卡地納健康 (CAH) 2003 Q4 法說會逐字稿

Please stand by.

The Cardinal teleconference will begin shortly.

Good morning.

My name is Matthew and I will be the conference facilitator today.

At this time I would like to welcome everyone to the Cardinal Health fiscal 2003 year end earnings results conference call.

All lines have been place on mute to prevent background noise.

After the speaker's remarks there will be a question and answer period.

If you would like to ask a question, press star and the number one on your key pad.

If you would like to withdraw, press the pound key.

Thank you.

I would like to turn over to Mr. Stephen Fischbach, Vice President Investor Relations.

Sir, you may begin.

Thank you.

Good morning and welcome.

Today we will discuss Cardinal Health's fiscal 2004 fourth quarter and full fiscal year results, I'm sorry, 2003.

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

If you have not received a copy, you may access it over the internet at our investor page at www.cardinal.com.

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

After the formal remarks, we will open the phone lines for your conversations and we always ask that you limit yourself to one question at a time.

Before we begin, please remember that today's call may include forward-looking statements which are subject to risk and uncertainties which could cause actually results to differ materially from those projected on slide.

The most significant of those uncertainties are described in Cardinal form 10-K and form 10-Q reports and exhibits to those reports.

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

In addition, statements made on the call may include adjusted financial measures governed by Regulation G. For a reconciliation of these measures please visit the investor relations page at www.cardinal.com.

At this time I will turn over to Dick Miller for discussion of the Financials, and then Bob will provide his comments on the quarter and outlook for fiscal 2004.

Dick?

Thanks, Steve.

Good morning.

As expected, Cardinal Health's 4th quarter financial results capped off the year that delivered on the financial commitment that we made to our shareholders at the beginning of the year.

Strong revenue growth across all of our business segments drove continued expansion and operating earnings.

Our focus on productivity and leveraging the capital requirements of our businesses yielded record levels of cash flow and returns on committed capital and equity.

The powerful diversity of our portfolio, Complimentary Healthcare Businesses, clearly demonstrated their composite value 4th quarter's financial results.

All in all, it was a great quarter to top off a great fiscal year.

You've received the detailed financial information distributed with the press release, so let me start with some overall comments on our consolidated performance and I'll add a few highlights from each of the business segments.

Let's first look at our consolidated financial model for the 4th quarter. 15 percent revenue growth drove return on sales to 4.62 percent, and that's a new growth quarter record, with solid contributions delivered from all of our segments.

Our disciplined operational and financial execution, combined with capital productivity to generate record returns on committed capital in each of our four segments with consolidated returns on committed capital reaching an all-time record of 38.4 percent during the quarter.

As we have been discussing throughout the year, the combination of strong earnings and capital efficiency continue to generate significant operating cash flow during the 4th quarter, bringing us to $1.4 billion for the full fiscal year.

As part of our ongoing program to redeploy low return capital, we sold another $156 million of - leases this quarter, bringing our total leases sales for the year to $356 million.

The net impact of our lease sale program on fiscal 2004 cash flow was to increase operating cash flow by about $300 million.

Therefore, for the fiscal year, we generated approximately $1.1 billion of operating cash flow exclusive of the - lease sales.

And that exceeds our guidance of $900 million to $1 billion dollars for the year.

Importantly, that $1.1 billion represents 78 percent of our net earnings for the year.

This is a strong testament to the quality of our earnings.

Our focus on capital productivity continued to drive dramatic reductions in interest costs, providing earnings leverage during the quarter.

Strong cash flow led to lower average net borrowing, which coupled with lower interest rates to yielding 11 percent reduction in overall cost versus the prior year.

This capital productivity can be further illustrated by the 4th quarter record, low net debt to total capital of just 11 percent, which is particularly impressive in light of our share repurchase activity throughout the fiscal year.

This gives us significant capacity and flexibility as we consider future investments and initiatives.

Despite being at record low net debt levels, we continue to deliver strong returns on equity, and in the 4th quarter at a healthy 21.5 percent and the fiscal year at 21.1 percent, which is a 60 basis point improvement from the prior fiscal year.

We ended fiscal 2003 with a record $1.7 billion in cash on our balance sheet.

This cash position was created from the combination of our strong cash flow for the year and the fact that we elected to opportunistically issue $500 million of medium term debt in the 4th quarter.

Obviously, we didn't need the $500 million immediately, but felt it was prudent to take advantage of very favorable market conditions.

While this debt carries an already low four percent coupon, our decision to swap back to even lower short-term rates will allow us to retain this opportunistic capital with an insignificant carrying cost until it is deployed.

Now, let me comment on just a few matters of importance in our various operating segments, beginning with the Pharmaceutical Distribution and Provider Services segment.

Strong revenue growth of 14 percent was driven by 42 percent growth from alternate site customers and 11 percent growth from chain customers during the 4th quarter.

Incremental revenue from previously announced new customer wins had a positive impact during the quarter and served to offset the expected dampening effect of a slow down in our wholesaler-to-wholesaler trading revenues, which had a one percent negative impact on our overall revenue growth rate.

A - charge of $ 5.7 million was recorded during the 4th quarter, versus a $2.3 million credit recorded in the prior year period.

The current year's charge primarily resulted from some unusual price activity experienced in generic inventories this fiscal year.

Excluding the impact, operating earnings to the Pharmaceutical Distribution and Provider Services segment could have grown 14 percent during the 4th quarter, and 15 percent for the full fiscal year.

As you may recall, the financial results for the 4th quarter in the prior fiscal year included charges totaling about $28 million which was primarily for inventory - related to the Binly Distribution facilities integration.

These charges reduced gross margin and operating earnings ratios by 29 basis points in the prior year and did not recur in the current year.

A very strong vendor margin environment effectively offset the impact of that Binly inventory write-off in the prior year.

In an effort to better manage products in the supply chain, some vendors have discontinued certain of the programs that were proving to be particularly lucrative last year at this time.

This obviously creates a short-term margin issue that is apparent in the current quarter results and which will continue into the first half of fiscal 2004 until we anniversary the point where these programs were phased out.

I will move on to Medical Products and Services, which had an outstanding results with strong top line growth of seven percent, which was leveraged to operating earnings growth at ten percent during the 4th quarter.

Importantly, new products succeeded our goal of delivering over $100 million in revenue throughout the fiscal year, and were a strong contributor to the incremental growth in the 4th quarter.

In addition growth and distribution remains strong, which bodes well for the future, as it provides opportunities for additional sales of our higher margin, self manufactured products.

Finally, this segment's expense ratio trend in operating earnings growth rate were negatively impacted in the 4th quarter by a mismatch in the recording of incentive compensation accruals.

Current year performance relative to internally established targets was significantly better this year than it was in the 4th quarter last year, leading to a larger accrual of incentive compensation this year versus last.

If this mismatch were factored out, operating earnings for this segment would have grown at a substantially faster rate.

As I turn to Pharmaceutical Technologies and Services, it bears repeating the financial results include the year over year impact of the acquisition Sincore International acquired on January 1, 2003.

Excluding the Sincore acquisition, the segment delivered an outstanding financial performance during the quarter, with revenues growing in the high teens and operating earnings growth in excess of 20 percent.

It is important to remember that the inclusion of Sincore has an apparent deleveraging impact on the segment as the Nuclear Pharmacy business models' gross margins are slightly lower and the expense ratios are slightly higher than the rest of the segment components.

The Sincore integration is proceeding very well and the Nuclear Pharmacy business is delivering outstanding results with earnings growth exceeding 20 percent.

The growth in the other components of the segment is well-balanced among our various proprietary products and services with Oral Technologies leading the way.

Particularly strong revenue gains were delivered during the 4th quarter from our manufacturing services for -- and [lillies], [diprecticitis] and [mileis amnesteen].

Last but not least, let me discuss the Automation Information Services segment.

This segment continued its tradition of ending the fiscal year with strong momentum, delivering a all-time record performance with 19 percent revenue growth and 21 percent operating earnings growth for the quarter.

Importantly, robust demand across the entire product offering increased the backlog of committed contracts awaiting installation to an all-time high $233 million.

So in the quarter when we set our all-time record for product installation, we also achieved the largest increase in our backlog ever, adding $31 million to the backlog during the quarter.

This performance is a clear indicator of the strong market demand for our proprietary products while also providing excellent visibility into future expectations.

Let me conclude my comments by providing some further detail on our special items for the 4th quarter.

We incurred $25 million of merger-related charges primarily relating to the continued integration activities of recently acquired businesses.

In addition, we recorded approximately $24 million of other special charges during the quarter which related primarily to the execution of restructuring and rationalization plans in two of our segments.

In the Pharmaceutical Technologies and Services segment, we rationalize capacity in our packaging services and Health and Nutritional Product categories in order to improve future productivity.

In the Medical Products and Services segment, we realigned a number of our self manufacturing product lines, including our custom Sterile Operation, in order to better utilize the capacity to meet the growing demand in this segment.

Thank you for your attention and I now would like to turn the call over to Bob for his comments.

Good morning.

Our solid 4th quarter performance capped another strong year for our company.

The financial results for the year were outstanding and we did deliver on the commitments.

Once again, a management team at Cardinal Health demonstrated they can effectively execute for its customers and shareholders in dynamic times.

On August 12 in New York City, we will be hosting a luncheon to go into the details of our strategy and performance of our last fiscal year and the drivers for fiscal 2004.

I think it's important to spend time today on 2003 and how we see fiscal 2004 shaping up.

In our analyst meeting last August, we forecasted 14 to 17 percent revenue growth and a 20 to 22 percent earnings per share growth for Cardinal Health, and our performance was right on target.

We achieved those results while continuing to invest in the future of the business.

We increased our investment spending by over 20 percent in fiscal 2003 as we continue to build our breath of manufacturing services in Pharmaceutical Technologies and invest in new products in Automation and Medical Surgical businesses.

Now, for some of the highlights from the 4th quarter in fiscal 2003, from my perspective, strong revenue growth across the company, and each segment delivers at or above our expectations.

Strong gross margins in each of our manufacturing businesses, in Medical Surgical, Pharmaceutical Technologies, and Automation.

These strong gross margins were due to favorable pricing for value delivered and to improve manufacturing efficiencies and higher capacity utilization.

Expense productivity was just great everywhere, bar none, reflecting none only management discipline but also continued investment in technology that are driving lower distribution in manufacturing cost.

Additional highlights are a very strong cash flow and substantially higher return on capital throughout the corporation.

With our high return on capital and strong cash flow, we ended the year with the lowest net debt to capital ratio with have $1.7 billion in real cash on the balance sheet at year-end.

The final highlight is a continued demonstration of our ability to invest our available capital.

We invested about $1.5 billion during the year in R&D, investment spending, capital expenditures and acquisitions.

And these investments ensure our strategic position and our growth in the future.

We added capabilities and businesses that were right in line with our strategy of focusing on health care, of investing in scale of broadening the offering to customers, and continue to move the mix of our operating earning towards higher margins for products and services.

The largest investment for the year was the $900 million acquisition of Sincore International which made us the leader in the fast-growing Nuclear Pharmacy business.

This investment met all the strategic objectives and is meeting the performance goals established at the time of the acquisition.

While Sincore was were neither creative or dilutive to our earnings per share in fiscal 2003, you can bet on it contributing to earnings growth in the future in a meaningful contributor to the strategic relationships we enjoy with our customers.

Strategically and operationally, we made a lot of progress in fiscal 2003 that will set us up for growth in 2004 and beyond.

Let me describe some of that progress in each segment.

In our Pharmaceutical Distribution business we substantially improved our productivity with the dramatic reduction in expense ratio.

The final Binly facilities were consolidated in the Cardinal Centers and the last major expansion or retrofitting of our distribution operations was completed.

Revenue growth was strong with some important new relationships being established that provides us more from a supplier that moves us more from a supplier of products to a solutions provider.

The business earned over $1.2 billion with a dramatic improvement in return on capital in extremely strong cash flow.

Now, the Medical Products area.

Medical Products management team made a number of important gains in fiscal '03.

First, was to build sales momentum.

They accomplished that through improved penetration in distribution and a current self- manufactured products.

And by the very successful launch of new self- manufactured products that are both proprietary and higher margin.

These new products come from our past investments in R&D.

For example, the new esteemed surgeon's glove helped drive growth in the surgeon's glove business by over 20 percent.

We are quite optimistic about the - lines, two exciting new offerings in the - business.

More about medical products.

Their growth margins were strong because of the success and self-manufacturing product sales, because of significant gains in manufacturing efficiencies, and because of increased out sourcing of products manufacturing to more cost-efficient geographies.

Obviously, the outsourcing has helped our tax rates.

Medical products focused on expense reduction through facility rationalization and use of technology.

And finally, the team managed assets more aggressively achieving a substantial increase in return on capital and strong cash flow.

So recapping for '03 for Medical Products, they played the entire business equation well.

From revenue through margin expense and finally, assets.

They are even better prepared for '04.

Pharmaceutical Technologies and Services is a great business and the investments that we've made in this area are paying off.

Last year at this time, I forecast that this would be our fastest growing business in FY '03.

It was, but that included an acquisition.

Without Sincore, its operating earnings growth rate was in the high teens for the year, but accelerated to over 20 percent in Q4 and should be even faster growth in FY '04.

PTS revenues in the future looks strong coming from a number of different sources.

First, the strong core growth in current products using our technologies like ZYPREXA - -- we are also experiencing new demand for our manufacturing and packaging capacity for other products already in the market, particularly in the sterile area.

Additionally, there a number of large products in the pipeline awaiting FDA approval that we expect to launch in FY '04 and beyond.

In addition to the manufacturing demand, the opening of our Technologies and Service Center in New Jersey is adding to our pipeline of future business.

Customer interest in the Technology Center has accelerated throughout the second half of this past year and is leading to a market increase in deal flow.

We are also adding capacity in PTS to handle this increased demand.

In the UK, we are in the process of adding capacity to our facility.

In the 4th quarter we expanded our sterile capacity in Albuquerque and are quickly filling that expanded capacity with several products that are already approved.

Our Raleigh, North Carolina facility will be validated in FY '04, bringing additional capacity online.

We added to our capability and capacity in Puerto Rico.

We would not be adding all of this capacity if the demand for offerings was not there.

So in PTS, demand is there, and along with it, strong margins.

We have invested well in capacity and capability, and we are becoming more effective at integrating our offering.

Finally, Automations business had another big year with our expanded product line, continued investment in new product innovations, the customers need for cost and labor savings, in the focus on patient safety, the demand for PIXUS offering has never been stronger.

And so far, I am just referring to PIXUS' traditional product line.

In FY '03, we took PIXUS to the patient at bed side with Patient Station.

It is logical, innovative, and at the right time for the market.

So the market potential for PIXUS just grew dramatically.

What's really interesting is that Patient Station is creating a new market, something that PIXUS has repeatedly done over the last 15 years.

PIXUS grew revenues 19 percent, expanded its already healthy operating margin, raised its return on capital, and added sizably to its backlog.

Profits were up 27 percent for the year.

Our lease renewal rate stayed at 98 percent, a strong indication of customer satisfaction and demand for additional product solutions.

The customer is seeing the benefit of expanding PIXUS system-wide with its Med Station and Supply Station offerings.

And Patient Station is off to a strong start.

For example, a recent order from a large health system includes well over 1,000 Patient Station units, one for each one of its beds.

We have continued to funnel R&D investments into PIXUS, a business that’s proven it can innovate.

So the quarter in year, yet again demonstrates how the breadth and diversity of our portfolio of businesses provides unique value and diversity to our customers and consequently, to our shareholders.

I would like to say we are a mutual fund of healthcare products and services with a growing proprietary nature.

The solutions that we offer manufacturers and providers can't be matched in the market place.

And both sets of customers are increasingly relying on the scale and breadth of services that Cardinal Health offers.

The pharmaceutical manufacturers, the quality and scale of our manufacturing is critically important, providing quality processes that are equal to or greater than our customer's standards in making the best use of capacity in the industry, our manufacturing customers get high quality at a lower cost than they could get in their own operations.

Healthcare providers came to rely on the breadth of the solutions that we provide.

Notice I said solutions, not just products.

Solutions are formed around customer needs.

Let me conclude today's call by talking about the future of Cardinal.

Our future will be built on the same fundamentals that have driven our growth for the past 20 years as a public company.

Those fundamentals are; first, focus on the fast-growing healthcare industry, second, building scale to achieve leadership positions of number one, number two, and everything that we do.

Third, focus on improving the proprietary nature of what we do and finally, continue to build the breadth of our offering for customers.

That basic business model is how we've operated in the past and how we will build our business in fiscal 2004 and beyond.

While the strategic direction and financial models for Cardinal will be similar in 2004, as in the past, the guidance we are giving you in 2004 for EPS is less than the past for two reasons only.

First, we have concluded that it's prudent to be more cautious about vendor margins in this environment, particularly in the first half of '04, and particularly when compared to a strong vendor margin environment in '02 and '03.

And second, we are choosing to give ourselves more flexibility on the timing of the deployment of our excess capital so we can continue to be strategic -.

And consequently, we are not planning on any benefit for this deployment, either of stock buy back or acquisition.

Not withstanding the fact that we have a lot of opportunities on the horizon.

We recognize that we are not operating at the optimal capital structure with such low debt.

It is my job to move us strategically towards a more optimal capital structure.

Now, let me be specific on what these words on guidance mean for '04 and beyond.

First, we are giving you our long-term growth rate when we say mid-teens or better.

We see mid-teens, those two words, as our base minimum annual commitment much as our 20 percent meant in the 20 percent or better guidance that we gave previously.

And the "or better" words means that we have a lot of range above that minimum base which we expect to reach for.

Much as we have in the past, when we said 20 percent or better, and delivered over 25 percent for ten years, and 21 percent over the last three years.

Given you our minimum commitment at mid-teens allows us the flexibility to choose the timing of our capital deployment and the freedom to be prudent in investing for the long term.

It is our style to be long-term oriented and strategic.

We recognize that we could deliver 2-3 percent more earnings per share growth in '04 with a reasonable stock buyback program using a portion of the cash on the balance sheet at year- end.

Now, with regard to the guidance I've just given you for '04, let me remind you of three things.

First, after providing for caution in vendor margins in RX distribution, and after providing for appropriate other contingencies normally inherent in our budgeting process, our operating earnings growth rate for all of Cardinal will be at the same pace in '04 as in '03.

But the composition of those operating earnings will be even richer.

Secondly, our optimism for all other operations is unchanged for '04 and beyond.

And third, the impact of the caution relative to vendor margins in '04 affects overall Cardinal growth rate by two to three percent in '04.

Pharmaceutical Distribution will be 35-40 percent of total Cardinal operating earnings in '04.

In the unfavorable comparability in '04 versus '03 goes away in fiscal '05.

Also, we expect to redeploy a lot of capital in '04, and to do it strategically, so, obviously our optimism for '05 is for higher growth than '04.

Last comment on guidance relative to timing.

First, after completing the normal budgeting process in late June, and after review of June actual results in mid-July and assessing the vendor margin trends and potential at that time, we conclude to be more cautious about vendor margins, particularly in the first half.

This has nothing to do with the excellent positive conversations that are ongoing with our manufactured partners and nothing to do with sales or expense ratios in Pharmaceutical Distribution, or a change in our outlook for any other segment of Cardinal.

And secondly, reaffirming our belief not to include in our guidance the assumption of deployment of capital intended for the long-term in order to benefit the short-term.

Let's look at the formula for '04.

First, we are confident that revenues in each of our segments will continue to be strong.

And I've already given you some of the reasons for that.

Revenue growth for the corporation should be in the mid-teens.

So there is a lot of confidence in sales.

In gross margins in Medial Surgical Products, Pharmaceutical Technology and Automation, the information will be strong.

Growth margins in the Pharmaceutical Distribution business will be lower.

Every segment will continue to achieve substantial improvements in expense ratios, and consequently, operating earnings are expected to grow at the same pace as in fiscal '03 with each segment generating a robust flow.

That is all really good news because that formula is dependent on known trends and existing operations, that is all internal growth.

Now let me discuss Pharmaceutical Distribution in a bit more detail.

Again, we expect strong revenue and continue to expect improvement, but as we pulled our budget together for the fiscal year and reviewed recent activity, we came to the conclusion vendor margins will be down when compared to a relatively strong '02 in first half of '03.

Some manufacturers are seeking a distribution relationship that pulls inventory out of the channel when compared to fiscal '02 and fiscal '03.

Their goal is to match production in sales more closely to script demand at the patient level.

Keep in mind, I said some, but not all.

I want to accommodate their needs as we view them as our upstream customers.

And convinced, after extensive conversations with many of our manufacturing partners, that they are not seeking to pull margins from the distribution partners.

Our relationships are strong and favorable.

They understand the need to maintain the margin, they pay us for distribution.

This shipments closer to patient demand model will streamline the channel, eliminate cost to manufacturers at distributor lever, and free up capital for Cardinal.

Now, I want you to recognize that this shift is evolutionary, not revolutionary.

But it's important.

It's not threatening the position enjoyed by distributors in the marketplace.

Neither the manufacturer nor provider can replace the quality or efficiency of distributors logistical, administrative, or information services provided.

So our position is secure.

In the role of a distributor, requiring a trader's mentality will still be present, but to a slightly less degree.

In the past, Cardinal Health has passed on our improved efficiencies and a portion of our growing vendor margin to the provider customer.

The balance of the growing vendor margin was kept by us, driving up a return on sales.

In the future, with somewhat lower vendor margin, more of the future efficiencies will need to be retained by us, and - margins should level out instead of decreasing.

Return on capital will rise and cash flow will be strong.

So, fiscal '04 will be strong in spite of relatively weaker buy margins in Pharmaceutical Distribution.

The second half will be stronger than the first and even more optimism for '05 as we move to more normal comparisons.

As we move to more normal comparisons in vendor margins in our Pharmaceutical Distribution.

And as our other businesses continue to remain robust.

Here's what I like.

I like the prospects of each of our businesses.

I like the overall diversity of our earnings base.

I like to increase richness of our earnings base as the higher margin proprietary offerings become an even larger component of our overall earnings, and finally, I like the size of our resources and our competitive position.

One last comment before going to questions.

And that is about deployment of our -capital.

We have a lot of opportunities.

A strong management team that can manage more, and a demonstrated history of deploying capital profitably and wisely.

Our capital will get used and it will be accretive to shareholder value.

Operator, I would like to open the call now to any questions.

Operator?

If you would like to ask a question, please press star, then the number one on your telephone keypad.

Again, that's star, then the number one if you have a question.

And we will pause for just a moment to compile the Q and A roster.

Your first question is from Raymond Falci with Bear Stearns.

Good morning and thanks.

I would like to follow-up on some of your concluding remarks on the overall vendor margin and overall margin outlook for your - distribution business.

I guess my question is, number one, what gives you confidence that this is more of just an issue of a anniversarying a good environment and that we don't have a structural, I guess, deterioration of your margin structure, and then number two, to the extent that you said longer term and you hope to be able to retain the synergies that you gain, which would suggest a stabilizing on your sell side margins.

I was wondering if you had any recent discussions to support that view?

Good morning, Ray.

Well, why I know this is not any major structural problem is I recognize -- first of all, I talked to the leadership and not just trade relations people.

I've talked to the leadership of major pharma. and if they were doing it with mostly branded products, we're certainly not dealing with generic margins.

I've talked to the leadership at the top of - and reaffirmed their feelings about their dependency on us for the services we provide.

We know about the dependency of our customer on the services we provide, at the efficiency level we provide.

Now, over the 20 years in business margins, the major mix changes over time.

And how you place your customer changes over time.

This is evolutionary, not revolutionary.

I have been in the business for a long period of time and have a good perspective on this.

With regard to retaining efficiencies, we -- there is a lot of visibility on the part of our customers to how we make money.

That visibility they will see our margins expanding on the side.

They are in the market and aware themselves they can't buy direct, but they know about the profitability is.

If we have more buying margin available, that is just part of the equation.

The market is certainly competitive.

Our competitors have - margin available.

That tends to get passed on to customers through reduced seller margins.

We are confident in our relationship downstream with the providers and we are confident we will be in a position to continue the kinds of returns that we have.

That's how I would answer your question.

Okay, I guess, I mean, I was really focusing more on timing.

Is it a function of when your next set of contracts come up for renewals that you believe the discussions may go to a slightly different direction or are there other mechanisms that - I understand it's evolutionary, but that could maybe change that timing?

I don't understand your question.

I guess we are always dealing with customers.

We are really dealing with, I think, a very strong margin environment in '02 and '03.

Our view is that the '04 comparability to '02 and '03, it won't be as strong for us.

It doesn't mean we have to go back and change our pricing to customers, obviously, we are also getting more efficient.

And what I said is, I don't see us passing on the same amount of efficiencies to our customers over the next couple of years because it's a balance.

You get buy margin and you have margin from manufacturers and you have to price your services to the customer base on that.

So there is an ebb and flow of that and we obviously, another factor in it is efficiency you have in your cost structure.

We have a real leadership position in cost structure in this industry and that's a nice position to be in.

There is not any revolutionary thing that has to happen with customers here.

We are talking about comparability of our buying margin going forward with what I think was pretty robust periods in the last two years.

Can we go to another question?

The next question is from Larry Marsh with Lehman Brothers.

Just to clarify.

I guess you're going to be giving more of the detailed views on August 12?

Is that right, by segment like you usually do?

Surely. here will be a lot of details about all of the segments and to help you get to even more closely on why I was optimistic about new products, for example, PIXUS, or PTS, or whatever.

We will be in a lot more detail on that.

In February and April, you talked about the business model for Cardinal more predictable than margins, some reduction, greater cash flow, and so I think you have been talking about through this evolution for a while.

I guess my question is this a further revolution of what you have been saying?

Or is there something, when you went through the budgeting process that was a real change in what you thought you had been seeing two or three months ago?

And then along with that, I know last quarter you talked about one particular manufacturer - and felt like they weren't into their new relationship, not giving you any appropriate compensation.

I wonder if there's any updates in that relationship that you can speak about?

Yeah, Larry, as I said in my talk, and I tried to stamp at home, my optimism is not any different than 90 days ago when I talked in February.

Other than one thing, we freed up -- there is less inventory, and I first said this in January.

I thought there was going to be less inventory available on the pharmaceutical side.

And if there is less available in the market, I said that's what we experienced in our December quarter.

That does affect your vendor margin.

In April, I was wrong, there was less available, and what I'm saying is that there was less inventory buying availability to generate more vendor margin, but that also generated more cash for us to take and reinvest.

You have a timing gap and we don't feel in a rush to reinvest that.

Nothing wrong with the overall model and how we priced the customers and our returns on capital, and we will be up in the Pharmaceutical Distribution business.

It's really about, I think, vendor margin and mismatch.

Profitability and vendor margins in the next six to nine months versus a strong '03.

With regard to Bristol-Myers, I choose not to talk about any one manufacturer, but to say that I'm happy with the conversations we are having with Bristol-Myers and believe they would say they are happy with the conversations we are having.

And that this is led to the statement I made on the call in April led to more active conversations at the high level with other manufacturers and I am very pleased with those conversations and met with the CEO's of some of the major pharma. manufacturers to talk about and make sure they know about distribution and make sure they understand how moving to what I call a closer -- a model that has sales in production and closer to demand of the patient.

When they move that model, we need to change how we get paid by them.

They can't be clumsy about moving there because I have been reassured we are not trying to take margin from you.

I said fine, then.

One of my conversations is that I guess we were kind of clumsy about how we went about that.

We need to straighten that out.

We already did with that one.

We are managing the model.

I remember in '92 when the Clinton Administration came in and we had a high dependency on 8-9 percent inflation and then the inflation in pharmaceuticals went to two.

There was a - I wouldn't call it a panic, but a lot of concern about what happens to the model?

It evolves into something slightly different as we manage the inflows of our margins and how we priced downstream.

I guess that's the way I would answer your question.

Thanks.

Next question.

The next question is from Tom Gallucci with Merrill lynch.

Good morning, everyone.

Just as a follow-up to that first, you are managing the model, and I'm wondering, I guess, given the change in the last few months in expectations, is it taking you longer or is there more management of the model required than you thought?

My other question separately is on the deployment of cash flow.

It seems like there's a lot more cash there than we thought.

It's a strong debt to total capital position, what are your thoughts on share repurchases, potentially on dividends, and how are you thinking about the acquisition landscape today?

The good news to managing the business for the first question about this managing the ebb and flow.

There is good news to talk about it in basis points.

Let's put this in perspective, in my conversation I said that that the less optimism on buying margin, vendor margin for the next six months affected the overall growth rate of Cardinal's operating earnings by 2-3 percent.

Now, if you calculate that, what you figure out, that's something like $50 million or $60 million.

If you take that back and figure out what is the basis points, now Cardinal has a superior return on sales.

What does that mean in terms of -- it means 20-30 total basis points in our Pharmaceutical Distribution business.

Not a disaster, but a lot of money and we look for every penny.

This is not a major thing for the corporation because I want to remind everybody that we love Cardinal distributions, great long-term business.

Great customer relations, good top line growth, great secure position, but it's also only between 35 and 40 percent of Cardinal's earnings.

At some point, we want everyone to understand there are a lot of other gross margins things going on inside of Cardinal distribution that are favorable around generics and things like that.

There favorable gross margin things in our other businesses.

That contributes 60 for next year and 60 plus percent of operating earnings.

That's perspective I did on you, I said we're managing the model.

We are not managing the model in wild flings, but every basis point is a lot of money and I need to put it in the right perspective.

Yes, we have more cash flow and cash on the balance sheet than we expected.

We expected cash flow to be as strong, but we made the commitment and thought it would be over a billion dollars and it was.

We freed up capital in the distribution business that is good news.

If you believe we can use that capital.

I would remind everybody in the 10-year period of the '90s, Cardinal reinvested in external capital through acquisition and joint venture and whatever.

We reinvested at a rate of $1.3 billion.

That was at a time when we had to manage that.

We had to find opportunities, we had to manage that.

That was at a $1.3 billion per year and that means it was at a time when the company was on average less than half our size, I don't think it's a daunting task to reinvest this.

We are not talking about new platforms, we are talking about building and enhancing what we do.

Our cash flow -we will evaluate dividends and shown we are able to do stock buybacks.

It's a fairly easy thing to do.

If you view the stock buyback we did last year, we went out and gathered up shares knowing we would have to issue shares in a -- stock options or for a $1 billion acquisition.

I think you might view us as right now not - I mean, we can do stock buyback, and maybe we will, but I think there's an inclination that we want to horde more - to put into other growth opportunities.

If there is some beyond what we think is reasonable, we'll do a stock buyback.

That depends on where our stock price is etcetera.

That's where we are.

We feel we are in a great position.

I said I thought our optimal capital ratio was - not at that often with capital ratio.

I recognize that I have a responsibility to get us closer to that.

And 11 percent net debt to total capital is not where we should be.

Frankly, we should be closer to 30 percent or higher.

That gives you some idea of what my objectives are over the next several years.

Next question?

The next question is from Chris Mcfadden with Goldman Sachs.

Thanks for the detail on the call this morning.

First, clarification.

In your prepared comments, you talked about the Pharmaceutical Distribution and Provider Services segment being at 35 to 40 percent of operating profit.

To make sure we are talking apples to apples, does that compare to 50 percent of operating profit that that segment represented in fiscal '03, and then second question would be as we think about that same division, you had great success in '03 at the operating leverage line in part due to the synergies this year.

This year you had about $50 million in less operating expenses than you did in F '02.

How would you expect it to How would you expect the operating expense comparison to play out for F '04?

Thanks.

Okay, Chris, thanks for reclarifying that.

I know I have given so many numbers, but let's just be specific.

In that segment which is Pharmaceutical Distribution and Provider Services, you have a -- what people know as the general line traditional, we used to call it core drug distribution business and we have other provider services.

That might be our medicine shop and service of consulting services to hospitals and there is lots of other businesses in there.

Our specialty distribution business.

When I refer to the 35 to 40 percent, the funding for the distribution is about 80 percent of the -- about 80 percent of that segment.

So what I said was Pharmaceutical Distribution will be just that. 35-40 percent.

That segment next year will be more like 45 percent.

The total segment.

That's helpful to get clarification.

The reason I picked out just the comparison of Pharmaceutical Distribution, is, at the time they did the first acquisition which broadened the offering to the customer, that was medicine shop in '95, first time we did that, somebody asked me, do you ever see the day when Pharmaceutical Distribution, that traditional business we had was less than 50 percent?

I said yes.

So today I'm telling you it's between 35 and 40 percent.

Second question, operating ratios in that business, you have had a lot of success at it and we are good at operations.

We have no operating problem going on in the company.

We can deliver the product at the right price and get increased productivity and customers are happy with that.

In distribution, our operating expenses are coming down pretty dramatically and there still opportunities to drive them down further.

We're talking about in the next year, more in the 20 basis point reduction and then maybe a 40 basis point reduction which we probably averaged over the last five years.

Thank you.

Okay.

Next question?

The next question is from Michael Fitzgibbons -- from Morgan Stanley.

I was thinking about the timing of -- you talked about the margin having an impact in '04 and improvement in '05.

It seems like is your -- is this year of the first half of '03 having a significant benefit with a tough call for the next six months?

Is that something you discovered more recently and part of what changed in the last six months since the analyst meeting in New York or why is your view of that difficult comp changed?

One other question was on the sell margin.

If you presumably have been starting to talk to customers that you will renew contracts with and talked to them about the possibility of looking at customer more in the future to get your margin, if the vendor margin is down, in recent conversations, what has been the response?

Have you had any contracts for getting traction there and starting to maybe have increases in pricing versus the historical decline?

Okay.

Two questions.

One is about what's changed from either conversations or feelings in February or anything along the line in the last six months.

I would say the only thing that's changed, I don't want to keep emphasizing, but our view about availability of investment in inventory available in the market in the branded area.

When compared to what our expectations were.

There two effects on that.

We are expecting then that there would be less margin relative to strong buying margin opportunities.

We are expecting that there will be more cash available for reinvestment.

There will be by and large, you signal that that's the only change, with regard to living, I would say with regard to the other areas, we frankly have increased confidence in the area, but don't feel compelled to reflect increased areas that increased guidance about the areas right now.

But they are in great shape and the budget process came out well and a high degree of confidence and spent lots of time with their management.

That's kind of where we are.

With regard to dealing with customers, I don't want to get into that as a competitive, but we have a great relationship with customer and it's a negotiating process and if you have more money in your pocket, it will be a margin and you negotiate to what you think is an acceptable return.

That's the way the process works.

It's works in every business that way.

So we won't pass on efficiencies to customers, but what I said is in the past, Cardinal's operated on the basis that we are very aware of what the margins are.

As we got more buying margins and vendor margin and as we got more efficiency, if you look at the history of what we've done, you would say we passed all of the efficiency on to the customer and the second thing, you pass some of the buying margin on to the customer.

If there is somewhat less buying margin available, we can't pass it on to the customer and we have some of the efficiency which we create in the future.

That's the model.

That's what I believe will happen.

I believe it's a competitive environment and we will have to ask the others what they expect to do.

We are trying to communicate to you this is the way that the business works.

Our returns will be terrific and they are.

We feel really secure about the relationships in what we do.

Incidentally, in our passing efficiencies on to the downstream customer, the provider, the benefit of doing that is they are now able to acquire product through us at substantially lower cost than if they tried to do address or pricing in the right way relative to other opportunities they might have to acquire product.

This is the right thing to do because it ties those customers in to acquire product through the wholesale distribution channel.

That has been done in an extremely well.

Good job by us and major competitors.

We have the provider that needs us and needs our service and we do things they can't possibly do themselves.

Emergency delivery and five day a week deliveries on electronic connectivity to us and 100 percent service level.

The model is in good shape.

Next question?

The next question is Robert Willabee with Banc of America.

Morning, Sean Harrington in for Robert Willabee.

In terms of the guidance change, in terms of the factors, what's having the greatest impact in your mind?

The vendor change, elimination of reinvestment of capital going forward?

What's the primary driver there?

To repeat what I said in the presentation, that the only change, only two changes to our guidance, that is that this is for '04.

I already said that very optimistic about our growth rates in '05 being faster than '04.

We are saying it's two changes.

One, more conservative about the prospects for vendor margins and distribution and we have freeing up of capital investing in inventory and Pharmaceutical Distribution and the mismatch of timing in reinvesting that capital recognizing that any capital is sitting on the books today and we earned one half or two percent or something like that.

That's really the only changes.

The rest of our business are robust and strategy is working.

The customer relations are terrific and deal four and PTS is magnificent and we try to stamp home and say this is a good story the fact that we are dealing with an issue here and we have all these other things that we are focusing on.

They are doing very well.

In terms of redeploying the capital --.

Is there another question?

I'm not trying to -- if we have time we can come back to that.

Any other questions at this point?

You have a question from Steve Halper.

Relative to your competitors, do you believe that you are more conservative in line or more aggressive in achieving the margin?

Your perception.

My perception is we have two smart competitors.

We have a slightly lower cost of capital and probably more capital.

We have a long history of -- my expertise, I said that for us and all competitors, there is a trader's mentality, there is always opportunities to acquire product in a price advantage way.

There is many reasons that manufacturers want to place product in the marketplace.

They are smart.

They have good buying operations and they have plenty of capital.

I would say historically we have probably been more deeper in inventory than they have been.

Recently, the difference is not all that great, but I guess fortunately they don't give their internal financial statements and I'm guessing, but we are knowledgeable about it.

This was not that complicated.

We have committed a lot and view it as part of how you run a good distribution business.

If you run a good distribution business, you have plenty of inventory to make sure your service level on a critical products, which is pharmaceuticals, is extremely high.

Secondly, we have to look to the margin to make sure you acquire product at the best available price at the time.

Wal-Mart does that in their business and everybody does to make sure.

So I believe that our competitors are aggressive in doing that.

Probably historically, relatively, you may have been more aggressive in doing that.

That's good for us.

Nothing wrong with that.

I view them as knowledgeable buyers.

I think at this point we will wrap up.

I appreciate you taking the call.

We are feeling confident about the future and look forward to getting into the details on all of our businesses and not just Pharmaceutical Distribution, on August 12th in New York City, where we will host an analyst meeting and get into more of the details.

Thanks for participating this morning.

This concludes Cardinal Health's conference call.

Thank you for your participation and you may now disconnect.