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PharMerica Corporation (NYSE:PMC)

Q3 2008 Earnings Call Transcript

October 31, 2008 11:00 am ET

Executives

Teri Hartlage - VP of Finance

Greg Weishar - CEO

Mike Culotta - EVP and CFO

Berard Tomassetti - SVP and CAO

Analysts

Adam Feinstein - Barclays Capital

Melissa Jaffe - Merrill Lynch

Robert Willoughby - Banc of America Securities

Charles Rhyee - Oppenheimer

Constantine Davides - JMP Securities

David Woodyatt - Keeley Asset Management

Jason Gurda - Leerink Swann

Operator

Welcome to the third quarter, 2008 PharMerica Corporation Earnings Conference Call. My name is Carmen, and I'll be your coordinator for today. At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder ladies and gentlemen, this conference call is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Ms. Teri Hartlage, VP of Finance. Please proceed.

Teri Hartlage

Good morning and thank you for joining us for the 2008 third quarter conference call for PharMerica Corporation. On the call with me today are Greg Weishar, Chief Executive Officer, Mike Culotta, Executive Vice President and Chief Financial Officer, and Berard Tomassetti, Senior Vice President and Chief Accounting Officer.

Before beginning our remarks regarding the third quarter results, I would like to make a cautionary statement. During the call today, we will make forward-looking statements about our business prospects and financial expectations. We want to remind you that there are many risks and uncertainties that could cause our actual results to differ materially from our current expectations.

In addition to the risks and uncertainties discussed in yesterday's press release and in the comments made during this conference call, more detailed information about additional risks and uncertainties may be found in our SEC filings, including our annual report on Form 10-K and our more recent quarterly reports on Form 10-Q. Copies of these documents may be obtained from the SEC or by visiting the Investor Relations section of our website. PharMerica assumes no obligation to update these matters discussed on the call.

During this call we will be referring to non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is available on our third quarter 2008 financial results press release. We have made available to you our press release and our 10-Q filed with the SEC. In addition, this webcast will be on our website along with the transcript from this call.

I would now like to turn the presentation over to Greg.

Greg Weishar

Thanks Teri. Welcome everyone. As always, we are pleased to discuss our company's results today, and once again we have made solid progress, I'm pleased to report, both for this quarter and year-to-date. But before I get started, I want to remind you the combined business of KPS and PharMerica LTC were merged on July 31 of last year. Therefore, comparative financial standpoint the results of the prior year's third quarter and the nine months ended September 30, 2007 represent the results of operations and cash flows of KPS for those full periods and for PharMerica LTC effective August 1st, 2007.

As always, Mike will provide the details, financial details later, but let me give you the highlights.

Yesterday we released our third quarter results and we filed our 10-Q. Our diluted earnings per share, was $0.14 for the quarter, the integration, merger related cost and other charges represented $7.1 million or $0.13 diluted loss per share. Excluding the integration, merger related costs and other charges, diluted earnings per share totaled $0.27. Our total diluted earnings per share for the nine months ended, excluding the costs described above was $0.68. Total revenues, were $486.2 million and we dispensed approximately 10 million prescriptions again this quarter.

Our adjusted EBITDA was $25.1 million, giving us a 5.2% adjusted EBITDA margin. This represents solid sequential improvement in EBITDA margin, given the second quarter adjusted EBITDA margin was 4.6% and for the year 2007, adjusted EBITDA margin was 3.1% on a combined basis.

We continue to generate strong cash flow over $17.5 million in the third quarter of 2008 and $41.7 million for the nine months ended September 30th, 2008. Year-to-date, the big takeaway from our last three quarters, is that you are seeing greater consistency in our financial results, as we both consolidate the pharmacies and streamline operations.

The adjusted EBITDA, on a combined basis year-to-date was $68.6 million, compared to $45.8 million for the first three quarters of 2007. We're clearly capturing the operational and overhead synergies from pharmacy consolidations and integrations. Recall, this was the driver and the thesis of the merger. We're also very proud that we have decreased our debt leverage. The coverage ratio has fallen from 3.1 times EBITDA at our inception to 2.1 times EBITDA as of September 30th, 2008.

So, in the last year, we've been able to significantly reduce our leverage, through a combination of debt pay down and improvements in our operations. I'm also pleased to report we have now completed over 90% of our pharmacy consolidations. Of the total planned 26 consolidations, 24 are now complete. We have one more to complete this year and then one in '09 and then we are done.

We are confident we will exceed the $30 million synergy target and in 2009 we anticipate further improvements and margin from consolidations, pharmacy consolidations and other integration savings.

After the pharmacy consolidation phase, we have about 17 legacy KPS locations to convert to the LTC 400 operating system. We will approach this effort cautiously and move slow. It will take us several years to complete. Our focus in 2009 turns to improving customer service, sales growth and closing and integrating future acquisitions.

Speaking of acquisitions, I'm pleased to announce that we have recently completed our first acquisition. We have acquired a small institutional pharmacy with revenues of about $25 million. We will consolidate the acquired business into our existing pharmacies and the acquisition is consistent with our goal of buying pharmacies that we can merge within existing pharmacies. The acquisition price was within our target range and currently our acquisition pipeline exceeds $200 million in growing. Given the current environment, we are confident we can close several acquisitions a year. We will continue to be very disciplined in how much we pay.

Now we'll turn to sales. We are making progress in growing our sales pipeline. As we stated before, we had virtually no pipeline at the time we merged. Our pipeline is growing and we are closing new business. But overall, the sales cycle remains longer than normal as perspective clients are taking away easy approach, given service concerns in consolidated pharmacies. We believe it will take a few more quarters but expect to see improvement starting in mid 2009. As in aside, our sales this year are roughly equivalent to our sales from last year.

As I have done in the past, I want to update you on our company's key initiatives. We call these initiatives the operational focus of our company and our key to long-term sustainable growth. Overall, they are designed to drive operating and financial improvement across the entire organization; proving client service and proving billing and collections, capturing the synergies and the operational and overhead synergies, development and implementation of e-prescribing and developing key operational and financial metrics of the initiatives. I am not going to go into specific details, but let me just say that overall we are making great progress.

Bad debt is down over last year by over 40 basis points. Our client service organization has improved significantly. For example, client retention is projected at about the same levels as prior years. This is a big win given the potential disruption the pharmacy consolidations can create. Our client service, integration team and operating books have done a great job.

Moving onto the area of metrics, in the past year we have significantly improved reporting capabilities in the views of our business. Mike and his team have been able to do that, while at the same time integrating the financials and hardening the financial controls. We will continue to refine our metrics to assist management and driving improved operating results.

E-prescribing continues to be of interest to CMS and the industry at large. We have a head start here and driving this into our pharmacies and continue to believe we will see increased adoption in the next couple of years or so as CMS provides position incentives.

Now let me talk about our growth prospects. Recall a year ago, we laid out acquisitions as a key component of our growth strategy. Today in announcing our first acquisition, we are showing that we can close acquisitions.

As I mentioned earlier, our pipeline is growing and we are increasingly confident of our opportunities here. Finally, we anticipate the ageing if America will provide us plenty of room for growth over the next decade. Demand for long-term care services is rising and we see a vibrant market for our pharmacy services for years to come.

Finally, let me discuss briefly how we see the economic landscape affecting out business. Our industry has not been as impacted as other segments of the healthcare industry nor for that matter the retail pharmacy or PBM industry. We don’t see that changing. The vast majority of our patients in skilled nursing facilities are fully covered by either Medicaid or Medicare.

They do not pay any co-pays or deductibles under the plans. We do see the potential however for increases in receivables for some nursing homes maybe impacted by Medicaid payment delays. However, on balance, we believe our exposure to an impending recession is significantly less than the healthcare industry and the pharmacy industry as a whole.

We have completed another quarter and are encouraged by our results. As I said earlier, we still have a lot of work ahead of us as we build the platform for the future. Our operating strategy in 2008 continues to be one, of execution and consistency.

As we wind down our first full year of operations for America Corporation, I trust we are demonstrating to our shareholders that we can execute our business strategies. We believe the ground work that we are allowing this year and next, will yield significant value in the coming years. We are experiencing some very interesting economic and political times that are bringing us great opportunities.

I’ll now turn it over to Mike to discuss the details of the quarterly results.

Mike Culotta

Thank you, Greg, and good morning. Let’s spend a few minutes on the result of our operations. This is only our fourth quarter that both KPS and LTC have been included in the results of operations for the full quarter. As you noted in our 10-Q, there are two sections in the MD&A. The first section is based on the third quarter of 2008 and nine months then ended, compared to the historical third quarter of 2007, and its respective nine months then ended.

Remember, as Greg mentioned for 2007 the results of operations in cash flows only include KPS for those full period and PharMerica LTC since August 1st, 2007. The other section of MD&A is the comparison of the second quarter of 2008 to the third quarter of 2008, a sequential quarter comparison we believe this is very useful to you, the investors and analyst. As you recall, we also furnished an 8-K on November 8, 2007 that combined the operations of KPS and PharMerica LTC, included in that 8-K was also statistical data. Throughout these discussions, we have obtained information from this source in our previous earnings calls.

Let’s now discuss our revenue trends and metrics. As Greg has previously stated, our third quarter revenues were $486.2 million. This is an increase of $4.4 million over the combined operations for the third quarter of 2007 and relatively flat from the sequential second quarter. Our prescription dispensed were 10.04 million this quarter, compared to 10.07 million in the second quarter, and 10.03 million in the third quarter of 2007 on a combined basis.

Customer-licensed beds under contract at the end of the quarter were 325,613 or decline of 5,686 from the second quarter of 2008. Our institutional revenues per script were $46.95 this quarter, compared to $46.82 for the second quarter of 2008 and $46.68 for the third quarter of 2007 on a combined basis.

Let’s now turn to the cost of goods sold and gross margin. Our total gross profit was $70.3 million for this quarter or $6.72 per prescription dispensed compared to $70.8 million in the second quarter or $6.74 per prescription dispensed. The declining gross profit and gross profit per prescription dispensed was attributable to certain duplicative and productivity cost caused by the number of consolidations we had in progress during the third quarter lower rebates and fuel surcharges due to the increase in energy cost.

Our fuel surcharges were approximately 1.1 million in the third quarter of 2008 and approximately 0.7 million in the second quarter of 2008. These items were reduced by decreases in cost of drugs as we continue to see brand-to-generic changes and synergies from earlier consolidation and further reduction in other cost and scaling of certain pharmacies for which the consolidations had been completed.

On a combined basis for the third quarter of 2007, gross profit was approximately 69 million or $6.63 per prescription dispensed. The increase over comparative quarters was due to the staffing changes as a result of efforts to appropriately staff pharmacy levels to production, increases in generic dispensed and rebate.

Rebates were $12.1 million in the third quarter of 2008, compared to 13.9 million in the second quarter of 2008. During the second quarter of 2008 we received rebates of approximately 1 million that are normally paid annually.

Selling, general and administrative expenses includes function such as pharmacy, regional and operations management, IT, billing and collection functions, legal, HR, finance and other departments. It also includes certain costs, such as provision for doubtful accounts. SG&A costs were 50.5 million or 10.4% of revenues for the third quarter of 2008, compared to 54 million or 11.2% of revenues for the second quarter of 2008.

Largest declines were in labor related and other cost. We continue to be very focused on driving cost down. Selling, general and administrative expenses on a combined basis were [$457.8] million in the third quarter of 2007. Overall SG&A cost increased due to cost of being a public company but decreased as a result of staff downsizing and other cost reduction measures, as we continued to challenge all of our cost and processes. On a combined basis, our provisions for doubtful accounts were as follows.

7.2 million or 1.05% of revenue in the third quarter of 2008 and $5.5 million or 1.1% of revenues in the second quarter of 2008. On a combined basis, the provision for doubtful accounts was 7.9 million in the third quarter of 2007; excludes that this is exclusive of the one-time adjustment of 27.9 million recorded in the third quarter of 2007.

The company’s combined adjusted EBITDA for the third quarter of 2008, was 25.1 million compared to 22.4 million in the second quarter of 2008. We were impacted favorably by the $2.1 million employee benefit reduction as it related to the reimbursement of over charges on health insurance claims. On a combined basis, the adjusted EBITDA was $15.1 million in the third quarter of 2007. Again as Greg previously stated the adjusted EBITDA for the first nine months of 2008 was $68.6 million compared to $45.8 million on a combined basis for the first nine months of 2007.

We continue to focus on operational efficiencies, cash collections, cost controls and completing our integration processes as well as improving existing processes. Our adjusted EBITDA margins were 5.2% in the third quarter of 2008 compared to 4.6% in the second quarter of 2008 and 3.1% on a combined basis for the third quarter of 2007. Of course this is exclusive of integration, merger related cost and other charges.

Turning to the balance sheet and cash flow, our DSO's were 41.1 days. We continue to evaluate the net realizable value of our receivables and client payment patterns. Our total debt outstanding is detailed in our 10-Q as are the covenant calculations. You will note that we continue to improve on our covenant ratios. As Greg previously stated, our cash flows from operations for the quarter were $17.5 million and for the nine months ended September 30th, 2008 were 41.7 million.

Our guidance has been updated in the press release. As you have noted some of the primary changes were; the adjusted EBITDA being increased. But let's remember consolidations of our pharmacies have an impact on current results. Increasing net income and earnings per share, this number of course is exclusive of integration, merger related cost and other charges, decreasing CapEx and increasing the estimated integration merger related costs and other charges. Thanks very much, Greg.

Greg Weishar

Thank you, Mike. As we indicated before we continue to be bullish on the opportunities ahead of us. And are certainly pleased with the progress we made to date. We view our industry as essential in providing the medication needs to the frail and the elderly and clearly this need is only going to grow as the population ages. We believe we are on track to achieve our targets and continue to see solid growth in 2008 and beyond. And we are focused as Mike has indicated on both the internal and external growth and will continue to drive our business to more profitability. And once again I thank you for your interest in our Company.

And I'll now turn it over to the operator, Carmen to begin our Q&A.

Question-and-Answer Session

Operator

(Operator Instructions). And the first question comes from the line of Adam Feinstein from Barclays Capital. Please proceed.

Adam Feinstein - Barclays Capital

Alright, thank you very much. Good morning everyone, very strong quarter. Just wanted to just ask few questions here, I guess it seems like everything is going well with the consolidation in the synergies. Just as you think of your synergies do you have a cumulative number in terms of what percent you have hit that far?

Mike Culotta

Adam, this is Mike. I think one of the things to look at really is to look back historically what was the run rate that this company had and the run rate when you look at everything that's been disclosed. The run rate was roughly around $62 million to $65 million and when you look -- let's just use the upper limit of our guidance and you look at our upper limit which is roughly about $92 million and you take the difference between those two since the time that the companies by now.

We've improved operation $30 million, at the same time that's roughly decline in beds, net beds of about 15,000 with no acquisition. So, when you really step down and you take a look at it. We right now are looking at right now at the $30 million and again that includes some inefficiencies that we had throughout the year so. Again when you take a look at it from a global area we've hit the 30 million.

Adam Feinstein - Barclays Capital

Yes, I know it certainly. Certainly it seems very, very strong. And then just as you think about just this product mix in the quarter, just curious was there a significant change in terms of your generic mix and just curious in terms of on some of the new products such as Risperdal in terms of the impact, some of that may impact in the quarter.

Greg Weishar

Well I'll take that one. But clearly we -- Adam we've seen growth in our generics, continue to see growth in our generics. In terms of Risperdal it came out as an exclusive and looks like that's going to be changing this month. But I don't think there are any surprises; we thought that Depakote sprinkles might get out before it did, but obviously that didn't happen there, it looks like its going to come out this quarter, the fourth quarter. But I would say there were no surprises there.

Adam Feinstein - Barclays Capital

Okay. Alright and I am sorry in your prepare comments Greg you made a comment about us the 17 legacy [sites] or you are still converting the systems. Just want to make sure I had heard you there. Can you just repeat the comment later on?

Greg Weishar

Well, we just wanted to make sure that; number one, we were clear that we were pretty much done with the consolidations. We had one more to go as I indicated in the Q1. And then, we have a long-term goal of getting everybody on the same operating platform and we think that's to our strategic goal and a goal that's worthwhile. However, there's a point of clarity, we want to make sure that the market understands that we are just going to take our time and proceed in a very thoughtful and slow manner there because those types of integrations from one platform to another can be very challenging and we are not going to move fast on that; number one, because of its service potential, service issues; and number two, because there's really no economic upside to it in the short term, so

Adam Feinstein - Barclays Capital

Sure.

Greg Weishar

Okay.

Adam Feinstein - Barclays Capital

Okay, great. And one final question. I just want to see if you could address the contracts, the two big one with Kindred and Beverley, any updates in terms of anything related to pricing or any thoughts?

Greg Weishar

We will begin, let me talk about Golden first and we have been having, I would call it peripheral, discussions about our renewal, and I think that in the first quarter, January or so we will start having serious discussions with Golden, and I can tell you and we were anxious to get those started and we were confident that we will able to come to a mutually agreeable relationship and continue and we are comfortable that that's going to happen.

In terms of Kindred, we are very much into conversations with Kindred and we had very constructive discussions and we think that will have the contract, a new contract with them fairly soon, and we had hoped maybe to be able to talk about that in more detail today, but we were just not quite ready to talk about it, but we will advise you as soon as that contract is finalized and what that means to us.

Adam Feinstein - Barclays Capital

All right. Great. Thank you very much.

Operator

And the next question comes from the line of Melissa Jaffe from Merrill Lynch. Please proceed.

Melissa Jaffe - Merrill Lynch

Good morning.

Greg Weishar

Good morning, Melissa.

Mike Culotta

Good morning.

Melissa Jaffe - Merrill Lynch

Can you just offer some color on types of conversations you and your team are having with potential new customers. Like, I mean, what are they getting that you think you can offer -- what are they not getting you think you can offer? And due their needs or differ by customer segment?

Greg Weishar

Melissa, this is Greg. I think, as you probably know, the needs of our customers are very diverse. Some of our customers are very rural, some are urban, some are chain-based regionally, some are chain-based naturally, some have more density than others, but I think, there's three common themes that our customers really want and that is, the timely delivery, no [medicationaires] and consulting services that, that they count out to help them save money, as well as make sure that they are compliant with their survey.

So we have, I think, one of the best consulting teams in the country. That’s a competitive advantage for us. We have been challenged, I think, with the individual small standalone nursing home facility in terms of, if you think about where our bed losses come from, they come from that. That’s the profile. And we are seeing increased competition from independent pharmacies that may be closer to those rural facilities and provide maybe a little quicker turnaround time in terms of their deliveries. But we remain strong on the chain side and the regional chains remain strong, I think they like the fact that we can bring them a consolidate bill and a consistent consulting service. So, it’s a mix of those types of dynamics that drive our business.

Melissa Jaffe - Merrill Lynch

Okay, great. And then, I know you're strengthening your balance sheet pretty quickly with the cash flow, and as the CapEx sort of winds down maybe late next year, other than acquisitions, do you have any thoughts on other types of capital deployment?

Mike Culotta

No, Melissa, it's predominantly going to be used for acquisitions.

Melissa Jaffe - Merrill Lynch

Okay. All right, great. Thanks a lot.

Operator

And the next question comes from the line of Robert Willoughby from Banc of America Securities. Please proceed.

Robert Willoughby - Banc of America Securities

Hi, Greg or Mike, what is your advantage bidding for some of these assets against the larger competitor. And just secondarily, can you give us any details around what you just acquired. You gave us a revenue number, but where is that number of beds. Anything else anecdotal about that asset?

Greg Weishar

Hi Robert, this is Greg. How have you been?

Robert Willoughby - Banc of America Securities

Not good Greg, but I am holding in.

Greg Weishar

Okay. Well, Robert we are reluctant to talk to you much about what our competitive advantage is on the air-waves here. I mean, we feel like that there is a lot of, first of all this is our first one. We are talking to a lot of people. And one single does not make a home run, so we don't want to be presumptuous in terms of that we’ve got the answer here. But, clearly we're talking to a lot of prospective sellers out there and I think to some degree each seller has their own dynamic in terms of what they are looking for but, they are looking for a fair price. But they are also looking for a good fit in terms of their customers, in terms of their employees.

I will tell you in terms of our recent acquisition, it was predominately located in Texas and the business that we acquired fit very well with our existing pharmacies and we'll close a pharmacy down there. But in terms of beds and things like that, I would prefer to just turn on that question.

Robert Willoughby - Banc of America Securities

Okay. And just maybe for Mike just the transition agreements with ABC and Kindred I guess, are pretty much done now. I guess one is done shortly here. Can you in fact give us an idea of what kind of savings you'd hope to see from those agreements being discontinued if any?

Mike Culotta

Yeah Bob. We finished all of the transition services agreement both with Amerisourcebergen and Kindred. The only remaining items we still have relating to this you probably know is the PVA, the Prime Vendor Agreement in terms of our purchases with Amerisourcebergen and our IT agreement with Kindred. So, overall savings, I think the key thing that we are starting to see now is our run rate is starting to drop a little bit in the IT agreement. Again, there were a lot of costs that we were incurring in the early days, so, right now we are starting to see about 200, possibly a little bit higher than that per month drop a little bit. So, we should see some more savings going forward in the IT agreement.

Robert Willoughby - Banc of America Securities

Okay. Thank you.

Operator

And the next question comes from the line of Charles Rhyee from Oppenheimer. Please proceed.

Charles Rhyee - Oppenheimer

Thanks. Just a couple of questions here. First, Greg, you were talking about the sales efforts and the client retention. Obviously you've talked a little about your big customers. But, when I look at the bed loss, a little bit higher, not necessarily on the bed loss but on the organic beds gained, now can you talk a little about the sales cycle here and what do you think the challenges were in the quarter and do you still feel comfortable about achieving sort of positive beds organically by mid year, next year?

Greg Weishar

I think the big area is, we have two challenges ahead of us. Number one, well, actually we have three challenges ahead of us. The first one would be is, to some degree, the two companies coming together created an unknown entity out there. I mean we have new management team coming in and there is a hesitation on the part of the market, who are these guys? Are they going to stay to course and continue to provide good customer service? So there was always that hesitation.

The other piece of the hesitation was given the experiences; some of the market experienced and prior consolidations, there was a lot of fear and lot of anxiety with regards to pharmacy consolidations and how those would go. We've been averaging roughly 10% turnover in our business a year and we are going to be probably 10% to 12% overall at the end of this year, which I think is a pretty [damn] good experience. And in terms of the pharmacy consolidations, we know its hurt us a little bit and has created some anxiety and people are waiting to make their buy decisions.

And then the third piece was, is that we basically had to rebuild our sales force. We had lost over half of our sales people in both the Kindred sales force also the PharMerica sales force. And in addition to that, we had certain duplications where we didn’t loose people. So, we have a pipeline that basically had dried up as the acquisition lingered on.

So, given those three dynamics, we had a lot of work to do this year. I'm comfortable that we are making progress. I think that we're all anxious to see it happen quicker but we recognize that there is a fairly long sale cycle in any event in this marketplace. So, I would say that we are very comfortable that we are going to be making solid progress year-over-year by next, by the end of, let's say by July. So, I think we are going to see positive growth.

Charles Rhyee - Oppenheimer

Great. Maybe a couple of questions for Mike here. You talked about the fuel surcharges. Obviously, the price of oil has fallen and so is price of gas. Do you have a sense on should we just start seeing a benefit on fuel surcharges in the fourth quarter and going forward?

Mike Culotta

Yes. Definitely. Usually there is about a month, month and half, two months tail on those surcharges so we should start seeing that improved in the fourth quarter, as long as the prices stay low.

Charles Rhyee - Oppenheimer

Okay. And then in terms of these sort of duplicative inefficiency cost, can give us a sense on what that number was in the quarter and when should we start to see that sort of tail off? Obviously, it seems like you are saying it ticked up here in the third quarter. Should we expect it to tick up again in the fourth or when should we start to expect those tail down?

Mike Culotta

Okay. Great question. That amount was approximately $2.5 million in the third quarter. As you recall, was about $1.5 million for second quarter and about $1 million in the fourth quarter. We're probably going to be at or near that level in the third quarter. Some of our larger consolidations have occurred during the third quarter and into the fourth quarter. And when we say the consolidations, remember, once you close a facility, it still takes a good two, three, four months after you close a facility into another facility for which you have that timeframe where you have a little bit of those inefficiencies taking place. And again, some of our easier ones were done in late '07. And as the year progressed in '08, we had the harder, more complicated ones that we did.

Charles Rhyee - Oppenheimer

Okay. So then, what you are saying is sort of, even though we have shut down 90% of the pharmacies, a lot of our costs running those pharmacies are still running through the system?

Mike Culotta

That is correct.

Charles Rhyee - Oppenheimer

You have a sense on like, how many are, maybe like pure; sort of 100% on where we should start seeing those benefits more?

Mike Culotta

It is really just a small handful that we are still seeing a little bit of the tail rolling, and then you will add another one in the fourth quarter. So, predominantly by the end of the first quarter going into the second quarter, we should see all of that tail off.

Charles Rhyee - Oppenheimer

Okay. Great. Thanks, guys.

Operator

And the next question comes from the line of Constantine Davides from JMP. Please proceed.

Constantine Davides - JMP Securities

Thanks. Good morning. Just a couple of quick follow ups on the acquisition. Greg, can you just remind us what that price range is that you alluded to earlier, either in terms of an EBITDA or sales basis? And then with this transaction, can you tell us anything about when the deal will close and what kind of customer mix you have in there, be it more of a sniff basis or assisted living facility?

Greg Weishar

Let me take the simple stuff, when the deal will close. I understand my sign as of today. Okay. In terms of the book of business, it is virtually all sniff business and clearly we are more comfortable buying sniff beds than we would be buying assisted living beds for all the reasons that we know.

And then the third case in terms of what we are comfortable of paying. I think that again, I am just more comfortable talking about that on a private basis, but the reality is every deal that we look at depending on the sustainability of revenues and the ability for us to retain those beds that we buy and the profitability profile, which also effects in terms of whether we can consolidate them or have that continue to operate as a standalone pharmacy.

There are many, many variables that go into what we are willing to pay. And I think we look at this as, if you have a ten-year contract with a client and that pharmacy has long-term agreements versus short-term agreements, obviously the long-term agreements we are willing to pay more on and so we look at this as a range of risk that we are willing to take. Some cases we wouldn’t be one times EBITDA and another cases we might pay it. I just don’t want to be signaling the market that we are buyer here that’s not going to look at those characteristics, because we do have a lot of situations that we look at that we basically have a book of business that they think they should get a high multiple on and the their book of business wouldn’t want that. And so, we just have to take them one at a time.

Constantine Davides - JMP Securities

Okay. Great. And then just wondering if you can comment heading into '09, just how are your negotiations with the PDPs going and what are you expecting in terms of year-over-year economics there? Thanks.

Greg Weishar

We are in pretty good shape. In fact I think, clearly we are doing the math right now in terms of [useful] lives. And what does that mean to us, where are they going to go and doing the probability in terms of where they might go, and given the competitors that they are, the reasons those lives? And I think, I was just told yesterday we are in pretty good shape from a PDP standpoint. Clearly, we have some challenges with certain payers and we continue to have discussions. But, I would say all in all we are in better shape than I thought we would be at this time. So, so far, I am comfortable where we are and clearly we are going to continue to do everything we can to educate PDPs on what it is that we do and why are we not like a retail pharmacy, which you might think they might understand that intuitively but they certainly don’t. And they don’t really understand the PDPs, fundamentally don’t understand the institutionalized sector and all the other additional services that we provide and the challenges that we have operationally that don’t exist in a retail store. So, we have been educating the PDPs and to their credit they have been I think fairly open to listening to what we have to say. So we are making progress there.

Constantine Davides - JMP Securities

All right, Greg. Thanks.

Operator

And the next question comes from the line of David Woodyatt from Keeley Asset Management. Please proceed.

David Woodyatt - Keeley Asset Management

Keeley Asset Management. In spite the great success you have had after becoming an independent company then with the merger it appears there may still be a fair amount of room for margin. And I was wondering if could talk more specifically about that and what the sources of further margin might be before you get to the acquisitions for further growth?

Mike Culcotta

Yes David. The main items that we have in margin expansion is a continuation of our consolidations as we talked about little bit earlier on the call, some of our inefficiencies, the majority of that actually is actually there in the gross margin lines. And also other things that we're doing to look at any other cost savings that we could be looking at, such for example, our transportation cost, or delivery cost in terms of those contracts.

So, there is still is some opportunities there, but when you dig into the numbers and you look inside from quarter-to-quarter, why haven’t we seen the bigger amount predominately what is occurring are these inefficiencies as we consolidate. So, once we get through those, we should be able to see more and more of that.

The one thing that I just want to remained everybody, also just remember that, usually in our first quarter you normally see our higher employee benefits because you start over on the FICA, the FUDA and the SUDA. So usually, when you go from the end of the year to the beginning of a year you are always have that blip, and usually that’s about $2.5 million to $3 million of additional benefits that occurs for us in the first quarter. So, that’s the part of that will be eaten up in the margin on that, so.

Greg Weishar

I think it'd be fair for us to say that we remain conservative on margin expansion. I mean, we have on the one end, the upside opportunities with generics in the short-term but longer term and as the some of the generics start cycling through there in achieving that reimbursement, we have certainly margin pressures on generics.

And next year you will start seeing some of that because some of those generics came out in '07 and are starting to get fairly well and trenched into the business. The other side of it is, is even though we remain somewhat cautiously optimistic on our relations with the PDPs and our education process, there clearly is going to be constant pressure from the PDPs. And so I think, from the pricing standpoint we will continue to see margin pressure there and I think we've made good run on our margins here, but I wouldn’t be looking at our margin's expansion to be significantly in the 7% to 8% range. And I don’t think I've ever said that, so just want to make sure that everybody is looking at this.

We've kind of always said that we thought somewhere between 5 and 6 was the right number.

David Woodyatt - Keeley Asset Management

5% to 6%, is that is that’s pre tax number or operating margin or what?

Mike Culcotta

That’s adjusted EBITDA.

Greg Weishar

Correct.

David Woodyatt - Keeley Asset Management

Is there a point in time that you think you will have gotten through these consolidations, and you will probably, at least largely accomplish the margin improvements as possible.

Mike Culcotta

Yes. As we continue finishing up the consolidations into '09 we will have some cost, again as Greg said, as we will have the 17 other locations, there will be like any company, there is always a cost of conversion. So you will have that that will occur subsequent to the completion of all the consolidations.

David Woodyatt - Keeley Asset Management

Okay. Thank you very much.

Operator

The next question comes from the line of Jason Gurda from Leerink Swann. Please proceed.

Jason Gurda - Leerink Swann

Good morning, thank you. Greg, I just wanted to verify, so you are raising your target there, I think on margin expectations for the Company in long term, is that correct?

Greg Weishar

I am not sure I said that.

Jason Gurda - Leerink Swann

Did you say, taking it to 7% versus?

Greg Weishar

No, no, I said that I think when we were speaking about margins over the last year we’ve always said 5% to 6% seems like a reasonable target. And I think I have also talked to a lot of you all about the fact that if you look at the other distributors in the business that's a significant margin. So, I think there is a lot of recalibration in terms of how we should be perceived in terms of what our margins are, and clearly, when you look at some of our competitors out there, their margin has historically been quite higher and you're starting to see those come down.

And I just look at this business as who our customers are today and the Part D plans are a little more aggressive in the way they come after us on pricing. And clearly the long-term care facilities are going to be following some of those opportunities. So, I am just trying to reaffirm that 5% to 6% is I think a healthy margin in this business.

Jason Gurda - Leerink Swann

Okay, okay. Thanks for clarifying that. But I do recall, I think at the end of the first quarter of this year you had given a range of 5% to 7% as a long term range. Has anything changed over the last two quarters or is this just, may be you are just in a more optimistic mood back then or is it pretty much the same expectations?

Mike Culotta

This is Mike, Jason. I think we are pretty much at the same place where we were. Predominantly what we were looking at there is we have more in these acquisitions similar to the one that we just acquired. You'll start seeing more margin improvement that, we believe in the existing book of business. We should be able to get this to the 5% to 6% range. How we get higher than that would be as we tackle on these both on more acquisitions. So, getting higher would be based on those acquisitions and getting leverage throughout everything that we have.

Jason Gurda - Leerink Swann

Okay, thank you. That’s very helpful. On the bed losses that you've seen since doing a consolidation is it -- would you say it as expected maybe when you are thinking about it before hand or has there been anything that’s been different than what originally anticipated?

Greg Weishar

Well I probably was -- I am little, on the one side I wanted to do better in terms of net beds and I was hopeful that we could kind of breakeven on that. We haven't done it but on balance I think if you look at it and all the challenges that we have and as compared to some of our other efforts in the past. I think we’ve done a really, really good job and but I had hope that we could kind of breakeven through a combination of keeping retention somewhat flat which we did, but our sales efforts have not matured as quickly as I felt so.

Jason Gurda - Leerink Swann

Okay.

Greg Weishar

That’s, where we are.

Jason Gurda - Leerink Swann

Okay. And then the last question is. What percentage of your business is to assisted living and have you seen or do you expect to see any economic impact in that area?

Greg Weishar

Well I would say less than 10% of our business is assisted living. In terms of economic impact, I am not sure I -- in terms of the economic Jason or...

Jason Gurda - Leerink Swann

Exactly, meaning if you will expect to see lower census levels or.

Greg Weishar

Oh yeah. Well, I think if you look at that segment of the business the real estate situation really drives their dynamics but as far as prescription usage of the assisted living patient and resident, they are subject mostly subject to co-pays and if there are on a Part D plan they would have donor holes in example. So we would expect to see that population that experienced symptoms of similar to what you are seeing on the retail side where people are reducing their utilization to save money.

Jason Gurda - Leerink Swann

But it's less then 10% of the business overall?

Greg Weishar

Yes and significantly less than 10%.

Jason Gurda - Leerink Swann

I see, okay.

Greg Weishar

Okay.

Jason Gurda - Leerink Swann

Okay. Thank you.

Operator

(Operator Instructions). And the next question comes from the line of Charles Rhyee from Oppenheimer. Please proceed.

Charles Rhyee - Oppenheimer

Yeah, thanks. I just had a follow-up question here for Mike. When I look at -- you obviously raise guidance here after the quarter, it seems like you've done about $0.66 of earnings year-to-date that kind of implies fourth quarter earnings down sequentially. Can you talk about what are your assumptions in there given that we should start to see maybe some more of your efficiency gains, can you give us a better sense on what you guys are expecting here?

Mike Culotta

Couple of items we still have the inefficiencies that are taking place and like we said we have got some of our larger locations that have occurred in third and will take place in fourth quarter so, we would see that number continue to be there, the other item is we want to be pretty conservative on the bad debt relating to that again nobody has a crystal ball relating to those things, but with the economy the way it is particularly with as Greg, mentioned with state Medicaid programs for example, what occurred in California during the third quarter where there was a actually no payments been made for several weeks, did have an impact on cash flows during the third quarter. So, we wanted to be conservative there and looking at what we have, but predominately continuation of the consolidations takes place, again the net bed account stand a little bit, so we wanted to adjust for that, so.

Charles Rhyee - Oppenheimer

But, in terms of that have you seen any other state I mean minus 10 is California is back to paying and have you give the indication of other states are hitting that kind of issue?

Mike Culotta

We, the one you normally see that always normal has been Texas, but its normal that's normal the way they do things as they are pretty slow in some of their payments particularly Medicaid pending. The only other state we heard was New York, but we are not there. New York or New Jersey we are not there. And Illinois, a little bit in Illinois.

Charles Rhyee - Oppenheimer

Okay, great. Thanks guys.

Operator

And there are no further questions. I will now like to turn the call back over to Mr. Weishar for closing remarks.

Greg Weishar

Thank you, Carmen. Again thank you for your interest in our company and look forward to further discussions and thank you for taking time out to listen to our call. Good bye.

Operator

This concludes the presentation for today. Ladies and gentlemen, you may now disconnect. Have a wonderful and safe weekend.

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Source: PharMerica Corporation Q3 2008 Earnings Call Transcript

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