卡地納健康 (CAH) 2003 Q3 法說會逐字稿

Good morning ladies and gentlemen.

My name is Paul and I will be your conference facilitator today.

At this time I would like to welcome everyone to Cardinal Health Third Quarter Earnings Conference Call.

All lines have been placed on mute to prevent any background noise.

I would now like to turn the conference over to Steve Fischbach, Vice President of Investor Relations.

You may begin.

Good morning and welcome.

Today we will discuss Cardinal Health's Fiscal 2003 Third Quarter Results.

A portion of our remarks will be focused on the business segment attachment of our earnings release.

If you not received a copy of our earnings release, you may access it over th Internet at cardinal.com in the Investor Center.

Speaking on our call today will be Bob Walter, Chairman and Chief Executive Officer, and Dick Miller, Chief Financial Officer.

After their remarks we will be opening the phone lines for your questions where we will also have available Jim Millar, President and Chief Executive Officer of Products Life Sciences and Services, and George Fotiades, President and Chief Executive Officer of Life Sciences Products and Services.

As always, as we get to questions we ask that you limit yourself to one question at a time.

Before we begin, please remember this today's call may conclude forward-looking statements, which are subject to risks and uncertainties, which could cause actual results to differ materially from those projected or implied.

Most significant of those uncertainties are described in Cardinal's form 10-K and 10-Q reports and exhibits to those reports.

Cardinal undertakes no obligation to revise or update forward-looking statements.

In addition statements may include adjusted financial measures governed by FCC regulation G. For reconciliation of these measures, please visit the investors relation page a www.cardinal.com.

At this time I will turn it over to Bob Walter to begin today's discussion.

Good morning.

Cardinal Health delivered another solid and balanced quarter, with product improvements and better asset management we converted a top line to exceptional operating earnings and cash flow.

The return of sales on capital were outstanding.

In addition to our financial progress, we made significant strategic progress during the quarter, continuing to build scale, develop new products, and integrate our products an services across the company.

The notable aspect of this quarter was that our results were driven by the performance of our medical products and service segment, by our pharmaceutical technologies segment and by automation information segment, rather than the pharmaceutical distribution and provider service segment.

I'll explain that in detail.

Looking at our results, we generated several records and met or exceeded th guidance that we provided in February in each of the four key metrics.

First, revenues were up 11%.

That was 10% without the benefit of the Syncor acquisition.

That compared to our long-term guidance for revenue growth of low to mid teens.

Earnings per share were up 21% compared to our long-term guidance of high teens to 20%, and our short-term FY'03 guidance of 20%.

Return on equity was 22.7%, compared to our long-term guidance of low to mid 20s range.

Our free cash flow is on track to deliver our target of free cash flow greater than 60% of net earnings per year.

We had another great quarter that clipped along at a pace in line with our long-term guidance in demonstrated record performance ratios.

An important observation should be that we gained strength from the diversity of our earnings base.

And with one quarter left in our FY'03, we're well positioned to meet short-term earnings per share expectations of plus 20% earnings per share growth for the year and enter FY'03 with good momentum.

Now we'll discuss with you the current quarter performance for each segment.

And some of the issues and opportunities we're dealing with in each segment.

Most of this is good news for the short-term and all of it is really positive for the long-term.

I'll start first with the segments that drove our performance this quarter.

First, our medical products and service segment, which is 24% of operating earnings this quarter.

This quarter marks the fourth anniversary since we acquired allegiance.

There's been a lot of change over that period.

I'm here to report our medical products and service business is in the best shape with the most momentum since joining Cardinal Health four years ago.

Revenue growth was solid, particularly in self manufactured products.

We expect you will see our overall and self manufactured sales continue to accelerate over the next several quarters.

I base that forecast on signed contracts and strong acceptance of our self manufactured product lines and new products.

The growth of new products will drive not only top line improvements, but more importantly, continue the improvements in gross margin.

Noteworthy for the quarter was FDA approval of Tiburon fabric for our business.

This is a big opportunity for Cardinal Health.

Over the past two years as as a result of organizational restructuring and new facilities, MPS has become even leaner and more effective at expense control and asset management.

Results were outstanding for the quarter, delivering 18% operating growth on a 5% top line improvement.

Gross margin percentage is improved and expense percentage has declined.

The return on sales rose to 9.95% up 107 basis points, and return on capital exceeded 40% for the first quarter -- for the first time.

Quite a quarter.

I've really been pleased with MPS's progress since the acquisition.

With this kind after quarter, I think I should give you some perspective about how they have done over a four-year period of time to give you a better perspective about what they can accomplish in the future.

Operating earnings have grown over this four-year period of time at a compounded 19% growth rate.

Return on sales started out at 6.1% four years ago.

And this quarter reached 9.95%, an amazing 475 basis points improvement in operating and return on sales.

Return on committed capital measured the same way, improved 50% going from 27% four years ago to over 40% this quarter.

Operating cash flow generated in that four years was approximately 1.5 billion with capital expenditures of $400 million, so delivering free cash flow of over $1 billion back to the corporation over that period.

So the MPS segment is humming and ready to deploy more capital into external growth that will make them even stronger.

The long-term industry revenue expectation for this segment is between 2 and 4%.

Growth we clearly expect to exceed industry growth with rising return on sales.

The pharmaceutical technology and service segment, 14% of operating earnings had a terrific quarter as well, but it's a little more complicated to explain because of the Syncor acquisition completed at the beginning of the quarter.

Let me simplify this by dealing first with the nuclear pharmacy service business, which is Syncor and Cardinal's previously-owned central pharmacy services.

Quick summary on that nuclear pharmacy service segment is great quarter, on target.

Revenues were up in the high teens, and operating earnings were up even greater, at an even greater percentage, in fact over 20%.

This is a business that has great cash flow and a very high return on capital.

Incidentally Syncor was nets accretive nor dilutive to EPS results for the quarter.

The balance of the segment, that's the non-nuclear pharmacy service aspect, it grew revenues and operating earnings in the mid to high teens.

I would say that performance was several percentage points below our short-term goals.

But we're getting there in performance over the next several quarters will prove it.

The key revenue and earnings drivers were in our sterile manufacturing area and in certain parts of our oral manufacturing operations.

Amnesteem, the generic form of [Isotretnoin] was on the market for a third quarter and doing quite well.

We saw the continued growth of Lilly's Zyprexa.

The segment was hurt by the slowdown in the health and nutrition market.

And the planned eighth week shutdown of our Albuquerque sterile manufacturing plant to expand capacity.

Albuquerque is finishing validations, and we will be back up and running this month with strong and profitable commitments in place to utilize that new capacity.

But despite this shutdown, the sterile business still had a great quarter.

Looking forward, demand is there for PTS's offerings.

We have the facilities in place and have built capacity to meet the demand that we see in our pipeline.

The big pharma and biotech demand for sterile is just tremendous, and we are ready for the market.

You will see strong top line growth with rising returns.

As a reminder, we gave long-term guidance for industry growth for this segment of 12 to 15% and said we would exceed that.

Now, let me turn to automation information service segment, which is mostly Pyxis, and it represented 10% of operating earnings.

It sustained it's record of operating performance.

Operating earnings were up 21%, impressive when compared to the strong fiscal -- strong third quarter of fiscal 2002.

Margins, expenses, and operating earnings are all in great order.

Return on sales almost reached 39%, and return on committed capital was 44%.

Committed contracts and the backlog remained high at over $200 million, but we're a little below what we planned.

We were hurt by two significant unusual factors, providers were focused on meeting new HIPAA compliance regulations that had a mid April deadline, and we were further hampered by contracts with the military being delayed at the end of the quarter.

With the HIPAA deadlines behind us, we've already seen many of those contracts that we were working on at the end of the quarter signed in early April.

We expect very strong new committed contracts for the fourth quarter.

And to go into FY'04 with a great backlog.

Incidentally, the fourth quarter is traditionally our largest quarter with new submitted contracts representing traditionally about 1/3 of annual contracts.

Automation information is experiencing solid demand more its med station and supply solutions.

Patient safety and cost containment continue to create real demand.

We continue to raise our R&D spending so the future looks great.

The long-term revenue growth guidance that we gave to this segment is over 20% and will be near that this year and in excess of that in the future.

And finally pharmaceutical distribution provider services.

PDPS, that's 50% of our operating earnings delivered a strong 3.28% return on sales and a phenomenal 39% return on committed capital.

The core distribution business was strong this quarter, with segment revenues, excluding the trading company, with segment revenues excluding the trading company up 15%.

This growth reflects strong gains from chains and mail order customers.

While those results were outstanding when compared to other companies, I was disappointed with the reported 11% in operating earnings.

The primary explanation for this slow growth, this slowdown was the lack of availability of pharmaceutical products from manufacturers which had an impact on both revenue and profit growth in the quarter.

I mentioned this same phenomenon after our call in February after experiencing reduced availability of product in our December quarter.

I said at that time that I anticipated that product availability would return to normal.

It did not happen.

Let me take a few minutes to explain how this new pattern will affect our vendor margins in the short-term, but also to demonstrate how to drive up our capital in the long-term.

So what is happening?

The change is a reaction to the so-called channel stuffing of a few pharmaceutical manufacturers and as a result of the desire by all manufacturers to have greater visibility of product in the channel, information about sales activity with provider customers, and improved productivity in their manufacturing plants.

Cardinal Health, and I suspect the rest of the industry, is working with many manufacturers to adopt a different purchase pattern to provide expanded service to meet manufacturers new objectives.

These new purchase patterns and expanded services will provide different potential vendor margins for wholesalers and allow lower commitments to inventory levels.

The impact in the short-term is we expect to have somewhat lower vendor margins but a dramatically higher return on capital as working capital requirements will decline.

And our expenses will benefit over time as we handle inventory only when we need it to support demand from our provider customers.

Also interest expenses will be lower with less capital deployed.

Gross margins will be more predictable and less seasonal.

This change affects only a portion of our overall vendor margins.

Distributors will still need to be active marketers with requisite trader skills to acquire product at the best price.

Those skill requirements won't change and are a long-time strength of Cardinal.

Now, remember a couple of things in this transition.

First manufacturers are not attempting to take margins from distributors, but they are trying to get their manufacturing capacity and marketing savvy closer to real demand.

And second, remember that manufacturers cannot efficiently achieve their objective without the distribution functions we perform.

Both providers and manufacturers choose to use our distribution channel to efficiently achieve their objective.

I don't see a viable alternative with the same rewards for them.

And the reason is very simple and basic, and that is that the distribution industry has created a propriety position with its low cost and information rich logistics structure.

The pharmaceutical distribution model serving the provider requires availability of all products from one source.

Though it is inefficient for a manufacturer to ship direct or a provider to buy direct.

Historically the distribution industry has passed along many of th efficiencies created in the channel to benefit both its trading partners, the manufacturers and provider customers, and to ensure the wholesalers permanent position in the channel.

So Cardinal Health is adjusting the distribution -- so Cardinal Health is adjusting its distribution terms with manufacturers to meet their new needs.

Note I said we are adjusting our terms.

Distribution terms between manufacturers and distributors result from a negotiation process.

They are not dictated by unilateral decrees on either side.

They are negotiated uniquely by each wholesaler and with each manufacturer.

But suffice it to say that Cardinal Health will not in the future distribute pharmaceutical manufacture lines under economic terms that are less favorable than those that exist today.

Our pricing model to our customers won't allow us to do that.

And frankly, neither will our shareholders.

I'm quite confident the changes in the industry will allow us to continue earning the same return on sales we currently enjoy but an even higher return on capital.

A couple of details about how the shortage of products specifically affected this past quarter.

First of all, with less product available overall, Cardinal Health wasn't in a position to move inventory to our trading company.

That's the wholesale to wholesale business.

During the quarter we prefer to use available inventory for our core distribution business to maintain consistently high service levels for our customers who have scrips in hand.

So sales of profits at our trading company were down considerably.

Keep in mind our trading company is not a strategic part of our business.

Importantly, as I indicated earlier, our core distribution business remains strong with segment revenues, excluding the trading company, up 15% for the quarter.

We expect for the near term to grow the core business above the growth rate for the pharmaceutical industry.

The second impact from less product availability of the quarter was lower buying margin and therefore lower profit opportunities in the core distribution business, particularly when compared with a very strong Q3 last year.

However, working capital needs were down dramatically and return on committed capital went to a phenomenal 39%.

Obviously some very good news here.

And expense management across the segment continues strong with SG&A as a percentage of sales at 1.6%, roughly comparable to the second quarter And dramatically better than prior years, and sustainable into the future.

So what can you expect in the future for PDPS?

I stand firmly by the industry segment growth rates of at least double digit.

Cardinal Health will operate a bit above that as as a result of our higher mix of sales.

I'm sorry, as a result of our mix of sales that's oriented towards a higher -- segments that have higher growth rates.

Our gross margins will reflect the impact of new IMA's with manufacturers, expenses will trend down, although at a slow pace, and our committed capital will trend down.

The formula comes together to allow us to maintain our return on sales while becoming more capital efficient, yielding a higher return on committed capital.

So I continue to be extremely enthusiastic about Cardinal Health's long-term position for continued profit growth and visibility, driven by even greater balance of earnings growth across its portfolio.

The formula for success remains unchanged, earnings growth accompanied by rising growth of sales and capital while using our improved cash flow to fund future investment.

It's a dynamic environment as always, and the puzzle pieces may shift from time to time, but the industry economics and Cardinal's competitive position in each of its cor businesses leads me to conclude over the long-term, we will continue to be one of the highest performing large cap companies.

I like our position.

I'll turn this call over to Dick, then we'll have question-and-answers afterwards.

Thanks, Bob.

This was another excellent quarter for Cardinal Health.

It was a quarter that produced high quality earnings and strong cash flows, combined with outstanding productivity and capital efficiency.

This was also the first quarter that included the financial results of our Syncor acquisition, which was completed at the beginning of the quarter.

Since Syncor was accounted for as a purchase, it had a positive impact on our growth rates increasing reported revenue growth rate by 1%.

However, since it also increased our diluted shares, it was neither accretive nor dilutive to our earnings per share.

Let me start with some comments on our consolidated performance which reflects the powerful diversity of our health care businesses combined with common themes of growth, productivity and capital efficiency.

Our financial model starts with revenue growth of 11%, which was leveraged to operating earnings growth of 16%.

Importantly, operating earnings grew faster than revenues in three of our four segments, driving return on sales to an all-time high, 4.81%.

Continued focus on operational efficiencies yielded a 4% increase in productivity during the quarter, generating an all-time high $2.07 of gross margin for every dollar of expense incurred.

Disciplined operational execution enabled us to continue leveraging the capital requirements of our businesses.

Each segment achieved third quarter or all-time record return on committed capital.

That resulted in a 650 basis point improvement in consolidated ROCC to an all-time record of 38.2%.

I think that's pretty amazing in the current economy where we're experiencing low inflation and low capital cost in the market.

The quality earnings and capital productivity continue to drive strong cash flow.

We delivered $157 million of operating cash flow during the third quarter, and that brings us to $516 million year to date.

That's nearly $1 billion better than where we were last year at this time.

Strong earnings and a reduced investment and owned inventories are the primary drivers of this performance.

We've always explained that we only invest and hold inventories when we are a able to generate a return on our investment.

As Bob explained the current environment with certain of the pharmaceutical manufacturers has reduced our opportunities to make such investments.

Additionally, the growth of generics and working capital synergies achieved from the Bindley merger have allowed us to be more efficient in managing working inventories.

Accordingly, we've reclaimed capital from the pharmaceutical distribution business and re-deployed that capital for the benefit of our shareholders, primarily by re-purchasing our stock, which in turn was used to fund the stock acquisition of Syncor.

Based on our cash flow performance to date, we remain confident in our ability to achieve our goal of generating over $1 billion in operating cash flow for the year and free cash flow of at least 60% of our net earnings.

Our focus on capital productivity continues to drive dramatic reductions in our interest cost providing significant earnings leverage.

Lower average net borrowings, coupled with slightly lower interest rates yielded a 23% reduction in overall cost versus the prior year.

This capital productivity can be further illustrated by the third quarter record low net debt to capital of just 20%, which is especially impressive in light of our share re-purchase activity and a 120 basis point increase in our return on equity to 22.7%, and that's an all-time record.

Now, let me comment on just a few matters of importance in our segments.

I think there's several important trends to highlight in the pharmaceutical distribution and provider services segment.

In the third quarter last year, inventory trading opportunities and purchasing synergies from the Bindley merger drove gross margin to 5.33%.

That was the highest level achieved over the last three years.

The decline in trading opportunities and the annualization of the Bindley synergies combined with the impact to customer mix resulted in a gross margin decline to 4.88% this quarter.

However, on a sequential basis, the gross margin rate actually improved by 45 basis points versus the second quarter of this fiscal year.

Consistent with the trend that began last quarter with the completion of th Bindley facility integrations, the expense ratio declined dramatically to a record low 1.60%, and that's due to lower facilities cost and reduced headcount driven by the integration efficiencies.

On a sequential basis, the expense ratio improved 2 basis points versus the second quarter of this fiscal year.

The direct to customer based business and pharmaceutical distribution is strong.

If we take trading activities out of both this year and last year, the current quarter for this segment would reflect revenue growth of 15% and operating earnings growth of 16%.

And pharmaceutical technologies and services I'd like to add perspective to the impact of Syncor acquisition.

Syncor had a slightly different financial formula, causing the apparent deleveraging in this segment.

Syncor's gross margin ratio is slightly lower than the rest of the segment and their expense ratio is slightly higher than the rest of the segment, causing that deleveraging impact.

However, the return on capital is better than the rest of the segment.

Excluding Syncor the segment experienced low to high income growth in the mid to high teens.

Let me just conclude my comments by saying while the financial equation may be shifting slightly in certain areas of our business, we will continue to drive the same financial disciplines you've come to expect from Cardinal.

We'll deliver quality earnings with rising returns while generating strong cash flow, driving continuous improvement and productivity, and continuing to exercise disciplined expense control and asset management.

When these are combined with our market leading positions in the healthcare market, which continues to have strong, long-term growth prospects, I'm confident in our ability to continue to deliver on our commitments and increase shareholder value.

Thank you for your attention.

I now would like to turb the call back over to Bob.

Thanks, Dick.

Let's get to Q and A. We're anxious to answer your questions.

Ladies and gentlemen, if you would like to ask a question, press star and the number one on your telephone keypad.

Star and the number one on your telephone keypad.

One moment, please, for your first question.

The first question is from Larry Marsh with Lehman Brothers.

Thanks, Bob and Dick.

Maybe a thought on inventory turnover.

You've added about one turn to inventory over the last year, it looks like.

I was curious as you think about running the business, where do you think inventory turnover can get to say in the next two years under this, you know, expanded model, and just -- I'll just have a quick follow-up on the trading busine.

Okay.

Let me talk generally about the whole inventory management process and what's going on.

This is nothing that we don't understand or aren't managing through.

Obviously we've taken a lot of capital out of -- you're speaking mostly about the pharmaceutical distribution segment.

We've taken a lot of capital out of that, and I'm going to talk a little bit later about re-deploying that capital, and how we can re-deploy it.

The distribution business is still, obviously, very vibrant and Dick covered that.

We only deploy capital where there's an opportunity to earn substantial returns.

So there's less opportunity under the new kind of arrangements we're talking about with manufacturers.

Let me put it in -- some perspective around that.

First of all, the comments I want to make around all this inventory management changes and agreements with manufacturers, I'm speaking really only for Cardinal, and that will become clear, but I'm not speaking for industry, I'm only speaking for Cardinal.

And I don't want to get into the details on any of this, for two reasons.

One, our overall strategy is particular to us.

I'm not here to help our competitors.

They are quite capable of having their own strategies, and they have different characteristics, and so these -- our overall strategy is I don't want to get into what our strategy is and how we're negotiating with the manufacturing industry overall, because we have different circumstances and different services for us.

The second thing is, I don't want to talk about any specific manufacturer arrangement or deal that we're negotiating.

One of the things that's interesting about this is that each one of these negotiations is unique.

Now, I like that a lot.

And it's unique because the manufacturers have different needs and different priorities, different requests, volumes, product lines, et cetera.

And that is really good for us.

But these -- so they are all individual.

So we have gotten some questions over the last week about some specific things going on in the market, and I want to preempt those questions by not talking about the specific manufacturers.

We have gotten a lot of questions, for example, about a new inventory management program of Bristol-Meyers that they have just recently put into place.

This aspect is all about managing the flow of inventory in the marketplace.

It would be unfair for us -- unfair to Bristol-Meyers for us to disclose to the public, or certainly its competitors, the extent of the discussions under way between Cardinal and Bristol-Meyers about this aspect of our overall trade relationship with them or our entire service or fee relationship.

It would be easy for me to tell you that the new inventory management program of Bristol-Meyers that managed inventory more closely to the channel doesn't, by itself, adequately compensate us for the value in our distribution channel.

And frankly, we've told them that.

But the good news is that we are in active, positive discussions about the breadth of our existing services, about Bristol-Meyers' specific needs, and a cooperate effort to add value to each other in the -- in a broader relationship.

That means more service to Bristol-Meyers.

That means meeting their specific needs, and more compensation to Cardinal for value delivered.

So I predict that Cardinal and Bristol-Meyers will be happy in the end, since from an historic standpoint, Bristol-Meyers has used the independent distribution channel for the last 50 to 100 years and I expect they will need to do it for the next 50 to 100 years.

I only bring up their name because we've been asked a lot about that particular new program.

We use it in terms of talking about the industry and saying each manufacturer has different needs, and we will be stocking inventory and providing services different for different manufacturers.

And I don't want to get into any individual manufacturers, but there's a couple of important learning points here.

One is that all negotiations over service offerings and fees paid are individual to different manufacturers, as they all have different needs, as I've said.

We're all very good at this, which is innovatively finding solutions to meet the needs of our customers.

Secondly, as I said in my prepared remarks, that the development of these individual agreements is just part of the ongoing process of re-defining trade terms between manufacturers and distributors.

Sometimes it means we put product into our channel, sometimes we take it out.

And this has been going on forever, and it's how much inventory we carry is just part of what we do for manufacturers.

Providing data is part of what we do for manufacturers, and that's something our manufacturing community is valuing even more, because what I've said their objective is, they want to be closer to the market and know about what is really moving and who it's moving to.

The other thing I said in my remarks is these discussions aren't unilateral and I want to hit this ball out of the park so people understand this.

I think there's a belief by some analysts that we just accept terms.

And what is important here is the distributors have influence over the breadth of the service offerings to the manufacturers, including no service, meaning we won't stock.

So we have that choice.

Consequently we have a choice and ability to influence our growth margins, influence the component of our gross margins between the manufacturers an distributors.

So we don't just receive terms from manufacturers.

So we have a valuable, irreplaceable, logistical tool for hiring in the marketplace.

None of that has changed.

But what changes is, you know, what are some of the needs of the marketplace.

The new model that's developing is the manufacturers, as we said, wan mor data, want to be closer to the marketplace, closer to what's selling and also want to create more efficiency in their manufacturing plant.

We're quite happy to accommodate them for that.

I like our position.

We sell a distribution tool to the marketplace.

We won't sell it at a price below the price that gives us an adequate return, but it's going to be dirt.

So for example, if we take capital out of this segment, we will re-deploy that capital someplace else.

Getting to your point, Larry, about terms.

I don't think we'll take substantially more capital out than what we currently have taken out.

In other words, I wouldn't expect our terms to go up in this segment dramatically higher, maybe a little bit more.

So we've already taken a good piece out of it.

Some of it actually came out of our trading business.

The third learning is that our job is to manage the three components of the distribution channel, that is the margin component for manufacturers and the margin component from the provider.

And finally our operating expenses in between.

These three of totally linked to each other in the supply channel.

And we've proven over the last 20 years we've been able to manage the relationship.

Here is what's happening in the channel.

Manufacturers want a different service, we have to -- I mean, they want some of the same services we provide, they want some different services and they want it delivered in a different way.

We will individually negotiate those services because they are unique to eac manufacturer.

We will end up getting compensated, including the use of our capital in the equivalent way we've gotten compensated in the past, because, frankly, if we didn't, we'd have to talk about how we would raise prices to the provider downstream, and that's not an objective.

So we'll probably have a little less capital in this business, our returns on capital will go up.

I like some of the directions I've seen here and Cardinal will have an opportunity to re-deploy some of that additional capital.

What we calculate is, because I know this will be on everybody's mind, and I realize this is a very long answer to your question -- but what we calculate is that after considering the additional margin that we're receiving from manufacturer for the services that we're providing, additional services, that the capital we're pulling out of this business, we need to re-deploy at slightly more than 8% pre-tax.

I'm quite confident that in my career I'm able -- I'm quite confident I'm able to do that and look back in my career and realize 8% return on capital is very low.

We'll be able to re-deploy that capital, but the formula is going to be a little bit difference.

Larry, you had a second question about our trading business.

Following up with that, the reduction in trading volume, would you define that to be market related, or is this a change in strategy, specifically pulling capital out of they?

I think it ties to the same phenomenon.

Let me just ask Jim to address the issue on the trading company.

Larry, really it's a change as the market conditions, as Bob alluded to, we put capital and inventory, if you can envision, in two pools.

One we buy inventory for our distribution business, which obviously we will take all that we can put there.

We get excess inventories, we then move those through the trading company as their price advantage, we share some of that product and some of that profit to another wholesaler.

Obviously with the skinnying down of inventories in the channel by the manufacturers, there is really little product available to handle the trading function.

As a result, our volumes are affected by it.

If you compare this quarter, March 30th, to last year, last year was before there was any issues of channel stuffing by any manufacturer.

Now we're in the first quarter where that's really taken root and the IMA's are in place.

So more a condition of the market.

Just a reconciliation, the 5% difference this quarter versus 2% top line last quarter.

Is that somewhat mitigated because of some new businesses coming in this quart?

Are you asking about the new business for the quarter, Larry?

In other words 15% X trading, 10% with.

Last quarter you said the difference would be 200 basis points between X trading and with trading.

I want to make sure I understand the difference and I'll get off the call.

The question is how much did the decline in the trading business affect our top line growth last quarter?

Versus this quarter.

I think you made some comment about last quarter.

We don't know the answer to that one right now.

We'll get back to you.

Is there another question?

Your next question is from Robert Willoughby with Banc of America.

Good morning.

Should we expect a new share repurchase authorization or are we waiting for another acquisition before we see anything on that front?

Well, we buy stock back because we perceive that -- two things, one it's a great value.

And secondly, that we have excess capital.

And so I think you watch closely if we don't buy stock back when we certainly are sitting here with excess capital.

I think you should make an assumption that we intend to deploy that capital in other external -- in acquisitions.

If you really look at what we did, we weren't going to tell you that last year, but we contemplated we would complete the Syncor acquisition, so essentially we were pre-funding making an acquisition for cash, by buying our stock back well before we did the Syncor acquisition.

So, you know, I think , we want to be careful around the rating agencies and stuff.

I think we've got a lot of elbow room if we want to start buying stock back now.

The board hasn't made a decision on whether we will do that now.

But frankly, you know, depending upon their stock price, we have plenty of capital, that's for sure.

But you should expect that we intend to deploy capital with acquisitions, because I think our management team is a good space, we've got management capital, and we've got financial capital.

So that's about the best way I can answer the question for you.

That's great.

Thank you.

Other questions?

Yes.

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

Just a quick follow up to what you said earlier.

You said in your comments that the overall market, you continued to be confident with the double digit growth rate in the market.

I guess embedded in that statement you're assuming none of the weakness or lower than expected revenue growth that we saw today was a function of some softening or weakness in the market.

You know we've all been obviously focused on some of the recent trends reported by some of the data companies.

You said yourself you're providing data.

Have you soon any change recently in the underlying market growth at all?

Glen, the top line growth of our core business-- let's define this in distribution of having a core and non-core business.

Our trading company is wholesale to wholesale business.

Obviously we're pleased to sell.

We only put things into our trading company if it was excess inventory that we couldn't use ourself.

We're not here to help, particularly -- we're pleased to sell to competitors, but we want to help ourself first.

And they realize that.

If we don't have excess inventory we're not going to put it in the trading company.

So we go to our core business, which is to take care of the provider who has the prescription in hand.

That business grew 15%.

An it will pick up as we move into the fourth quarter.

It will be at a rate higher than that.

We have good, solid demand.

So that business is very healthy.

What we've seen in the market is there's some -- first of all, we cannot reconcile our growth rate.

I suspect the growth rates we'll hear from the other two major competitors, we can't reconcile those three data points or the things we saw from Pfizer or Lilly or anybody, what the data providers talk about in terms of growth.

So I can't reconcile it.

Have we seen a slowdown?

We read that there's a little slower prescription growth in same-store growth in some of the chains.

Frankly our sales are pretty healthy.

If there's a slowdown, it's one or two points.

It's not a major perceivable slowdown.

You've got factors like a weak flu season.

We just don't know how to factor that out right now.

We're not seeing a weakness that's really worth talking about.

Okay.

Thanks for the comment.

Your next question is from Ray Falci with Bear Stearns.

Good morning.

Bob, on one of your prepared comments about the economic model as its evolving in TDPS.

You basically summed it up with a comment that we will not do business that doesn't sort of meet our economic goals or words to that effect.

I guess my question is to the extent you have two sides to the economic equation, buy side and sell side, how do you manage the possibility of sort of a timing disconnect there, where there are trends going on on your buy side of the world that may not have been contemplated in prior sell side contracts which still may have a couple of years left on them.

How do you manage that just from a timing standpoint.

Well, that's a good question.

First of all, I said there's three pieces to the puzzle here, which is managing th margin from the manufacturer, managing the margin from the customer, and then managing our expenses.

We first start with the margins from the manufacturer, then we know where we can get expenses and that's how we price to our customer.

And that's, you know, just simple logic.

That's the way it works.

It follows the flow of product through the channel.

And that's the way it's been forever.

And so for the last, as long as I've been in the business, we run a calculation say how efficient can we be with this new business and where is the cost going and what's our margin coming in from the manufacturer?

So our customers know that we pass onto them the efficiencies that we achieve.

And if you would call it excess margins from manufacturer, we pass some of that on.

So they are very knowledgeable, they know that, they are well schooled in that.

If there was some radical change in margin coming from the manufacturer, we probably couldn't change quick enough the pricing to our customers so we'd have to eat it for a couple of quarters.

But your question almost implies that there's a radical change in manufacture pricing here.

What it really is is this is something that's evolving, it's no different than things we've dealt with in the past, with things like we had to figure out how to properly account -- price for the whole hospital business around chargebacks and things like that it's just an evolving thing and we'll manage through this.

So one of the things you have to realize is as we change this model, we get paid back immediately from manufacturers as we take capital out and re-deploy it.

We have low interest cost and we re-deploy it.

I don't see a big timing miss match.

Because A, it's not that radical.

B, we get immediate payback by new terms with manufacturers to begin with,.

And we have lower capital immediately.

If we weren't able to deploy capital, I suppose that would be a problem to us, but I don't think that's not going to be the problem for us.

If there was -- if inflation went away, it would be reflected, the change in our pricing patterns to customers.

Frankly, I would say they fully, fully understand that piece of it.

Obviously we have to manage, manage the three pieces of the puzzle.

I think the good news for Cardinal, while I've said this is not a radical thing, I've probably spent a lot of time, because the thing we get the most questions about is this whole IMA, what does it mean, manufacturers, some people implied we're at war with the manufacturers or fights or stuff like this.

For example, I used Bristol-Meyers as an example.

We've got a great relationship with them, long-term partnership relationship, we're not at any war.

How do we meet their new needs and create value for each other.

So this is an evolving thing.

But the great news for Cardinal is, even if there is some short-term implications to it, we've got a lot of diversity of earnings, things that have short-term positive indications in other segments.

That's how I would respond.

A quick follow up to Dick.

You said Syncor was a nuclear pharmacy business with high teens revenue growth, and I guess 20 or better operating income.

My question is have you gotten any synergies, yet, out of combining that with your existing business or should we assume you've gotten no benefit.

The merger only happened in the first -- we obviously planned for all that.

They have only been together meeting in the same room now for the last 90 days, so we're on the front end of trying to achieve those synergies.

And the only reason we even gave you these subsegment growth rates is, , you know, just to give you an indication that as this approximately $1 billion cost acquisition comes into Cardinal, it's doing fine.

It is a segment that's got a lot of really solid growth to it, and the financial formula works out fine.

We're just on the front end of the synergies.

I think we talked a bit about there are a lot of consolidation opportunities there.

George, anything you want to talk about regarding Syncor?

I think the focus has been on the international business and their imaging business.

And as we said, we were looking to dispose of those assets, which is proceeding well and the main focus.

The synergies component will materialize more in our first half of fiscal year -- in fiscal year 2004.

Okay.

Any other questions.

Your next question is from John Kreger with William Blair.

Thanks, Bob, would you update us on experience with generics, profitability, also talk about the unit volume trends you're seeing in generic versus brands.

And if that differs at all versus your different customer class?

I'm going to let Jim address it.

The environment is really healthy.

We kind of give an overview that, you know, the -- there's a lot of, I guess, seems like mystique around generics.

It's not that complicated.

It's a higher return business for us.

It's growing faster, it's got a lower cost structure.

What is there not to like about that business.

Jim, why don't you just address kind of an overview of the generic business.

Let me begin with it remains our most profitable highest return component of our business.

It is attractive to us.

Its outlook is very bright.

First you asked about the generic volumes, I guess it's a question about pill versus pill, when a brand goes to generic.

That Is what you're referring ?

I'm really trying to get at your capture rates.

When a brand goes generic are you capturing and keeping some of that volume or to some degree is more of that going direct to your customers and going around you.

There was a recent publication or study that was done by one of the qualified people and it kind of implied that.

Yes, to a certain degree there is a little bit of a leak when you have a warehousing chain that may have relied heavily on the distributor for the branded product, then when it goes generic, takes it into the warehouse, where they didn't warehouse the brand before, there's a little bit of a leak there.

But really it depends on the customer type.

Obviously there's a leak when a brand goes past generic, like Claritin, goes right over the counter.

That was a bit of a loss.

Some of the conclusions that are broadly made about the generic mix of business, not a whole lot different than they have been over the past decade, , you know.

That whole issue of leak and warehousing chains and the mail order business has been around for years and years.

So it was really nothing new in that conclusion.

Our mix was about,our mix by customer type, varies as much as customer type.

Because generics in hospitals are entirely different than generics in retail.

So it's hard to draw conclusions there.

There's just a lot of things.

I guess my bottom line would be that the generic market situation really hasn't changed that dramatically other than there have been a lot of branded products that have come off patent recently and has allowed for our mix of business to expand.

Now you'll get a little bit crazy if you start looking at it as a percentage of total drugs, because keep in mind the first six months of the brand -- the branded product loses its patent, the generic product is sold at nearly the branded price.

If you have a lot of big products like Prozac and Prilosec, some of the major products that came off patent, they are called generic but they are sold at a branded price level because the price erosion hasn't hit.

There's a lot of distortion in these numbers, you know.

Hard to give any more detail.

Let me just summarize, you know, I suppose there's some leak, but it's pretty small.

And it's been going on for a long period of time.

The economics of the business in generics is terrific.

Another question.

Your next question is from Tom Deluchi with Merrill Lynch.

Good morning, thank you.

In terms of the trading operations, just trying to get a sense of where we are in the evolution of what's going on there, ie., is there significant potential for further deterioration, versus like the 5% hit that you point to this quarter?

So maybe if you can give us a little more color there, that will be helpful.

Let me just make this one simple.

No.

There was such little product available in the market in the quarter, we just basically absorbed it totally internally, so there was literally very little trading business, which obviously takes away profit, so you can look at that standpoint, but took away sale of trading -- the sale of product to other wholesalers.

So it's so miniscule in the quarter that, you know, there's no deterioration left.

Okay.

If I could ask one other follow-up.

Hold on.

Jim wants to say something.

What you're experiencing now, the trading company, we've lost about 3/4 of th volume in the quarter.

That's impact prior year.

It's going to have a bit of a wind-down period, but you're not going to see it as dramatically affected as Bob alluded to in the subsequent quarters.

Okay.

That's perfect.

In terms of one other thing we've been talking about a lot on this call so far is the re-deployment of the capital as you obviously use less capital in the core business.

You've kind of alluded to the fact that isn't a problem in your mind.

Can you give us maybe some more color on the types of things we should expect, is it filling in existing businesses, getting a new leg to the business, maybe just a little more color there.

I probably could have been a little more clear on that.

I said in my prepared remarks that -- let me start for a couple of things I said medical surgical product area had great momentum and was preparing itself, was in good shape, whatever my words were, to do more external development.

So we would expect to put capital behind that segment.

And if Ron is listening, which are I'm sure he is, he knows about this, and he's actively working, as we are, on those kinds of opportunities.

So that is an area we're looking at further capital going into the PTS area.

And George knows that.

And we're also looking at other services that may not -- that are very closely related to what we do to our same customers.

And I don't want to get into what those are, but nobody would be surprised if we did them.

We have plenty of opportunities.

It's an extremely fragmented healthcare business.

We do a good job of tying businesses together going to customers, and so the re-deployment of this capital, which we're really talking about probably would be -- if we pulled a billion dollars out, it's not really that big a deal.

Your next question is from Lisa Gill with J. P. Morgan.

Bob, can you give us your thoughts around specialty pharmacy and any opportunities there for Cardinal Health.

And secondly maybe if Dick could talk about SG&A as a percentage of revenue.

Are we continuing to see any of the synergies from the Bindley acquisition or what's the expectation going forward as far as the costs go on the pharmaceutical distribution component.

Thanks.

Let me just take the first one.

Specialty pharmacy.

Let me differentiate.

We have specialty pharmaceutical distribution businesses, meaning we're shipping to specialty pharmacies as differs from owning specialty pharmacies.

You could describe Syncor as a specialty pharmacy.

Here is where we draw the line.

It's been made clear to us by certain customers that they are in some specialty pharmacies that they consider their territory.

We're not going to compete with customers.

So don't expect us to go into some specialty pharmacy areas that you might interpret would compete with some of our existing customers.

You say what about Syncor.

Syncor doesn't compete with any existing customer.

There's nobody in that segment of the business.

It's a fit in many areas.

I don't see us going into specialty -- we will not, let me be clear, we will not go into specialty pharmacy areas that compete with our customer.

With regard to SG&A, Dick, do you want to answer that.

You tied it in with the Bindley integration, that's the way to look at it.

The way these integrations work, they don't all get completed in a quarter's period of time.

They happen over time.

You know, really, the integration of the operations with Bindley was completed last quarter as we really integrated the last few facilities.

So our facilities cost, our head count has come down over time.

Last quarter our expense ratio was 162, this quarter at 160.

You know, we expect to see that rate sustained and continue to come down over time, not as quickly as it came down as we were going through the integration process.

But I think that's been the big driver.

Any comments from you?

Any other questions.

Yes, your next question is from Michael Fitzgibbons with Morgan Stanley.

In terms of the trading business slowdown and the timing of that.

If you're not expecting the same kind of impact as you saw this quarter, Jim, as you mentioned, that implies you actually started to see that slowdown in the June quarter of last year.

Is that right?

You're sort of anniversarying that impact.

And if that's the case, if there's still some of that impact to come, are you still comfortable with the mid teens revenue growth expectation for next quarter, or are we still, if it's underlying 15% are you not going to get there.

By the same token are you still comfortable with the fiscal '04 earnings outlook that you laid out in February, you reiterated your long-term expectations.

I'm curious if the '04 expectations are still the same.

We're comfortable with the guidance we've given in February.

The question about slowdown of trading company, we saw a slowdown of this beginning certainly in our June quarter a year ago.

So the revenue growth indicators we've just given you for Q4, which talks about mid teens for our pharmaceutical distribution segment includes the consideration of a slowdown in trading.

So therefore by definition, you would have to assume that our nontrading business we expect to grow above that.

So that means we're expecting strong growth in our April quarter, with what I call our core distribution business, nontrading, stronger than frankly I believe you think it's going to be.

And that's what we're seeing in April, and so we feel good about that.

One more question, then we'll kind of wrap up here.

Your next question is from Kip Hewitt with Legg Mason.

Let me just understand a little more on this.

You've said, in effect, this is diminished as a part of your business.

Is that -- something to the affect that maybe 3/4 of this volume has gone away.

But I didn't understand that it was going to be coming back.

In other words, has the trading business diminished as a source of your earnings and revenue growth, and is that going to -- are we simply re-basing it at another level, or is that largely disappearing and we're moving to different sources of your -- drivers of your revenue, then are we in an interim period until those new investments take hold.

Why don't you look at it as we had capital in the trading business that wasn't a strategic part of that business and we make money in every place we put it.

There wasn't anything we could buy, there's no inventory, and so obviously we didn't -- you could look at it as we withdraw capital.

We re-deployed that capital into something else, which is what we've done and will continue to do.

So just a business that wasn't strategic to us.

Will it come back.

Trading activities ebb and flow.

There won't be -- trading isn't related to prescription demand, trading is really related to did we have more inventory than we needed for our primary customers, which are the providers, who hold prescriptions in their hands.

Did we have more inventory than we needed, so we would then sell that off to other wholesalers, which some of them do the same thing.

And so we don't have access to inventory, so that's not a place for us -- that's not a business for us to be in.

But I've seen this for 15 years grow and shrink and grow and shrink.

For those that have been around long enough, we talked about ten years ago about this.

This trading business was visible, it was part of Bindley that we acquired, very visible how much it was that they made it clear.

I wouldn't view this as anything strategic, other than to stay -- I wouldn't view it as strategic, period.

I would then say that what it is, you said, this was a place where you could put half a billion dollars and earn a good return, now you've got to find another place to put the half a billion dollars so it doesn't affect your strategic position at all.

That's the way I would characterize it.

Okay.

Let me wrap up.

This was a long call.

Some of the Q and A was long because I took so much time to explain to you the inventory management changes, because we want to make sure you understand pulling capital out and why and our relationship with the manufacturer and why it's positive, and how that helps us with the return.

Going to a 39% return in a business, starting to talk about that being sustainable is pretty phenomenal.

So this is a terrific business.

We've got a lot of good things going on.

We have challenges all the time.

As you would you try and grow a business this size with the rate we expect to grow returns.

Challenges are consistent with the challenges we had in the past in terms of the degree of difficulty.

We're quite confident, when I said that we're on track to perform like we said we would perform for the final quarter of this year and with the kind momentum we need going into '04.

We took a lot of time to try and make sure people understand how things ar developing.

I appreciate people's attention on this, and we'll look forward to reporting your year end results in July.

Thank you very much.

Thank you, ladies and gentlemen for your participation.

This concludes today's Cardinal Health Third Quarter Earnings Conference Call.

You may now disconnect.