卡地納健康 (CAH) 2004 Q3 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to Cardinal Health third quarter 2004 earnings conference call.

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

After the speakers' remarks there will be a question-and-answer period.

If would you like to ask a question during this time, simply press star, then the number 1 on your telephone keypad.

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

Thank you.

Mr. Hinrichs, you may begin your conference.

Thank you.

Good morning and welcome to everyone.

Today we are here to discuss Cardinal Health's fiscal 2004 third quarter.

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

So if you don't have a copy of that or haven't received one you may access it on the Internet at our investor page at www.Cardinal.com.

Speaking on our call today will be Bob Walter, Chairman and CEO who will open up with comments about the quarter and future outlook, George Fotiades, President and COO, who will discuss the key operational highlights and Dick Miller, Executive Vice President and CFO who will provide a walk-through of the company's financial highlights for the quarter.

After their formal remarks we'll open the lines up for your questions, and as always when we get to questions we ask that you limit yourselves to one at a time.

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

The most significant of those uncertainties are described in Cardinal Health Form 10(K) and Form 10(Q) reports and exhibits to those reports.

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

In addition, statements on this 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'll turn the call over to Bob Walter who will provide comments on the quarter.

Good morning, everyone.

Overall Cardinal Health third quarter performance was very solid in line with expectations and showing a number of very promising trends.

Having said that, it wasn't an easy quarter, and we're all in a challenging period for certain segments, although the long-term growth prospect everywhere is quite positive.

George and Dick will get more into the operational highlights and specific performance of each business in a few minutes, but let me make a few high-level comments.

First, the results from this quarter clearly highlights one of our key strengths.

The diversity of our earnings.

The fact that we delivered 15% earnings per share growth in a quarter where we are not getting any earnings growth contribution for pharmaceutical distribution and provider services, which is our largest segment, is clear evidence that our business model of creating diverse market leading positions in healthcare is working well.

We feel very good about the fundamentals of all of our individual businesses and our market positions are stronger than ever.

We are confident that the growth in all of our segments will continue to be very strong relative to their competition.

We are gaining market share based on value delivered, not price.

Additionally, our integrated selling approach is clearly additive.

When we look at the growth rates for our businesses and customers who have embraced the concept of working with the one Cardinal Health by signing corporate agreements, the results are very impressive.

Every segment is growing significantly faster inside these corporate agreements versus their baseline growth rates.

And that is value marketing, not price bundling.

Distribution, medical products, and automation are all benefiting significantly from these integrated efforts.

With regard to drug distribution, my own impatience aside, we continue to make really fine progress in our discussions with manufacturers and are seeking strong evidence -- or seeing strong evidence that the evolution to a more stable fee-based model is happening.

George is going to give you a lot of additional color on that transition so I won't say any more.

The cash flow result for the quarter were outstanding exceeding our plans and internal projections.

We're way ahead of our cash flow targets for the year which begs the obvious question, what are we going to do with it?

First of all, during the quarter we did repurchase 7 million shares of stock, nearly completing our $500 million authorization announced February 22nd -- 27th.

Additionally, during the quarter we acquired Snowdonn Penser, a privately owned manufacturer of specialty surgical structures primarily in the laparoscopic and cosmetic surgery areas.

This is a great fit for MPS.

This acquisition increases our presence in the operating room by expanding the breadth of our product offering and size of our sales force.

As you all know we have a very successful track record with acquisitions, and we continue to be mindful of the following three-point formula that has made us successful.

First, there must be a strategic fit for us in healthcare.

Second, the culture and values that fit with Cardinal Health must be present.

And finally, after meeting the first two criterias, the expected economic return that exceeds our weighted cost of capital must be obvious.

As we look at any capital deployment project we are disciplined in staying true to this formula and performing all necessary due diligence prior to investing.

Let me assure that you we are extremely active in a number of fronts that are very strategic to us.

And as we mentioned in February, George's appointment as COO has freed me up to spend more time on business development, and I am hopeful to have more to announce on this front as the year progresses.

Taking our results this quarter and looking forward to what they imply for our full-year performance against our long-term financial goals we believe we are on track to deliver on our full-year EPS guidance of mid teens or better.

Given that we expect our fourth quarter to have consolidated financial growth rates much like those in the third quarter, we will be at the lower end of our earnings per share target range.

We are not changing any recent guidance for '04.

We are, though, trying to be as specific as possible when we add our fourth quarter internal forecast to the already completed three-quarters.

This is not really very complicated.

Nothing has changed for our long-term guidance.

With regard to other metrics, when we compare our third quarter to our long-term financial goals, metrics like low to mid teens revenue growth, return on equity higher than 20%, and cash flow greater than 60% of net earnings, we're well on track to meet or in the case of cash flow, significantly exceed our target for this quarter.

Now, I said earlier this hasn't been an easy year for us.

Distribution, the business that has fueled our growth for so many years and remains our largest segment, is not contributing to earnings growth.

Because we are at the lower end of our earnings per share growth range for this year, we are looking, obviously, at all kinds of productivity improvements and looking very closely at expenses to make sure we are in line with our overall performance.

One example is incentive compensation for our management team which is being reduced to reflect our performance and will be at the low end the range.

Of course we will not be spreading our incentive compensation like peanut butter.

We will always recognize outstanding performance at the segment and individual level but this overall reduction is proof that the company and its management team take our financial goals very seriously.

And let me emphasize something.

Of course we have not reduced any investment spending, which I consider the life blood of our future.

So in the quarter, our investment spending was $31 million.

We're all enthused about the strength of our business and the long-term prospects, but we also recognize that it is a pay performance and will be naturally reduce -- it will naturally be reduced when we come in at the lower end of our most -- of our most important financial target.

As we move through 2005, we're confident that the pharmaceutical distribution will once again return to a formula where operating earnings will grow at least as fast as revenue.

So this is obviously a comforting thought for the future.

Looking long term let me explain why we're so enthusiastic.

In addition to the fundamental strength of our base businesses and the healthcare industry itself, and, of course, this transition in pharmaceutical distribution which I mentioned, a number of new product initiatives will serve as growth drivers and represent high return areas for capital deployment.

Some examples.

Sterile manufacturing in pharmaceutical technologies.

We continue to build and validate additional sterile manufacturing capacity.

Over the past several years, from when we bought our first blow-fill seal operation our sterile manufacturing business has grown its earnings more than two and a half times and the future growth prospects of this business are tremendous.

Second area is investing around patient safety.

It continues to be a strategic priority for the company.

Patient safety is one example of that investment, especially as we refine the clinical applications associated with it.

We're also working on a strategy to determine how to best provide hospitals an integrated product offering around the unit dose bar coding regulation.

Patient medication safety will continue to be one of the hot buttons in healthcare and well positioned to deliver solutions.

In medical products area we continue to invest in R&D, focus on key product areas such as infection control fabrics, specialized surgical, and radiological tools and, of course, gloves.

In geographic expansion, our international business is doing really quite well this year and we recognize the potential growth of these markets and continue to invest in expanding our geographic reach.

And finally, as I alluded, a major event in the quarter was the organizational change that resulted in the appointment of George to President and Chief Operating Officer role.

George is transitioning rapidly into this new role and I'm extremely pleased at the way the organization is embracing these changes.

George is an exceptional leader and in his first few months as President and Chief Operating Officer has confirmed that we have the right person leading the operations of Cardinal Health.

With that said, let me now turn this over to George.

Thanks, Bob.

Starting with distribution, the core business is doing well with strong demand across all customer groups driving revenue growth and improved earnings performance versus last quarter and we expect to see the positive trend continue in the core distribution business.

Another important measure of our progress to the just in time business model as seen in our day's inventory on hand, which declined a significant seven days versus the year-ago period, driven largely by distribution and Dick will talk more about that.

So this new aspect of the new models moves remarkably fast, which brings me to our progress on how we will be paid differently in the future.

I just returned from the National Association of Chain Drugstores annual meeting where I had the opportunity to meet with several manufacturer and provider customers.

And I came away very encouraged and impressed by our leadership and progress in the business model change discussions.

As we've characterized this before, we're managing a process rather than a one-time event.

And while the process will vary by manufacturer, there is clarity on the ultimate goal.

Which is a payment structure that is fee rather than inflation-based.

Today we have several agreements signed that are fee-based, some that I would characterize as transitional agreements and are a mix of fee and inflation, and the remainder which are inflation-based as we are at the earlier stages in the process with these manufacturers.

And while most everyone can agree on the merits of JIT in a transparent fee-based system, we recognize we needed to approach the process with a comprehensive data driven analysis and recommendations.

We also knew that this process was going to engage all levels of our manufacturer partners over the course of several months.

The sales and marketing group, operations, logistics, finance, and senior executive management and that is exactly how this process is progressing.

I want to describe our particular approach because it will give you insight into the analysis and discipline we are bringing to effect the transition.

We have deployed what we describe as a next-best alternative analysis which has three goals.

First is to determine and validate the manufacturer wholesaler provider model as the most effective alternative for the healthcare system which we have confirmed that it is and the major manufacturers agree as well and we now know the cost of the next-best alternative by each manufacturer.

Second goal of the next best alternative analysis was to determine a logical service matrix driven by specific product characteristics to establish a transparent means for setting fees for each manufacturer.

And the third goal was to determine which manufacturers today may be overpaying or underpaying for services.

So we begin by assessing numerous dimensions to segment service requirements by manufacturer, including customer sales revenue, high, medium, low, product concentration, you know, consolidated or fragmented, handling requirements, whether it's special handling is required like refrigeration, or if it's fragile.

Fourth item, the number and nature of shipp-to points, and finally product value, whether it's an expensive product or more conventionally priced and what were the units and unit costs.

Now from this we categorize manufacturers and their service requirements into eight clusters, such as large pharma with special handling, or large pharma with both a fragmented line and special handling, et cetera.

Our analysis then took each manufacturer and their specific service requirements and examined two next-best alternatives to the current model.

First would be that the manufacturer builds their own capabilities, and second that they outsource to a third party logistics provider.

Not surprisingly, these alternatives are more expensive than utilizing our distribution capability but the point was to quantify a logical benchmark in establishing how to value our services.

And from here we can then have very specific discussions with manufacturers about what they've been paying in the past, and where we believe a fair fee-based compensation ought to be.

The reactions by manufacturers to our approach have been very positive as they appreciate the homework that we've conducted to back up Cardinal Health's vision for the model.

At the same time, it does take time to absorb the learning and to progress the education process within their organizations.

And in some cases they're hiring their own consultants, many of whom we're working with to educate and share what we have learned.

And we welcome these actions because we believe these manufacturer who do their own validation reach conclusions which are similar to ours and this helps advance the transition.

On the sell side of business, we're starting to see signs of improvements in the pricing environment and while it's still too early to characterize these as consistent change we're hopeful that the sell side of the business is moving in the right direction.

We've been extremely disciplined in our pricing of new business and in our analysis of the economic value of every contract.

As we talked about at the February analyst meeting, we did sign a multi-year renewal with Express Scrips and likewise other big customer renewals during the quarter are going very well.

We will not participate in prices that do not meet our financial hurdles and our profitability targets.

Moving to the next business, medical product, this segment was really a stand-out performer for the company this quarter.

Simply put, they are winning in the marketplace by leveraging their strengths and focusing on better service alternatives.

The highlights of the business continues to be better than market revenue growth in part reflecting recent distribution contract wins such as Health Trust.

The self manufacturers business is being led by new products, especially our newest esteem and new thera gloves which are seeing very solid uptake.

While revenues were up 14% in the segment operating earnings were up 11%.

This margin impact as we've explained in recent quarters is driven by the rapidly growing but lower margin distribution component of the overall business mix in MPS.

Expense efficiencies helped partially offset the reduction, but it's safe to say that we will continue to see lower margins as this new distribution volume continues to come in.

We expect to start seeing better margin leverage as we continue to drive increased share of our manufacture products this our channel and invest in new more efficient distribution facilities and continue to launch innovative higher margin product as a result of our continued strong R&D investment.

Finally, we are particularly encouraged in the quarter by our international business in MPS, albeit from a very small base both the top line and earnings growth in our international business were very strong.

They are ahead of our plan and much higher than last year.

And we're going to continue to invest in geographic expansion in the MPS business and look forward to seeing continued growth.

PTS.

They had a solid quarter despite the fact that sterile product and regulatory delays that we've been talking about had continued for the past few quarters.

The good news is that the most important product delay has ended as we just received word of FDA approval at our Albuquerque, New Mexico facility for Prevnar.

And Wyeth made that announcement in their press release as well.

There will obviously be a steady ramp-up period to the fourth quarter and our goal is to provide flawless execution of this important product for our customer, Wyeth.

The future growth of the sterile business looks very good.

We've got a strong pipeline of projects we're working on and continue to qualify capacity in the U.S. and in Europe to support future requirements from customers with global supply needs.

The fact that we are able to integrate our Europe and U.S. customer support is a major plus.

For the quarter, nuclear pharmacy services and packaging services led the growth of the PTS segment which reflected steady demand and operating efficiencies and the integration of inter-care continues to go well with particular strength in their MartinDale brand of generic products.

And finally, we have essential completed construction of a new prefilled syringe injectable plant in Brussels and are beginning the validation process.

For PTS going forward here's how to think of this business.

We've now put together a business that represents a broad collection of services across the pharma and biotech industries.

Our sterile business will be very high growith business.

Nuclear and packaging service will continue to be good growth businesses and our oral technologies business will be a slower grower coming off the strong performances of the Amnistene products on soft gel and Zyprexazitis.

In total, this combination will lead to an overall business that will be Cardinal's strongest performer over the long term.

Automation.

Sales growth for the quarter in automation was 4%.

These are disappointing results driven in part by an industry-wide softening of demand at the hospital level, but at the same time we've looked deeply at the reasons for this slowdown to ensure that it was not related to a competitive issue or product problems.

And first let me say no competitor can take credit for our slow quarter.

Our renewals remain strong at over 98%.

We had a number of new customer and competitor take-away during the quarter.

Committed contracts were up 8% in the quarter.

Ending backlog was down from $207 million to $186 million.

Both of these figures were less than we expected, less than you've seen in the past.

And all indications are that this softening trend will continue over the short term and particular since the year-ago fourth quarter was a phenomenal quarter for Pixus.

However the underlying long term growth drivers of patient safety are real and cost savings from automation are still very real.

The demand is not diminished so we're confident that our market leading pipeline of new products and the continued focus on patient safety will lead to strong long-term performance.

Looking at the newest innovation automation, patient station.

It continues to make steady progress.

Patient acceptance continues to be very high.

We have a thousand units currently installed and more than 5,500 under contract.

As we continue to work with our hospital customers to help them understand the economic value of patient station and how to predict and maximize the revenue per bed and looking at different ways to share in the risk and value of the product.

During the quarter we received the AHA, American Hospital Association, endorsement of patient station as frontrunner in hospital technology platforms.

The uptake of patient station has been slow but steady.

We're committing lots of resources of Pixus right now given the strategic importance and we're confident that the investment will pay off the down the road as the economics are better understood and the push for better patient safety intensifies.

I want to close by summarizing how the overall picture in the operations is coming together.

Our business and organization strategy of integrating our product and services around our customers is clearly working.

This is exemplified by the strong pace of performance in our medical products business as well as overall hospital performance and drug distribution.

The sales growth in those hospitals where we have corporate agreements is stronger than it's ever been and much higher than the overall marketplace.

Likewise at PTS, we're now able to collect data that tell us that one quarter of our new business opportunities are coming from cross-selling activity.

So it's data like these help reaffirm our belief that the potential of continuing to drive more integration behind innovation will lead to meaningful growth for the entire company.

With that I'll turn it over to Dick.

Okay.

Thanks, George, and good morning.

At this point between the information in the press release and Bob and George's comments you've received a lot of good information and I have no intention of repeating it here.

What I would like to do is just take a few minutes to share with you some additional financial analysis around a couple of key themes and then add a few clarifying remarks about certain of the financial metrics in the segment.

Let me begin by breaking down the financial benefits we're achieving from our diverse portfolio of market leading businesses.

While we're very encouraged by the sequential improvement in the pharmaceutical distribution and provider services segment, the reality of it is that it represents 48% of our business that had no earnings growth in the quarter.

So how do we generate 15% EPS growth?

Basically two reasons.

Strong performances in productivity in our other businesses and contributions from our fifth segment, our exceptional cash flow.

Consolidated -- our consolidated operating earnings grew 9%.

That was led by 22% growth in 16% of our business, the pharmaceutical technologies and service segment, combined with 11% growth in another 26% of our business, the medical products and service segment.

Now there's an additional benefit that occurs when these two segments are the fastest growing.

Since they're also the segments with international operations, they contribute a greater mix of income that is taxed at lower rates, thus reducing our effective tax rate and creating good net earnings leverage.

The rest of the leverage to achieve 15% EPS growth comes from the direct benefits of our strong cash flow which I'll discuss in more detail in just a minute.

The first benefit comes from reduced interest cost as the working capital needs of the business are funded internally, providing the leverage to convert 9% operating earnings to 10% pretax earnings growth.

The second benefit comes from having excess capital available to repurchase our shares at times when our own stock is an attractive investment.

Through the first nine months of fiscal 2004 we've invested nearly $1.5 billion in repurchasing our stock.

That provides the leverage to convert 11% net earnings growth to 15% EPS growth in the third quarter.

So while this is not the financial model that we want to live by in the long term, I do think it's an excellent example of how the strength of our diversified portfolio combined with our ability to deploy capital and value creating ways allows us to achieve our financial goals, even when nearly half of our business is going through a temporary period of low earnings growth.

The second area I want to discuss is our capital productivity and the related cash flow.

Each of our segments raised its return on invested capital this quarter which in turn drives significant improvements in cash flow.

Our return on invested capital rose 35 basis points to 9.06% versus 871 a year ago.

Equally important is the fact that we improved 116 basis point sequentially from the second quarter.

I expect this sequential improvement trend to continue in the fourth quarter such that the full year return on invested capital should come in around 8.5%.

We generated $787 million of operating cash flow and $669 million of free cash flow during the quarter.

At our investor conference in February, I discussed the fact that the business model change in pharmaceutical distribution was allowing that business to be much more capital efficient which would result in our beating our cash flow goals for the year.

Our performance this quarter confirms that prediction.

Year-to-date, we have generated over $1.3 billion of operating cash flow and over a billion dollars of free cash flow.

Both of which exceed our commitment for the full fiscal year.

For the nine months ended March 31st, our free cash flow exceeds 90% of our net earnings.

Additionally, we expect to have another good quarter to end the year.

And you should look for at least an additional $200 to $300 million of cash flow in the fourth quarter.

What I'd like to do is take a little closer look at the drivers of the third quarter performance.

Net earnings of $428 million was a key contributor but equally important was our working capital management.

Revenue growth of 14% would generally require some level of increased working capital.

However, our networking capital March 31st, 2004, is nearly $200 million lower than it was a year ago.

This result is a function of our normal capital productivity discipline combined with the working capital benefits of the business model change in pharmaceutical distribution.

Our days of inventory on hand declined by seven days from last March and improved sequentially by three days since December 31st.

Those are meaningful improvements when a day of inventory amounts to more than $150 million of working capital.

But there's another piece of the equation.

Our payables.

Since the true impact on cash flow is driven by the level of our own inventories.

During this period of reducing our inventory days our payable days have remained relatively constant, thus allowing the reduction in inventory days to fall through to cash flow.

While this is an excellent start, there is additional improvement to be achieved.

Over the next couple of years we should continue to see incremental improvements, ultimately reaching a days inventory on hand level in the low to mid 40s.

This is the primary driver of the billion dollars of capital that we estimated will come out of the pharmaceutical distribution business as it goes through the model change and contributes to that business delivering even higher returns on capital.

There's also a key element of our expectation to generate nearly $5 billion dollars of free cash flow over the next three years.

While this inventory performance is impressive we've not forgotten receivables.

Our receivable days improved by one day versus last March and have only increased 4% since December.

As we continue to focus on being judicious when granting credit and maintaining disciplined collection procedures.

Let me just finish up with some clarifying comments about our segment performances.

In pharmaceutical distribution and provider services, excellent revenue growth was driven by strong demand across all customer classes.

Let me break it down for you into the pieces we've discussed previously.

Direct store door sales increased 24%.

The strong growth in direct store door sales is being partially offset by a reduction in the amount of full case bulk from stock sales which actually declined 48%.

During this period of transition in the pharmaceutical distribution business, I believe that the best barometer of downstream customer demand is to aggregate all sales, including the bulk deliveries to customer warehouses which are not included in operating revenues.

For the third quarter this aggregation yields an increase of 14%.

Now the third quarter of fiscal 2004 had an extra business day versus the same quarter a year ago.

Which is relevant to the high volume businesses in pharmaceutical distribution and provider services and medical products and services segments.

In both those segments the additional day added approximately 2% to the reported revenue growth rates.

In pharmaceutical technologies and services we've now anniversaried the Syncor acquisition so we're now on an apples to apples basis for that transaction.

However, this is the first reporting period that includes a full quarter of the financial results of our Intercare acquisition which we closed in late December 2003.

We achieved high teens organic earnings growth in this segment despite the absence of earnings results -- despite the absence of earnings resulting from a delay in the start-up of commercial manufacturing of a key sterile product.

As George mentioned, manufacturing of that product is now underway and we will begin to see its contribution during the fourth quarter.

The intercare business is comprised of two pieces.

Pharmaceutical manufacturing component focusing on fast-growing sterile generic and injectable products and a specialty pharmaceutical distribution business.

For segment reporting purposes we've included the relatively insignificant specialty pharmaceutical distribution business, which is about $87 million of revenues and $2.6 million of operating earnings for the third quarter.

We've included that with the pharmaceutical distribution and provider services segment.

Besides being theoretically correct from a segment reporting perspective, this classification has virtually no impact on the pharmaceutical distribution and provider services segment but if we left it in the pharmaceutical technologies and services segment, this relatively low-margin business would have significantly restored revenue growth rates and return ratios.

That is, if we would have left it in PTS, we would have reported in that segment, revenue growth of 28% versus the 14% reported and our return on sales segment would have been 162 basis points lower.

Thank you for your attention.

Now I'll turn the call back over to the operator as we're ready to begin accepting questions.

At this time I would like to remind everyone in order to ask a question simply press star, then the number one on your telephone keypad.

Please hold while we compile the q&a roster.

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

Hi, Bob, really just the same question for you about deploying capital.

Are your opportunities so big on the acquisition front that there really is not enough capital to accelerate the share repurchase activity and dividend hikes?

Okay.

Good morning, Bob.

I think the question is is do we have enough capital to complete the acquisition opportunities?

First of all, I'm not going to repeat what our criteria for acquisitions is but I will tell you the areas we're focused on.

We're focused on manufactured product in the medical-surgical area, we're focused on international opportunities that, for example, would match PTS's capabilities in the United States for manufacturers internationally, so, for example, what George and Dick referred to, the intercare, for example, gets us sterile capability in Europe.

And we're focused on a customer area which is really our broad offering in the acute care marketplace so those are generally some areas, so don't expect a new segment from us.

Now with regard to whether we have adequate capital I think that we've always been deep in capital.

Certainly we would feel comfortable accessing the equity market, meaning buying a company using our stock.

On the other hand, we certainly, as you know, cherish our stock but also we've got ack -- we've got ack -- we've got adequate capital from a -- from a cash standpoint.

We will have acquired $1.5 billion in stock this year, and -- in other words, repurchased stock, 1.5.

You shouldn't expect that to be a continuous trend.

That was -- we certainly knew that we were going to have -- generate excess cash.

We knew that there wasn't going to be an opportunity to use that on the short-term, and we consider that to be an opportunity for us.

Now, we will -- so we will balance -- we expect to generate, as Dick said at our conference, about $5 billion in cash flow over the next three years.

I'm actually more optimistic than even Dick is on that.

So we have a lot of internally generated funds.

We certainly don't consider ourselves highly leveraged, so I guess to wrap it up, I've told you where we can -- are targeting.

I've said to you don't expect a major new segment for us.

We're quite confident about the cash flow coming in, and we're underleveraged, so I think we're fine, in terms of having adequate cash, and I also indicated if the seller of a business properly appreciates the value of our stock, then we'd be willing to use stock also.

Next question.

Your next question is from Ray Falci with Bear Stearns & Company.

Yea, good morning, Bob.

I'd love to have you talk about a topical item, reimportation.

I'd love to hear your thoughts on how this will play out but obviously talk beyond Canada of other mark where reimportation could originate what your thoughts are on that, secondly whether or not this topic is being brought to the table as you're negotiating with DSA's with the drug companies.

Okay.

That's a good question.

As you know there's new bills or new ideas in bills and amendments happening all the time and I don't know whether it got introduced yesterday or not, which they're talking about a broader reimportation beyond just the individual patient, allowing the individual patient to order product through the mail from just Canada, they're talking about a broader implication of reimportation at the wholesale level, then extending it to Europe and extending it to Australia, et cetera, so this is a broader issue, and but I think it is extremely straightforward for Cardinal.

And let me see if I can express it clearly.

First of all, we consider reimportation an inefficient solution to healthcare costs and access.

And that that inefficient solution has two very bad consequences.

First of all, we think it puts the patient at increased risk.

Around product safety, accuracy, availability of product in the right channels, certainly increases the possibility and probability of counterfeiting.

It adds more complexity to this whole issue of product condition, and it will lead to a dramatic increase in the complexity in the supply channel.

So don't just focus on patient ordering through the mail.

You need to, you know, recognize they're now they're talking about wholesale importation.

This channel in the United States is today, and has over the long history, been consolidating, and that increases efficiency, increases safety, ability to track product.

We're now talking about deconsolidating something, a channel, which will increase costs, will decrease efficiency and put product at risk more difficult.

So, first of all, I think it puts the patient at risk.

That's a bad consequence.

The second thing, it disrupts the normal flow of pharmaceutical products, so we're talking about potential decrease in availability of product in some channels at the right time, we've talked about it would definitely promote a secondary arbitrage wholesale environment that isn't adding value.

Again, increasing the risk.

And it will add a lot of cost for testing, packaging, additional security that's not required in the channel that currently exists in the United States.

So it's a bad idea.

Now, Cardinal, we've been telling you that there are two important aspects of Cardinal is to promote patient safety, to do all we can, and whether that's at the Pixus level deeper into a hospital or at the wholesale level to ensure we eliminate counterfeiting, I talked about this over a year ago.

And the second thing is that we've said we are committed to just-in-time inventory logistical partnership all along the channel that is secure and safe, and that addresses that partnership with the pharma manufacturer, so we will be unequivocally partnering with the pharma manufacturer to find a more elegant solution without adding risk to the patient, that I've cited.

This is just plain right for healthcare.

And, yes, we are in active conversations and expect to take a lead in this role, in having these conversations with the pharmaceutical manufacturers so that it's not just viewed as how do we handle mail order coming in from Canada.

I can tell you they view us as a great partner in helping them find a better solution to this.

So that's where we are on importing -- reimportation.

Next question.

Your next question is from Larry Marsh with Lehman Brothers.

Thanks.

And good morning.

Bob, my question is on MPS.

Is it fair to say that, I guess you're disclosing that maybe you spent about $60 million for acquisitions in the quarter.

Is it fair to say that most of that went to the Snowdon Penser?

Seems like a nice add-on.

And I guess maybe a little elaboration, Bob.

I know when you first acquired Allegiance, you know, back five, six years ago, so it was a great opportunity to drive more self-manufactured product through the channel, it sounds like today you're saying it's as big an opportunity as ever.

You know, how much do you think you can increase the amount of self-manufactured product?

I mean, in broad terms, and how much of an opportunity do you see that, you know, here today versus even a couple years ago?

Okay, first of all, Larry, I'm not going to confirm what the -- what we spent on Snowdon Penser.

It's a privately held company.

We have a, you know, we have an agreement with them that, you know, we're just not going to talk about the price.

But anyway, I would ask George if he would just talk about the issue of the opportunities in the MPS area.

Well, we've, you know, two months ago when I came into the position we also, you know, created the integrated provider solutions group.

We did that to bring more focus around the total -- the total hospital market and to be able to identify all the opportunities that could be there for Cardinal Health in the hospital.

Or would be in MPS but could be elsewhere also by segment.

Ron Labrum leads that group.

Ron has tremendous experience over the years as he came to us from Allegiance.

The rest of that management team also very strong management team.

They've spent a great deal of time doing a fairly detailed analysis about the market, the marketplace, the economics by particular group, where it's in the stronger growth areas that could complement our hospital offering and our -- and our self-manufactured product offering.

And, you know, doing that in a fairly meticulous way, you know, across the different areas of the -- of the acute care market.

So it's -- it's really being driven, the opportunities we see are being driven by having a very strong management team in place and one that is done the homework which is why we're, you know, we're poised to act upon that.

Next question.

Your next question is from Christopher Mcfadden with Goldman Sachs.

Thank you.

Good morning, and congratulations on the nice results.

A couple of questions all revolving around PTS if I might.

Firstly, George or Bob, are you satisfied with the overall financial and operating performance at PTS?

Is it performing at your expectation and I guess could you talk around how, if there's a delta to your expectation how you expect to close it?

The second part of that question would be, you know, at the margin, are you seeing changes in the attitude of large pharmaceutical manufacturers towards partnering with organizations like your own that offer outsourced services?

We certainly see that in other parts of the pharma enterprise.

And then finally, George, you said in your prepared comments that you expected PTS to be, I think, quote, the strongest performer in the Cardinal portfolio.

And I was wondering if you could just quantify what that means from a top and a bottom-line perspective to the extent that you're comfortable.

Thank you.

Okay.

Chris, good morning.

First of all, with regard to satisfaction, for those that have followed me for the 20 years on these calls by quarter, we're internal, the answer is no.

We're sort of never satisfied that we've done enough and there's just, feel like we could have done better and but don't look back and say how are we going to get better.

So let me kind of just shift it over to George to address, you know, to address that and say, yeah, we could have done better but here's where we're going and this is what we think the opportunity is.

Bob took that first because he was afraid what I might say.

Yeah, look, I think on the PTS business overall, I mean I like where we're positioned, Chris, in terms of what we have in an offering where we've built our capabilities and pharmaceutical development, and all the different important dosage form areas how we've positioned ourselves and our manufacturing capability on a commercial scale how we're working to integrate that around the customer so that, you know, we are coordinated and they see us as an integrated operation globally so I like all those things that we have done to position ourselves.

I think we've gone in the past four years in PTS from -- from -- from a couple of acquisitions to, you know, nearly a $3 billion integrated organization and it's taken, you know, it takes time to do.

Admittedly I wish that we had executed faster and better and could have been in an even stronger place from a results standpoint.

Just takes a long time to do start-ups.

At the same time as I said, our position is strong, and, you know, we, over the past few quarters, we have been impacted by the sterile regulatory delays.

That game is always a waiting game.

It's binary.

You're either 0, not going, or 1, you are going.

And so, you know, we've always sort of built it into our forcast it's going to happen based on some reasonable assumption about the progress of the FDA and our work with customers and our own progress in validating operations.

You know, in this case over the past, you know, the past fiscal year, you know, we've -- we've seen the set-backs.

That said, you know, we were dealing with products that were approved products, we were going to become the secondary -- or source of supply.

In the case of Prevnar, we are the source of supply going forward so that's a predicable opportunity so that we've placed there from sterile standpoint will, you know, will start to pay off.

So likewise if I look across the total PTS, as I characterized it, it's a business that's not an algorithm like you can predict in the distribution or the pharma distribution or med-surge distribution.

It's very event-driven.

And the goal has been if you get enough scale and breadth of services that essentially you become a mutual fund of services and capability for the pharma and Biotech industry.

And it's taken some time to get there but I think we're there if you look within that mutual fund you could characterize the sterile business as the high growing product, nuclear and pharma packaging services as a good grower, and oral will be a slower grower in some measure because we had the amnestine product that has been quite substantial and also the Zyprexicide.

So, in combination, we see that as the strongest grower in Cardinal's portfolio long term.

What exactly that means, you know, for our guidance, is mid teens or better.

Earnings growth PTS will be at the higher end of it.

That's probably about as specific as I could characterize it.

In terms of are we seeing different behavior in our pharmaceutical customers it depends on the customer, Chris.

I think, you know, some are looking more assertively at outsourcing and how they can in some ways see it as a means to more efficiently manage the capital base.

I think that's going to become a more significant opportunity particularly as things like reimportation and pricing pressures compel people to look differently at how to provide, you know, or deal with better pricing as opposed to going through the work around the reimportation so I think it can benefit outsourcing but it's really those that have been more externally focused that will lead that.

And then ultimately followed by those, you know, that get pushed into it because of the events that are happening around them and of course Biotech is an all together different matter but you think your question was more related to big pharma.

Okay.

Next question.

Your next question is from Tom Galluci with Merrill Lynch.

Good morning.

Thank you.

I was just wondering, George, if you could you give us a little bit more color on the discussions with manufacturers toward these fee-for-service type arrangements, obviously recognizing the sensitivity of the discussions but I think you mentioned categorizing manufacturers into eight clusters.

Could you talk maybe at least at a high level about how the nature of the discussions and the issues involved might vary between the clusters?

If you ultimately expect all manufacturers to enter into these t.ype agreements or if some, you know, ultimately probably won't and maybe what your update on the expected time frame would be at this point to have it be a more mature issue as opposed to early stage issue.

Okay.

Well, first of all I'm very pleased with the progress that I'm seeing.

Being able to go to the NACDS annual conference was very timely, you know, met with a number of manufacturer customers there as well as provider customers.

You know, look, this business historically was a logistics business, it moved to a buy and hold business and now it's returning to a logistics business and that's, you know, that's where it's headed.

I think could I say that the manufacturers we have agreements with them today, the nature of those agreements are going to change, and everybody's looking for ultimately moving to a new agreement.

I think what has certainly helped the discussion is that the discussion has moved from -- through the theory to, you know, to the practical application.

And that's been helped by the enormous body of work that we've been doing over the last literally six months to analyze each customer, analyze each product line, and to go into the detail that I mentioned, and to put it into these eight clusters and then to be able to take this information and sit down and basically walk through a, you know, a presentation but that presentation in some cases will be several presentations over the course of several weeks because we basically, you know, start with your day- to-day contact and you ultimately this gets to the CFO because this does become an important consideration from a financial standpoint, and then ultimately it makes us way to the CEO.

I think if you look at some of the customers, our manufacturer customers like Merck this was an initiative, you know, that they've been looking at.

We obviously were looking at and came together on it and made rapid progress because they had been spending some time educating themselves on the cost of doing business so that's why I said I think the customer -- the manufacturer customers who are coming to the table and starting to do their own work is where we're seeing the greatest progress.

I think ultimately all of them will be doing that because they will see that as an opportunity, again, in an environment where they're looking to manage their cost of doing business particularly the intangible cost going forward.

I think the biggest, you know, one of the considerations that they're trying to manage is that these new agreements move to a financial impact that goes from being a loss of sales revenue to an item on their P&L and that obviously is a transition.

And so obviously we are working with us to help address that and some are starting to bake that into their planning processes depending upon their fiscal year and, you know, so our timing on this is particularly good.

That's probably one of the bigger issues they have but it's one they'll work through because those who are getting at the analysis are understanding that ultimately, they can help get costs out of their business by moving to a just in time system and to recognize in a transparent way on their P&L and ultimately they'll see some bottom line impact as well from the supply chain cost that they can address.

So I think these discussions are now moving into a much more informed kind of discussion because, you know, they now know it's real.

They're starting to do their own work and it's making good progress.

In terms of the timing I can't predict dates because like I said, these things -- this is an evolution.

We have agreements with everybody today and those agreements are going to continue to get refined and we'll continue to see improvements in our business as a result.

Okay.

I guess we'll take one more question, please.

Your next question is from Glen Santangelo with Charles Schwab.

Yea, thanks Bob.

I just have one quick question.

You know, the revenue growth in the drug distribution business clearly was a little bit better than what was expected.

Now IMS has been reporting very soft revenue trends in the U.S. pharma industry in the first quarter I was wondering if you could sort of reconcile as to what you're seeing, the secondly for Dick, was there a LIFO debit or credit, you know, in the quarter versus last year given how much you bled down inventories?

Thanks.

Dick you want to just make a comment on LIFO quickly then I'll get to --.

Yea.

Glen, there was no charge or credit in the third quarter for LIFO.

With regard to growth we think industry growth -- first of all we think we've got -- we will grow faster than the industry for several reasons.

Some of which we cited and talked a lot about which is the integrated -- the integrated provider approach that -- marketing approach we have is an example.

On an apples for apples basis no acquisitions or anything, you know, to have an acute care market growth be in the 15% is, and you know, there's not price leadership here we must be winning for based upon the services we're providing and the breadth of our offering.

So we're going to go faster than the industry.

You know, we read as much as you read about it and look at and talk to manufacturers and I think we're comfortable that with unit growth plus expected pricing -- price increases that we expect the industry growth to still be somewhere in the distribution industry growth to be somewhere in the 10 to 12% range.

We think we're going to be on the upper side of that and above that range, based upon the breadth of the offering and the quality of the distribution service we provide so that's about as much guidance I think as we can give you right now.

We're not really triangulating off -- I know IMS puts a lot of data out.

We're not triangulating off of whatever their last months' data is.

Anyway, that's where we are.

Let me just kind of wrap it up by saying we're looking forward to completing the fourth quarter and I've already given you guidance for that and moving into '05.

L's a lot going on here.

Things are coming together well, and look forward to the conference call in late July.

Thank you very much.

Thank you for participating in today's Cardinal Health third quarter 2004 earnings conference call.

You may now disconnect.