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Cardinal Health (NYSE:CAH)

Q3 2010 Earnings Call

April 29, 2010 8:30 am ET

Executives

Jeffrey Henderson - Chief Financial Officer

George Barrett - Chairman, Chief Executive Officer and Chairman of Executive Committee

Sally Curley - VP IR

Analysts

Ricky Goldwasser - Morgan Stanley

John Ransom - Raymond James & Associates

Charles Boorady - Citigroup Inc

Thomas Gallucci - Lazard Capital Markets LLC

Helene Wolk - Sanford C. Bernstein & Co., Inc.

Lisa Gill - JP Morgan Chase & Co

Steven Valiquette - UBS Investment Bank

Richard Close - Jefferies & Company, Inc.

Glen Santangelo - Crédit Suisse First Boston, Inc.

Operator

Good day, ladies and gentlemen, and welcome to Third Quarter 2010 Cardinal Health Earnings Conference Call. My name is Karma [ph], and I’ll be your coordinator for today. [Operator Instructions] I would now like to turn the call over to your host for today, Ms. Sally Curley, Senior Vice President of Investor Relations. Please proceed.

Sally Curley

Thank you, Karma [ph]. 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 our SEC filings and the Forward-looking Statement slide at the beginning of the presentation, found on our Investor page of the Cardinal Health website, for a description of those risks and uncertainties. In addition, we will reference non-GAAP financial measures. Information about these is included at the end of the slides. A transcript of today’s call is also posted on our investor website.

Before I turn the call over to Chairman and CEO George Barrett, I would like to remind you of a few upcoming investor conferences in which we will be participating; notably, the Bank of America Conference on Tuesday, May 11; the Citigroup conference on Wednesday, May 26; and the Sanford Bernstein conference on Thursday, June 3. The details of these and other events are or will be posted on the IR site of our website, so please make sure to visit that often for updated information.

Finally, as always, I'd like to ask you to please limit your questions to one with one follow-up in order to allow for others to also ask questions.

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

George Barrett

Thanks, Sally. Good morning, everyone, and thanks for joining us on our third quarter call. Let me start by saying that I'm very pleased with our performance during the March quarter, and our continued momentum throughout the first nine months of fiscal 2010. We continue to execute well on our strategic priorities as we reposition our business, and this is resulting in stronger bonds with our customers, better financial performance, and growing enthusiasm from our employees around our overall mission and greater optimism for the future.

For Q3, revenue was $24.3 billion, up 1% over the prior period. Non-GAAP EPS was $0.61, down 8%, while non-GAAP operating earnings decreased by 7% over the prior Q3 results.

Our overall operating performance was better than we originally expected. And I'm pleased with the progress we are making to deliver sustainable growth and value to both our customers and to our shareholders.

As a company, our results reflect solid performance in both segments driven by several key highlights. Significant ongoing improvement in our Generic business, of particular note is a further increase in generic penetration rate, or what we refer to as share of wallet; continued stellar performance under our branded manufacture agreements; strong performance in Nuclear, particularly given the ongoing global supply shortages; solid growth on our Medical segment’s preferred products; and excellent revenue and profit growth in Canada from new suppliers and products. We have also been very successful with our working capital improvement and had another a very strong quarter of operating cash flow.

Now let me comment on each segment separately, starting with Pharmaceutical. Continuing a strong momentum in Q3, our Pharma segment delivered strong performance and improving margins. Segment sales increased slightly versus the prior-year periods. The sales growth was in line with our expectations, dampened by the previously disclosed loss of two customers in the first half of this fiscal year. Segment profit improved, increasing 7% in the quarter versus Q3 of fiscal 2009. This was driven primarily by an increase in overall margin rates due to excellent performance in our generic initiatives, continued solid performance under our branded manufacture agreements and disciplined expense management within the segment as a whole.

As I mentioned earlier, we continue to see good progress in our Generics program, both on the sales and sourcing side. We have developed a highly attractive offering for our customers and they are responding enthusiastically. Last June, we set a target for ourselves to increase our generic penetration rate by 10%. We have already exceeded that annual improvement goal. And our customer loyalty scores further validate that we are on the right path.

We saw a healthy 10% increase in overall Generic sales this quarter, driven by continued progress in our retail independent customer base. And Generic sales for our Medicine Shoppe customers in the first nine months of the fiscal year have exceeded full year 2009 Generic sales.

We believe that improving sales effectiveness is key to further increasing share of wallet with our existing customers as well as capturing more new business. Our sales college [ph], launched earlier this year, take the best-practices approach to building these capabilities. It provides comprehensive on-boarding training for all new sales reps, as well as ongoing training for all reps and managers in an integrated curriculum model, positioning us to serve our customers with an even higher degree of satisfaction.

Additionally, several months ago, we began a purposeful cross-selling effort in the Ambulatory Care channel with our Medical segment sales force. While still early, this effort is beginning to deliver benefits to both our customers and to Cardinal Health.

It has been an unusual stretch for our Nuclear business, and I'd like to take a little extra time today to discuss this part of our Pharmaceutical segment. I'm extremely proud of what this team has done to manage an incredibly difficult raw material shortage. While supply constraints had an impact in overall volume, the team continued to take care of our customers and deliver solid bottom-line growth.

In response to the supply shortage, the nuclear team engaged several of our own Six Sigma operational excellence black belts to maximize the available product through just-in-time delivery, working closely with our customers to adjust patient schedules and calibrate delivery times, to help meet the needs of the most critical patients first. And where appropriate, customers have substituted a different imaging modality using thallium, a compound that we also supply.

Our people have been working around the clock to compensate for these extraordinary circumstances, and our customer loyalty scores, already at a high level, have actually increased during this difficult time, a testament to the trusted-advisor role that our team has earned with their customers.

But that's not the end of the story. In the category of “You Can't Make This Stuff Up”, the volcanic eruption in Iceland further hindered the ability of raw material as suppliers of European-processed Moly-99 were unable to ship to U.S. manufacturers technesium [ph] generator. Our current expectations regarding supply is that the production from the Petten reactor in the Netherlands and the Chalk River reactor in Canada will normalize no earlier than late August/early September timeframe. The impact of the volcanic eruption and our expectations on nuclear generator supply are reflected in our forecast for Q4.

In the quarter, we also achieved strong results in our small but growing positron emissions tomography business through continued sales growth, clinical trial support and operational efficiencies. This is an exciting area, as PET imaging agents are being developed to detect and treat diseases such as Alzheimer's and other neurological and aging-related diseases. We play a key role in supporting these clinical trial efforts and are well positioned to future growth in this space, through the manufacturing, dispensing and distribution of these and other products. And just a reminder that the technesium [ph] generator supply issue does not affect the PET business.

Turning to the Medical segment, the quarter came in about as we expected. Revenue grew a respectable 7%, largely based on strong performance from our business in Canada, growth in both Ambulatory Care and Lab, and increased sales of our self-manufactured products. While segment profit was down 16% compared to last year's strong third quarter, it was up sequentially from Q2, as we forecasted on last quarter's call. An unusual year-over-year comparison in the cost of goods sold created a tough comparison versus the prior period.

Further influencing our results from the Medical segment were higher expenses in the period, primarily driven by year-over-year comparison in performance compensation accruals and by our Medical Business Transformation investment. Apart from this investment we continue to tightly manage our core expenses.

We are closely watching hospital admissions and procedures as this does influence demand for our products. There were clear signs that consumers have been cautious with their medical spending, with both inpatient and outpatient volumes down slightly. This along with a weak flu season did somewhat dampen our hospital supply business in the third quarter. We will monitor these factors carefully and are hopeful that the job growth data and other signs of some economic recovery will begin to translate into higher utilization.

We are extremely focused on improving the Hospital channel and continue to build out our preferred products categories, including self-manufactured and private label products. Progress during the quarter in our private label initiative included the launch of new OR and nursing products, and in the first nine months of the year our portfolio of private label products has grown at double the rate of the rest of our Hospital Supply business.

We believe that these preferred product programs will create benefits for our customers and have a positive impact on our margins. We have recently realigned our resources within the entire Medical segment around customer channels and product categories in order to leverage our collective capabilities in manufacturing, distribution and sourcing in order to bring a higher level of value and service to our customers.

Canada had another excellent quarter, posting both revenue and profit growth well in excess of 20%. New products and supplier agreements, with some upside from foreign exchange, fueled this outstanding growth. Ambulatory Care and Lab also continued to perform well this quarter, although showed slower revenue growth due to lower flu volumes. And work on our Medical Business Transformation continues to meet our timeline and budget expectations. We completed the design stage and are now in the build stage of this important project to enhance our technology platform and processes. In short, further reducing supply chain costs will make it easier for our customers and suppliers to do business with us.

As is true with the segments, at the Cardinal Health enterprise level, we continue to focus on tight expense controls and the prudent use of capital. We continue to manage our balance sheet carefully with a strong emphasis on reducing working capital. I'm particularly proud that we were able to continue to reduce inventory days while keeping our service-level rates high.

Operating cash flow was very robust, bullied by our business performance and working capital focus. Given this performance, the cash we have on hand and the additional cash we expect to generate from the sale of CareFusion stock, many of you have asked how we intend to deploy our capital going forward. With the exception of our policy on and our commitment to a solid dividend, we do not bring a fixed formula to our capital deployment strategy. Our goal is twofold: To ensure that we are well positioned for sustainable competitive advantage; and two, to create shareholder value. The investments we are making are focused on those two things. To the extent that we need to complement our internal capabilities or scale with an external move to achieve our goals, we will explore acquisitions. And in this mix, we will consider other strategies such as share repurchases.

Based on our performance during the first nine months of this year and our visibility into what is effectively the remaining 60 days of the fiscal year, we are increasing and narrowing our non-GAAP earnings per share guidance for fiscal 2010 to a range of $2.15 to $2.20. The implication is that our fiscal 2010 fourth quarter will be weaker than last year's fourth quarter. This is as we expected. And Jeff will walk you through our assumptions around the remainder of the year in a moment.

Consistent with the comments I made in the first and second quarters, we came into this transition year with clarity about what we needed to do to put the company on the path for sustainable long-term growth. What we expected to face on that journey in fiscal 2010 and a determination to get the work done. Our renewal of the company has progressed at a more accelerated pace than we originally anticipated, and I'm delighted that coming out of fiscal 2010, we expect earnings growth off a larger and more stable base than we originally anticipated.

Although we don't typically provide annual guidance at the end of the third quarter, this has been an unusual year, and we would like to provide investors with our early thoughts on fiscal 2011 on this call. Given the data we have at this stage and the progress on our underlying business performance, our initial outlook for fiscal 2011 non-GAAP EPS is expected to be in the range of $2.35 to $2.45. On our fourth quarter call, after we have finalized our annual budget, we will provide more details. Jeff will walk you through our core assumptions for the remainder of fiscal 2010 and for our preliminary view of fiscal 2011.

Before I turn the call over to Jeff, I'd like to make a few comments on healthcare reform. As you are well aware, since we last spoke on our second quarter call in January, this historical legislation has been passed. It is important to note that the Patient Protection And Affordable Care Act marks the beginning of healthcare reform, not the end. With more than 2,700 pages of legislation to interpret and implement, there will be a long administrative, regulatory and legal process, as the appropriate agencies work through to the details of implementation. This will be a very interactive and iterative process in which Cardinal Health plans to participate.

While there is much work to be done, we are well positioned to address healthcare reform's two main goals: coverage and costs. Clearly, adding more than 30 million new patients will put greater demand on the U.S. healthcare system, a system already under stress. This additional pressure will increase the relevance of our capabilities to improve the cost effectiveness, quality and safety for our customers' operations, allowing them to focus on patient care.

Finally, let me end by saying that I feel very good about our performance in the quarter, and our rate of progress to this point. Our organization is tightly aligned around our strategic priorities, intently focused on execution, and our people are passionate about continuing to improve the customer experience.

With that, I'll hand the call over to Jeff to provide more details in the quarter. Jeff?

Jeffrey Henderson

Good morning, everyone, and thanks for joining us. It's a pleasure to be reporting our Q3 end results, and I'm very proud of the organizational execution and financial performance we have delivered in the third quarter and fiscal year to date. First, I'll provide an overview of our Q3 results and key drivers. Let me build on those as well as touch on our revised FY '10 guidance and preliminary fiscal '11 outlook.

To begin, as you may recall, before the start of this year, we identified a few key financial metrics that we needed to focus on to win, specifically margin expansion and working capital improvements. Driven by a number of the performance initiatives that George has already referenced, we have made some great progress in both of these areas.

First, we are pleased that after the second quarter in a row, consolidated gross margin rates have increased year-on-year. In Q3, this rate increased five basis points versus last year to 4.15%. And non-bulk profit margins within our Pharma segment were 2.24% versus 2.05% in Q3 of FY '09.

Second, regarding working capital, we've continued to see the hard work of our people pay dividends. Both year-on-year and sequentially, inventory declined by two days largely due to the efforts of our operating teams and our lean Six Sigma programs. At the same time, our accounts receivables days outstanding improved versus last year. These initiatives, combined with our earnings performance, helped to generate $879 million of operating cash flow in Q3, bringing our year-to-date operating cash flow to just over $1.8 billion. And in the timing of payments, our cumulative operating cash flow for the full year will likely be below this in a range of $1.5 billion or so. But it still represents a significant number and is much higher than we projected coming into the year.

To summarize, we're making great progress with our performance initiatives as beginning to consistently show in our key metrics. Although we’ll always see some quarterly fluctuations and margin rate trends and working capital levels, due to the nature of our business and external factors, we feel we have the actions in place to continue to move these in the right direction over time.

Now let me add a few more details regarding our Q3 performance starting with the segments. As George said, we are pleased with the business progress and financial results in Pharma. Revenue increased by 0.5%, split almost equally between non-bulk and bulk customers. [Indiscernible] of a relationship with two significant customers in the first half of the year, there had been sales growth by approximately 150 basis points. These are the same two low-margin accounts we had referenced in previous calls.

Certain of our large customers also grew their orders less than market in the third quarter which further impacted the growth rate. Within the Pharma margins in the quarter, we saw strong performance under our brand agreements, particularly related to brand inflation from our price contingent vendors as well as our generic programs. This benefit was partially offset by the continued Medicine Shoppe and Pfizer DSA transitions and previously referenced contract repricings which are largely pulling [ph] through as anticipated.

In the Medical segment, profit declined 16% versus last year to $108 million, primarily due to an unusual year-on-year comparison and the cost of goods sold, the year-on-year impact of performance-based employee compensation, and increased investment spend associated with the Medical Business Transformation. The decline was partially offset by revenue growth from our Canadian lab and ambulatory services and our portfolio of preferred products. Segment profit increased sequentially, by $5 million, despite that left benefit from commodity price changes and the absence of a significant Q3 flu season. In fact, after a much higher than usual positive impact in the flu in the first half of fiscal '10, that trend pretty much reversed itself in Q3.

Let me now cover a few items in the consolidated level. Non-GAAP operating expense is up over 9% from last year, largely driven by funding our performance-based employee compensation programs that did not occur in the prior year period, and to a lesser extent, investments spend on key initiatives. If you exclude those drivers, our core SG&A is down year-on-year, reflecting the continued tight focus we have on this area.

Let me spend a few more moments in this composition issue given its significance to our expense line [ph] in this quarter. As I’m sure you’ll recall, last year in late Q2 and Q3, we were in the midst of the global financial crisis. At that time, we had not yet spun off our CareFusion capital equipment businesses. The economic crisis had begun having a very negative impact on hospital capital equipment orders, significantly impacting our CareFusion business. As we recognized this downturn in our full year financial forecast for FY '09, we also brought down our management bonus accruals across the entire company commensurately and as particularly impacted Q3 ’09. This year, our bonus accruals have increased based on strong performance versus target. The net year-on-year impact of those accruals moving in opposite directions is reflected in our SG&A growth this quarter.

Compiling this increase is the decision we made heading into FY '10 to tie more of our employee-related expenses to company financial performance and hence make more variable. Specifically, we replaced a portion of our 401k benefit that was a fixed employer contribution with a variable contribution linked to financial performance. And again, better-than-planned performance this year resulted in higher accruals for his expense in Q3.

Moving on, our non-GAAP tax rate for the quarter was 38.2% versus 37.3% last year. A higher rate in the current quarter was attributable to changes in income mix and a few discreet items. On the balance sheet, we finished the quarter with over $2.6 billion of cash, approximately $400 million of which is overseas.

Now let me turn to Slide 7 and take a moment to walk you through the items that accounted for the difference in our GAAP and non-GAAP EPS numbers. It always figures that our reviews ar on an after-tax basis. The biggest item in this category is a $23 million gain from sales of 5.4 million shares of CareFusion stock in the quarter. This accounted for approximately $0.06. The next item is the impairments and loss sale of assets of approximately $0.04. The majority of this relates to the closure of a facility, as well as final tax true-ups related to a divestiture. The other three items, restructuring and severance, litigation charges, and other spin-off costs netted to approximately $0.01. The [indiscernible] of all these items resulted in a GAAP EPS of $0.62 versus non-GAAP of $0.61.

Now turning to Slide 8, an update on the status of our CareFusion stake. As mentioned earlier, during Q3, we sold 5.4 million shares that generated $136 million in proceeds and a gain of $23 million. We’ve accrued no tax on the proceeds of the sale. After these sales, we now hold 30.5 million shares of CareFusion stock which had a value of $805 million on March 31. During Q3, we had a pretax unrealized gain of its remaining [ph] ownership of $43 million, which does not have an earnings impact until shares are actually sold and capital gains or losses are recognized.

As we’ve said in the past, in order to maintain the tax-free nature of this spin-off, we need to divest of the remaining shares within five years from the spin-off date. We intend to complete this by the end of fiscal '11, and are continuing to assess the best method and timing to do this based on market conditions and other factors.

Also during the quarter, we signed a definitive agreement for the sale of Martindale in the U.K., and are expecting to close this by the end of fiscal 2010. This, along with the sale of Specialty Scripts, the closing of which we announced earlier, complete the portfolio rationalization activity that we projected for this year.

Now let’s [ph] review our revised FY '10 outlook. Let me begin with some [indiscernible] comments about how we now view the full year from a forecast perspective, particularly given our [indiscernible] strong financial results in the first three quarters. Certainly our performance thus far has been better than anticipated heading into the year. This is being driven by two major categories of items. First, we've had very good execution against our key initiatives this year, including our Medical supply chain strategy, generics programs, our progress in retail independence and strong performance in nuclear, despite supply shortage issues. But we’ve also benefited from certain external factors including generic launches that happened at a higher level than we had planned, lower deflation on certain generic products, accelerated compensation from our branded vendors relative to price increases and a higher demand for certain med surge products resulting from a stronger and earlier flu season in the first half of the year.

For the full year, although we will get some net benefit from those factors, we are assuming that they are largely normalized in the fourth quarter. In total, the sum of these items has added up to solid performance in the first nine months of the fiscal year, and this is reflected in our increased guidance of $2.15 to $2.20. [Indiscernible] is that Q4 will be down from last year based upon several factors which I’ll attempt to walk through.

Our Pharmaceutical segment assumptions for Q4 include the following: the headwinds of the Pfizer DSA and Medicine Shoppe transitions continue to play out as anticipated. The earlier-than-anticipated [indiscernible] price inflation realized in the first three quarters is not [ph] expected to continue in the fourth quarter. In fact, we had originally expected price increases from a major branded contingent vendor in Q4 which we no longer anticipate. The negative year-on-year impact of the generic launches in deflation was not as significant in the first three quarters as we anticipated, again due to several unplanned launches and slower deflation on certain products launched. However, we are not projecting any significant high-value generic launches in Q4.

Finally, let me comment on the financial impact of the nuclear generator supply situation which George covered in some detail. The supply shortage had unfavorable EPS impact of $0.01 to $0.02 in Q3 and based on what we’re seeing so far, we’ll have at least $0.02 impact in Q4.

Turning to our Medical segment: the first three quarters' results show revenue growth to be above overall market trends, driven by our mix shift, strong growth in Canada ambulatory and lab, an exceptional flu season in Q1 and Q2 and a one-time revenue recognition benefit from the CareFusion spend.

In Q4, we expect that segment revenue growth may moderate somewhat, given the absence of a few of these unique items and a slightly cautious view of the market due to some softness in utilization we saw during part of Q3.

In the first half of 2010, this segment also saw greater benefit from commodity raw material prices and higher flu-related sales than we had originally projected. These did not continue in Q3. In fact, all [ph] prices moved higher over the past months, and as you recall, there's a lag effect regarding the impact of these movements in our income statement. These factors make for a harder second half comparison. That all said, after a tough [ph] compare in Q3, we do expect the Medical segment to return to year-on-year profit growth in Q4.

On Slide 10, we provided our corporate assumptions for fiscal 2010, which are identical to what we have shared previously. The only comment I’ll make in this area is that we expect that our full-year tax rate will likely be north of 37%, which implies a fourth quarter that could be four percentage points or so higher than last year's unusually low Q4 rate. Taking all of this into account and based on our performance during the first three quarters of this year, as George had mentioned, we are increasing and narrowing our non-GAAP earnings per share guidance for FY '10 to $2.15 to $2.20.

Now let's turn to Slides 12 to 14 and have a look at our preliminary FY '11 guidance. As George mentioned, we thought it made sense to provide you all with an early look at next year given the somewhat unique circumstances of 2010. Our initial thoughts for fiscal 2011 non-GAAP earnings per share range are between $2.35 and $2.45. Implicit in this is our expectation for relatively modest revenue growth on a consolidated basis.

Now that said, let's spend a few moments going through some of the segment-specific assumptions in more detail. On Slide 13, you can see the Pharmaceutical segment assumptions. Let me hit on a few highlights. Importantly, our FY '11 guidance assumes a renewal of all existing major customer contracts. Brand inflation is projected to be on a comparable level to FY '10. We do not anticipate a significant change from FY '10 related to the year-on-year comparison of generic launches and price deflation. We do, however, expect continued benefit from our generic sourcing programs. And as we did heading into this year, we have risk-adjusted a basket of potential at-risk launches losses in FY '11 to come up with our forecast. In the Nuclear business, we expect the Moly [ph] supply shortage to moderate during the first half of next year. The Nuclear will likely face a tough first half due to the supply shortage.

Now let's turn to Slide 14 and our assumptions for the Medical segment. We expect to benefit from increased preferred product sales and customer mix shifts to higher margin classes such as ambulatory care. We do project a negative impact from rising commodity prices that we saw over the last several quarters, as the increased cost slowed through our P&L through FY '11. We did not anticipate the extraordinary demand from the pandemic flu season that we experienced in the first half of this year. Our Medical Transformation initiative expense will continue at a similar level to FY '10 as we continue to position our Medical segment for long-term growth.

And we are also making some further strategic moves in the Medical segment related to sourcing and category management which derive [ph] long-term benefit. In addition to the segment-specific items noted, I want to highlight that we will continue to take additional broad-based actions to improve the cost and capital profile of our businesses. As you would expect, we will be providing an updated look with additional details at our Q4 call. But I hope this preliminary look at FY '11 is helpful.

Let me conclude with some final remarks on healthcare reform, building on what George commented on earlier. At this point, it is difficult to accurately quantify the impact that some elements of the reform package will have on volumes or margins, although we are optimistic that increased access will provide an overall benefit to us in the medium to longer term. Further, there are two areas that are a bit easier to quantify. First, with regard to the cost of our employee benefits, we expect the ongoing impact to be relatively minimal, and we'll be taking no charge for postretirement healthcare as we do not have a company funded retiree healthcare program.

With regard to the 2.3% tax on sales by med device manufacturers, we expect to see, which is scheduled to take effect on January 1, 2013, will have some impact on us. The final language, as [indiscernible] devices to include in this tax application, was a little more inclusive than we would have liked. [Indiscernible] for you, based on today's look at business and after any actions we may take to mitigate or share the impact hit to our Med/Surg manufacturing business would be about $20 million to $25 million annually.

With that, I'll turn it over to the operator to begin our Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from the line of Tom Gallucci from Lazard Capital.

Thomas Gallucci - Lazard Capital Markets LLC

Some of the upside that you mentioned in the quarter in the Drug segment, some strong inflation, generic etc., you’ve done a pretty good job in the last couple of quarters at identifying sort of the relative magnitude of the upside from unexpected aspects of those areas. Can you provide any more clarity on that front for the third quarter?

Jeffrey Henderson

At our Q2 call, I mentioned that the year-to-date breakdown between what I would say are external factors and sort of internal performance factors was in the range of 75, 25 or thereabouts. Now, as I also said at time, it’s always hard to come to a definitive break between those two because clearly, as we improve our internal performance, our ability to capitalize on external changes increases so it’s a bit of a gray line. But I would say that rough breakdown that I talked about in Q2 probably still applies to Q3 and the overall year-to-date.

Thomas Gallucci - Lazard Capital Markets LLC

George, just as a follow-up, you mentioned real strong performance in terms of the year rising, generic compliance and penetration rates. Can you sort of frame for us where you are as you think about how much more room there is to go given you've done so well in the last year?

George Barrett

It's been very encouraging progress on this account. I think there's still room to ro, Tom. I don't know how -- I can’t give you a complete quantification. I can tell you that we are significantly north of what we had set as a target. But I still think we experienced some leakage, and we're working very hard to continue to close any gap in our compliance rates. So I think there’s still room to go, but certainly I'm pleased at the progress we’re making.

Operator

The next question comes from the line of Glen Santangelo from Credit Suisse.

Glen Santangelo - Crédit Suisse First Boston, Inc.

George, I wanted to kind of talk to you about your investment spending that you made in 2010. Basically, if we go back to analyst day last year, you laid out a whole bunch of initiatives in terms of investment spending that was required that negatively impacted your margin in fiscal '10. Could you maybe quantify that for us as you kind of look back maybe how much you spent, maybe how much that impacted your margins and then as we look out to this initial fiscal '11 guidance that you're giving us, could give us a sense for maybe how the investment spending in fiscal '11 might compare to fiscal '10 so we can maybe think about what a more normalized margin run rate would look like?

George Barrett

Glen, let me just start in sort of a qualitative sense, and then I’m going to turn it over to Jeff. We really set out a game plan with some of these investments very well articulated upfront to ourselves in terms of what we want to do. And then we also knew that there were some key initiatives and highlights that were being considered inside the business units. And I would say we're making good progress on both counts. What I'll do is to turn it over to Jeff. I think he can give you a little bit more of a sense of breakdowns particularly as it relates to the [indiscernible] investments that we’ve made.

Jeffrey Henderson

Let me break it down into a few different areas, starting within the Med segment. There were two major transformational initiatives going on this year that we invested in. One was our overall Med Transformation which was a multiyear, pretty significant overhaul of our processes and systems with our Med supply and manufacturing business. Incrementally, this year, we're going to spend about $25 million more on that program than we did last year, and last year's spend was relatively minimal. The spend next year will be about the same. So there won't be a positive benefit from it next year, but it will be pretty much neutral in terms of the year-on-year spend. The other major transformation within the Med segment was in our ambulatory space, particularly related to customer-facing IT systems and ordering platforms. The bulk of that investment has happened already. There will be a little bit still to be finished up next year, but I would actually expect that to be a net positive next year both due to lessened investment but also because we're reaping the benefits of that transformation that we've done over the past year and a half. On the Pharma side, the biggest investment we've made this year has to do with our ordering systems that we put in our customers’ pharmacies. We're in the midst of rolling that out to our customers across the U.S. There was significant spend related to that this year. I would expect the spend next year to be about equivalent for that implementation. So again, neutral impact from FY '10 to '11. And then, as always, there's a certain amount of investment spend that sort of hold at Corporate to fund certain initiatives and strategic imperatives over the course of the year. That was a negative variance from FY '09 to FY '11 –- I’m sorry, from FY ’09 to FY '10 in the range of I’d say $15 million or so. I would say it would be largely neutral going into next year. So hopefully, that helps.

Operator

The next question comes from the line of Lisa Gill from J.P. Morgan.

Lisa Gill - JP Morgan Chase & Co

Jeff, I just had a couple of follow-up questions around the guidance for next year. In your initial guidance, are you making any assumptions around share repurchase in that number?

Jeffrey Henderson

All I’ll say on that for now is that at a minimum, we assume that we'll do share repurchases equal to the amount required to offset the dilution from equity share ratios under our management programs.

Lisa Gill - JP Morgan Chase & Co

And then the fee for med tech that you have now [ph] for $20 million to $25 million, is that also included in your expectations that you initially gave us?

Jeffrey Henderson

Lisa, actually that does not begin implementation until January 1, 2013, so that would not impact the FY ’11 at all.

Lisa Gill - JP Morgan Chase & Co

Obviously you're sitting on $2.6 billion of cash. Do you have thoughts around acquisition opportunities? Clearly, you’re trying to work more on the ambulatory care area. George, do you see opportunities to make acquisitions there? Do you think that it's better to build it out internally?

George Barrett

Lisa, I probably would revert a little bit back to the general comments I made. We're really trying to do this without a fixed model. We have sort of a balanced view of this. Certainly, our goal is to create a competitive advantage for ourselves and to make sure that we're generating shareholder return. And so we’re looking at every way to do that. And so, if that can be done organically, obviously, we’ll pursue it and pursue it aggressively to the extent that we think building out a capability in one of our target areas requires some kind of external mover that we could turbo charge the effect, then we’d certainly look at those things.

Lisa Gill - JP Morgan Chase & Co

So generally speaking about acquisitions, is there anything that you see right now that you think is interesting and you think would be additive to your well-positioning of the company going forward?

Operator

The next question comes from the line of Steven Valiquette from UBS.

Steven Valiquette - UBS Investment Bank

You guys have given some updates on the dollar amount of generic profits where I think we left off at down $75 million at the end of last quarter for this fiscal year. I wonder if there’s a further update on that? That’s question 1. And question 2 is really the same question for fiscal ‘ll where you say generic launches and deflation comparable to fiscal '11 -- I want to make sure that means flat as opposed to comparable guidance where you’re saying it’s going to be down and try to clarify that as well for the initial view for next year?

Jeffrey Henderson

The answer to your first one, in the last call, we said that the total impact from both the fewer generic launches this year and generic deflation from products that launched last year was the net impact was going to be about down $75 million year-on-year. Based on what we saw in Q3, where we saw a few more launches than we had anticipated and a little less deflation on a few products than we had been anticipating, we now view that number for the full year to be closer to around down 50. And to clarify my comments regarding next year -- I'm glad you asked that because that probably needs clarifying -- what I meant is the net impact from generic launches from deflation next year from a dollar standpoint is about neutral -- so flat to this year.

George Barrett

And Steve, just a bit of extra color. Part of the -- the interesting phenomenon, as you know, having covered the generic industry is that we've taken a sort of risk-adjusted approach to modeling, and that's something we articulated about a year ago. What happens, of course, is when you get launches at risk or settlements, of course, those don't come out risk adjusted. They're binary. They either happen or they don't happen. It's been a year in which we've had quite a good number of launches at risk as well as some settlements and that's the phenomenon that we deal with and of course, we'll deal with every year.

Operator

The next question comes from the line of Garen Sarafian from Citigroup.

Garen Sarafian

On the Pharma side, your generics programs seem to have been very successful thus far and exceeding your goals. So without sharing your secret sauce, what types of activities have really led to your success?

George Barrett

Well it's a bit of a question of integrating the pieces. There's no one part. It starts with focus and making sure that everybody understands the goal of growing this part of the business, growing share of wallet and expanding our generic presence. We've done a lot of sales training, as I mentioned during my prepared comments. We are making sure that our incentive systems are aligned to drive the right behaviors. We've tried to create programs for our customers that are really flexible and tailored to their unique needs because every one of our customers is different and has different needs and making sure that we're monitoring measuring this important factor all the time, then linking it to a proper kind of sourcing model. And so I think it's the integration of those pieces and we're making some good progress there.

Garen Sarafian

And moving on to your Canadian operations, you highlighted another strong quarter. Can you elaborate on what's driving this growth and if you could quantify year-over-year growth in revenue and earnings on a constant dollar basis?

George Barrett

So our Canadian business has done a terrific job. They've been able to bring in new customers, as well as expand their business with existing customers who see their extraordinary distribution and service support as a way of penetrating the market.

Jeffrey Henderson

Yes, Garen, I think on the sort of currency-adjusted revenue growth rate year-to-date, I would peg it at about mid-teens. So even when you backed out the currency benefit, they've had a very, very strong year, which I'm always very proud of.

Garen Sarafian

Last quarter, I think it was in excess of 20%. Was that also a constant-dollar basis last quarter?

Jeffrey Henderson

I would say that 20%, that was again, probably five percentage points or so of currency benefit.

Garen Sarafian

Was included in the 20%?

Jeffrey Henderson

Yes.

Garen Sarafian

And just one quick follow-up on fiscal '11 guidance. You mentioned hospital admissions as it impact your Medical segment. Your early guidance, what does it assume in hospital admissions for next year?

Jeffrey Henderson

Could you repeat that?

Garen Sarafian

Just on your early fiscal year '11 guidance, what does it assume regarding hospital admissions? Does it assume any sort of a pickup due to economy picking up? Or is it what you're seeing now?

George Barrett

I think we're assuming that we'll track the market again. So we're not modeling in at this point a pickup related to the economy. We are, of course, somewhat encouraged by what we've seen in recent weeks or days in the broad economy but still taking a cautious outlook.

Operator

Your next question comes from the line of Charles Boorady from Oppenheimer.

Charles Boorady - Citigroup Inc

Maybe for Jeff, I think you talked about it, I might have missed some of the items. You talked about some of the things helping fiscal 3Q that you said might normalize in the fourth quarter. Can you just kind of repeat some of those things? And does that relate to also the things that are impacting the 4Q margins?

Jeffrey Henderson

Yes, I would say the biggest one, Charles, is the contingent brand inflation, that we saw some fairly significant increases from the branded vendors that still fall into our contingent category of fees in Q3. Quite honestly, in Q4, we are expecting very, very little of that. In fact, one of our largest contingent vendors that typically would do a fairly significant price increase in Q4, our expectations are that price increase will not happen. So again, our income from brand inflation from contingent vendors is a very conservative view of Q4. That both is responsible for the largest step-down from Q3 to Q4 in terms of farm income. It's also the largest driver of the decline from last year to this year. But there's a few other factors in Q4 as well. Clearly, we still face the headwinds related to the Pfizer DSA transition, which also impacted Q3. But the impact on Q4 is slightly higher. We expect fewer generic launches this year versus last year. As you may recall, Adderall launched in Q4 of last year, which was a fairly significant value generic launch for us. We don't see anything of even comparable size in our Q4. And then as we indicated, our nuclear supply shortage continues to be quite severe. That impacted us for part of Q3. It's going to impact us for the entire Q4, and it has turned out to be a pretty big challenge for us. So those would be the big factors. Again, the other thing I'd point out is that our tax rate in Q4 will be about four percentage points higher than it was in Q4 of last year.

Charles Boorady - Citigroup Inc

So when we look at sort of overall brand price inflation in the market and you're saying that, that sort of diverges from the brand price inflation that you see from your specific vendors and then the vendor pricing from that one vendor you're talking about not happening in 4Q, would you expect that to happen then in September quarter or later?

Jeffrey Henderson

In answer to the first one, yes, we actually track two types of branded inflation. There's just the general market inflation, which tracks very closely to what you would see in the published reports, which I think by most published reports this year have been in the sort of high-single digits. But more importantly, from sort of a quarterly swing factor perspective, we also track the brand inflation from our contingent vendors. And that does differ from the overall market. And this year has been more in the mid-single digits as we've commented on before. But we think that most of that happened in the first three quarters of the year, which is why we're not projecting much in Q4. Regarding whether we'll see those price increases happen next year, don't know. I mean we always assume a certain level of contingent branded price increase in each year. Now exactly the timing of those and which ones will happen at which rate, again, we sort of look at it largely as an overall portfolio. So it's hard to say which specific ones will happen in Q1 or not.

Operator

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

Larry Marsh

It sounds like if we sort of think about your midpoint, you're taking down the fourth quarter number, maybe a nickel versus consensus. I know you don't guide to -- do quarters. But it sounds like you're calling out maybe a couple of cents from this manufacturer not raising prices in fourth quarter, and I would assume that just gets pushed out to Q1, maybe an incremental penny from Nuclear. Sounds like Medical will be back up. I'm still struggling a little bit to understand the other couple of cents because just running thorough the numbers, it looks like your Drug business would be down 25% year-over-year to kind of get there. Any just additional clarification, Jeff?

George Barrett

I just want to start and then I'm going to turn it to Jeff because I do think there are sort of natural fluctuations to the quarters, number one. We don't guide by quarter and that's actually a very good reason for it. Right now, I would say again, the characteristics of the business continue today as they did two months ago. These are largely the mechanics of our business. The one thing that I would probably call out is just that we were going through this nuclear shortage but actually have done very well in light of it. And while we'll suffer a little bit from that comp in Q4 in Nuclear, this is largely the mechanics of business flowing through. But I'm going to just turn it to Jeff at that point.

Jeffrey Henderson

I fully understand your question, Larry, and let me just build on what George said. First of all, I wouldn't view it as us taking down Q4. I would view it as taking up the year and recognizing that there were shifts between quarters and probably some of the stuff that we were expecting in Q4 before happened in Q3. But let me be a little bit more specific regarding some of the year-on-year negative drivers in Q4. First of all, the headwinds from the Pfizer DSA and MSI transitions that we've been talking about all year probably hit us to the largest degree in Q4, given past timing of Pfizer price increases. And that's worth $0.03 to $0.04 of negative impact year-on-year. Other brand inflation that we think sort of got shifted primarily earlier and that's in the $0.04 range. Lack of generic launches is $0.01 to $0.02, again versus last year. The impact of the nuclear supply shortage, as we've said, was at least $0.02, so I'll put that in the $0.02 to $0.03 range. The tax rate increase is worth about $0.03. And then, we'll probably be occurring at higher performance compensation rates as well in Q4, which could be worth another $0.03 or so. So I think as you add those up, you can quickly get to the difference between growth and the negative growth we'll be anticipating. The final thing I'll point out, and obviously, you know this, Larry, but just to state it, our Q4 is traditionally always lower than our Q3 due to just the nature of our business.

Larry Marsh

Secondly, then just the same sort of question for fiscal '11. I mean, again, I think it's smart to get out ahead of the Street to give a number here so thank you for doing that. But just again, looking at that just in my model, if I'm assuming Medical grows some next year and I think you've been bullish about that business, I would sort of assume Drug is going to be flat. Without pinpointing you, I guess would you be disappointed if you went through fiscal '11 and your Drug business was flat in profits?

Jeffrey Henderson

And we're glad to be able to give some really look at our expectations for '11, but we will, as you would expect at the end of Q4 when we've completed our final budgets, we'll provide greater detail on the segments. Right now, I'm actually feeling good about where we are as a business. I'm feeling good about 2011 but I think at this point, it's probably too early to be giving any direction on the segments. But again, I'll suffice it to say the things we've done during the course of this year to help position us have been productive and probably a little faster than we might have otherwise modeled. There is a little bit of color in the slides that we gave you on some of the, let's say, assumptions in our general thinking about next year, but I think I'll come out of 2010 feeling pretty good about where we going to be going in 2011. But we'll provide some greater detail when we get to that at the end of Q4.

George Barrett

Just a final thing, I was following up on a question of [indiscernible] and talk about what you're going to do with your capital, but I would think if we sat here six months from now and had a conversation and the cash was still in the balance sheet, would you come and say, "Look, we want to be prudent but I'm a little disappointed we haven't been able to put it to work." Or is it just we're just going to wait for the right things?

George Barrett

Again, I'm going to probably sort of [indiscernible] this up a little bit to the general comment, but I will say this: It is certainly not our goal to trap cash. That is not necessarily productive for our shareholders and we want to make sure that we're putting cash to work effectively in any number of forms and including investment on the right things internally. So I won't give any more color on that. Other than that, we're going to take a very balanced look at this with that [ph] pre-existing formula and from that we'll say it as we go.

Operator

The next question comes from the line of Bob Willoughby, Bank of America [BAS-ML].

Robert Willoughby

George or Jeff, our take from some of the ambulatory care providers was that demand for services was somewhat soft. How are you guys characterizing your experience there, your gains? Is this a market share grab? Or is the market actually doing a bit better than thought? And then secondarily, any success with some of that formulary approach to managing the SKUs for the Med/Surg [Medical/Surgical] Supply business?

George Barrett

I think what we track is really outpatient procedures, elective procedures, admissions and discharges. I would say the data has been generally a bit soft as you're hearing. We've been growing, largely, by -- again, we were a relatively small position, and so partly we're growing through focus and the kind of IT investment that we've talked about and making the experience with ambulatory centers more effective. So I think it's some share movement. I would say the market is certainly experiencing a little bit of the softness that you've described. As it relates to our formulary approach, this is really -- we've just really begun to build out our capabilities and to reorganize around both the right channels and the right business categories. The early efforts, particularly as we see as to our private label work, is showing good result. But I'd say it's early days so I don't want to get ahead of us, but we're really excited about this as a model for serving customers in the way they need to be served and creating value for them. And we think that will provide a margin expansion for us as well.

Operator

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

Robert Jones

So in thinking about the medical transformation initiative, I was wondering if you could give us a little bit of a sense of the improvement in margins that you're expecting in fiscal 2011 verse (sic) [versus] fiscal 2010. And maybe just qualitatively, is fiscal 2011 when you expect to see that meaningful impact from this initiative?

Jeffrey Henderson

No, I would say we start seeing material benefit towards the end of 2012 and then a very significant benefit in 2013. We're identifying some early wins along the way, which we'll try to accelerate and capture as quickly as possible, but I think in terms of meaningful impact on our working capital and our margins, we're really looking late fiscal '12 and then fiscal '13. And it's probably too early to quantify that at this time [ph].

Robert Jones

And then I just had one on the redesign sourcing initiative. I was just curious if there's been any fallout from some of the generic manufacturers that might not have been on the preferred list. And as we think about -- you mentioned at-risk launches and such. As we think about exclusive product opportunities going forward, is there any risk of the non preferred manufacturers having these products and how those products will come through Cardinal?

George Barrett

No, we're really pleased with the way this program is rolling out. First, let me remind you that we continue to do business with the entire mix of generic suppliers. As it relates to our preferred program, we've been able to narrow that group. We did this with, I would say, a relatively thoughtful strategic perspective by product, not just by company. So thinking about which products we're going to launch, where exclusivities would lie, who was involved in the mix, who had what capabilities, who was specialized in which areas. So I don't think there's been any fallout. And again, I would also remind you that we've got, I would say, strong relationships with all the suppliers. And so some of these companies that might have not been the number one player were in a bad position. There've been, as you know, some disruptions in the market this year and some of those players have been available to us to step up. So we're pleased with the way that's unfolding and think we're on the right path.

Operator

The next question comes from the line of Richard Close with Jefferies.

Richard Close - Jefferies & Company, Inc.

George, you talked about essentially your target 10% improvement on the generics and that you've exceeded that this year. Can you quantify the amount you exceeded that by and then what your thoughts are for fiscal '11 in terms of additional improvement?

George Barrett

Well I don't think I'm prepared to set out a goal. We will internally, and that's part of our final budgeting process. I'm always a little reluctant to give exact numbers. I would tell you that we have substantially exceeded that growth target. So exact rate is probably not something I'm comfortable describing at this point. But we're very pleased with the rate and I would say through nine months, we're well past the target.

Richard Close - Jefferies & Company, Inc.

And Jeff, I was curious, you guys have talked about the bulk margin over the last couple quarters. And I think it was 22 basis points in the December quarter. Any thoughts on where that shook out in this quarter or maybe I missed that?

Jeffrey Henderson

The bulk rate for Q3 was 48 basis points, which was about two basis points lower than the same quarter last year.

Operator

The next question comes from the line of Ricky Goldwasser from Morgan Stanley.

Ricky Goldwasser - Morgan Stanley

First of all, Jeff, on the interest expense line, are you still expecting interest expense to be $110 million for the year? I think that implies a pretty significant step up from third quarter levels.

Jeffrey Henderson

No, I think it's in that range, Ricky, $110 million to $115 million, perhaps. And that would imply a fairly comparable level to what we saw in Q3. I think you have to back out though the benefit of the CareFusion sale in the Q3 numbers. And you may be comparing the GAAP numbers because there's a significant -- that $23 million gain that we recognized appears in interest and others. So when I refer to that $110 million level, I'm excluding the CareFusion gains we've realized this year.

Ricky Goldwasser - Morgan Stanley

And then on the fiscal year '11, what are the generic compliance assumptions you're making for '11? Are you assuming pretty much steady state? Or are you assuming additional progress? And then, I know that you mentioned that the guidance also factors in contract renewals. I think big contracts are in Kmart and Kroger's. If you can just remind us what the timing for these contracts are and when should we be hearing about them? On the generic compliance, basically, what are your assumptions for fiscal year 11? Are you assuming steady state? Or are you factoring in improved compliance rates?

George Barrett

So while I won't give you targets at this point, we haven't even finalized them internally, I will say that we're assuming some ongoing improvement of genetic compliance or generic penetration rate. As it relates to the second, these are both spring, I think, June dates on the renewals. I can tell you definitively that one of them is in final contract negotiations today, and we feel good about our progress on all of those conversations.

Operator

Our next question comes from the line of John Kreger, William Blair.

Unidentified Analyst

This is Robbie Estrada [ph] in for John. Can you quantify your growth with independents this quarter? And perhaps how much of the $1 billion in business that you lost last year that you've won back at this point?

George Barrett

Yes, Robbie [ph], we had relatively modest growth. We really followed the market, which is in the 1% range this period. So I think the noteworthy success for us was the growth of our generics inside the independent that total growth of independents was just following the market at this point. This is a great question. People ask it all the time. I wish I knew how to answer how do you describe what we were covered from the last business during the challenges of 18 months ago. And the probably is you can't do a one-for-one comparison because in a sense, there's always some churn, so we're picking up business. We don't know for sure whether or not it's exactly the business you lost, partly because we were doing business with most of those players throughout, but they significantly reduced business during that stretch. So I don't know how to answer the question about how much exactly from the amount lost was picked up. We can just give you a general sense of growth, and we believe it will continue to grow this business.

Operator

And the next question comes from Helene Wolk from Sanford Bernstein.

Helene Wolk - Sanford C. Bernstein & Co., Inc.

First a question about revenue: I just want to understand or get some more color around the revenue growth in the quarter and the outlook for the balance of the year in '11 around sort of what you're seeing or hearing relative to some of the customers underperforming the market.

George Barrett

Yes, so let me start by saying as you know and you've touched on, we do have a couple of large customers, so to some extent, our revenue growth is linked to the performance of any of those customers. I'm not really all that comfortable characterizing their business, that's really for them to do, other than to say that with a couple of these major customers, we're enormous suppliers. We are doing a bulk of their -- the vast majority of their business, and so to some extent, we track how they do. Beyond that, and I'll turn it to Jeff to sort of just give you the general thinking about the revenue assumption here.

Jeffrey Henderson

First of all, just to build a little bit on what George has said about what happened in Q3. Given the very large nature of some of our customers, particularly on the bulk side, you can sometimes get a fairly significant swing in the cord [ph] just because of timing of orders. It may not necessarily track their demand, but they may place a very large order on December 29 and that may shift something from Q3 to Q2. So with our very large customers, it's always hard to read too much into the timing of the orders. Regarding our view going forward, I'd say within the Pharma side, we're generally going to track the market, although recognizing that those two large customer losses or terminations that we had earlier this year still haven't lapsed. So we'll still feel the effect from that going into Q2 of next year. But if you sort of adjust for that, we expect to generally track the market and exactly how close we'll track the market will depend on how our customers perform in terms of market share versus the broader market. On the Med/Surg side, again, we had a few unusual events this year that for the first three quarters tended to abnormally elevate our revenue growth. Again, we had the recognition of revenue related to the CareFusion spin in Q1. We had a extraordinary flu season in Q1 and Q2. Those events clearly won't repeat in Q4 and probably into next year. So I would say generally, we expect to track the market and the markets we participate in. And I'd say we have a somewhat cautious view for the next couple quarters until we see exactly where the economy settles out, et cetera. But I'd say in general, we see modest growth for the current periods.

Helene Wolk - Sanford C. Bernstein & Co., Inc.

And then just a question on the generics guidance around what you're expecting for fiscal '11. Just sort of trying to understand whether the removal of product, how's that respond to Naloxone and Protonix, whatever transpires here is impacted or forecasted into your assumptions.

George Barrett

Yes, Helene, it's George. You can assume that whatever has happened and is in the public domain, and there're a few that I know you're referring to, that's assumed into our preliminary outlook here. So yes, it has been some interesting stuff in the last few weeks, and it's all essentially built into this assumption.

Jeffrey Henderson

Clearly, the supply situation in Nuclear is having an impact on their revenues as well, which fall into the Pharma segment. That had some impact in Q3, will clearly impact Q4 and very likely most of Q1 until the supply situation stabilizes heading into Q2.

Operator

And the final question comes from the line of John Ransom from Raymond James.

John Ransom - Raymond James & Associates

As we think about branded inflation, you'll be fully transferred to ether [ph] service by fiscal '12. Is there going to be less -- it sounds like there's still a fair amount of quarter-to-quarter relativity on branded inflation. How will the getting Pfizer to a fee-for-service model and move into '12, how much will that reduce the volatility?

George Barrett

First of all, I don't want to say that it'll be completely converted over in our entire book of business by 2010. It is possible but that's not something I could tell you. It's not, at this point, clear. There's no question that every time one of the major players converts, it does smooth out the nature of our business. And as you know, today is still a relatively small part, but it can from quarter-to-quarter show up, and we do think that, that volatility that comes from that mechanism of compensation will diminish the volatility.

Jeffrey Henderson

The sort of annual portion of our branded by margin that is now contingent-based is less than 20% after the Pfizer transition. It seems like a small amount, but as George said, when that 20% occurs quarter-by-quarter, it can have significant quarterly swings, which is also why it's sometimes difficult to predict exactly how those numbers will play out.

John Ransom - Raymond James & Associates

Yes, because I don't think we really stressed tested fee-for-service in that low-inflation environment, and I'm a little concerned there may be more volatility than some people expect.

George Barrett

Yes, John, I actually don't think so. I think what's been noteworthy is that we had one player convert from one system to another. And the other thing that's been noteworthy is that I would say price increases used to be relatively predictable in timing. And so in a sense, we could provide greater color on that, and I think all of you learned to have the expectation. Actually what's happened with the few players that do this, it's just a little bit less predictable in the last 12 months. So that's probably just part of a phenomenon in the system.

John Ransom - Raymond James & Associates

We're certainly seeing at the retail pharmacy levels more stress on pharmacy margins, particularly generic margins, and yet your generic economics continue to be pretty good. Are you getting any push back at all? And then secondly, are you getting any push back at all from the branded and the generic guys on some of your fee for services as you renew some of those agreements?

George Barrett

Well let me just again, describe it generally. Look, the generics market is, of course, a competitive market. And we expect it to be that way. We've just, I think, done a better job of making our offering attractive and making sure that we're doing the right things on the sourcing side to make us an attractive partner with the generic companies. So I would certainly not say suddenly it's not a competitive market. Of course it's a competitive market. So we live with that every day. On the branded relationships, we feel good that we've got strong and pretty deep relationships with our branded suppliers. And so we've continued to have very productive conversations. We feel very clear and we hope we articulate well to our branded partners how we create value for them and being their partner and getting products into the system. So I fell relatively good about that. But everybody feels the pressure, it's part of the system today and we'd just assume that going forward.

Well thanks, all of you. I know this has been a little bit longer of a call, but we wanted to make sure that we gave everyone time to ask questions. And so I'll just end by reiterating how encouraged we are by our performance in the quarter and through the first nine months. We do remain focused on executing on our strategic priorities and continuing to improve the customer experience and we're pleased that, that's showing up in some of our progress. So we look forward to providing more detail on our initial guidance for fiscal 2011 on our fourth quarter call. We look forward to talking with you then and thanks for your time today.

Operator

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

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Source: Cardinal Health Q3 2010 Earnings Call Transcript
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