卡地納健康 (CAH) 2002 Q3 法說會逐字稿

Good morning my name is David and I will be your conference facilitator today. At this time I would like to welcome everyone to the Cardinal Health third quarter earning's conference call. All lines have been placed on mute to prevent any background noise. Our lead speaker today is Mr. Steve Fischbach the Vice President of Investor Relations, Mr. Fischbach you may begin your conference.

Good morning and thanks for joining us. Today we'll discuss Cardinal Health's fiscal 2002 third quarter results. A portion of our remarks will be focused on the business segment attachment of our earnings release. If you have not received a copy of that release you can access it over the Internet at our investor section of www.cardinal.com. Additionally, we have provided slides that will be shown on the Internet during today's call. Those slides can also be accessed at Cardinal's website at cardinal.com. Speaking on our call today will be Bob Walter, Chairman and CEO, and Dick Millar, Executive Vice President and Chief Financial Officer. After their informal remarks we will open the phone lines for your questions where we will have available Jim Millar, President and Chief Operating Officer of Phamaucedial Distributions and Medical Surgical Products and George Fotiades, President and Chief Operating Officer of our Pharmaceutical Technologies and Services Businesses.

So when they conduct this call within the timeframe allotted and in consideration with other callers that have questions, we ask that you limit yourselves to one question at a time. If you have additional questions you are welcome to get back into the queue. Before we begin I'd 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 of those forward-looking statements. The recording and our rebroadcast of the call is expressively prohibited. At this time I would like to turn the call over to Bob Walter to begin today's discussion.

Good morning. It's good to be with you this morning particularly since I can report another great quarter here at Cardinal Health. In the past 20 years I've been talking about the same formula for success. Taking advantage of our balanced portfolio of Health Care businesses to grow earnings in excess of 20 percent combined with rising returns on sales and capital. I probably sound like a broken record but the song this quarter is the same one you've been hearing for a long time. As a result of our execution, earnings per share rose 22 percent on an apples per apples bases to $0.71 for the third quarter. Cardinal Health generated all-time record with revenues $11.5 billion, an increase of 12 percent over last years 35 percent top-line growth. This result is an all-time record operating earnings $533 million a 19 percent increase. Cardinal had solid sales growth this quarter but that alone did not drive the bottom line results. What again drove the company's success was our team's ability to execute and translate revenue growth into outstanding bottom-line performance. Looking a little closer at the results, growth margins are up in every segment. Our expense ratios are down in every segment. These improvements along with solid operating earnings, a solid operating revenue growth again drove strong increases in return on sales in every segment. We also raised our return on committed capital in every segment. That's my definition of great executions, and so the main theme for this quarter is just continue outstanding executions that's in every segment. Dick will give you details in the quarter, but let me offer a few things that I believe are significant.

First, Pharmaceutical Distribution Provider Services delivered an unbelievable performance. Our return on sales is an all-time record high, and not even I would have imagined a few years ago that our return on committed capital would exceed 31 percent as it did this quarter. This morning I looked up what our return on capital was, this is apples for apples, exactly 10 years ago in this segment. It was 15.43 percent apples for apples. So we've almost doubled our return on capital in this segment. Secondly, I know many of you in the past have expressed concern about the sustainable growth rate of our automation and information service segment, which is primarily Pyxis. While Pyxis continues to execute over the past five years, Pyxis has grown earnings about 30 percent compounded per year. During that time we spent over 55 million on R&D in an effort to bring new products to market. Our investments and our execution are paying off. The third point I want to make is that the business models for medical surgical products and services in the pharmaceutical technologies and services bore fruit in this quarter. In the Med. Surg. area we increased the overall mix of self-manufactured products and expanded our international manufacturing production. Both helped us improve our after-tax earnings.. In PTS we've invested heavily to prepare this group for an increasing mix of higher margin pharmaceutical products. This quarter reflects the payoff we're beginning to realize from these investments.

Now let me turn this to some of the highlights for the segment. Each of the segments turned in a solid performance and continues to track to the full year earnings targets that we laid out for in January, actually laid out for you last August. The largest of our segments, Pharmaceutical Distribution and Provider Services, set many financial records this quarter. Total revenues were up 13 percent to an all-time 9.5 billion. The distribution portion of this segment actually grew faster. Now our revenues this quarter were combined with higher growth margin. I've said in the past that I expect growth margin declines to slow. In fact, margins increased this quarter. Growth margins were strong for three important reasons. First, is the move of products from branded to generic and I'll address this industry trend more fully in just a minute. Second, is the investment opportunities and products with priced advantages offered by manufacturers continues to be ample, and the third reason, the gross margins were strong is that the selling market erosion has somewhat abated. The Industry has generally reduce the selling price to its customers to the point where's there's really little room to move downward from here without corresponding reduction in the industry cost structure. Our third quarter revenue growth in this segment at first glance appears lower than our recent growth rates. Let me give you some perspective. First, one less billing day, which impacted growth by about 2 percent. Second, we had a phenomenal year in 2001, and the comparison to this quarter was against a quarter and that grew 39 percent. Over the past two years our growth in this segment has been tremendous. And this quarter compares favorably to the two-year growth rate that we experienced in the September and December quarters. For The first six months of this fiscal year we grew this business on a two-year compounded average growth rate of 23 percent. This quarter our two-year compounded growth rate is 25 percent as we continue to grow the business at our historic four in a half times the market growth rate. As the population ages the demand for pharmaceuticals will continue to be strong, and I have no hesitation in reiterating what I said after our last quarter. That the revenue growth of this business over the next few years should be in the high teens where earnings continue to meet our 20 percent or better standard as a result of favorable margin and expense leverage. I would like to step back for a moment and comment on two issues that are current topics of conversation within the drug distribution industry. The first is a possibility of excess inventory in the channels. Consistent with our historic practice we won't comment about any particular supplier, but I did want to address the issue. Wholesalers have always provided a critical service to the manufacturers and providers by positioning inventory close to demand. Inventory levels fluctuate for logistical, for marketing and for economic reasons. It is our job to acquire products at the most favorable terms and conditions consistent with our responsibility to support manufacturer programs and provider needs. We are experts at doing this. All of the hype over excess inventories in wholesale channel over these past of weeks is just that hype. Why there may be some extra inventory positioned at the wholesaler levels for a few manufacturers with special marketing needs. On balance our inventories are normal for this time of the year. If we position extra inventory at our level for manufacturers you can be sure that we did it on economic terms that are favorable to us. I've spoken for years about the critical training skills necessary to be successful in pharmaceutical distributions. I've spoken about the lack of product opalescence, and about the ability if required to return to inventories to the manufacturer. Further, the capital cost for Cardinal to carry additional inventory is minimal. The benefits of extra inventory far out weigh the risks. One last comment, we only recognize profits on appreciated inventory when it is shipped to the customer. Our March quarter is historically our highest margin quarter. There was nothing unusual in this quarter's performance when compared with prior years. Positioning extra inventory in the channels is a normal occurrence and one that offers little risk to the wholesaler and often considerable benefits to the manufacturer or the provider or both. The second topic of note is generics. This past year the industry had over $7 billion of branded products go generic. Next year we expect that over $18 billion will go generic. All wholesalers including Cardinal Health make higher gross margins in dollars and percent on generics than on branded products. In addition, our return capital employed in generic products is much higher than for branded. Nothing has happened in the past year to change these facts that isn't positive for the wholesale trade. Generics are a big part of our profitability and a factor in the increase in our growth margins of this quarter. Generics were also a factor in our top-line performance. While generics will moderate revenue gains over the next several quarters, they will improve our margins, our earnings performance and our return on capital and that is a very good thing. Frankly, that I believe that our returns on branded products are far too low. This is an issue that the industry must face in the future.

Turning back to Cardinal Health performance, let me address the medical surgical products and services of segment. Here again we've achieved improvements in all of key profitability and productivity categories. Return on sales reach an all-time high of 8.9 percent. The return on committed capital was also a record. Revenues were a record of $1.6 billion up 4 percent. This growth was slightly lighter than our expectations partially due to one less billing day in the period, and a slower implementation of new contracts that we secured in the December quarter including those with the Mayo Foundation and other innovation institutions. We will deliver benefits from these new contracts in the final quarter of this fiscal year. Self-Manufactured products particularly surgical instruments and custom kitting products were phenomenal during the segment. Growth in self-manufactured products and excellent gains in manufacturing productivity drove gross margins to record highs in the quarter. We also had market improvement in asset utilization driving record returns on committed capital. Let me now shift to pharmaceutical technologies and services. While the earnings growth and returns ratios improved nicely I was not completely satisfied with the revenue performance in PTS. We produced record quarterly earnings on improved gross margins in cost efficiencies. However, we were disappointed that a couple of product launches, which we expected in the quarter, are now forecast for fiscal 2003. We have three businesses in this segment, Development and Analytical Services, packaging and product manufacturing and services. We continue to see tremendous potential and ramp-up in revenue in our development and analytical service offering. That business was right on target this quarter and the strength of the launch of pharmacy is Dextrol and other new and long-term contracts. Well our packaging business was also strong and on target. Our third business is product manufacturing services had mixed results. The major products already in the markets saw continued solid revenue growth. Like

,

,

and the pharmacy is Detrol. But we were surprised by the change in the expected launch of

,

and the delay in the launch of domestic generic

. The move of these important launches was the primary reason that we did not grow here on the top-line at quite the rate that we thought we would. Our outlook for PTS remains as bullish as our communications were last quarter. Return on our investments across the segments will be substantial. I will stand by my statement that this will be our fastest growing segment in fiscal year 2003. Our pharmaceutical technologies and service center opened this month in New Jersey. Combined with the Magellan Laboratories an acquisition that we completed last year, Cardinal Health has built by far the most robust analytical service and development capability serving both the pharmaceutical and biotech industries. These services will drive downstream demands for our product manufacturing and packaging services. Turning to our fourth segment automation and information services I was absolutely thrilled with our performance in this segment. I'm pleased to report that the momentum here has continued to accelerate. The stats are inspiring, revenue was up 27 percent to $142 million and earnings grew 29 percent to $53 million. As I had pointed out earlier, our investments are fueling new products like supplied station 30 and an entire suite of patient safety products. Both were major contributors to our performance this quarter. Pyxis's backlogged increased yet again this quarter, which means you can look forward to more strong growth in the future. And this segment has committed contracts rolls into revenue as products are installed. Pyxis not only delivered top-line performance in the quarter it executed on all levels, gross margins were strong as Pyxis continued to price based on value delivered to the customer. Operating expenses decreased to a third quarter low based largely on the company's transition to a bill-to-bill order manufacturing process and on productivity improvements instituted in calendar year of 2001. Return on sales was the third quarter record so we're firing on all cylinders in this segment. But overall a key message for you this quarter is that Cardinal Health delivered balanced and record growth in revenue and earnings and delivered record or strongly improved results across all businesses. It is worth repeating that all of the key profitability and productivity metrics were up and often up significantly in each and every one of our four business segments. In addition, we achieved phenomenal performance in managing our capital. Our balance sheet is stronger than it's ever been, which continues to afford us the flexibility to meet our strategic objectives. We generated over a half of billion dollars in operating cash flow this quarter and expect to meet our goal of generating operating cash flow of $800 to $900 million for this fiscal year. We remain on-track to achieve a 20 percent or more earnings per share growth for both the fourth quarter and fiscal year. As we look into 2003 and beyond we have plenty of confidence in our perspective performance. Cardinal Health's three-year growth model as we presented in January remains on-track. That model centers on strong pharmaceutical distribution growth, on rapid growth, in self-manufactured medical surgical products, on accelerated earnings on PTS as a result of strong demand for outsourcing services to manufacturers and continued to invest in development services and finally the continued the momentum in the automation information service segments based on providing solutions to medication air problems and expense challenges from our provider customers. Now Dick will provide you with an even more perspective on the financial results.

Thanks Bob. I'm pleased to report yet another great quarter. One with profitability and productivity gains in every segment and at the consolidated level. Today, what I'd like to do is share with you my perspective on the quarter focusing on first of all the quality of our earnings, talk a little bit about productivity and our earnings leverage, asset management and our cash flow and then finish up with an outlook for the future.

Before I start let me just remind you that since we adopted

statement 142 at the beginning of the fiscal year we had no good reline amortization in our current period numbers. In our effort to provide comparability we eliminated goodwill amortization from the prior period numbers in providing financial details. We've tried to be very clear on this point in our press release and all amounts, ratios and growth rates that I will discuss today reflect an accurate apples to apples comparison. Additionally, all of my remarks exclude the impact of special charges, which are comprised primarily of merger related charges incurred in the current period as a result of our prior acquisitions primarily Bindley and Bergen and Medical.

Now let me start off with a few comments on the quality of our earnings. Once again we delivered our commitment of growing earnings per share at 20 percent with rising returns. Our EPS rose 22 percent in this quarter to $0.71. We had excellent balance in profitability performance across all of our business segments in the quarter. Every segment set new records in many areas and delivered excellent operating earnings growth. At the consolidated level and in every segment we delivered improvements in our gross margin ratio, our return on sales and our return on committed capital. We achieved these results while remaining focused on investing for our future. Investment spending in the quarter was approximately $25 million. This investment spending represents the use of current earnings to investment projects that would generate growth in future periods. And then finally our return on equity reached a record level in the quarter and is now above 20 percent. That's particularly notable given the low level of debt that we've maintained. Let me just take a minute to elaborate on a few of those key financial metrics. Once we look at gross margins in each of the segments. First of all, Pharmaceutical Distribution and Provider Services increased its gross margin ratio by 4 bases points in the quarter to 5.45 percent. Strong vendor margin opportunities in our business mix drove that expansion. In line with our guidance for slower top-line growth this quarter revenue growth for the segment was 13 percent. In Medical-Surgical Products and Services we expanded gross margin by 42 basis points to 22.39 percent. Growth in our self-manufactured products and especially surgical instruments and custom kittings has

improved manufacturing productivity led to that strong performance. In Pharmaceutical Technologies and Services we widened our gross margin by 85 basis points to 32.83 percent driven primarily by an increasing mix of pharmaceutical products. But we're also experiencing the positive margin impact resulting from the rationalization of the domestic health and nutritional business in the third quarter of last year. This margin improvement occurred on slower than anticipated revenue growth of 5 percent. While, we continue to see strong demands for our development, analytical and packaging services, revenue growth for our manufacturing services was mixed, impacted primarily by the delayed launch of certain new products as bob discussed, which dampened the overall segment of performance in quarter. And finally in the automation information services segment we had an outstanding quarter. Growing our revenues over 27 percent while also improving gross margin by 25 basis points to 69.06 percent. These results continue to reflect a positive impact in the business model changes implemented at the beginning of this fiscal year as well as favorable product mix driven by strong sales of the MEDSTATION Safety Net patient safety product.

Let me turn to return on sales. This is another key metric that

our earnings and the fact that we improved our return on sales to record levels in every segment. Each segment leverages expenses to a lower percentage of sales in the current quarter. This leverage combined with the gross margin improvements to drive return on sales improvements in every segment. The return on sales ratio was an all time record in our two largest segments, Pharmaceutical Distribution and Provider Services and Medical Surgical Products and Services. Traditionally, we achieved a third quarter record in pharmacy technology in automation and information. These improvements are particularly noteworthy because they're key indicators of our focus on both improving the quality of our existing business as well as our disciplined approach in ensuring quality of all new business that we take on. In the area of our return on our committed capital we continue to focus on leveraging our valuable capital. In our four segments operating earned grew faster than our capitals deployed generating improvements in ROC in each segment and at the consolidated level. Notably, the return on committed capital in our medical surgical segment achieved a new all-time record. And finally our return on equity. The fact that we are increasing our return on equity is a significant quality metric. Despite the fact that we continued to deliver the business and that our net debt to total capital was down to 21 percent at the end of the quarter versus 26 percent last year our strong earnings growth continues to drive improvements in return on equity. This quarter we achieved an all-time record of 21.5 percent bringing us up to 20 percent year to date.

Let me now switch gears and discuss our productivity and earnings leverage that we achieved this quarter. We invested heavily each of our businesses to make them scalable and operationally efficient. The benefits of this are evident as each segment of our business increased its margins percent dollar in current quarter. On a consolidated basis we improved 5 percent going from generating a $1.90 of margin last year to generating a $1.99 of margin this year. That means for each dollar of expense incurred we generated an additional $0.09 of margin this year. We continued to leverage our strong operating earnings growth even stronger in net earnings growth, which was up 22 percent this quarter. While we have clearly benefited from lower interest rates, our focus on asset management and the generation of positive cash flow were key contributors to achieving a 9 percent reduction of our net interest costs. The execution of our long-term strategy to continue to be more tax efficient by making our mix of international and domestic activities. Also contributed earnings leverage while took 20 basis points that's off of our tax rate. Now this is less than our 50 basis point reduction we had achieved in the first half of our fiscal year due primarily to mix of earnings we experienced in the current quarter and our desire to be conservative as we head towards our year-end. Nevertheless, we still expect to see an overall reduction in the tax rate of 40 to 50 basis points for the full year, which we intend to true up in the fourth quarter.

Let me just take a few minutes now to highlight some items from our asset management and cash flow performance. Continuing our trend to focus receivables management our receivable days defined to an all-time low of 18 days that's down from 21 days a year ago. Another quarter consolidated sales when ours grew 12 percent while receivables actually declined. We've reduced our inventory by at least $350 million sequentially from the second quarter reflecting the normal seasonality of the business. Furthermore, our asset management focus combined with strong earnings lead to the generation of $504 million of operating cash flow. Which is more than doubled the performance we had in third quarter of last year. And to safety trends historic in the fourth quarter to announce to achieve our goals of generating $800 to $900 million of operating cash flow for the full year.

Let me finish up by turning to the outlook. I'd like to start by reiterating our continuing confidence in the three-year growth model that we outlined at our January investor conference. In the near term, we positively reaffirm our continuing commitments to deliver 20 percent UPS growth with rising returns in the fourth quarter and for the full fiscal year. For the most part the second half guidance that we provided at January investor conference remains intact with just a couple of adjustments that I'd like to share with you. First of all, revenue growth in pharmaceutical distribution and provider services will pick-up in the fourth quarter to the mid to high teens level that's even when compared again to stronger than last year, which grew 28 percent. The second item I'd share is that the product timing factors mentioned previously related to the pharmaceutical technologies and services segment will continue to impact our performance in this segment in the fourth quarter. I would expect this segment to deliver revenue growth in the low to mid-teens while continuing to improve returns. Thank you for your attention. Now let me ask the operator to open up the lines for questions.

At this time I would like to inform everyone if you would like to ask a question press star then the number one on your telephone keypad. If you would like to withdraw your question press star then the number 2 on your telephone keypad. And please limit your participation to one question. We'll pause for just a moment to compile the Q&A rooster. Your first question comes from Chris McFadden of Goldman Sachs.

Thank you and congratulations on nice results. A couple of questions if I might. But firstly could you quantify in dollar terms what the day meant for you in the drug distribution business. And then secondly, could you talk about the recent FDA decision relative to Claritin, it's movement over to the OTC environment, and how you expect that decision to affect you in the Zydis area, thanks.

This is Bob. I didn't understand your first question we've got to just handle one question. I think your first one is a pretty fast one. Did you ask to clarify what's the difference in number of billing days the impact on us?

Yes, in dollar terms you mentioned it was roughly 2 percent, could you kind of give us just rounding that off to us in dollar terms?

One-hundred and fifty million dollars, I think is that about it Dick? OK. George Fotiades is with me why doesn't George to just comment on Claritin and your expectation of it.

Chris, we've known obviously for some time that Claritin would be going generic in December of 2002. So The decision that the FDA rendered yesterday what that does is just basically clear the way for having Claritin product go OTC or over the counter for all indications which probably means therefore there will not be any indication left for any generic Rx to be available for Claritin past December 2002. What that means for us, you know, again as I've said we've been expecting that it would go generic and that our sales based Claritin would tail off on Zydis going for it. It's probably happened faster than we thought it would in part probably extenuated by their decision to go OTC with the product. The other aspect of this was Clarinex, again it has an approvable letter from the AFC but it has not been finally approved. We had excellent expectations that that would have happened by now. We expect it will happen but that isn't part that's contributed to what's happening the quarter earned PCS revenue. Again, we expect that it will happen and it be a Zydis Rx version of Clarinex and the other aspect is on Zydis to Claritin the

did file Zydis version OTC in addition to the rest of their Claritin line so presumably our maybe a Zydis OTC version sometime, you know, later in the fall or in 2003 when we launch the OTC.

Next question.

Your next question comes from David

of Merrill Lynch.

Yes, with respect to the core distribution business going forward, you've obviously provided the fourth quarter outlook and I think at the start the call Bob you mentioned high-teens revenue growth of sort of sustainable growth rate over the next years, but there are some factors that are going be etiquette that pulling that down including the generic introductions, the OTC Claritin, which will come in a much lower price. Kmart fading somewhat over time at etcetera. Can you just help us understand how you'll get to that high-teens revenue growth rate on a sustainable basis and core distribution over the next few years?

I'm going to turn it over to Jim in a minute or so but I--so you start off with real unit demand for pharmaceuticals based upon and you now all of this, David, and based upon this aging population and speaking to pharmaceuticals being a solution to healthcare, and so you got a basic demand there that we still believe is in the 12 to 14 which takes under consideration these kinds of matters. The things that are specific to Cardinal when dealing with our customer mix being more favorable in the industry. The Kmart slow down Jim will let Jim on comment what affect that had on us. A third factor of how we get to a high-teen which would be factored than ours expected industry 12 to 14 percent is that we think we execute better in the industry, we think we have some of cross-selling advantages the industry doesn't have and we have a faster growing segment. Now, products going generic hurts the top-line, but frankly what we watch inside Cardinal is our gross margin dollar growth and as you know we're managing the spread. So, you know, while that may hurt the top-line growth, you know, it certainly helps their dollars as we move forward. Jim can you make any other comments.

I think you hit most of them just a couple comments on the Kmart situation. The Kmart's situation is obviously been turmoil over the last quarter and that did have an impact on some of our sales probably about one percent in the impact up through December that up about 17 percent and actually it resulted this five-core January through March their sales probably not to anybody's surprise declined with the announcement of the store closings and bankruptcy and all these issues. But that is it's going to be a situation and I don't strategically it plays because in fact those scripts move through the market to play and move to customers that we would doing business with as well. But, I think, you know, David, as Bob eluded to it's mixed, our customer mix, I think it's the industry growth and I think its our cross selling leverage that holds well for our future strength.

OK, that's great and just so we understand Kmart closings, when are those going to be done?

Well, I think Kmart's a better position to answer that. My understanding is they were trying to get the majority of them done by the end of this month. They were going to transition files in about half of the stores over to other stores and then the other ones they are going to sell off the script files and so on. This is kind of a

situation that I really rely on Kmart's comments more than ours.

Let me comment on Kmart because I know there's questions out there. They've been a good partner of ours, at times, they've listed our growth rates, this quarter they depressed our growth by a bit over a point. It's our job to go replace, you know, slower growth business with faster growth business, and we've had a long-term relationship with them and would expect to continue that relationship. I know that there's questions out there about OK. Your folks

growth rate pharmaceuticals Distributions because, you know, that segment is 50 percent of our earnings and I don't want to be overly defensive about this. I want you to be careful about projecting growth rates off of one quarter's numbers here and remind you that we grew 39 percent a year ago so it's a pretty tough comparison. Just on a point of interest, I pulled out our 1995 report I find its interesting earnings per share were at the same number. A 12 percent top-line we said almost the same things. We were compared to a quarter when it was a 30 percent grower in that prior year and we talked about generics and we talked about getting operating leverage providing us the flexibility to invest for the future. While we spent $25 million more investments this quarter to get us prepared for the future and so I looked back and I said in my call here it's been interesting I don't want to sound like a broken record, as maybe that records been going on since '95 or so, but anyway I want to remind everybody that our earnings that quarter were $20 million, so as things change they stay the same. Can we have our next question.

Your next question comes from Robert

of Credit Suisse First Boston.

Thank you. Bob it looks like the average committed capital base for the distribution business did rise sequentially by about $300 million or so, it's clear your getting paid for judging by the ROCS but why would that have increased with reconsolidation, inventory liquidation in just a normal generic penetration rates being higher. Is this Kmart inventory or is all forward-buying inventory or something else going on?

Let me just see it pretty clearly up. With the consolidation of Bindley we're moving there--that would be a positive thing as we consolidate facilities that you would take some capital out of that. First of all, you've got to appreciate we have grown the business, so if we didn't turn our assets any faster you're going to have more capital than in the business. Things that would raise our capital in there is its good to be finding the issues on inventory being in our warehouses. You also have to realize that is that Bindley was a considerably shorter on capital than we are and so as we locked the Bindley business into Cardinal we actually invested more inventory behind that to support better margins for us for that same sales volume going through that same sales volume. Now the sales volume is now going to our facility so we'll get some of advantage in reduction in safety stock but we actually have taken up our inventory investment and we outlined that I think at the time of the Bindley acquisition. But those are the primary things. Going the other direction our receivable days are down and that's beneficial but it might be some kind of being deeper in investment opportunities but that pretty much covers what's going on in that market. As I said in my call during my statements that our inventories are normal for this time of year normal when considering what our opportunities are and the seasonal aspect. Next question.

Your next question comes from Larry Marshall of Lehman Brothers.

Thanks and I just wanted to say I thought the recent Forbes article was a good characterization and I think when looking in there you talked about the long-term growth rate of the drug industry and euro mind really not changing all so its really something that's part of your thesis. I just wanted to follow-up kind of--I know you don't usually comment on specific customers but obviously, you know, you're biggest customers you've highlighted, you know, CVS, do you have any comment on just general growth trends with CVS that might help us sort of understand the thought process going forward. If you comment on that?

I think where we don't comment on a particular customer but I think what you can look is the programs we had in place with CVS a year ago at this time, we have the same programs in place today. So, in other words we haven't dramatically expanded our penetration of CVS meaning they're buying the same kinds of things from us today. So, our overall growth rate on the products flowing through Cardinal should end up because we have the same relationship to pretty similar to what CVS own announced growth rate is. If we develop some new programs with CVS we would announce those in the future. The relationship with them is excellent. I can't remember right now if they have the same store growth rate I think last quarter in the 9 to 11 percent and then they've added other stores and so their actually growth rate of pharmaceuticals was up above that I just don't remember the number but their purchase through us would look similar to their growth rate.

And your message bob that as Kmart reorganizes and even if they sell stores you're thought is you would anticipate picking up some of that business, you know, from newer customers, is that correct?

We have about a 30 percent plus market share at the retail level so if you just closes a store the customers got to think of somewhere to get the prescription. They're not going quit getting their prescription on the sympathy for Kmart. So, you know, logically we're going to gather I mean just statistically we're probably going to gather 30 percent of it. Obviously, we will work to try and Kmart will also move some of their scripts to their own stores and so, therefore, you didn't lose that and then there maybe some of our customers that acquire scripts. So, I would like to not see stores being closed. It will have some impact as far as I'm concerned what it means, you know, we always talk about customers or segments that pull up our growth rate and ones that are holding down and we're talking about growth rates here and whether Kmart won't be a driver over the next year or so on the pharmaceutical growth rates. They pay their bills, we have good relationship, we're pleased to be their supplier and that will give you any perspective on Kmart.

Thanks and they're only closing I think they've announced closing less than 280.

Two hundred and eighty stores, 204 will have pharmacies in them.

Out of the total how many stores do they have left pharmacies?

About 1,500. Under something under 15 percent of the stores would have pharmacies. Next question.

Your next question comes from Lin

of Banc of America Securities.

Hi, with a record number of drugs going off patent next year even significant in terms of generic pricing and a significant amount of the overall pharmaceutical industry growth rate, should we be able to expect that your gross profit margin all of things being equal will be able to improve on the pharmacy distributions and services side of the business on the year over year basis and if you don't mind a second thing that could breakdown in pharmacy distribution what the sales were by the various segments and the growth rates what they've done?

There's a lot of factors that affect our growth margin. I tried to outline what I thought were the three major factors, which was inflation of pharmaceuticals, placed in a selling margin our sell margin of customer and generics. I would expect that inflation of branded products over the next year to move similar to what we've experience over the last year. And so that's generally positive. I would have expected generics would be favorable and that's positive. Now, you've got the last thing to the wholesale side margin. As wholesalers historically make strong margins sometimes they hand them back eventually to the customer. And so a lot of that is what will happen with

side margins and, you know, we don't think that it is based just on price. We price to the customer based on the value we deliver. I can't say that all of our competitors do that. We can't ignore, you know, how they price. I said earlier there is some abatements from competitors on pricing. As industry cost structures have come down unless you can reduce costs you're not going to be a position to pass the sell side margin reductions onto customers. So, the wildcard here is what will our competition choose to do because obviously we have to aware that while we'll we say we price to value which we do we still have to aware of what the competitive environment is out there for pricing. And so I don't find all of our competitors pricing to value or delivering the same kind of returns on sales through their shoulders as we do. So, I'm guardedly optimistic about growth margins but I'm watching carefully what our two main competitors do and how they approach the market. We intend to maintain our customer base and our first way to maintain our customer base is to provide excellent service and distribution, and second is to provide the widest array of services by portfolio and products services. The third thing you have to be aware of is price always comes into to it. So, Lin, I'm guarded optimistic but I can tell you we've announced how we go to the market and have been consistent for a long time. So, you know, we just have to watch how our competitors do it. We can take one more question and I think we need to wrap up here.

Your final question comes from John

of William Blair.

Great thanks. Can you expand a bit on the outlook for PTS, Bob, I think you mentioned that you still expect that business to be your fastest growing in the coming quarters. What really do you see driving that?

Yes, John I'm going to let George talk about what drives it, you know, I think a way I chose to say it my prepared remarks is I'll stand by my prior statements which I means I guess I'll go on my reputation that I try and tell the truth. Let me let George give you more perspective on the facts.

We, you know, continue to remain confident in the long-term growth rate that we've presented at our investor conference at the end of January, which was is for operating earnings growth at 25 percent or greater. As we talked about earlier three ways we look at the business, packaging services, development services and manufacturing services. Packaging services are seeing strong revenue growth benefiting retail by cross selling across CTS. I feel very confident about their pipeline of products. In the development services area that is probably going to be our fastest growing area with the opening of the Somerset New Jersey facility as well as with the acquisition of the Magellan, which is considered the premier provider pharmaceutical development services. It will be integrating the New Jersey facility with Magellan and we see, you know, tremendous coming from that as a business in its own right they're also helping drive down

revenues as we commercialize the products and developed there.

On the manufacturing services area, as we've mentioned, that - this particular quarter we've had strong growth in the established businesses. Two launches that we expected to happen will now not happen until the first quarter of 2003. So obviously that will help to -

help 2003. But also driving manufacturing services is strong growth in the biologics manufacturing area, which we are - you know, we're seeing across-the-board in our sterile technologies group. The Raleigh facility which we acquired won't come on-stream until the end of fiscal year 2003 but, again, demand for the use of that facility is high already, and we haven't even begun to open it. So we continue to see - you know, we continue to be very bullish on the growth in manufacturing services in that particular area.

So I think the combination of those three things - we've got a lot of good things that are going on. Our services have broadened well beyond when we used to do the traditional share business in a number of areas, and all combine to make us feel confident about the long-term, despite the launch situation in the quarter.

Great. Thank you.

OK, thank you for participating in the call today. Let me end with a couple thoughts.

In short, the model of Cardinal Health is working. We have a diversified portfolio of high-growth companies, all within health care, who offer the broadest portfolio of products and service for our customers. And we believe the future for service providers in health care has never been better. We know how to work the formula top-to-bottom, which includes managing our assets.

Our fiscal year 2003 budget planning process is currently underway. I'm pleased by how the forecast is shaping up. While we're unable to share details with you at this point, rest assured that we'll grow earnings per share at the historic rate. We'll continue to raise our return on sales and capital and investing for the future.

We'll look forward to giving you a wrap-up at the end of our fourth quarter.

Thank you for participating in today's Cardinal Health Third Quarter Conference Call. You may now disconnect.