry Marsh - Barclays Capital: Just one more quick question on Medical. It seems like in (my math) the base for '12 is now slightly lower than I'd estimate with some incremental costs that you've called out. But I guess the direction for profit contribution for Medical for fiscal '13 directionally seems like you're saying you're as confident as ever that that's going to be the case. I know George you've talked about this being an extraordinary complex business proposition. So, is it a matter where you are now with the rollout that the level of confidence even around timing is extremely high and do we – is there any sort of directional timing of ramp of margin for fiscal '13 in that business that we should think of?

George S. Barrett - Chairman and CEO: Let me let Jeff at least start this one and I'll jump in because I think you're asking a little bit about margin direction.

Jeff Henderson - CFO: Right. I'll be a little bit careful here because we haven't provided fiscal '13 guidance and in particular, I'm not going to get into quarterly trends or anything. That all said, as I referred to during my prepared remarks, if you look at the underlying trends, whether it'd be ambulatory or preferred products or the soon-to-be launched the implementation of MBT, many of the key strategic initiatives that we've been investing in to drive margin expansion continue to progress very well and that's obviously very important. Then on the top line, again, good top line growth, net customer wins, again signs that bode very well for the future and really validating the value proposition that we're bringing to all of our customers acute care and ambulatory. That all said, it's a little bit early we're talking about fiscal '13 is something still have to play out and we are still watching commodity prices closely, but all I can really say is the underlying trends that we are executing on are performing well, and we feel good about them as we continue to FY'12 and prepare for '13.

George S. Barrett - Chairman and CEO: Yeah. Larry, just little to add to that other than to say this, I think, we have a game plan and are clear about those things that for us will drive value for our customers and drive margin expansion. I think we can only do them better and we are going to keep driving to push those things hard, and so hopefully we'll never be satisfied and we'll keep pushing at it.

Larry Marsh - Barclays Capital: A quick follow-up. George, one of the things you have suggested to us is that you had anticipated the profit contribution from new generic launches this fiscal year to be less than that for last fiscal year, given some of the great performance you showed last year. Is that still your view? Or given the strong results, has that been altered?

George S. Barrett - Chairman and CEO: I'm going to let Jeff start with it and I will jump in again.

Jeff Henderson - CFO: Yeah. What we've been saying is that, it would be slightly lower in fiscal '12 than we saw in fiscal '11. I think that's still the case, although probably some of that gap has been closed a little bit as we've gone through the first six months of the year, but I think slightly lower is probably still a accurate description. Honestly, there's still some big launches to come and we are only a month and a bit into Lipitor, so there's lots of the year still to play out. So, I wouldn't want to start making a far prediction too early until some of these things work themselves through.

George S. Barrett - Chairman and CEO: Yeah. Again, these things, as you know Larry, they really move throughout the course of the year. So, right at this stage, I'd say we're relatively encouraged by what we are seeing, but we'll take measure as we go through the year.

Operator: George Hill, Citigroup.

George Hill - Citigroup: Jeff, number one, you were talking about a price increase pull forward in the quarter, but can you talk about whether or not that was material and what the contribution could have been to revenue and earnings?

Jeff Henderson - CFO: One specific one I was referring to was probably worth a penny to two. So not huge in the scheme of things, but it was slightly different than our expectations.

George Hill - Citigroup: I have another (eye-doting) question. Can you talk about what organic growth in China looks like? So ex acquisitions I thought you said revenue growth in China was about 37%, but how should we think about that on same store sales basis?

Jeff Henderson - CFO: I would say it's low 20s. Let me put this way, very little acquisitions are in that 37% that I referenced. So I would say virtually all of that is the market or our ability to take share. So if that was your question what is it excluding acquisition, I would say it is very close to that 37% of LDD that I referred to. By the way, our overall growth rate in China was in the low 20s. The 37% was the local direct distribution which has been a key focus area for us. Our view of the market if that's your question is that it appears to be in the high teens right now in terms of the overall pharma market growth rate that we've seen in the last quarter or so.

George S. Barrett - Chairman and CEO: I think just to add, the pieces that we will look at are obviously the natural organic growth that we can drive through expansion of the market and market share whatever we might do through acquisitions but also building product lines. So that for us is another potential source of growth.

Operator: John Kreger, William Blair.

John Kreger - William Blair: George, if we can just go back to your comment about Specialty, I believe you said that business grew something like 37% in the quarter. Can you just talk a little bit more about what drove that? If we thought about that business in terms of income contribution, would it be around in pace. So I guess I am really asking how aggressive is pricing as you try to build that business?

George S. Barrett - Chairman and CEO: So the bulk of our revenue growth was really driven by our sort of emerging distribution business and that as you know has been the priority for us to get started as we build our relationship stat with the community practices to make sure that we can leverage that to build distribution business. So I would say that that business is actually going well. As you know, the distribution business is a lower margin than the peer services part of the business. So in a way that compresses the margin rate, but it's actually good news for us, because essentially it's all growth business, that's probably as much as I can share on, on that topic.

Jeff Henderson - CFO: The only think I'd add is that we continue to invest very aggressively in that area as well. So as we continue to show success and grow, some of that increased profitability will be put back into the business because that we want to continue to establish a platform in both oncology and other disease states that can be long-lasting, and we will continue to do that as we shall progress in the area.

John Kreger - William Blair: Quick follow-up. As you look across your businesses at healthcare utilization, are you seeing anything that surprises you over the last three or four months in terms of trending?

Jeff Henderson - CFO: Yeah, I think the only thing I can say that's surprising is sort of the volatility of the externally reported data, the choppiness of it. If you've trended out, it doesn't look all that particularly changed or dramatic, but it is choppy particularly when we look at physician's office numbers. $if you've looked at the last quarter of the year, it's very, very choppy. When you look inpatient and outpatient service, it's probably a little more stable I would say that generally speaking we're not being a material change if you sort of smooth out the lines. So it would be hard to characterize a particular trend and I wouldn't say anything particularly surprising other than the choppiness when we look at the reported physician office data.

Operator: Steven Valiquette, UBS.

Steven Valiquette - UBS: Just a question here on the branded drug inflation and on the balance sheet. I mean, I know you guys have mentioned that with fee-for-service. There is now much less opportunity for forward-buying profits, but I was just curious about the $1.4 billion increase in inventories, in particular in the quarter. I mean, that's one of the biggest jumps ever for a December quarter ahead of January price increases. So, I guess, any comments on your inventories and also just on the January brand inflation trend you're seeing year-over-year?

Jeff Henderson - CFO: Yeah, well, first of all, if your comparison is versus last year, keep in mind that we've had some pretty significant businesses that have continued to grow. Specialty has grown at a very high rate over that period, and obviously, we're building up inventory to support that. China has continued to grow the top line very aggressively, so we're building up inventory for that. Was there some inventory at the end of the year to take advantage of certain price increases? I would say that was a portion of it, but definitely not the overwhelming portion. Then we also had some – as we always do, we have unique ordering patterns at the end of – particularly at the end of calendar years as people are looking to build inventory up for the holiday season et cetera. So, the end of Q2 is always a very difficult one to both predict and quite frankly depending on the (stage) that we could end et cetera we can have a fluctuation of $200 million, $300 million, $500 million just based on unique ordering patterns. So, other than those things, I don't think there is anything particularly unique to point out.

Steven Valiquette - UBS: As far as just the brand inflation trend that we're seeing in January, any comments on that versus how that was stacking versus last year?

Jeff Henderson - CFO: We said before that we expect our fiscal '12 to be very similar to what we saw in fiscal '11 and I would say so far it's playing out almost exactly like that.

Operator: Charles Rhyee, Cowen.

Charles Rhyee - Cowen and Company: First, a quick clarification, Jeff, on the 15 incremental spend, you said part of that is start to depreciate out. Can you give us – and quantify the run rate on the depreciation part of it?

Jeff Henderson - CFO: I'm not sure I want to get that specific for just one part our business quite frankly Charles, but it's a multi-hundred million dollar project that gets depreciated over generally a five to eight-year period. So, I think you can get an idea from that what the annual run rate would be.

Charles Rhyee - Cowen and Company: Then maybe a follow-up here on China. Obviously, the business itself is growing well. It sounds like though some of the more interesting opportunities are layering on new product lines, George and Jeff, you both talked about it. Maybe can you talk about with the progress we are in terms of some of these initiatives, particularly on the medical device side and then maybe on consumer healthcare side?

George S. Barrett - Chairman and CEO: Let me start Charles, and then I'll turn it to Jeff. Our primary focus post acquisition was integration and making sure that we are driving the Pharmaceutical business – their traditional business, making sure that we are getting the right positioning in markets to right distribution network, getting the right, as Jeff said, LDD business. And so that's been the priority. What's been interesting in China is looking at these product line opportunities and some have turned out to be less exciting and some actually very exciting. So, we are just really in the early stages in some work around our medical products business. Some very interesting opportunities in the lab space, even some in more consumer activities, and Jeff can touch on that in a second. So it's been a very interesting process. I think, the key when you are in a market like China is that everything looks interesting and you have to use a lot of discipline to identify those opportunities that really you can have an impact and move the needle on those opportunities that are interesting but not net necessarily going to make good business. So, we've been really working at it. It's been an exciting time, but maybe Jeff can touch on that a little bit.

Jeff Henderson - CFO: Yeah. Let me touch on three of those that we referenced. First of all, med devices, I think since the acquisition, we built up a pretty nice med device 3PL business. We are also growing that into a more full service line business for med device and a have a number key multinational partners that have launched with us or we are in discussions with. So, again, I think that's layering on very nicely. And we are developing the national infrastructure that really facilitates that as well, so we continue to build out our distribution center and LDD base. Second one is distributing and selling consumer healthcare products to retail, particularly retail pharmacies. That's the business that we launched at the end of fiscal '11. We have a strong partner that we must start with it in that regard, and we are continuing to build that out with additional suppliers. That business is growing nicely. It's profitable already. I'd still say, it's still relatively small in the overall scheme of things, but I am very encouraged about its potential. Then, the last one is sort of a piloting we are doing of specialty directed patient distribution, and that's in its early stages. But again, I think it has significant potential given the unique characteristics of the Chinese market. So, those are three of them that we are sort of building up, but feel very good about.

Operator: Robert Willoughby, Bank of America.

Robert Willoughby - Bank of America: You've gotten most of mine, just Jeff, no share repurchase in the quarter, what's the guidance for the remainder of the year assume on the share repo front?

Jeff Henderson - CFO: With the $352 million that we – 352 million diluted shares outstanding, I knew I get that eventually, that would assume that there is no further repo for the rest of the year, Bob.

Operator: David Larsen, Leerink Swann.

David Larsen - Leerink Swann: In terms of the specialty business, have you guys provided any color around the size of it or the earnings or revenue contribution to the overall book?

George S. Barrett - Chairman and CEO: This is George. No, we have not. This is again a business that is still subset of our Pharmaceutical segment and we will try to provide some color on the progress that what really is a growing business, but at this point not broken out those details.

David Larsen - Leerink Swann: So if you were to say win VA contract, are you confident that you'd be able to basically supply all the specialty drugs that that large client would need?

George S. Barrett - Chairman and CEO: Yeah, so let me just give a general answer because we've been asked about the VA and that's always a tricky. All we can say is this that we have the capacity and the capabilities to do anything called for should the VA contract come our way.

David Larsen - Leerink Swann: And then quickly, think you won a $1 billion defense logistics agency contract in April of '11, which I thought was very big. And it's my understanding that that would start in 2H fiscal '12. Is that correct and was there any impact this quarter to that from the contract?

George S. Barrett - Chairman and CEO: Yeah, so actually we were excited to get that that win because of some of the systems issues that the DOD was experiencing. They shifted that out a little bit so that has not an impact on us and will shift out towards the end of the year.

Jeff Henderson - CFO: Yeah, we had originally expected to start implementing that in January yet of this fiscal year but DOD informed us that they're going through systems implementation. We will prefer to push off that transition, and so we are now expecting it to start rolling out in May of this year.

David Larsen - Leerink Swann: So you get benefit from that and also margin improvement in fiscal '13 from the medical transformation, okay. And then Express Scripts, that's a bulk contract, correct?

Jeff Henderson - CFO: Yeah, we classify all mail order business as sales to bulk customers.

Operator: John Ransom, Raymond James.

John Ransom - Raymond James & Associates: Jeff, could you help us if we look at fiscal '13 versus fiscal '12, what's the net headwind in the Medical segment when you net the increased depreciation versus the decreased implementation spend. Can you size that for us?

Jeff Henderson - CFO: I don't want to get into specific guidance on the Medical segment specifically or particularly that specific. All I will say that when you net out everything, so net out the benefits that we are getting from the implementation and some of the reduced projects spend to implement it versus the increased depreciation, we are looking at a fairly healthy benefit next year, but I wouldn't want to get more specific on that at this point.

John Ransom - Raymond James & Associates: Yeah, that was a math question, not an essay question but you did really well. And fairly healthy, I will put that in my model. The other question is Lipitor, did that drug contribute as expected given some of Pfizer's imaginations and it looks like they held on to maybe 30% of the market. Was that what you would assume or is that a slight little headwind?

George S. Barrett - Chairman and CEO: John, no, actually that was about as we modeled it. I think we assumed this is a bit of unique drug obviously with plenty of attention and unique characteristics. And I think we made some assumptions, it turns we're relatively close.

John Ransom - Raymond James & Associates: Finally on the AMP rule that came out, could you just help us with your independent pharmacy base what – do you have any idea what their Medicaid mix is in their pharmacy business and what your early thoughts are about helping them with that? I guess, my other question is, our concern is that it might bring some unwanted transparency that kind of line by line generic pricing and is that something that will create some complexities for you as you deal with these customers going forward.

George S. Barrett - Chairman and CEO: Yeah, John, so I can't give you the specific breakout as it relates to independent pharmacy and as you probably know, it's about 8% on a national basis. It's hard to characterize. AMP has been out there, as you know, for many years. It has been an incredibly noisy subject. We've always dealt with sort of interesting and challenging reimbursement dynamics around the system and I assume that we'll deal with this one as well. So, it's really hard, the report that – the piece that came out is, how many pages long, 200 somewhat pages. So, it's incredibly complex and we'll work our way through it and again, it's not direct effect to us, but we'll be watching very closely.

Operator: We have no further questions at this time. I would now like to turn the call back over to George Barrett for any closing remarks.

George S. Barrett - Chairman and CEO: I'd like to thank everyone for being on the call. In closing, we're very encouraged by our first half of fiscal 2012 and again, thank all of you for joining us today.

Operator: Ladies and gentlemen, that concludes today's conference. Thank you so much for your participation. You may now disconnect. Have a great day.