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PharMerica Corporation (NYSE:PMC)

Q2 2008 Earnings Call Transcript

August 8, 2008 11:00 am ET

Executives

Terry Hartlage – VP of Finance

Greg Weishar – CEO

Mike Culotta – EVP & CFO

Analysts

Eric Gommel – Stifel, Nicolaus & Company

Adam Feinstein – Lehman Brothers

Aron Gornin [ph] – Bank of America Securities

Frank Morgan – Jeffries & Company

Jason Gurda – Leerink Swann

Operator

Good day, ladies and gentlemen and welcome to the Q2 2008 PharMerica Corporation Earnings Conference Call. My name is Latetia and I’ll be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this call. If at any time during this call you require assistance, please press star followed by zero and a coordinator will be happy to assist you. I would now like to turn the presentation over to your host for today, Ms. Terry Hartlage [ph], Vice President of Finance. Please proceed.

Terry Hartlage

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

Tomassetti, Senior Vice President and Chief Accounting Officer

Before beginning our remarks regarding the second quarter results, I would like to make a cautionary statement. During the call today, we will make forward-looking statements about our business prospects and financial expectations. We want to remind you that there are many risks and uncertainties that could cause our actual results to differ materially from our current expectations. In addition to the risks and uncertainties discussed in yesterday’s press release and in the comments made during this conference call, more detailed information about additional risks and uncertainties may be found in our SEC filings, including our Annual Report on Form 10-K and our more recent quarterly report on Form 10-Q. Copies of these documents may be obtained from the SEC or by visiting the Investor Relations section of our Web site. PharMerica assumes no obligation to update these matters discussed on this call. During this call we will be referring to non-GAAP financial measure. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is available in our second quarter 2008 financial results press release. We have made available to you our press release and our 10-Q filed with the SEC. In addition, this webcast will be on our Web site along with a transcript of this call.

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

Greg Weishar

Thanks, Terry. Welcome everyone. As always, we are pleased to have the opportunity to discuss our company’s results with you. We have just achieved our one-year milestone and while we are satisfied with what we have accomplished in the past year, we also know there is lot of work ahead of us.

As you recall, the combined businesses of KPS and PharMerica LTC were merged on July 31, 2007, and what this means is from a comparative financial standpoint, the results of prior year second quarter and the six months ending June 30, 2007 only represent the results of operations and cash flows of KPS. Mike will go into the financial details later, but I will give you the highlights.

Yesterday we released our second quarter results and we filed our 10-Q. Our diluted earnings per share were $0.10 for the quarter. The integration, merger-related costs and other charges represented $6.6 million or $0.12 diluted loss per share. Excluding the integration, merger-related costs and other charges, diluted earnings per share totaled $0.22. Our total diluted earnings per share for the six months ended excluding the cost described above were $0.41. Total revenues were $486.3 million and we dispensed approximately 10.1 million prescriptions. Our adjusted EBITDA was $22.4 million, giving us a 4.6 adjusted EBITDA margin and we are seeing good sequential improvement here given the first quarter adjusted EBITDA margin was 4.3% and for 2007 it was 3% on a combined basis. We continued to generate strong cash flow, over $13 million in the second quarter of 2008 and $24.2 million for the six months ended June 30, 2008. I think the takeaway from our last three quarters is that you are seeing improved consistency in our financial results and that is as a result of consolidating our pharmacies and streamlining operations. If you compare the adjusted EBITDA on a combined basis for the first two quarters of 2007, it was $30.7 million compared to $43.5 million for the first two quarters of 2008.

I think from these comparisons you can easily see we are capturing the operational and overhead synergies from pharmacy consolidations and integrations which is one of our key initiatives and really the focus of putting the two companies together. We have now completed 57% of our pharmacy consolidations overhead and of the total planned 26 consolidations, 17 of the pharmacies are now completed. We will have completed about 70% by the end of the third quarter and over 90% of the consolidations by the end of the fourth quarter. We are confident we will exceed the $30 million synergy target. The financial impact of our efforts will become more evident in 2009 as you will see further positive impact on margins from these consolidations and other integration savings. Once the pharmacy consolidation phase is complete in 2009, we will then have 17 legacy KPS locations that we will be converting to the LTC 400 operating system which is our operating platform. So, by the end of 2009 we will expect to be on one operating platform and have completed consolidations and systems conversion all of those related to the merger business. We believe one platform gives us a long-term competitive advantage and certainly simplifies the management of our business.

Let’s now discuss the brand-to-generic pipeline. As you recall, we stated the profits on generics are attractive for the first couple of years. After that, profitability falls to an average margin as increased manufacture availability permits payers to lower reimbursement. We have about a two-year window of generous profits as we mentioned earlier. As you know, brands drive rebates and revenue whereas new generics drive improved gross margins while they pressure revenues. We are doing a great job of converting to generics and we have presently a generic dispensing rate of just about 70% and generics are good for our customers too, they are lower cost alternative which gives us the ability to align our interest with our customers’ interest as well as drive margin. Remember we have a different population in the retail pharmacy industry; clearly our drug index is more heavily weighted on anti-seizure and other mental health medications as opposed to say cardiovascular or antihistamines and those types of drugs. Some examples of the top brands prescribed by geriatric physicians are Risperdal, Depakote, Topamax and Keppra and these picks [ph] are going to go generic in six of our top 50 drugs or about 12% of our total drug spend will go generic by 2010. Speaking of 2008 risks in terms of generic drugs, Risperdal has received the most recent exposure and we originally estimated that Risperdal would generate an improvement in 2008 margin of about $500,000 and the later six months of the year and we are still comfortable with that estimate and there are lots of moving parts here. We don’t want to over-promise and under-deliver especially in matters that may not be within our control.

As I have said in the past, I will give you an update on our company’s key initiatives and recall these initiatives are the operational focus of our company and are essential to long-term sustainable growth. They are designed to drive operating and financial improvement across the organization. Let me review with you what they are

improving client service, improving billing and collections; capturing operational and overhead synergies, which we just previously discussed; development and implementation of an e-prescribing platform; and developing key operational and financial metrics. Let me now give you an update on our progress.

Improving client retention, as I discussed previously, we continue to believe we can meaningfully improve client satisfaction and retention over the coming years. We are committed to improving service that is how we can differentiate our company and deliver sustainable growth. We have completely overhauled our client service organization and client service philosophy. Previously service was delivered out of the pharmacy under the direct supervision of the GM. While we continue to focus on improving responsiveness with our clients and customers at the pharmacy level, we have instituted territory account management and installed a centralized client support centre. We believe these enhancements will drive operational consistency and improve our ability to engage our clients at both the operational and strategic levels. Client engagement is necessary for us to make progress. So, it is essential that we get closer to our clients especially in the operationally challenging Part D environment which requires more coordination with the nursing home facility. We are essentially finished with the reorganization of account management and we broke our account management group field management into client segments and we have most if not all of those positions filled. We will begin operations of the Client Service Center in September of this year and are confident this initiative will bear fruit in 2009 and beyond.

Now I would like to talk about billing and collections. We have strengthened our resources in this area, and we will continue to commit resources to improve the billing and collection infrastructure. In addition our new account management organization which we just discussed is very involved in billing and collections and that is an area where they were not involved in before. We have seen significant improvement over the past several months. For example, bad debt held at 1.1% this quarter, which was consistent with our first quarter and we recall bad debt last year was above 2%. We continue to see improvements in cash collections. Cash collections as a percent of revenue again this quarter approximated 100% but I again stress this is a two to three-year effort and we are just getting started, we have a lot of infrastructure work to do here as well and we believe there remains an opportunity for improved performance and productivity.

Capturing operational and overhead synergies, I don’t need to add much to what we have previously discussed here other than to say we are confident we will achieve our synergy targets.

The e-prescribing platforms, we are starting to see traction, market traction here. Recently the Medicare improvements for patients and Providers Act of 2008 which (inaudible) they got past and overridden and enacted into public law on July 15, that act has instructed Medicare to make incentive payments to physicians for electronic prescribing beginning in 2010. Beginning in 2012 physicians that do not have and do not use electronic prescribing will be subject to a reduction in payments. So, we see this as a key aspect of driving demand for e-prescribing. Additionally, the Congressional Budget Office believes this will lower partly spending and has significant potential to improve quality which we believe to be true as well. We just finished our development work here and are looking for a pilot opportunity and from our perspective, in addition to improve quality care we see reduced order entry cost and other operational efficiencies and as you know we’re paying pharmacists over $100,000 a year, pharmacy techs are in short supply, so our ability to participate in this technology not only improves care but reduces operating costs.

Lastly, development of key performance measures, we kind of considered this initiative done. Last year we began to process including in our 10-Qs key operational information and I think the big difference that we bring to the table here is we look at our business as a scalable script business, and we really want the financial market to evaluate our performance on both financial and operational improvement and that like. We manage every piece of our business using key performance indicators, all performance goals are met and we are trying to drive accountability and operating performance and assure ourselves that we are getting alignment from the corporate office to the pharmacy because the pharmacy is where all things happen and we will continue to refine our key metrics as we move forward but we essentially made great progress here but I think the main message here is that we are not just focused on consolidating and integration but we are also focused on improving our core processes.

Now let me talk about our growth prospects. Recall a year ago we laid out acquisitions as a key opportunity for growth. We are exploring a number of opportunities with the goal of making selective acquisitions, targeting opportunities that we can roll right into our existing pharmacies and as we look at this acquisitions we have noticed a number of instances anyway that the earnings look good but cash flow is falling short of the valuation the sellers are seeking. So, we will be disciplined in how we approach these and we are being disciplined. That said, our pipeline is growing and we are confident, very confident that our acquisitions efforts are going to bear fruit and very optimistic about what we are seeing there. We see that there are opportunities for us to wrap up a few acquisitions in the near term.

Secondly, in terms of our growth, our industry continues to grow at a good pace. We are certainly not seeing the topline growth of 6% to 8% that we experienced historically, but with improving margins due to generics and improved scale efficiencies, we are comfortable that we can grow in 2009 and beyond. Finally, we anticipate the aging of America will provide us plenty of opportunity for growth over the next decade. Demand for long-term pharmacy services is rising, and we see a vibrant market for our services for years to come.

So in wrapping up, we have completed another quarter, we are pleased with the results, we are not getting complacent, we still have a lot of work ahead of us but we are building a platform for the future. Our operating strategy in 2008 continues to be one of execution and consistently improving the financial and operating discipline in our company. I trust we are showing the investment community that we can execute. We are successfully integrating and consolidating our pharmacies. We are improving our processes for billing and collections resulting in improved bad debt rates and improved collection rates.

Looking forward to 2009, we want to demonstrate we can improve client retention and drive organic sales. We believe the groundwork that we are laying in 2008 will yield significant value in the coming years.

I will turn it over to Mike now to discuss details of the quarter’s revenue results.

Mike Culotta

Thank you, Greg, and good morning. Let’s spend a few minutes on the results of our operations. This is only our third quarter that both KPS and LTC had been included in the results of operations for the full quarter. As you noted in our 10-Q, there are two sections in the MD&A. The first section is based on the second quarter 2008 and six months then ended compared to the historical second quarter of 2007 and its respective six months then ended. Remember, as Greg mentioned, for 2007 the results of operations and cash flows only include KPS since it is the predecessor. The other section of MD&A is a comparison of the first quarter 2008 to the second quarter of 2008, a sequential quarter comparison. We believe this is very useful to you, the investors and analysts. As you recall, we also furnished an 8-K on November 8, 2007 that combined the operation of KPS and PharMerica LTC. Included in that 8-K was also statistical data. Throughout these discussions, we have obtained information from this source in our previous earnings calls.

Let’s now discuss our revenue trends and metrics. As Greg has previously stated, our first quarter revenues were $486.3 million. This is an increase of $6.2 million over the combined operations for the second quarter of 2007 and an $8.8 million decrease over the sequential first quarter. Our prescriptions dispensed were 10,067,000 this quarter compared to 10,212,000 in the first quarter and 10,129,000 in the second quarter of 2007 on a combined basis. Customer-licensed beds under contract at the end of the quarter were 331,229 this quarter or a decline of 2,927 from the first quarter of 2008 and a decline of 9,844 from the second quarter of 2007 on a combined basis. Our decline in sequential quarter revenues in scripts [ph] were the result of a seasonality (inaudible), lower patient volume and growth in generics. Our institutional revenues per script were $46.66 this quarter compared to $47.08 for the first quarter of 2008 and $46.05 for the second quarter of 2007 on a combined basis. As it relates to the sequential quarter comparison in the institutional pharmacy segment, the decrease of $8.9 million was driven primarily by a rate price difference of $4.2 million in revenue per prescription dispensed and a volume differential of $4.7 million. As Greg previously stated, we were at a 70% generic dispensing rate.

Let’s now turn to the cost of goods sold and gross margin, particularly as it relates to the institutional pharmacy segment. Our gross profit was $67.9 million for this quarter or $6.72 per prescription dispensed compared to $69.7 million in the first quarter or $6.83 per prescription dispensed. The declining gross profit and gross profit per prescription dispensed was attributable to certain duplicates [ph] and productivity costs caused by the number of consolidations we had in progress during the second quarter and fuel surcharges due to the increase in energy cost. Our fuel surcharges were approximately $500,000 in the first quarter of 2008 and approximately $1 million for the second quarter of 2008. These items were reduced by decreases in cost of drugs as we continue to see brand-to-generic changes and synergies from earlier consolidations and further reduction in other cost and scaling of certain pharmacies for which the consolidations had been completed.

On a combined basis for the second quarter of 2007, gross profit was $63.1 million or $6.23 per prescription dispensed. The increase over comparative quarters was due to the staffing changes as a result of efforts to appropriately staff pharmacy levels to production, increases in generic distanced and rebates. Gross profit margin improved 90 basis points from the second quarter 2007 on a combined basis to the second quarter of 2008. Rebates were $13.9 million in the second quarter of 2008 compared to $12.7 million in the first quarter of 2008 and on a combined basis $11.8 million in the second quarter of 2007.

Selling, general and administrative expenses includes functions such as pharmacy, regional and operations management, IT, billing and collection functions, legal, HR, finance and other areas. It also includes certain costs, such as provision for doubtful accounts. SG&A costs were $54 million or 11.2% of revenues for the second quarter of 2008 compared to $57.3 million or 11.7% of revenues for the first quarter of 2008. Largest declines were in labor-related and other costs. We continue to be very focused on driving cost down. Selling, general and administrative expenses on a combined basis were $57.9 million in the second quarter of 2007. Overall SG&A increased due to cost of being a public company but decreased as a result of staff downsizing and other cost reduction measures, as we continue to challenge all of our cost and processes. On a combined basis our provisions for doubtful accounts were as follows

$5.5 million or 1.01% of revenues in the second quarter of 2008 and $5.2 million also 1.1% of revenues in the first quarter of 2008. On a combined basis, the provision for doubtful accounts was $10.1 million in the second quarter of 2007. As Greg stated earlier, our initiatives in this area particularly as it relates to cash collection efforts are having a positive impact.

The company’s combined adjusted EBITDA for the second quarter of 2008 was $22.4 million compared to $21.1 million in the first quarter of 2008. On a combined basis the adjusted EBITDA was $14.3 million in the second quarter of 2007. Again, as Greg has previously stated, the adjusted EBITDA for the six months of 2008 was $43.5 million compared to $30.7 million on a combined basis for the first six months of 2007. We continue to focus on operational efficiencies, cash collections, cost controls and completing our integration processes as well as improving existing processes. Our adjusted EBITDA margins were 4.6% in the second quarter of 2008 compared to 4.3% in the first quarter of 2008 and 3.0% on a combined basis for the second quarter of 2007. Of course this is exclusive of integration, merger related costs, and other charges.

Turning to the balance sheet and cash flows, our DSOs were 40.7 days. We continued to evaluate the net realizable value of our receivables and client payment patterns. Our total debt outstanding is detailed in our 10-Q as are the covenant calculations. You will note that we continued to improve on our covenant ratios. As Greg previously stated our cash flows from operations for the quarter were $13 million and for the six months ended June 30, 2008 were $24.2 million.

Our guidance has been updated in the press release. As you have noted, the primary changes were one, changes in revenues being increased; two, the adjusted EBITDA being closer aligned to the top end of the range, remember consolidation of our pharmacy do have an impact on our current results; three, decreasing interest, depreciation and amortization expenses to be more in line with our current run rate; four, increasing the effective tax rate, this was caused by (inaudible) differences; five, increasing net income and earnings per share, this number of course is exclusive of integration, merger-related cost and other charges; and then six we did note increasing estimated cost of integrating and merger-related costs and other charges. Greg?

Greg Weishar

Thanks Mike. As we stated before, we continue to see opportunities ahead of us and we are very pleased with the progress we made to date. We view our industry as an essential component of providing the medication needs to the frail and elderly, a need that will only grow as our population ages and we believe we are on track to achieve our targets and continue to see solid growth in 2008. We are focused on both internal and external growth and we’ll continue to drive our business to more profitability. We are committed to achieving what we say. Once again I thank you for your interest in our company and now I’ll turn it over to the operator to begin our Q&A.

Question-and-Answer Session

Operator

(Operator instructions) our first question comes from the line of Eric Gommel from Stifel Nicolaus & Company. Please proceed.

Eric Gommel – Stifel, Nicolaus & Company

Good morning. I was wondering if you could just given the level of integration you have done today and the integration cost related to that, can you give us sort of a sense as what additional cost you expect to incur for the rest of the year relative to the rest of your integration?

Mike Culotta

Yes Eric. We’ll probably have probably another close to $10 million associated with it and predominantly the merger integration and related costs are as we close an existing pharmacy, the predominant large dollar amounts are one, as we close that pharmacy, we accrue the rent expense on the remaining lease term. Number two, we write-off any assets which we are unable to use or transfer to another location. Number three is any inventory that we are unable to use in the move to the location, we would be writing-off that and destroying that and number three would be any items like stay-on bonuses, things of that nature as we try to maintain the workforce as we are shifting the work over to the other pharmacy.

Eric Gommel – Stifel, Nicolaus & Company

Just a follow up, I just want to kind of clarify one line item, the employee cost, what goes into the employee cost, the integration cost and other charges?

Mike Culotta

Mainly as we stated it is mainly items such as stay-on bonuses or it may be for example, as we staff up a particular location, we sometimes have to use contract labor. We know we are using them temporarily until we can get everything moved over then we will move some of our people over to the moved location. During that time frame, that extra cost of the contract labor which is only the incremental component, the piece that is above the amount that we are presently paying, that amount is being made into that area. So, in other words, if a contract labor for example is getting paid $75 and I am just using a number, we are paying someone $50 an hour, we are paying that $75 an hour, that’s $25 differential. It is only for a temporary time frame.

Eric Gommel – Stifel, Nicolaus & Company

Then my last question, I will jump off, the leverage for at least relative to our model this quarter, the thing that really drove the better margin was really the SG&A and so as I am thinking of that going forward for the rest of the year relative to your guidance, is that where we still see some more savings or are you thinking more on the gross margin line?

Mike Culotta

I would say from both places. We think we are both going to see it flow in the SG&A and as we continue to consolidate and the ones that are getting completed, we should start seeing some pickup on that. Historically what you see is they have a little bit of a tail with them, they have about a two or three-month tail where you still see a little bit of productivity challenges. So, to give you a little bit of flavor from the first quarter to second quarter, first quarter that productivity was about $1 million, in the second quarter it was about $1.6 million that was in the topline. In addition, again as we talked about in terms of the fuel surcharges that’s all up in the topline and the cost of sales, $500,000 was what we saw in the first quarter. We saw a $1 million fuel surcharge in the second quarter and in addition we just looked at this again this morning, also our utility bills which were part of again the fuel consumption, we saw an increase in that of about $300, 000 to $400,000. So, obviously the cost of energy did sort of impact us in the second quarter.

Eric Gommel – Stifel, Nicolaus & Company

Okay, great. Thank you.

Operator

Our next question comes from the line of Adam Feinstein from Lehman Brothers. Please proceed.

Adam Feinstein – Lehman Brothers

Okay, good morning everyone. Just a few questions here. Maybe you could talk a little bit about the scripts per bed just in terms of how you are thinking about that and clearly one of the trends is just more consumption of drugs per patient and just curious to get your thoughts in terms of what impacted that trends in the quarter and what your outlook would be for that in the back-half of the year?

Greg Weishar

Well Adam I think we have seen over the years increases in utilization and I think there is some question as to how much more upside there is there. However the data would show that we see continued utilization of drugs at a higher rate every year. So I think for us is we have taken a pretty conservative approach given the fact that our patients take a significant amount of drugs but nevertheless we continue to see a little marginal improvement there in terms of utilization rate every year. I don’t want to get into any more details on that.

Adam Feinstein – Lehman Brothers

Sure, okay. Alright. Then can I just get your thoughts, it seems like the industry environment has improved, just curious to get your thoughts whether you agree with that comment it seems like the numbers have been good out of everyone recently and that really contracts with a couple of years ago. So, just curious if you were to agree with that statement and if so, what do you think has really changed in terms of the industry backdrop?

Greg Weishar

Well, I think if you think about what caused a lot of the challenges that the industry is experiencing was the Part D management of bad debt, the co-pays and there is dual eligibles coming on and the whole flow of that volume in the duals, clearly a lot of that has settled down. So, some of the pressure of what the Part D plans were putting on us are still down. However we continue to be very challenged in billing and collections with co-pays, with prior authorizations and other operational requirements that the Part D plans are putting on us that really don’t make a lot of sense in the long-term care industry really designed for the retail industry. I think we have done a lot better speaking from PharMerica’s standpoint. We certainly I think are handling the challenges of Part D to a much greater and better degree than we did a couple of years ago and even a year ago. I do believe that we still have some significant challenges in the industry going forward.

Adam Feinstein – Lehman Brothers

Then, in terms of contacts, just curious to get your thoughts in terms of opportunity to win new contracts are there proposals that you guys are in the process of and just curious to get your thoughts as we think about just the contract cycle.

Greg Weishar

Again, we are rebuilding our sales force. We have our finger in a couple of transactions, proposed transactions, trying to get ourselves, trying to grow our business for some of the larger chains, I think it is too early right now to tell Adam. We clearly have some head wins with regards to some of the larger clients to be a little hesitant to deal with us given the fact that we have got some integration activities going on which tends to give a little bit of chill to them. So we are aiming just to get all that base behind us but you know I think one of the challenges we have is we are looking at a lot of long-term agreements on some of the larger business which I think you are aware of.

Adam Feinstein – Lehman Brothers

Sure, absolutely. This is my final question and I’ll get back to the queue, with respect to Risperdal you quantified what you thought the benefit could be and that was very helpful, just curious in terms of what you have seen that’s why with respect to the conversion rate and then all the discussions have been on Risperdal but there was some other major products you mentioned also, just curious if any of those products will have a similar impact or just help us think about the magnitude of some of the other products you mentioned as well.

Mike Culotta

Adam it’s Mike. What we did see in July we actually monitored that, so we were looking at the last three or four months going into June 30 on Risperdal, Risperdal was like our second largest drug from the standpoint of purchase cost and what we dispensed in all, as we monitored it, going into July we did see that significant downward on Risperdal and the increase in the generic. So, we are seeing very good positive result as it converted very quickly at June 30 to July 1. The other one mentioned is (inaudible) I think it comes into play July 31. So, right now it is a little bit early to gather all of our information but we did see very good turn, very positive results in July.

Adam Feinstein – Lehman Brothers

Okay, thank you very much.

Operator

Our next question comes from the line of Bob Willoughby from Banc of America Securities. Please proceed.

Aron Gornin – Banc of America Securities

Hi, this is Aron Gornin [ph] for Bob today. I just wanted to get your thoughts on capital deployment; I know we spoke about this a bit, in terms of the CapEx reduction and the debt reduction where do you see the capital deployment strategy going forward?

Greg Weishar

I will briefly touch on it. Obviously we are aggressively looking at acquisitions and some of that will slow down our debt repayment and our CapEx from an operating standpoint is fairly modest, $20 million or so a year, going forward we think that that is a number that we can live with. I think most of it will probably go to financing acquisitions but that is our initial plan but we are obviously looking at our capital structure and trying to understand the best way to approach these acquisitions. Mike I don’t know if you have anything to add to that?

Mike Culotta

No, it’s clear.

Aron Gornin – Banc of America Securities

Great, thanks.

Operator

(Operator instructions) our next question comes from the line of Frank Morgan from Jeffries & Company, Inc. Please proceed.

Frank Morgan – Jeffries & Company

Good morning. My question related to the inefficiency costs that are embedded inside of your numbers that you don’t strip out, I think you said that went to $1 million to $1.6 million sequentially, I was wondering if you could kind of give us some idea of what you thought those numbers might be over say in the third and fourth quarter of the year your expectations with regard to those inefficiency costs? Then secondly going back to an earlier question, I know Greg you mentioned that you are looking at new opportunities in terms of contracts and bigger chains; what about the existing base of business you have with larger chains, any of those contracts coming up any commentary on those? Thanks.

Greg Weishar

Do you want to hit the next question?

Mike Culotta

I will hit the first part first. Frank, we still continue to have a number of pharmacies that we are consolidating both in the third and fourth quarter and again as we talked about, we do have that two to three-month tail that takes place but saying that we probably estimate about $2.5 million, we are really like at $1.6 million in the second quarter, we will be close to $2 million, $2.5 million in the third quarter and possibly another $1.5 million to $2 million in the fourth quarter.

Greg Weishar

In terms of contracts, I think, the biggest one that looms out there is in March and that’s Golden [ph] ’09. We are currently renegotiating some rates with Kindred, we are in the early phase of that and then we are month to month with a couple of other what I would call top 10 contracts that we have ongoing negotiations on. I don’t want to get into the flavor of that too much. I don’t want to give you – because we are currently negotiating too much because we are currently negotiating with those accounts but we do have the process of negotiating with our clients every year, it is something that we do and to the extent that we are successful or not successful in those negotiations, we will certainly communicate that to you when that time comes Frank.

Frank Morgan – Jeffries & Company

I thought it was interesting that you mentioned that in terms of some of the new business you are looking at, the fact that you are in the process of to consolidate but that seems to be a concern to some people in terms of the fact that you are in the midst of some of these consolidations, but I mean I don’t think that is going to be an issue with your existing customer base, has it?

Greg Weishar

No, it hasn’t because they are experiencing – in general we have done a pretty good job I think with the exception of maybe one or two pharmacies and making those integrations famous on our customer base. So, this is an overhang of some of the prior integration efforts in the past in the industry that people are very concerned about and it is not atypical of a prospective client’s concern. There is a head wind there; there is no doubt about it.

Frank Morgan – Jeffries & Company

Okay, thanks.

Greg Weishar

Yes.

Operator

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

Jason Gurda – Leerink Swann

Thank you, good morning. Greg I have just a quick question. Now that you are I think 50% done with the consolidation, how long do you think it will take before all the synergies are realized? Is there an updated timeline there? Also besides the continued launch of generics, what other issues should we think about when we think about your margins and potential for next year?

Greg Weishar

I think the synergies [ph] we said in the last half of ’09, I believe Mike it is probably the best way to pick that we should be kind of running full bore on and not realizing the synergies of the integrations, however that is going to be offset somewhat by the work that we are going to have to do on the systems integration piece. So, we still have that ahead of us in ’09 but I think the full impact of the pickup of synergy from the integrations would be realizable on the last half of ’09. We continue to see the generic pipeline evolving, I don’t think that there is going to be a significant impact on upside on margins there but clearly we will hold our own. The goal clearly for ’09 is to improve our retention rate and organically grow sales and to last minute acquisitions and those would be the three components of driving growth in ’09. So, that’s kind of where we are at Jason.

Jason Gurda – Leerink Swann

So, on the pharmacy consolidation piece, are you still expecting that to be done by I guess mid ’09 that has not been moved to –

Greg Weishar

We are looking at early first quarter.

Jason Gurda – Leerink Swann

Early first quarter, okay.

Greg Weishar

Yes and we could do a little better than that but that’s kind of where we are at right now and as Mike indicated there is a three to six-month tail on getting those down to the point where we start realizing the synergies. We kind of have to recalibrate our business because we have been very cautious about client service and we basically staff up to make sure that our service levels remain the same. They cost us some money in the short term so the last half of ’09 would clearly – I think we would be running on all eight cylinders there.

Jason Gurda – Leerink Swann

Okay, great. Thank you.

Operator

At this time, there are no more questions. I would like to turn the line back to Mr. Weishar. Please proceed.

Greg Weishar

Thank you. Again I just like to say thank you for your continued interest in our company. We appreciate you all taking the time out of your busy day to listen to our call; I appreciate your questions and look forward to our next earnings call. Thank you very much.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect.

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Source: PharMerica Corporation Q2 2008 Earnings Call Transcript
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