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Executives

Patrick Lee – VP, IR

John Figueroa – CEO

John Workman – President and CFO

Analysts

Robert Jones – Goldman Sachs

Frank Morgan – RBC Capital Markets

Jason Gurda – Leerink Swann

Lisa Gill – JPMorgan

A.J. Rice – Susquehanna Financial

Steve Halper – Stifel Nicolaus

Brendan Strong – Barclays Capital

Steven Valiquette – UBS

Omnicare, Inc (OCR) Q3 2011 Earnings Call October 25, 2011 9:00 AM ET

Operator

Good morning. My name is Lisa and I will be your conference operator today. At this time, I would like to welcome everyone to Omnicare’s Third Quarter 2011 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator instructions). Thank you. I would now like to turn the call over to Patrick Lee, Omnicare’s Vice President of Investor Relations. Mr. Lee, you may begin your conference.

Patrick Lee

Thanks, Lisa. Good morning, ladies and gentlemen, and thank you for joining us today. With me on the call today are, John Figueroa, Chief Executive Officer and John Workman, President and Chief Financial Officer.

Before we begin, let me remind you that during this call, we will make remarks that constitute forward-looking statements. Actual results may differ as a result of a variety of factors including those identified in our earnings release and our various filings with the SEC. You are also cautioned that any forward-looking statements reflect management’s current views only, and that the company undertakes no obligation to revise or update such statements in the future.

Please note that this communication does not constitute an offer to buy or solicitation of an offer to sell any securities. A tender offer to purchase all issued and outstanding shares of common stock for PharMerica Corporation, is being made pursuant to a tender offer statement on schedule TO, including the offer to purchase, letter of transmittal, and other related tender offer materials that was filed on September 7, 2011 by Omnicare with the SEC.

Investors and security holders of PharMerica are able to obtain free copies of these documents and other documents filed with the SEC by Omnicare, through the website maintained by the SEC or by directly request to the corporate secretary of Omnicare.

For simplicity sake, and the focus on what we believe are the best indicators of our operating performance, we will discuss results from continuing operations and we’ll also exclude special items for all periods in our discussion today. A reconciliation of this non-GAAP information has been attached to our earnings release and is also available on our Web site. Also on our Web site, we have posted supplemental slides, which are intended to accompany our remarks this morning.

Before turning the call over to John, I would like to remind analysts to limit themselves to one question and one follow up during our question-and-answer session so others may ask their questions. With that, it is my pleasure to turn the call over to John Figueroa.

John Figueroa

Thanks Patrick, and good morning everyone, and thank you for joining us today on our call. Before we provide our prospective on our third quarter results and the key drivers behind our continued success through the start for the second half of the year, I’d like to give an update on where we stand with our $15 per-share offer for PharMerica. Following our remarks, we’ll be happy to answer your questions.

As most of you know, we recently extended our $15 per-share tender offer for PharMerica. We are pleased with the initial response from PharMerica’s investors, reflecting a 47% participation rate in that offer.

A large number of PharMerica shareholders sent a clear message that they are supportive of the offer, and would prefer our two great companies to negotiate a neutrally acceptable transaction without further delay.

While it remains our strong preference to negotiate a neutrally acceptable transaction with PharMerica, we will continue to move forward with the regulatory approval process. We are determined, but disciplined and look forward to bringing our companies together soon.

With respect to the regulatory approval process, we are working closely with the Federal Trade Commission to comply with their second request. I do not have a timeline for when we expect to complete the process at this point. However, we would not pursue a transaction unless we believe we could close expeditiously.

I believe the institutional pharmacy industry has been very competitive throughout history. And that the combination of our two company’s would not alter that.

I believe the time for the transaction of this kind is now. Any significant delay could result in both company’s losing the opportunity to realize the full strategic and cost savings benefit of such a combination. I believe it is consistent with the country’s effort to lower overall healthcare cost, and is expected to help customers manage and respond to on-going industry pressures.

And with the inherent demand within our industry, due to the aging population, I believe we have an obligation to accelerate the efficiency of our industry while improving health outcomes for the residents we serve.

Now, turning to the third quarter. We are pleased with our solid third quarter results, which reflect the progress we are making to becoming more operationally driven, and customer-focused company. We continue to execute on our operating objectives, while establishing new ones. And we remain focused on continuing to drive enhanced value for our shareholders, customers, and other important stakeholders.

For the quarter, we generated adjusted EPS of $0.54, which represented both a sequential increase and improvement from the comparable prior year period. This represents our second consecutive quarter of year-over-year growth in quarterly EPS, which underscores the continued progress we are achieving in executing our operating plan.

Our third quarter results were driven largely by an improved operating leverage with both gross margin and operating margin expanding approximately 80 basis points sequentially. We also continued to generate very robust cash flows, with cash flows from continuing operations 22% higher sequentially, and 44% greater than the third quarter of last year.

Moreover, our third quarter cash flows from continuing operations of $167 million brings the nine-month total to $448 million, which is the highest output of any nine month reporting period in our company’s 30-year history.

Our ability to generate significant cash flow is certainly a differentiator for us. Our cash flow is disproportionally higher as a percentage of our market cap when compared with many other companies in our sector, providing us with distinct opportunity to create value for our shareholders.

In addition, realizing consistent net organic bed growth, will enable us to free up additional capital that has historically been deployed towards acquisition to replace lost business.

Let me be clear, acquisitions are an important part of our growth strategy, but our goal is not to target acquisitions when the underlying intent is to offset organic losses. So we remain acutely focused on achieving organic net-bed growth in order to put of our capital to work.

I’d like to now turn to our three core operating initiatives, and discuss the progress we have made in these areas while providing some insight into how we see these developing.

Our first core operating initiative is establishing consistent organic growth in our long-term care group. As I consider our organic growth performance for the quarter, I am pleased with our progress. While we are not quite at 95% retention rate we believe is required to generate consistent organic net-bed growth, we have stabilized service levels in our retention rate. Third quarter bed losses were 16% lower as compared to the year-earlier period making the fourth consecutive quarter of reporting fewer bed losses on a year-over-year basis.

Importantly, two of our five divisions reached organic net-bed growth for the first time since we re-organized our long-term care group, marking a solid turnaround in our west and southeast regions. And I’m opportunistic that we will continue this momentum.

We have worked incredibly hard to improve the perception of Omnicare in the marketplace and believe the timing for this changing customer view is especially important now in light of the reimbursement challenges some of our customers are experiencing.

A critical component to improving our customer relationships is providing them with products and services that help them lower cost and operate more efficiently in a dynamic and rapidly changing environment.

At the beginning of the month, our nursing home customers faced a change in their reimbursement. And many skilled nursing facilities are concerned that there could be further revisions as a super committee convenes on deficit reduction alternatives.

I believe however, that Omnicares skilled nursing facility customers are uniquely positioned to help offset some of the reimbursement burden they have been forced to shoulder. Through our technology portal, Omniview, we offer a significant number of tools designed to generate savings for both Omnicare and its customers while further improving coordination.

And the opportunity here is that many of our existing facilities are leaving savings on the table. So we are focused on increasing adoption of Omniview, while encouraging those that currently use the system, to become heavier users to create even more cost savings.

But perhaps the most compelling component to Omnicare’s offering involves our efficiency with generic drugs. Because of our sophisticated direct sourcing program for generic drugs, and the value this creates for our company, I believe we are fully aligned with our customers to drive greater utilization of generic drugs.

While it is generally taking months, or several months in many cases to do a full conversion of branded generics, it only takes Omnicare a matter of days. Our speed to generic conversion has been a tremendous source of savings for our customers. And it will be even more critical during the next couple of years when new generic equivalence for many important branded drugs become available.

I believe the sales component is also extremely important and one of the biggest opportunities from a customer growth perspective. And we are moving rapidly to ensure that we build the appropriate infrastructure to improve our results.

We have practicably doubled the size of our sales force since the start of the year. And I believe as we refine our go-to-market message, we will have a much more effective sales conversion rate. As it stands, we added 19% more beds to our organic sales efforts than we did in the same prior year period. However, we’re still early in the process.

Moving on to our next core operating initiative; repositioning our Specialty Care Group for an elevated level of growth. Just as we have made investments to accelerate organic sales within long-term care, we have similarly done so with our Specialty Care Group. As most of you know, this business is distinct from our long-term care group, serving a customer base and providing different services, including brand support services, patient assistance programs, specialty pharmacy, third-party logistics, and disease management for end-of-care life.

We have always had a tremendous Specialty Care offering supported by some of the best people in the industry. The marketplace has not always recognized this strength because we are focused too heavily around servicing customers, or our existing customers, rather than establishing a new customer relationship and many more customer relationships.

Since creating a manufactured-focused sales organization earlier in the year, I am very encouraged with the preliminary results and remain opportunistic that our sales efforts will materialize into an elevated level of new business wins.

We have also hired a few key players to service platform-specific experts, who I believe will add a new element to our service offering, while cultivating relationships with our biopharmaceutical clients. So I am pleased with the improvements we have made across our Specialty Care Group, and I am confident that the investments we are making will continue to serve us well.

And finally, I’d like to address the remaining core operating initiative, creating more standard innovation across the company. Within our long-term care business, I believe we have the most sophisticated automation capabilities in the industry, although the machines haven’t always been fully optimized. I believe we are beginning to see some nice progress here, driving more volume through our most efficient script dispensing methods, to ensure that we are increasing our level of standardization, creating a more efficient cost structure for Omnicare, and a more predictable product for our customers.

And we have begun pilot testing two additional pieces of technology, one of which is intended to further improve the economics of our operating model, while ensuring Six Sigma quality standards. And the other is a piece of technology designed to improve the customer experience, while also limiting the level of customization in our delivery model. It is still early, but I believe these technologies will further standardize our operations. As we because more operationally focused and customer driven, we will continue to drive more consistency in our operations and predictability in our service level and delivery model.

And now, I’ll turn it over to John, who will discuss our third quarter financial results in greater detail, as well as provide a favorable update to our full-year 2011 outlook.

John Workman

Thanks, John. We are pleased with our third quarter results. We have filed supplementary schedules with our press release, providing additional information, which we hope helps with your analysis.

Our special items were much lower this quarter than a year ago, and were primarily related to one, debt-related charges, primarily as a result of our refinancing. Two, litigation-related settlements, and three, acquisition-related cost.

I will cover these later, but want to start by covering our continuing quarterly operating results, starting with operating statistics, which can be found on Slides 5 and 6. Third quarter scripts dispensed of 27.4 million were flat as compared with the scripts dispensed in the comparable year earlier period.

On a sequential basis, scripts were 68 basis points lower than the 27.6 million scripts dispensed in the second quarter. As John Figueroa mentioned, this decline was consistent with the industry statistics.

With respect to beds served, we ended the third quarter with 1,293,000 beds served, which was an increase of the beds served at the end of the second quarter 2011 by 10,000 beds, a decrease from the number of beds served at the end of the third quarter of 2010.

Late in the quarter, we acquired Pharmacy Advantage, which added approximately 18,000 beds and strengthened our Western U.S. presence.

We continued to experience losses in our customer base, although at a slower rate. The 8,000 organic net-bed loss in the quarter represents our best performance this year. As John Figueroa mentioned, we had two of our five divisions, long-term care show organic bed growth in the quarter.

It should also be noted that half the organic net bed loss in the quarter, was due to accounts terminated for accounts receivable issues. We believe we are on schedule to achieve net organic bed growth.

Our generic dispensing rate has continued to increase. It was 78.6% for the quarter. We believe this is consistent with lowering overall healthcare cost.

Turning to the income statement, consistent with past practice, we believe the most appropriate comparison for the quarter is on sequential basis excluding special items as Patrick mentioned. And as mentioned previously, we have provided supplemental schedules to facilitate the comparison that I will reference during my comments.

Turning to net sales, which can be found on Slide 7 and gross profit, net sales were lower by 11.5 million or 74 basis points in the third quarter of 2011, from the second quarter 2011 results. However, compared to the third quarter 2010, sales increased 28.2 million or 1.9%.

Adjusted consolidated gross profit increase 9.7 million in the third quarter with the margin rate as a percent of sales improving 8/10ths of a percent or approximately 80 basis points.

Next, turning to SG&A expenses, another element of the income statement, which can be found on Slide 8. SG&A expenses 1.2 million lower in the third quarter 2011, versus the second quarter 2011 and generally flat as the percent of sales.

The provision for doubtful accounts was 1.6% of revenue for the quarter, consistent with the second quarter rate.

Receivables continued to show improvement with day sales outstanding improving two days in the second quarter of 2011.

Interest expense was 1.7 million higher in the third quarter, principally related to the timing of our refinancing, which temporarily caused higher borrowings, coupled with unwinding of a fixed or floating swap in the second quarter. I will comment more about this later.

Interest expense is expected to decline in the fourth quarter as a result of our refinancing.

Finally, in looking at income taxes, net income and earnings per-share, which can be found on Slide 8. Our income tax rate for the quarter, excluding the impact of special items was 38.3%. Income from continuing operations excluding special items was 62.3 million for the quarter, or 4% of revenue.

Earnings per share for the quarter excluding special items equates to $0.54 per share. We purchased approximately 1.8 million shares in the third quarter of 2011. The average purchase price was 27.50 per share. Adjusted EBITDA had a nice improvement of 10.9 million over the second quarter of 2011.

Turning to the special items, as I mentioned, they were fewer in number than last year. The largest item totaled 26.3 million and included debt redemption cost, including tender premiums, and the write-off of previously deferred financing cost related to the repayment of our 2013 notes and 2015 notes, and the amortization of discount on convertible notes from the 2015 and 2010 issues.

The second item was litigation-related settlements, which totaled 6.7 million. The provision considers the state of discussions on varies regulatory and other matters that have previously been mentioned in our disclosures, including the DEA investigation.

As we have mentioned before, we believe there will likely be some additional matters that may arise against the company in the future, but we feel the large ones are behind us. Along this line, there were some additional lawsuits bought in the quarter related to the activities of prior years. Including two key [inaudible] where the government has declined to intervene. We believe all the cases to be without merit.

The last item was 6.7 million and consist of acquisition related cost.

Turning to the balance sheet, we continue to show strength in the quarter. Cash on hand was 682 million including restricted cash. Cash benefited by the timing of our refinancing by approximately 150 million, as we closed on our refinancing before the end of the quarter, but we’re not permitted to redeem the remainder of the 2013 and 2015 notes until October due to required notice period. This balance has actually spent approximately 50 million on share repurchases in the quarter, and redeemed an additional 25 million of our 2013 notes.

Accounts receivable were 47 million lower than the second quarter. As mentioned earlier, day sales outstanding improved 2 days compared to the second quarter. Accounts receivable was below $1 billion for the first time in many years. The settlement of a dispute with a large customer also benefited the balance in accounts receivable.

Inventory was 1 million higher than the end of the second quarter, but inventory days on hand improved approximately 1 day over the second quarter.

Now addressing cash flow, which can be found on Slides 9 and 10. Cash flow from continued operations in both the second and third quarter 2011 was $167 million, the third quarter benefited from the lower receivables in the second quarter.

As we have mentioned previously, the company benefits from a lower effective cash tax rate as a result of the amortization of goodwill for tax purposes, and the continued interest deductions though these will be less during 2011, due to our repurchase of 525 million of the 2015 instrument.

We believe the company also has modest capital requirements on an on-going basis. With the third quarter of 2011, capital expenditures totaled approximately 21 million. The third quarter was higher than normal due to monies being spent on information technology, as we have mentioned previously, and we would expect additional funds for information technology, and nursing home automation in the fourth quarter of 2011 and 2012 as we increase our investment in the business to improve operations and customer service.

As we mentioned on our previous calls, the company plans to continue to asset the use of cash flow in 2011, and deploy that cash in the best fashion to create value per shareholders in addition to acquisitions and debt repayments.

In this light, we have returned 54.6 million of our cash flow from operations to our shareholders in the third quarter through dividends and share repurchases. This amount is higher than our 25% target.

Looking at our capital structure, which can be found on Slide 11. For the year, we have repurchased 200 million of our 2013 bonds. We repurchased remaining 50 million in October 2011.

Combined with our refinancing earlier in 2010, we have successfully pushed out over 1 billion as we move to improve upon our strong capital base.

Our Board has authorized a repurchase of up to 300 million of common stock from time-to-time, over the two years ending in the third quarter of 2012. We have used approximately 221 million per-share repurchases, and have approximately 79 million remaining.

In the third quarter, we completed a new 750 million unsecured bank facility. A 300 million revolver, which is undrawn, and a $450 million term loan A as well as $150 million add-on to our 2020 notes.

The proceeds from the term loan and the add-on notes were used to repurchase the 2015 notes and the remainder of our 2013 notes. Because we had to provide 30 days’ notice for the redemption of the 2013 and 2015 notes, the final 150 million to redeem the full issues was not accomplished until October 2011.

A comment on discontinued operations. During the third quarter, we trued up the DME business to a new lower offer resulting in an additional $11.8 million non-cash charge. This business was discontinued in 2009. This basically writes it down to minimal value.

Before turning to our 2000 outlook and beyond, we want to comment on some CMS changes. The changes to the final CMS short-cycle rules will not impact Omnicare in 2012, and is not effective until January 1, 2013. With the increase in generic penetration, we believe the short-cycle rule will only be applicable to 2% of our total scripts.

Related to recent announcement on FUL pricing, CMS has published some preliminary guidelines and now a second set. Our preliminary analysis is somewhat more negative than originally anticipated based on the data provided.

However, we have been moving our contracts wave from FUL pricing, thus limiting our exposure to what we believe is 3 to 4% of revenues, including Medicaid. We believe there are several errors in the amounts published. We believe this has demonstrated in the second results recently published, which reflected significant changes from the first set, with variations from 20% to over 500%.

We are providing appropriate comments to CMS based on our review. We know that CMS is undertaking a very complicated process, and we hope to have the opportunity to work with them, so that a fair and correct result is published in a final rule.

Based on the knowledge we have at this time, and what we believe will be the outcome based on the changes of the FUL formula, our view of the future EPS growth we would expect to achieve and have commented on previously, is unchanged. CMS also include comments in his report on Part D considering proposing the consultant pharmacist to be independent of the dispensing pharmacy.

We do not believe this effort is good for patients, and would likely increase healthcare cost to our customers. We will respond accordingly to CMS. Having said this, if a separation were to occur, we believe we would have no material financial impact to Omnicare.

Lastly, turning to our 2011 outlook and beyond. As we stated in our year-end call, we would characterized 2011 as a year where we continue to transform the company into a customer-focused and operations-driven company, to build a strong foundation for the future. It will be characterized by investment in people, and internal technology to improve customer service and improve efficiency, and additional use of cash.

With this as a backdrop, we now believe our 2011 guidance to be; number one, revenue of 6 to $6.1 million. Remember branded generics will cause a revenue drop. Second, earnings per-share excluding special items, now to be 209 to 213 per diluted share, from 205 to 215 as previously disclosed. This effectively narrows our range for 2011 but in an upward fashion.

Cash flow from operations of 500 to $525 million excluding settlement payments, an increase over the 400 to $450 million that was increased at the end of the second quarter. Cash flow from operation for the year benefits from a tax refund earlier in the year, and stronger working capital performance, which we are not sure is recurring.

In summary, we have stated the second half would be stronger than the first half, and are seeing this start to unfold in our third quarter results. Having set the foundation in 2011, we believe 2012 will return the company to solid double-digit growth and EPS. Items that support this belief include branded generic benefits in 2012, which are both are good for Omnicare and healthcare cost overall.

Second, benefited bed loss retention program to improve customer service, efficiency in operations and a growth of specialty care. We will continue to stay focused on our capital structure and creating value for shareholders, which will include returning cash flow from operations to our shareholders.

With that, I’ll turn it back over to John Figueroa, for closing comments.

John Figueroa

Thanks John. Through three quarters, our team has successfully executed on our operating plan, enabling Omnicare to generate meaningful increases in operating margins, EPS, and most importantly, cash flows, while also delivering our year’s best performance in terms of beds served.

We have made substantial progress since the beginning of the year, and I believe we are rapidly reshaping Omnicare into a stronger, operationally driven, and customer focus company. And with that operator, please open up the line for questions.

Question-and-Answer Session

Operator

(Operator instructions). Your first question comes from Robert Jones from Goldman Sachs.

Robert Jones - Goldman Sachs

Thanks for the question. Good morning. It looks like the generic dispensing rate was again enough to offset some weaker utilization, you know, considering we have some attractive long-term care drugs going generic near term, I was wondering where you think this rate could actually go. I mean, it looks like we're nearing 79% now, is there a ceiling that you guys have in mind there around GDR?

John Figueroa

I think we have a variety of models looking at what's coming out over the next couple years. We definitely expect to be above 80, and I think in the low 80s is certainly possible.

Robert Jones - Goldman Sachs

That's helpful. And just going back to some of the regulatory concerns that came up inter-quarter, you know, specifically wanted to discuss the CMS proposed rule changes around the long-term care pharmacy consultant. And I know you guys did comment on this recently, but maybe if you could just give us a little bit more insight - if a rule like this was in fact put in place, could you give us a sense of the impact on the business? You know, maybe specifically how important are the consultant pharmacists?

John Figueora

Well, I mean, I think they're extremely important to the cost - the overall cost of healthcare when you look at the services they provide, and I think the unique services. Now let me start off with, it isn't our consultant pharmacists who actually do the prescribing, I mean that comes from medical doctor, what our consultant pharmacists do is evaluate the formulary based on the pairs formulary -be nursing homes formulary to make sure that the right thing is being done for that customer first and foremost. And that service, you know, is something that is relied upon within the industry. And I think statistically if you look at this rule, which took place, or is taking place currently in New Jersey, we're currently doing the analysis on, you know, what happens to script counts in the New Jersey setting compared to elsewhere in the country, I think you'll see a lot of this information gets published soon, that there is a material difference in cost - an increase in cost. What these folks do is good for the industry and certainly good from a cost perspective, in keeping costs low. To answer your question, how it affects us. There will be no material impact if in fact this was an independent pharmacy consultant as opposed to being part of our organization. What we do provide, however, is consistency of technology information systems and provide them with state of the art technology to help them manage these patients and separating the two. Again, I believe will increase cost.

John Workman

And probably increase cost for the nursing home customers, if they are doing this, you know, separately because we've developed, as John said, a pretty efficient and technologically equipped model we think. To help just emphasize, we don't prescribe, you know, formulary or a drug to the patient and are completely independent of the process that exists today, contrary to what some of the comments may have been from CMS. And I think you've seen this same comment being duplicated by any group that deals with long-term care pharmacy.

John Figueroa

Thanks for the questions.

Operator

Your next question comes from Frank Morgan with RBC Capital.

Frank Morgan - RBC Capital Markets

Good morning, my questions relate to the retention and obviously some good news on those two divisions showing organic bed growth. I'm curious, I think you said that was in the Southeast and the West, is there any particular characterization you can give to those regions as to why they have turned positive in the quarter? Is it something unique you've done there that you haven't done in other markets yet? Is it bigger percentage of large chains? Any kind of characterization of those markets would be helpful.

John Workman

You know that's a good question and we're certainly digging deep into determining why certain parts of the country are performing a little bit better than others. I think you're right, I think in parts of the country that have not achieved net organic bed growth you normally see a large chuck of business that may leave in a particular quarter - a 500 bed or a 1000 bed. So it's usually one or two, you know, key customer losses that would make the difference between net organic growth or not. And we saw that this year. I think in the West and the Southeast, you know, not only did they retain a higher percentage of their customers, they also had some pretty good sales gains that came in those areas. We also had parts of the country that had, you know, some of the A/R issues that we had to come to terms with and we had to, you know, actually vacate or leave the relationship based on the fact that they weren't paying. And that was consistent in some areas of the country and not as consistent in other areas of the country. So I think we're doing a nice job of all the categories in retention. We're doing a good job in bringing on new business. And we're certainly being disciplined from an A/R perspective as well, which is really why we're seeing the results that we're seeing.

John Figueroa

And I think the other thing that's gaining momentum Frank is as John mentioned, you know, the additional sales people and in the process by which there was first to focus on retention and then sales lagged because of existing programs. And as we revamp that I think we're starting to see some momentum gain on the sales sides too, as well as still having strong retention efforts.

Frank Morgan - RBC Capital Markets

I got you, maybe a follow-up for John Workman, or both Johns. On the assessing your book of business today, I'm assuming you have a pretty good picture on who are these problem customers and who's kind of on the border - or on the edge of being an issue - as you look at your book today, do you look - do you think you're getting close to the end of that or does it ever really go away, as you get this, you know, your bed base kind of pruned out there where you don't have these issues with, you know, non-paying customers or customers who don't pay on time?

John Workman

You know, Frank, it's something we continue to assess. I mean, we've been working through that, you know, I would say for the last year, year and a half, both on that and, you know, we've commented on per diem issues in the past too. And I think we're a long way through that and, you know have some more stability. Not to say those won’t occur. I mean, we constantly have to watch the help of our customer base too. And we don't - we don't want to create any kind of alarm. I mean, we don't see that at all, we have a very strong customer base and - but it's just something you continue to have to monitor. It so happens that in this quarter there was particularly one- I think one large customer where that situation existed. And that did not evolve overnight, that had been one we've been working through and, you know, made the decision to go ahead and just terminate the relationship. So they usually don't come up overnight, Frank, so we have some fairly good visibility. You know, we have a group that watches that and a committee that makes decisions, including components of legal compliance, operations, and finance. So I think we have a process in place that makes the right decision.

John Figueroa

And Frank I would say we are in a much better position today than we were a year ago, or even six months ago. So I'm really happy with the progress and I think as John indicated, we look at this real close and it's pretty predictable. And I feel pretty good about the position that we're in.

Frank Morgan - RBC Capital Markets

And you mentioned that you're on track to achieve organic bed growth, do you - do you still think that's a calendar year 2011 event? Or do you think that maybe rolls into next year?

John Workman

Yeah, I've been pretty consistent that the goal around here was to have that type of a 4th quarter, but I also have been pretty consistent in saying that could come, you know, the 1st quarter. I think that's about the time frame. We continue to make great progress, I'm very, very please, and I still think that over the next couple of quarters we'll definitely see that.

Frank Morgan - RBC Capital Markets

Thank you.

Operator

Your next question comes from Jason Gurda with Leerink Swann.

Jason Gurda - Leerink Swann

Hey, good morning.

John Workman

Morning Jason.

Jason Gurda - Leerink Swann

I wanted to as a few questions just about the regulatory review process for the PharMerica offer. How can that review process go without an actual deal in place?

John Workman

I mean, are you talking about the SEC review?

Jason Gurda - Leerink Swann

Yeah.

John Workman

Are you talking about the second request?

Jason Gurda - Leerink Swann

Yes.

John Workman

Yeah, I mean, we can take the second request all the way until the point where we have given them all the material that they're looking for, and it closes at that point.

Jason Gurda - Leerink Swann

Meaning, would they provide an approval of - or agree that, you know, this is what…

John Workman

You can get approval through the FCC without necessarily having a deal with the other party.

Jason Gurda - Leerink Swann

Okay, okay.

John Workman

And that the process that we're foreseeing.

Jason Gurda - Leerink Swann

Thank you. Second question is if you could provide any details on or quantify what's going on with the specialty business.

John Workman

Yeah, I mean, again I think we've done a nice job of articulating how we reorganized that business. There's really three core businesses that exist within specialty, and those businesses have been with Omnicare for a number of years through some acquisitions. However, they've been independently run, and I think this year was the first time we hired the new President, [Inaudible], to put all of the groups together and to determine some synergies from the corporate perspective in running these businesses. But more importantly a message to the customers that we have a continuum of services that can be offered to manufacturers, to physicians, any player within the specialty environment, we have the services to satisfy their needs. For that comprehensive organization and go to market strategy has been effective and as you know this market grows 15 to 20% on an annual basis and, you know, we are seeing faster than market share growth this year based on the new infrastructure we have. So we're excited about that, we've hired a new sales team that is specific around the categories of specialty. And this new sales team, again, is gaining some good momentum and we're looking forward to, again, faster than market share growth next year and beyond.

Jason Gurda - Leerink Swann

And that's about 15% of revenue, is that correct?

John Workman

In the specialty pharmacy business we're seeing that kind of, you know, growth in the industry and, you know, we're meeting or exceeding that level of growth.

Jason Gurda - Leerink Swann

I'm sorry, what I meant was as far as…

John Workman

Total revenues. I think you're asking as a percent of our total revenues, Jason that's about right. I mean, the businesses collectively…

John Figueroa

About $1 billion.

John Workman

About $1 billion in revenue.

John Gurda - Leerink Swann

Okay, thank you.

Operator

Our next question comes from Lisa Gill with JPMorgan.

John Workman

Hi, Lisa

Lisa Gill – JPMorgan

Good morning. I just had a couple of quick follow-up questions. As we think about rebates in general, can John Workman or John Figueroa, can you maybe help us understand how rebates work in institutional pharmacy?

John Workman

We server as an elderly, geriatrics set in certain drugs, you know, we are the number one or number two buyer of some of those drugs on the generic basis. Overall, these buy-in based discounts are looking at declining as we move more to generics, which is more an off-invoice cost. But again, coming back, consultant pharmacists have no relationship, you know, with that. I think that was your question. You know, they’re not involved in terms of directing or any kind of change relative to the type of drugs that are prescribed.

Lisa Gill – JPMorgan

So if we think about market share kind of moving rebates like we see on the PBM side, that doesn’t really exist, as I understand, on the institutional pharmacy side, this is more of volume based or a big buyer of a certain drug and therefore the manufacturer is giving you those discounts because the amount of product you’re buying. Is that the right way to think about it?

John Workman

That’s absolutely correct.

John Figueroa

And I think another important point, Lisa, is that, you know, with the increase of generics in our business, that’s something that benefits both Omnicare and our customers and that’s all just something that has an adverse impact on the level of these volume-based discounts.

Lisa Gill – JPMorgan

And then secondly, can you help us understand the magnitude of a generic versus a branded? So if we think about this next big generic wave, obviously Zyprexa coming this month, a big drug for you, how should we think about that in two stages. One, the magnitude versus a branded, in general terms, and then secondly, exclusivity versus non-exclusivity. Is there a period of time that that’s better, and how has that changed over the last couple of years?

John Workman

Well, I mean, each drug is a little bit unique because it all depends upon what is the level of volume of discounts, maybe on the branded drug and you know, what is the buying level and size of the generic drug. What we have published in the past, Lisa, I think you’ve seen that, is two things to point out. One of which is generic, drugs, even over the long term, deliver more gross profit dollars than the brand equivalent. And secondly, while I’m not giving a specific number, you know, we provide a graph that kind of shows what happens when a drug first goes to multisource, you know, reimbursement is typically still a little more attractive and you’re getting a cost savings and overtime, you know, reimbursement comes down, you know, Omnicare is uniquely positioned since we buy generics direct to also work on that buy side.

But typically, in the early stages, I think to you point, the gross profit dollars are a multiple of the gross profit dollars of the branded equivalent. We’ve demonstrated that in a graph and I think we have also publically stated that, you know, that the cost of a generic for a 30-day supply is going to be roughly 1/3 of the total cost of the branded equivalent. So if you take that math and you figure higher gross profit dollars, you can see the gross profit margin on a generic is significantly higher than on the brand equivalent.

Lisa Gill – JPMorgan

Okay, great. That’s really helpful because, you know, that’s a lot of the questions that we’re getting right now and I think for you to – in a public forum to brand this is very helpful.

I guess my one last question just would be, John Workman, I think you made that comment that many of your customers are moving away from FULs as their reimbursement benchmark. Can you give us an idea of what type of reimbursement benchmark they’re moving to?

John Workman

Yeah, it’s an AWP minus, Lisa. I mean, it’s usually a typical – it’s a price on branded and a price on generics. You know, sometimes there’s a floor. Part of that is, and then I think it’s demonstrated by what CMS is trying to accomplish. I mean, you know, that, you know, the (Lack) or AWP are still much more widely accepted common practices and have validity, whereas what CMS is trying to move to in an ANP, has a lot of subjectivity to it and you’re seeing that in a lot of volitility.

And we were anticipating, you know, some change. We’re also trying to give our customers predictability. I mean, you just – if you look at it, you know, what we just talked about, that with what CMS is trying to do, and huge amounts of volitility, you can imagine what that does for a company and a customer, whereas this is much more consistently applied concept and we work strongly with that (Mopar) facility based as well as our Part D providers. Exposure still exists on Medicaid and that’s a good portion of the exposure, but I think we’ve reduced that vulnerability going forward and now looking at the huge variability in some of [inaudible] publics, we think is the right thing to do. Not only for Omnicare, but also for our customers. It gives them a consistent view of what’s going to happen to their business.

John Figueroa

And I think it’s important to note that we’ve been working on the transition of changing that for over a year now. So I mean, I think we’ve accomplished a great deal, it’s something that can’t be done overnight. But we certainly have accomplished about 90% - 95% of our contracts to the new model.

Lisa Gill – JPMorgan

All right, 90 to 95% are already on the new model? Is that what you said, John?

John Figueroa

I believe the only exposure we have is around Medicaid and maybe – there’s…

John Workman

There’s some facilities, and I think one Part D. I think the way to look at it, Lisa, just to frame it, is that if you look at our Medicaid revenue, we probably have a similar percentage, 8 to 9% exposed on FULs. But remember, this only applies to generics.

Lisa Gill – JPMorgan

Right.

John Workman

Which while they may be a large buy in in unit based on a revenue base for about 20%, that’s where you heard in my comment, this affects maybe 3 to 4% of our revenue.

Lisa Gill – JPMorgan

Okay, great. I appreciate all the comments.

John Workman

Thanks.

Operator

Your next question comes from A.J. Rice with Susquehanna.

A.J. Rice – Susquehanna Financial

Hi, everyone. Thanks. A couple of quick questions here. Just tone up on your comments about PharMerica and the FDC. Obviously, one of the issues, I guess, is what’s your nursing home customer base is saying about the deal to the FDC and obviously, to you, how they like it. Can you give us any color on the extent to which you’ve had discussions with some of the large chains and sort of their reactions to the potential for the deal?

John Figueroa

Well, I mean, I will say that we are in constant communication with our customers on a number of issues and as this conversation has come up, I will tell you that, you know, they’ve been very positive in their response. I’m not sure exactly what has been said to the FDC, as I’m not privvied to those conversations, but the conversations they’ve had with our management team have been positive.

A.J. Rice – Susquehanna Financial

Okay.

John Workman

And I think the key focus is, we view this as lowing overall healthcare costs. I think that’s a point that resonates with customer base too.

A.J. Rice – Susquehanna Financial

Right. And then maybe you did mention early in your prepared remarks about the cut that the nursing homes are experiencing. I guess I’d ask you a little bit about what your interaction with them relative to that has been from the perspective? Are they asking you as you update contracts for incremental concessions to help them? I know you’re going to give them some benefit just from the generic wave in the next 12 months, but are they going beyond that and asking for any concessions that maybe are different than what has traditionally been the case?

And then alternatively on the positive side, do you think the fact that they’re under pressure creates the opportunity to maybe see some chain business move hands over the next year?

John Figueroa

You know, we’ve had some great conversations with a number of plays and I will tell you that they have been more receptive to using technologies and automation today than they ever have in the past. And as we show them and demonstrate to them utilizing or doing some things differently with our technology and the overall impact it will have to their bottom line, they are executing on those things faster than I certainly had seen in the year that I’ve been here.

And they’re seeing the impact of that. So I think we’ve had some good discussions in lowering their overall cost.

I would not downplay, though, the generic’s equation. When we can move brands to generics in a matter of days and you equate that to the overall margin that is impacting their business, they are looking for that to be done very, very quickly. And we’re the only company out there that can get that done. And if you look at what’s happening over the next two years, having that efficient model is a huge advantage.

To your last question about change, I’m sorry, change looking to do things differently, you know, we have had strong relationships with our regional customers, or independence and our large customers for a number of years and I don’t see any change coming because of these reimbursement changes. In fact, I believe that they are becoming even more intertwined with our operations as they’re leveraging all the good things that we could do for them, or help them do that affects the bottom line.

A.J. Rice – Susquehanna Financial

Just a point of clarification, I guess I was wondering whether there were any change that you don’t have – either have the business in house or work with the competitor where you’ve had – they maybe haven’t been open to talking to you in the last few years but because of these changes might now be open? Is there any of that?

John Figueroa

Yeah. I think that’s represented in the 19% increase in new beds that we’ve signed year over year. I will tell you that we are getting audiences now with folks that, quite frankly, wouldn’t open the door for us a year ago. And I think they’re opening the door for two reasons; number one, we have a compelling story of value to talk to them about and how we can affect their operations. And number two, I think the concept of the new Omnicare, the customer-focused Omnicare. It’s certainly a story of seeing [inaudible] in the market place and folks are giving us an opportunity to tell our story. And when we tell our story, we have a good opportunity to close that business and I think it’s been reflected in that in some of those new bed signings that we saw in the third quarter.

A.J. Rice – Susquehanna Financial

Okay, thanks a lot.

Operator

Your next question comes from Steve Halper with Stifel Nicolaus.

John Workman

Good morning, Steve.

Steve Halper – Stifel Nicolaus

Hi. Good morning. You talked about the timeline on FTC, that it’s pretty clear. What’s the timeline on challenging the poison pill, the PharMerica poison pill?

John Workman

Well, I mean, you know, hopefully, Steve, I mean, our desire has always been to engage in a conversation and engage with the management and the board of PharMerica. We did get a large proportion of their shareholders in a tender offer, included that tender offer as contingent on either the poison pill going away or the Board accepting that proposal. And we’d still hope that would be the outcome and we’re optimistic about that. I mean, if that doesn’t happen, and I think you know what the process is, eventually it goes to introducing a new slate of directors, you know, that would approve the transaction. We’re just hoping it doesn’t go there, but that would lead clearly into next year in advance of their annual meeting.

Steve Halper – Stifel Nicolaus

But is there a specific process to challenge the legality of the poison pill?

John Workman

That has been brought up in Delaware and also we’ll be pursuing that at the same time.

John Figueroa

We’re also questioning that in court. We’ve already done that. I think right now we’re concentrating on the FTC’s second request and that’s where - what we’re working on.

Steve Halper – Stifel Nicolaus

Thanks.

Operator

Your next question comes from Brendan Strong with Barclays Capital.

Brendan Strong – Barclays Capital

Hey, good morning. You know, I wanted to go back to Lisa’s question on the consultant pharmacists. I mean, clearly, you guys feel that, you know, they’re not playing, you know, if there is a change, it’s not going to significantly impact your business. I’m just curious, like if we go back, you know, maybe five years and look at the business prior to the implementation of Part D, I mean, do you think the answer would have been different that they maybe were playing a bigger role at that point in time?

John Figueroa

Yeah. I think it could have been a little different. I mean, I think the volume discounts were certainly higher back then, the penetration of generics was a lot lower back then. And I think some of the statistics that you actually read in CMS information was based on 4, 5, 6, 7 years ago and the framework was a little different back then.

Brendan Strong – Barclays Capital

Okay.

John Workman

And I think the other thing, Brendan, going back to prior 2006, one of the primary roles of the consultant pharmacist was to drive formulary compliance. But as we’ve seen in evolution in the industry, you know, the average length of stay has come down to where it’s only 15 to 20 days in that Medicare Part A population, and with the consultant pharmacist only being in the facility once a month, it’s just not a good business decision to have that person drive formulary compliance. Now we depend on tools like Omniview, that have an electronic formulary compliance program.

John Figueroa

I think one of the best statistics that we have seen as this topic continues to come up, I think one of the areas that is used as an example, the anti-psychotic drug class. And there’s speculation out in the nursing homes, you know, there’s a higher rate of anti-psychotic usage than anywhere else. When this came out, you know, we did our own analysis and looked back at the last five years and our consultants made over 700,000 recommendations around anti-psychotic use., and more than 99% of the time, our consultants made a recommendation to reduce the dose or eliminate the dose. I think that is compounding when you talk about the value that they bring into the marketplace, that they’re not looking to do anything other than what’s right for the patient. And you know, that’s a pretty compelling statistic in my opinion.

Brendan Strong – Barclays Capital

And so, you know, on that point, what exactly are you guys doing, or maybe even doing in conjunction with the nursing home industry to try to sell that point in Washington these days.

John Figueroa

Well, we came out with a press release to indicate our position on that and I think we’ve also made it very clear that we would love to sit down with CMS and show them our statistics and information and why we think this is effective. I think the nursing home industry will very much in favor of maintaining the status quo as I believe that they will also demonstrate that cost will go up and quality will go down. And I think that is the key component to the argument that the industry will make and I’m sure when CMS sees all of the information, you know, they’ll make the right decision.

John Workman

And we’re formulating, you know, you’ve seen there’s been various responses from professional organizations already and we’ll be preparing our own responses as well as the industry will be responding. But so far, it all seems to be uniform, I think, and this is not – is the best way to summarize.

Brendan Strong – Barclays Capital

Okay, great. And then just one last question. You mentioned on the cost side around generics, the cost of generics are going about 1/3 of the branded drug, can you give us a similar metric on the pricing differential between branded and generic drugs?

John Workman

Well, what we said was gross profit, Brendan, so we didn’t break it down between cost and revenue. Clearly, revenue starts to decline when a drug goes generic and it becomes multi-sourced it declines more and so what happens is over time that reimbursement will come down. And I think you’ve seen our chart, you know, multiple times. So we know their rate comes down. The point that we make, the gross profit dollars on that generic equivalent are always better than the branded equivalent. I think that’s what’s important for us and that’s because we are able to tap on that side. So we’re just saying it’s a multiple of the gross profit dollars.

Brendan Strong – Barclays Capital

Got it. Okay, I'm sorry. One other thing if you don’t mind. And I don’t know if you guys are open for answering these types of questions on the call. But did you guys provide any commentary earlier on on the call or could you provide some now around maybe your thoughts on the mass set around PharMerica’s 231 million in synergy estimates?

John Workman

We haven’t commented on synergies, nor do we want to comment on theirs other than their facility.

Scott Van Winkle – Canaccord Genuity

Thank you.

Operator

Your next question comes from Steven Valiquette with UBS.

Steven Valiquette – UBS

Hi, thanks. Just to kind of chime in a little bit more about the employment of consultant pharmacists, and when you think about the legal ramifications of just an outright ban for LTC pharmacies to employ consultant pharmacists, I mean, it kind of seems like it would be something from a legal standpoint that just – from that alone, it just could get complicated and will maybe take years and years of debate before something like this could be finalized. So I guess, you know, what are your thoughts around that and what do you think is a realistic timeframe for something like this that it could actually be implemented if it did ultimately go through? Are we talking, you know, years and years down the road, or you know, I guess, what are your thoughts around that from a timing and standpoint from that level of complication?

John Figueroa

Well, I think this could be a regulatory issue, in which case it would be challenged, it could escalate to be a legal interpretation that comes down. So I'm not sure exactly how it would come down through the industry. I am, although, you know, very optimistic. I mean, if you look at the short-cycle debate, that was an issue that I think needed to be debated with the facts and once the facts were presented, I think CMS did what was right for the industry. I believe that that will happen here as well. I think this is an issue that needs to be discussed, but I’m confident when all the information is on the table that CMS will make the right decision and it won’t have to be prolonged or a legal battle, or anything like that. I think they’re asking a question, they have some dated information and as that information gets updated, you know, we’ll have good conversations and come up with the right remedy.

Steven Valiquette – UBS

Okay. And just a quick follow-up, John, I think within that same CMS document, there was some discussion about market shares of maybe, you know, two or three largest companies in the industry and I’m just wondering if you’ve had a chance maybe to kind of follow up on that and you know, maybe where they were coming from, you know, that 90%-plus number and just, you know, …

John Figueroa

I think that was probably one of the biggest areas of information that came out and as a number of folks have tried to get clarification on where that number came from, there really hasn’t been an answer. My guess is they were including buying groups or a buying group into that statistic and as you know, a buying group represents hundreds if not thousands of pharmacies so equating that into one group of three players in the industry was totally erroneous. And I’m not sure exactly where that came from.

Steven Valiquette – UBS

Okay, that’s helpful. Thanks.

Operator

That is all the time we have for questions today. I would like to turn the call back over to our speakers for any closing remarks.

Patrick Lee

Well, thank you all very much for joining us today. We sincerely appreciate your interest in Omnicare and again thank you for your time.

Operator

Thank you for participating in today’s conference. You may now disconnect.

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