卡地納健康 (CAH) 2001 Q3 法說會逐字稿

Ladies and gentlemen thank you for standing by. Welcome to the Cardinal Health Incorporated third quarter fiscal year 2001 earnings conference call. During the presentation, all participants will be in a listen only mode. Afterwards you will be invited to participate in the question and answer session. At that time, if you have a question, you will need to press the 1 followed by the 4 on your telephone. As a reminder, this conference is being recorded Thursday, April 26, 2001. I would now like to turn the conference over to Mr. Steve Fischbach, Vice President of Investor Relations. Please go ahead Sir.

Good morning and welcome. Today, we will discuss Cardinal Health's fiscal 2001 third quarter results. A portion of our remarks will be focused on the business segment attachment of our earnings release. If any of you have not yet received a copy of our earnings release, you may access it over the Internet at our Investor Center at www.cardinal.com or you can dial 800-758-5804. At the prompt, enter the code number 128363 and a copy will be faxed to you immediately. Additionally, we have provided streaming slides that will be shown on the Internet during today's call. These slides can also be accessed over the Internet at our Investor Center at cardinal.com. Speaking on our call today will be Bob Walter, Chairman and Chief Executive Officer, and Dick Miller, Executive Vice President and Chief Financial Officer. We also have with us here in Dublin, Jim Millar, President and Chief Operating Officer of the pharmaceutical distribution and provider services segment. After the formal remarks, we will open the phone lines for your questions. So that we may conduct this call within the timeframe allotted and in consideration of other callers who have questions, we ask that you limit yourself to one question at a time. If you have additional questions, you are welcome to get back in the queue. I would like to remind everyone that some of the information discussed on today's call may include forward-looking statements, which are subject to risks and uncertainties, which could cause actual results to differ materially from those projected or implied. The most significant

of those uncertainties are described in Cardinal's Form 10-K and Form 10-Q reports and exhibits to those reports. Cardinal undertakes no obligation to update or revise any forward-looking statements. This recording and/or rebroadcast of this call is expressly prohibited by Cardinal. At this time, I would like to turn the call over to Bob Walter to begin today's discussion.

Thank you. Good morning. I'd like to take a couple of minutes to highlight a few items from this exceptional quarter. Dick Miller, our CFO, will then walk you through the financial details for our third quarter, and then I will spend sometime on our outlook, and we will have plenty of time for questions and answers. I'd first like to give you 3 important points as an overview of the quarter. First, the quarter demonstrated the strength of Cardinal's portfolio, the strength of the markets we serve, and the ability of our management teams to deliver by executing an effective strategy. Our 2 largest segments, pharmaceutical distribution and provider services and medical-surgical products, were also our fastest growing this quarter. Both delivered exceptional performance, growing revenues well above market rates. They generated strong growth in earnings, returns on sales, cash flow, and improving return on capital. Measured against our past, measured against the market, or measured against any of our competitors, our results are superb. In fact, in pharmaceutical distribution, I can't remember an internal growth rate even remotely as high in any period in Cardinal's history. Obviously, I'm very pleased with the overall performance of the company and with our prospects for continued success. The second point I want to make is that our diversity of products and services all focused on healthcare, continues to be a strategic advantage in servicing our customer and in delivering balanced and consistent financial results for our

shareholders. The quarter did present some environmental challenges like foreign exchange, commodity cost, softness in nutritional and protease inhibitor market, and demand for technology in the hospital area. However, the strength of the demand for healthcare overall, combined with our strong market position, diverse offerings, and strong execution, allowed us to deliver excellent earnings growth, rising returns on capital, and ample room to invest aggressively for the future. The third point I want to make is all about investing for the future. We increased our investment spending by over 90% in the third quarter this year compared to fiscal 2000. Last quarter, we reported that first half investment spending for R&D and other strategic initiatives was up 60% versus prior year, and we reported that we would be increasing our spending in the second half of this year at even a higher rate. We're doing that. We invest now so that 5 years from now I can look back, the same type of 20% earnings growth rate with rising returns that you have come to expect from Cardinal. We feel particularly aggressive about investment spending right now, because we see the opportunities and have confidence in our position in each of our 4 segments. The fact that we have aggressively increased our investment spending this year should give you some indication of our confidence in the current and future earnings power that we have in this company. Dick will now take you through an overview of our financial performance for the quarter.

Thank you Bob. We're pleased to deliver another excellent quarter, especially in light of the difficulties being experienced today in other parts of the economy. Our performance for this quarter and our outlook for the future speaks of the disability of the healthcare industry and the strength of Cardinal's business. I'm going to focus my comments today around 3 areas, first, our operating performance and the improving returns

that Bob referred to, second, our asset management and cash flow results, and then finally our balance sheet strength. Let's start with our operating performance. Once again, we exceeded our target earnings per share growth rate of 20% by delivering 22% growth. Even more impressive is the fact that we achieved these results while continuing our commitment to investment spending and overcoming the negative impact of higher commodity prices and fluctuating foreign currencies. We invested current earnings of approximately $22 million in the quarter. That's an increase of more than 90% from the prior year. Those investments were in research and development activities, and strategic projects like our Puerto Rican manufacturing services facility, the pharmaceutical technologies and services center, and our Vistant project. These are projects that are currently consuming earnings, but should add incremental profits in the future. We remain committed to investing a portion of our earnings back into our businesses to ensure our ability to continue to grow. Our growth was driven to a large extent by the exceptional performance of our pharmaceutical distribution and provider services segment, leading to a 35% increase in consolidated revenues. While such revenue growth is impressive, in my opinion, the more impressive performance relates to the incremental improvements in return on committed capital and return on equity, both of which reached all time record levels with significant improvement over last year. Our return on committed capital rose 220 basis points to 30.6%, and our return on equity rose 70 basis points to 20.5%. What this means is that we not only grew the business to record levels, we managed that growth very efficiently from a capital perspective, allowing

us to increase earnings at a faster rate than our capital consumption, leading to a substantial increase in shareholder value. Our consolidated return on sales declined from 4.77% last year to 4.22% this year. The primary reasons for this change are as follows; the mix of pharmaceutical distribution, which increased to 56% of our operating earnings from 51% a year ago, the impact of the acquisition by Allegiance of the distribution only business of Bergen Brunswig Medical Corporation, the effect of the slowdown in the domestic health and nutritional and the global protease inhibitor markets on the returns in the pharmaceutical technology segment, and then finally the impact of our increase in investment spending. Our capital efficiency not only leads to higher returns, but also improves our cash flow, which I'll discuss separately, and creates leverage in our interest costs. In the third quarter, our net interest costs increased only 12%. That's significantly lower than the overall growth rate of the business. International initiatives that we've implemented to make Cardinal more tax efficient continue to provide earnings leverage. Our tax rate in the third quarter declined by 140 basis points versus last year, consistent with the magnitude of improvement we saw in the first half of this year. We expect this tax rate leverage to continue for the remainder of this fiscal year. We did incur a special charge of $86 million or 62 million after tax in the quarter, which was due largely to the completion of the Bindley merger. So let me give you a breakdown of the elements of that charge. $49 million was for direct transaction costs triggered by the merger. 21 million was for exit costs and severance

related to distribution center integration plans. $7 million was for severance and facility exit costs related to shutting down RP Scherer's domestic health and nutritional plant. I'll discuss this further in my segment comments. And then finally, 9 million was for other merger-related costs that were incurred during the quarter. The Bindley merger provides us with an excellent opportunity to utilize the scale we have invested in our pharmaceutical distribution network, to reduce the number of distribution centers and drive significant operating cost efficiencies. Our current plans would be to reduce the combined distribution network of 41 distribution centers, by 13, within the next 24 months. One of these distribution center consolidations has already occurred with no operating issues or service interruptions. Given the extent of the integration that will occur as we put Cardinal and Bindley together, we expect to incur an additional $97 million of pre-tax merger-related costs in the future, which do not qualify for recording in the current period under SEC guidelines. That $97 million is comprised of $55 million for facility exit costs and employee-related expenses, $22 million related to system integration costs, $12 million related to operational integration costs, and then $8 million related to other functional integrations. In total, we estimate that the Bindley merger costs will approximate $170 million and will be incurred over the next 24 months. Let me now turn to the performance of each of our business segments. pharmaceutical distribution and provider services had another exceptional quarter across virtually all financial measures. Revenue was up a strong 39%. One footnote on this growth, since Bindley was accounted for the

pooling, this is all internal organic growth. We continue to benefit from an increasing mix of business in the retail chain markets, but also experience strong growth throughout the business with all customer segments growing at least 25%. Vendor margin opportunities were strong during the quarter, as we continue to effectively merchandize products for manufacturers. Customer mix and continued expense management drove improving productivity with our margin for expense dollar increasing to $2 and ¢29 of margin for every expense dollar from $2.16 a year ago. Our operating expenses, which include the allocation of corporate overhead, were at an all time low, 2.36% of sales. However, the most impressive performance metric is how this segment is managing capital. As you know, this is a high working capital business, and the growth we are experiencing normally requires significant working capital investment. However, the investment in scales we have made in our facilities, our systems, and our people over the last several years are paying huge dividends. We achieved 38% operating earnings growth while only increasing our committed capital by 2%. This was achieved through strongly receivables management, where our DSO declined by one day, and a focus on driving efficiencies in our working inventories, reducing our days in inventory by 6 days, and improving our turnover rates. All this was achieved without sacrificing quality or opportunity, and then our receivable again is in the best condition it has ever been, our service levels remain extremely high, and we continue to take advantage of every inventory investment opportunity that provides an appropriate return. All this adds up to a dramatic improvement in

return on committed capital, which was up 800 basis points to 31.2%, as well as the generation of $187 million of operating cash flow. Even more important, I think this gives you some idea of the strength of our position in this segment and the reasons for our confidence in the future. In the medical-surgical products and services segment, revenue growth was strong driven by growth in distributed products, despite one less billing day in the quarter versus a year ago. Cardinal's acquisition of Bergen Brunswig Medical Corporation continues to add significantly to the topline, but has a dampening effect on the operating ratios of this segment due to its distribution-only nature. Without Bergen and adjusting for one less billing day, revenue growth was a strong 9%. The integration of the Bergen Medical business is proceeding as planned. Productivity improvements, expense controls, and a continued focus on asset management including synergies from the Bergen Medical acquisition, combined to drive 20% operating earnings growth and a 110 basis point improvement in return on committed capital, to a record level of 31.1%. Additionally, this segment continues to be the key driver of our tax efficiency initiatives, making its growth on an after-tax basis even stronger. As we expected, results in the pharmaceutical technologies and services segment were dramatically impacted by the slowdown in the U.S. health and nutritional and protease inhibitor markets. Revenue growth was 6% while operating earnings actually declined by 4%, impacted by surplus capacity for health and nutritional product manufacturing. During the quarter, we critically evaluated the prospects

for our domestic health and nutritional product lines. The result of that evaluation was a decision to reduce our participation in this market to a more predictable and profitable product line, which would not justify a separate plant in Tampa. So we closed that plant in the quarter and will consolidate the remaining business in other manufacturing sites. That closure resulted in the occurrence of onetime facility exit and severance cost of $7 million. Excluding the impact of these two negative market trends, revenue growth in this segment would have been 11% and operating earnings would have grown 12%. We continue to see strong performance from our pharmaceutical offerings in this segment especially in Zydis and sterile liquid product lines. Automation and information segment revenues grew 10% and operating earnings increased 17%. While this is a good performance, we were disappointed in the results, as we believe the growth should be stronger. During the quarter, we did not see the growth in the supply station product line that was expected. This was not because of a lack of demand, rather it would appear to relate to customers electing to wait for the launch of our next generation supply product, which did occur in March, as well as an extension of the selling cycle for supply-related products, due to the amount of attention being given to medication safety issues. We did experience strong demands from net station safety net as hospitals continue to focus on reducing medication errors and allocating dollars to these efforts. Looking forward, this business segment, although only 9% of our operating earnings, remains a key part of our strategy to provide market-leading, value-added products to healthcare providers.

Thus we can assure you we will remain focused on initiatives to continue to grow this business, and we remain confident in the long-term growth process. Let me now turn to our asset management and cash flow. Obtaining the asset management throughout the company combined with our record operating results to generate record level third quarter operating cash flow of $251 million. The strength of this performance is magnified by the strong growth achieved in the working capital intensive pharmaceutical distribution and provider services segments. The specific drivers of our cash flow performance were, first of all, our strong earnings, but then from an asset management perspective, we experienced continuous improvement in our receivables management, where our consolidated day's outstanding declined to 21 days versus 22 days last year; also, our inventory management initiatives, which generated an increase in our inventory turnover to 6.6 times versus 5.9 times last year. Given this performance, we remain confident in our ability to achieve our goal of generating operating cash flow of $700 million in fiscal 2001 and free cash flow, which is after capital expenditures and dividends, of $350 million. These goals remain the same as before the Bindley merger. That's noteworthy because the Bindley merger has added an unexpected use of cash for merger-related costs, as well as the fact, that historically Bindley has consumed approximately $100 million of operating cash annually. Let me wrap up with some thoughts on our balance sheet strength. Our financial position continues to improve, enhancing our flexibility to be able to make strategic investments and take advantage of financially rewarding opportunities as they

arise. Some of the key statistics that highlight this strength as of March 31st are as follows. We have $5.1 billion of equity. Our tangible net worth is now at $4 billion, and our net debt total capital is at a third quarter low of only 26%, leaving us with over $2 billion of additional capacity before we would approach 45%. Our asset management practices and financial disciplines continue to pay dividends relative to the strengthening of our balance sheet and financial ratios. Our consistent performance provides Cardinal with a flexibility that has become our trademark and a key competitive advantage. Thank you for your attention. I'd now like to turn the call back over to Bob.

Okay, the rest of my prepared comments relate to our business going forward. A few key points to setup this discussion are that, first of all, we are in a business, we're in businesses that are experiencing extremely healthy market demand. In fact, about 80% of our sales relate to pharmaceuticals that are growing at 12%-13% and are expected to continue that rate for the foreseeable future. Second thing, we have market leadership positions in nearly everything we do with over 99% of earnings coming from businesses where we have a number one or number two market position, and we're tying these businesses together more effectively when we go to the customer. And third, we have all of the resources that we need to continue to drive the success of our business. When I mean resources, I'm talking about both capital and people. Those 3 factors all set us up for strong performance in the future, but the favorable mix of our businesses in the near term actually gives us even more upside. We tend to look at our business in 3 to 5-year time horizons. We have just recently completed the first phase of our

planning process for fiscal 2002, which looks at not only how we will grow earnings and returns, but also the strategic aspects of how we might improve scale and/or the proprietary nature of our offerings. I'd like to share with you a few thoughts that have come out of this process. We report in 4 segments, our 2 major segments, pharmaceutical distribution and provider services and medical-surgical products represent over 80% or just about 80% of our current earnings. But they will deliver substantially more than 80% of the earnings growth used by the whole corporation for the next 2 years. With our current market position in place, the benefits of cross-selling and the completion of 2 significant acquisitions, both of which are strategic and accretive, we are confident that our financial commitments to the market are secure. These 2 segments have strong markets and represent leading positions with more scale and breadth than our competitors. We have experienced management teams in place, and we are just flat out executing in these areas. Let me move onto the other 2 smaller segments. Automation and information services, which is about 9% of our earnings, grew earnings at a reasonable rate of 17% this quarter. That's not bad growth rate, and the returns are excellent. In fact, our returns on sales were up over prior quarters. While I said it's not bad, I believe that there are things that we can do and that business could grow at a faster rate. We continue to maintain our market share and to innovate with new product offers. Some of the factors that impact our business, short term, are the economic pressures of hospitals and the timing of new products and the implication of medication safety initiatives. I remain confident in the long-term ability of this segment to grow. Our automation products are critical to hospitals and represent a real asset for customers trying to reduce costs and

implement patient safety programs. The recent announcement by Healthsouth to build an all digital and safer hospital, to include Pyxis as one of 10 technology partners, is an example of Pyxis' leading role in the industry. We think that more hospitals will follow Healthsouth's lead and that Pyxis will become even more important to hospitals over the long term and continue its strong growth for the next several years. Short term, this segment will grow at a rate somewhat below its long-term growth prospects, but the future for Pyxis is still indeed bright. Our pharmaceutical technologies and service segment, which is 11% of our operating earnings, has been affected by the impact of foreign exchange and weakness in two product categories. Well, I don't like crybabies. I am just going to give you the facts. The sales slowdowns are primarily due to two product categories, nutritional and protease inhibitors. Nutritional market was softer than we anticipated, and we chose to exit the domestic market this quarter. As we indicated to you a couple of years ago, our focus was to move our mix of business in soft-gels towards pharmaceuticals, which deliver substantially higher margins than nutritional. The protease inhibitor sales category began slowing down last fall. While one of our products, Kaletra by Abbott, is experiencing strong growth, the overall demand for the category is below our expectations. On the other hand, the overall pharmaceutical drug delivery category, in total, experienced strong growth this quarter with particular strength in fast-dissolve and sterile liquid technologies. Our pipeline of products in all of our drug delivery technologies is strong from soft-gels and Zydis to dermatological and sterile liquids. As a result, this segment will show accelerated growth in the fourth quarter and over the next 3 years grow at a rate above our corporate earnings targets. You should expect us to continue our investments here including more

acquisitions that help us round out our capabilities. So in summary, concerning our prospects of two larger segments, which account for 80% of current earning, are cranking along quite nicely with two strategic acquisitions that will give them further lift in their performance. Those two segments give us the earning power and the confidence to continue our investment philosophy throughout the company. The two smaller segments in our mix have seen some short-term challenges that will hold down their near-term growth prospects, although they will continue to provide high returns in the near term, and both segments retain superior long-term growth and return prospects. When I look at the market's capabilities, resources, and people of Cardinal Health, I can tell you with confidence and a perspective that I have that our best years are still ahead of us. We have great people here with great financial discipline. Our financial formula is as strong as it's ever been, growing earnings, increasing our returns on capital, and generating strong cash flow, and investing aggressively in our businesses for the long term. At this time, I would to open it up to questions from the audience.

Ladies and gentlemen if you wish to register a question, please press the 1 followed by the 4 on your telephone. You will hear a 3-tone prompt acknowledging your request. If your question has been answered and you wish to withdraw your polling request you may do so by pressing the 1 followed by the 3. If you are using a speakerphone, please lift up your handset before entering your request. The first question is from Len Yaffe with Banc of America Securities.

Good morning. Could you please give us what the mix was between chain, independents, health systems, and others, this quarter, as well as in the year ago quarter, that would include Bindley?

Okay, Len. Good morning. I'll ask Jim to do that for you.

Len, our mix in terms

of our retail versus our institutionals is about 15% in the quarter for the independent, 46% for the chain, 24% for the institutional market, and in the alternate are it's about 14%. It's, in the mix for Bindley, they don't break it out quite in similar fashion, but they break it out as retail independent. We have got to reclass each of the customer bases to get to these numbers. So it will be roughly, retail and institutional will be 61% retail and 39% for the institutional market.

Great. Thank you very much.

The next question is from David Risinger of Merrill Lynch.

Thanks very much. Congratulations on the phenomenal performance. Would you comment on your Allegiance cost initiatives? Obviously, with you Jim now in charge of Allegiance, you can take a look at cost efficiency opportunities and bring some additional perspective to bear. Could you talk about some planned changes in the way that Allegiance operates and opportunities for profit improvement?

Dave, let me just correct something. Jim is not in charge of Allegiance. Ron Labrum runs Allegiance with really the same kind of structure that was in place before. The difference really is Allegiance reports in to Jim, and so Jim also has a good troupe, who runs pharmaceutical distribution business, reporting to him. One of the reasons for that is we recognize the opportunities to tie these two businesses

together as we go to the customer. We wanted to cross-sell ideas in a more effective way between the two companies. Allegiance has cost and margin initiative ideas and so does our distribution business. So at the organizational structure and with regard to cost initiatives that are in place at Allegiance, some of them are on the manufacturing side. I would start with that they have been in place for a long period of time, which have to do with new facilities that are more productive, with facilities that are in new locales meaning more tax advantage areas that are more productive, that has to do with material cost improvement and material usage improvements, and so all on the manufacturer's side. There is, I think, a very well orchestrated plan that's been put in place by Allegiance over a long period of time to get more efficiencies there. On the distribution side, we're beginning to share cost and analytics in a way that we in Cardinal distribution look at it and in a way that Allegiance would look at it, and starting to compare productivity measures and to challenge each other in different ways and so that's on the front end of it. Allegiance has had some of these programs in place, but there is opportunity for them to look at our cost structures, and again, it's not just cost, we are also going to look at the opportunities to manage our capital more effectively, what we can learn from each other. For example, Ron Labrum would probably say well if your hospitals can pay in 7 days for pharmaceuticals, what's the prospect for getting them to pay for medical-surgical on a much faster pay. So we're really sharing a lot of that

information, but Ron's responsible for implementing that. Jim, do you have any other comments you want to make on that?

That pretty much sums up. One comment, I would mention. When you look at Allegiance, comparing its cost structure, you got to keep in mind, you've got a medical manufacturing business in there. That is an entirely different cost structure than the distribution business. So if you are going to align it with like say an Owens & Minor, it's not really an apple's apple. The distribution business is unique, and obviously, one of the big initiatives we've got on the cost side of the equation deals with the Bergen Medical integration and ringing those costs out, then we'll look at the businesses internally for the purpose of measuring costs.

That's great. That was what I was looking for. Thank you very much.

The next question is from Larry Marsh of Lehman Brothers.

Thanks, and good morning everyone. Just a point of clarification if I could on I guess the assured business. I think you'd said that excluding some of the negative influences, I want to make sure my numbers are right, revenues were up 11% and operating profits would have been up 12%, just want to make sure that's right, and just a clarification on how we should think about that with the closedown of the nutritional plant? Is that something that's going sort of ramp back up in terms of comparisons pretty quickly, or just a little bit of clarification if you could?

Thanks Larry. First of all, I think I said in my comments I don't like crybabies. I don't like people that they will, if we'd haven't done this, we'd have done much better, and all that. While we're trying to make those comments give you some guidance of the impact that this was fairly significant exit in nutritional business. I think Dick's comments were that the pharmaceutical business portion of it, excluding the protease inhibitor business,

was actually up 12% in earnings 11% in sales. So that gives you some feel for the categories that, there is other categories now. When you look at this business, obviously, we have a packaging business, but then let's separate from that. The biggest parts of this segment are drug delivery technologies, and soft-gel capsule is just a portion of that, and so we have our liquid sterile business and we have other drug technologies like Zydis, and so we are looking at each one of these businesses, their pipelines, new products coming out, and profitability. So as we look at the business, we are quite optimistic that some of the costs that we had to incur in the third quarter to close facilities, some of the lack of productivity that resulted in the slowdown in those two segments, will become significantly less important to us as we move forward, and we get the benefit of the growth that's coming out of the other categories in the pipeline. Dick, any other comments you want to make about this?

Well, just to make sure you understand Larry, the numbers I gave, 11% revenue growth and 12% earnings growth, is what the segment would have experienced had we not incurred the year-over-year differences in the health, nutritional, and protease inhibitors.

Quick followup, Bob. I know I've asked you this before, but you continue to show that you take share in your distribution business and I know you said your goal has just sort of grown 50% faster in market, you are well above that, but just, is that something we should continue to think is sustainable, given opportunity of consumer consolidation in the industry? Does that change your thinking at all over the next 5 years?

Well, I'd like to. We're in a budgeting process right now. I'd like to sit down and convince Jim that he can grow his distribution business on the pharmacy side internally at 38% a year, but I think I might have a riot. But anyway, we feel very good about our prospects in that business that we can grow it at least 50% faster than the growth rate of the overall distribution business itself, which I said was 12 to 13. We try to outline to you so as, first of all we are executing. I mean, we do a good job for the customers there. We aren't losing business, which means once you get a business and you're servicing a low-to-high service levels, on time delivery orders, and all of that, and you don't lose it, that helps you in your growth rate 'cause you don't have to replace lost business. We are benefiting by cross selling, and we also said that would happen, and I think that's going very well. So we have some unique offerings. I think we do a good job, the prospects of business is good. I don't see that any further consolidation in the industry is particularly threatening to our topline growth prospects. So we would endorse a growth rate for the foreseeable future, which is in the topline growth rate, which is certainly in the high teens and probably more 20% plus on the revenue side. When you get the earnings, we have got a lot of other opportunities there that can give us a growth rate above that. Obviously, this was an exceptional quarter, at the high 30% growth rate. That will be sustained for a period of time, and our guys are challenged to deliver up surprises on what I just told you. So we are very optimistic, but we're surely not going to promise

38%. Any other questions?

No. Thanks a lot Bob.

The next question is from Chris McFadden of Goldman Sachs.

Thank you and good morning. I was wondering if you could update us on the Bindley integration? Talk a little bit about how the synergies and the pace, and how you are realizing some of the synergies? What you think, if any, customer retention issues that you have come across in the process? Where you think you might be, relative to your $100 million target? And then I guess, finally, just sort of talk about any operating or systems surprises that you have uncovered as you've gone through the process. Thank you.

On the Bindley, just as an overview, we were very well prepared for this meeting, and for those that follow for a long time, there are some similarities here to when we merged with Whitmeyer in 1994, and at that time, Cardinal had 24 distribution centers and Whitmeyer had 16, and it's almost the same exact arithmetic today as it was back then. The difference is we have spent a lot of money in the last 5 years building new centers with excess capacity and automation, and we've also converted to one system so that we can absorb a major undertaking like this more effectively and quickly. So, the environment is very good right now for that. I would say emotionally on how are people getting along, and I think great. The people thought it was going well. I'll let Jim address some of the other things that he'd like to say about the integration.

Quickly getting right on track on our consolidation plans, maybe even in the quarter coming up, we'll give one more [_______________] than we anticipated. On the customer side of the question, just got back from

the NACDS meeting, which is our chain drug business, and Bindley is a major player as we are there, and had nothing but warm receptions by all the customers. Actually, a lot of customer opportunity is going forward, which is necessary for our business because we're going to have to grow $6 billion more next year, which is the size of the Bindley acquisition in itself. In terms of our synergy target, right on track with it, optimistically, we are going to hit it right in the timetables as prescribed. A 100 million target by the way was in the third year target, as opposed to, I think our numbers, our guidance on that was 30 million in the first 12 months and another 60 million in the second 12 months and then a 100 million for the third 12 months. So we got an overlap here with our fiscal reporting. In terms of system surprises, nothing that we didn't anticipate, we do a lot of hard work on due diligence. We look under the covers, look closely, make sure that we don't buy a pig in a poke. We've had no surprises, and there are little nips and naps but nothing that we didn't uncover early.

Jim, and maybe as a quick followup, if I might. How about the opportunity to cross sell, I'm thinking repackaging services and other capabilities that Cardinal has that Bindley may not have been able to offer those same customers? You mentioned NACDS, any sort of update or progress report there?

Yeah, let me just take that up. We're already converting into our packaging. So, excuse me, I think we closed this transaction with Dick 45 days ago. We're already buying into our packaging operation. We're beginning to put in sales initiatives between the two companies, and Jim has already closed one facility. So it's pretty darn fast; it's moving along quickly. Now, I want say one other thing

is that Bindley's business by itself grew at almost the identical growth rate as Cardinal's business by itself. Now over time, we are not going to be able to report that because as you merge the facilities together, it's harder to keep a track, and it's not valuable to keep a track. But I do want to point out that the Bindley team, they weren't falling out of bed here. These guys were accelerating, and we knew that, and so they weren't in any way a drag on Cardinal. They performed right with our distribution business, and so here is two companies that independently would have produced this 37% growth rate for the quarter, which I think is phenomenal, relative to the other competitors in our space. And so hats off to the Bindley guys also. Other questions?

The next question is from Glen Santangelo with Salomon Smith Barney.

Yeah, thanks. I just have a quick question for either Bob or Jim. Relating to this high growth rate we've seen in pharmaceutical distribution, well, I think I do a decent job tracking all the large drug retailers out there. These guys are all reporting growth, some of them are in the teens. None of them are reporting 20% or greater, and you guys have more than doubled that growth rate. So I'm trying to get a better sense of this growth in Pharma distribution. How much of it might be from existing customers and how much might be from market share gains? And then as a followup to that I sort of noticed something interesting in Walgreen's call when they reported their earnings. They sort of said that their inventory levels were growing faster than their sales. So if you can comment, we're obviously going to see all the drug retailers report next week. So would you expect to see that trend continue? If you could just flush that out for me a little bit more that'll be great? Thanks.

I'm going to handle it. We are not going to be able to give you specific numbers on it because there are just too many factors going on here, but there is a couple

of factors here to consider. One, the chain drugs segments are growing their pharmaceutical same-store pharmaceutical sales in the high teens, okay? Now, we also happen to have as our customers some of the fastest growing segments there, which you mentioned Walgreen, and we're pleased to have a chance to do business, and have for a long period of time, with Walgreen and CVS, both of which are knocking down big sales growth at above the rates of the industry itself. Secondly, we are putting together new initiatives with both of these companies, which is bringing us more volume growth with each one of them faster than their own internal growth because there are new initiatives on purchasing and on stuff that is flowing into our distribution centers, rather than to their distribution centers. Another factor of our growth rate is the Novation business, the shift in the Novation business, which Cardinal came out a winner on that, and picked up substantial amount of new business. We are, of course, picking up new customers, and so that means we're shifting market share. I just can't tell you how much of the shift, how much of our growth rate is the shift of market share? There is strong underlying growth in the industry. So Glen over time we may figure out other ways to try and report it, but that's probably the best that I could give you as a summary right now.

Can you give us any specifics on Novation and how much incremental business you picked up?

Jim, have we published that or is that...

I think we gave some guidance in the previous quarter call. We're looking at about net gain on Novation, we're going to be probably 675 million this year. We have grown to, this is the first full quarter with all the businesses transitions, and we enjoy approximately 42% of Novation's business,

significantly up for us.

You guys can probably tell Jim is not into numbers because he can only report 675 and 42% but anyway...

Okay, thanks for the comments guys. I appreciate it.

What's the... Another question please.

The next question is from Robert Willoughby of CS First Boston.

Thank you. Bob, can you comment on where the average committed capital for the pharmaceutical and med-surg businesses could go with further acquisition consolidation and also generic drug penetration?

The question is where can we go to, return on committed capital, is that your question, Bob?

Yeah, the average committed capital actually. You break that out for each business line, and it's obviously only growing 2% for drug distribution. Can that trend down further with generic drug penetration and Bindley consolidation?

I am not sure Bob how to answer the question. There are a lot of things that are going on. Obviously, there is some seasonal issues. We are very focused on return on committed capital. This was a phenomenal performance, as Dick said. We think we can continue to raise our returns on committed capital. One of the things at both Allegiance and in our distribution segment, these two acquisitions, short term will consume capital, long term will free up some capital in the following way. When you have larger distribution centers and you consolidate, you will turn your inventories faster in a larger distribution center for the simple reason is that you require lower amount of safety stock and there are just other reasons like that, the minimum order quantities are different or your absorption to get a minimal order quantities is more effective. So we will actually, as we go to these

consolidations, we'll be able to pull capital out of the inventory side of it. We hope we'll improve the receivable turnover, and we expect to be able to do that. So we think that we can pull some capital out of it. On the other hand, there are opportunities for us to invest our capital to position our inventories better from a buy side margin opportunity. So I'd say there are opportunities to raise our return on capital in both of these businesses and on Allegiance's side, some of their improvement in return on capital is obviously coming out of their improvement in profitability in the manufacturing side. So it's not just an inventory turnover issue there. They are driving the profitability up there. So there are a lot of factors going on. I think we can continue to drive up our return on capital. I think I have focused really on the other two segments to where we can make our biggest improvements in return on capital, starting with Pyxis. We've said to you that we will be selling our leases or securitizing our leases, and if you look at that segment, when we sit on that portfolio, when we combine our return on capital on the leases with our return on capital in the operating company, it brings the return on capital down to 24%-25%, which is very unacceptable; it might be acceptable in other industries or other companies, but it's not acceptable to us. So we will be selling off leases because we don't need to own them. On the pharmaceutical provider services, as I said, we believe that our return on capital there can go to the mid 30s. This first quarter was low for us, certainly it's better for the 9 months and will be better for the year, and so as our profitability raises there, and particularly there are mixes moving towards more profitable businesses, you're going to see a return on capital move up there. So that's kind of the

return on capital story. Further questions?

The next question is from Lisa Gill of JP Morgan.

Good Morning. My question has more to do with strategy. Bob, at the beginning, you talked about extending the breadth of offerings for Cardinal Health. I was wondering if you could talk to us a little bit about what your thoughts are, and what direction you are moving in? Thanks.

Hi Lisa. Good morning. About extending our strategy, we're not considering any major move to a new platform. I mean, let me start there. So when we say we're extending our strategy, let's start with the medical-surgical provider segment. I mean, there is an opportunity for us to, we'd certainly want to move more strongly into the physician market, and Ron's doing that. We are looking at acquisitions to broaden our manufacturing capability and Ron's doing that. And so, I'd say, in that segment that's what we're looking at. In the pharmaceutical distribution area, we're trying to get stronger in our specialty distribution capability. We would look at other specialty distribution around pharmaceuticals as ideas, but I think we're doing a good job there. On the pharmaceutical technology area, we're going to broaden. We want to invest further there in other drug delivery technologies. Don't expect us to become a generic manufacturer in any way. We are not going to do that, but I think our strategy is fairly well set. We have invested in things like, we bought the Corby facility, which gives us more packaging capability, and I think you should expect us to have a particular interest in that segment for other investments, which I think are high return on capitals will make us more important to our

manufacturers. In the Pyxis area, we won't take our technology to other fields. I'd say this is the only area, which will see us move a little bit out of healthcare and that's with Vistant, and we will leverage our technology and our infrastructure for Pyxis type equipment outside healthcare. And so we're investing there. So I'd say that's an overview of what we're thinking about. Any other questions?

The next question is from Seth Teich of First Union Securities.

Hi. I have one question and a followup, if I may. Has the FTC contacted you guys at all, in the course of their review of the AmeriSource, Bergen acquisition, and maybe, kind of, give us a little insight as to what information they were asking and any response?

Good morning Seth. The FTC, certainly the merger of Bergen and AmeriSource will receive FTC review, and it's an important one, and I would suspect that the FTC has contacted most of the major participants in the industry, which includes us. So we're certainly obligated to respond, and we'll respond with the appropriate information to the FTC. As we said before, we have taken a public position on this merger whether it should be consummated or not. I don't frankly think that the FTC is interested in our opinion about it as a competitor. I think they're interested in knowing more about the market, and we will participate fully.

Okay, and then as a followup, if I may. In the distribution business, the gross margins came down about 30 basis points, but if I do a little bit of the math, I get that roughly 20 basis points of that decline year-over-year was due to the mix in favor of Bindley. I just wanted to know if that

was using good math? And then secondly on a reported basis, I was curious to know if Bindley grew its revenues 65% overall, again just a reported base on the year-over-year comps?

I think we said that Bindley's growth rate was comparable to the overall growth rate of the segment. And with regard to the drop in our, was your question on gross margins?

Yeah. It was the gross margin. I just wanted to know of the reduction. It seemed like you did better operationally. I just wanted to know how much of the reduction was mix for Bindley.

Of gross margin?

Yes.

Well first of all, since Bindley grew at about the same rate as everything else, and we pooled it, then there shouldn't have been much effect by Bindley on the overall gross margin in exchange. I'd say the majority of it was a decline in sell margin and a shift towards chain, which has the lower gross margin. On the other hand, as we've said that the market for a long period of time, we analyze every single customer by return on committed capital, and you should interpret that that if we're willing to grow and are seeking to grow our chain business more rapidly, that we think that it will provide us a higher return on committed capital. So I'd say that the growth of the chain business has probably driven up our return on capital and helped drop our return on sales a little bit. I think the other factor is that in the growth, we grew pretty rapidly on the hospital side because of the Novation thing, and in that environment, because of such rapid pay, we actually are willing to reflect the lower prices to customers if they pay us and some of

them pay us in advance. In fact, a lot of them pay us in advance. So probably those are the things that would affect gross margins, but I can't tell you whether it's 20 basis points of it or 30 basis point of it. I know Jim has got the answer to, but I don't think I want to get too deep into that. But those are the overall factors. I think we have time for one more question.

The last question is from Marie Rossi of Morgan Stanley.

Hi. It's actually [_______________] for Marie. First, do you guys still think that Pyxis can grow 20% plus in the long-term, and how low in the next couple of years, in the near term, do you think that growth rate can get on the topline? And then the second, I was just wondering if Allegiance grew 9% without Bergen, did those 3 small acquisitions have any impact on that 9%? And if so, how much?

Let me just deal with the Bergen thing, or the Allegiance. Those 3 acquisitions or businesses, which have higher margins, higher returns on sales, but are really fairly small revenue numbers, and so the impact was miniscule, in fact, way less than 1% impact. So it was really all internal growth rate. The other thing I want to tell you is we did not promise the 9% internal growth rate for Allegiance, we just reported it to you on what it was for this quarter. As we tried to say last quarter, when we had, I think, some difficult comparisons around the Y2K and other stuff when people were asking us well jeez, is Allegiance's growth rate only going to be only 3%? We tried to point out to them no, and the reasons for it, and so anyway we are confident that the Allegiance growth rate will be in the mid single digits, and maybe there are some opportunities for it to pickup above that, but that they can

still have the right format in place to deliver the 20% of the bottom line as they shift their business towards manufacturing, more manufacturing, and improve their productivity. On the Pyxis side of it, I believe that the long-term growth prospects for Pyxis are 20% percent. I think the whole issue is around new product absorption, new product introduction and absorption, it's around health of the hospital markets, our ability to move into the international markets, and the success of our new initiatives in the industrial marketplace. The good news on this is some of the incredibly high return on capital business. We're continuing to maintain, in fact grow, our market positions. We've got incredible connectivity to the hospitals where we've got interfaces on virtually 90% of all the hospitals, which means the electronic receptivity of new products by customers will be great. And so we are not under margin pressures. I don't mean we don't need to be efficient, but I mean, we have unique products that we think are priced fairly with value to the customer, and that there is good absorption. So that's the way I'd leave Pyxis. Well let me wrap the call up by saying we're obviously very upbeat. We're pleased with the performance and optimistic about the fourth quarter and the year ahead of us, the big opportunities that we see in all of our businesses, and we look forward to talking to you all at the next conference call.

Ladies and gentlemen that does conclude your conference for today. You may disconnect and thank you for participating.