卡地納健康 (CAH) 2004 Q4 法說會逐字稿

(OPERATOR INSTRUCTIONS) At this time, I would like to welcome everyone to the Cardinal Health Conference call. (OPERATOR INSTRUCTIONS) At this time, I'd like to turn the call over to Mr. Jim Hinrichs, VP of IR.

Sir, you may begin your conference.

As you probably know, earlier today we filed our fiscal 2004 Form 10K and released our fourth quarter earnings.

For those who don't have a copy of the documents, they can be accessed on the Internet at our IR page, at www.cardinal.com.

One important other thing that's on the website is some of the slides that we'll be walking through during the conference call today are also on the website, so if you don't have a copy of the slides, be sure to get to the website and get a copy of them as that'll be what Michael Losh will walk through.

On the call today are Bob Walter, Chairman and CEO, George Fotiades, President and COO, and Michael Losh, the CFO.

In a few minutes, I'll turn the call over to Bob, who will make a few opening remarks, and then he will turn it over to Mike, who will spend the bulk of the call walking through a summary of the fourth quarter and the information that's in the 10K.

After Bob and Mike's prepared comments, we'll open it up for a few questions, and as always, when we get to the questions, I ask that you limit yourself to one question at a time.

A few housekeeping items before we get started.

First of all, I just want to apologize to everybody for the lack of the warning and the tight timing of this filing and the conference call.

I'm sure you can appreciate, we wanted to file just as soon as possibly could, even at the expense of giving advance notice of the filing and the call.

We also did have a bit of a technical glitch here in the last couple of hours, which delayed the filing a little bit.

We obviously recognize that the 10K that we just filed is very long, it was filed only a few hours ago, or actually about an hour ago, and therefore you have not read it completely yet.

The purpose of this call is really to highlight some of the key items contained in the 10K and help you focus on the important pieces of information that are in the document.

Of course, IR will be here tonight after the call and in the coming days to answer any detailed questions you may have.

Second announcement is I'm pleased to announce we've rescheduled our analyst meeting.

The meeting will be held in New York City at the Hudson Theater at the Millennium Hotel the morning of November 5th.

The plan is to release first quarter earnings around that time, either after market close on November 4th or early the morning of November 5th, and then use that meeting that morning to discuss the first quarter results and update you on the operating plan for the rest of 2005, so look for an invitation in the next day or so.

And finally, before begin, please remember that today's call may include forward-looking statements, which are subject to risk and uncertainties, which could cause actual results to differ materially from those predicted or implied.

The most significant of those uncertainties are described in Cardinal's Form 10K and Form 10Q reports and exhibits to those reports.

Cardinal 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 IR page at www.Cardinal.com.

And at this time, I'd like to turn it over to Bob.

Go ahead, Bob.

OK, thanks, Jim.

We filed our 10K today for the year ending June 30th.

It was a long time coming and the work involved in getting it done should not be overlooked.

Therefore, I'd like to acknowledge and say thank you to everyone that contributed to getting this document filed, in particular, Mike Losh and the finance team and Paul Williams and his legal team, all of whom have put in many long days and I can tell you, nights, over the past few months, to make this happen.

So it may have taken longer than we originally expected.

I'm pleased that we took the time and employed all internal and external resources necessary to do it right.

Mike will walk you the process that was followed.

The circumstances around this call are a bit unusual, in that the first quarter of 2005 is already complete, and we're restricted in what we can say about the current operations or results.

So we'll focus today on the fourth quarter, the full year of 2004, and the information in the 10K.

Mike will lead us through these items and he will spearhead the bulk of the call.

George Fotiades is also available during the Q&A period.

Incidentally, as Jim said, our first quarter earnings release will be next week, followed by the analyst meeting.

Now I'll make a few high-level comments about issues that I know must be on your mind.

The first thing, regarding our fourth quarter and full-year performance for fiscal 2004 -- we achieved mix results for the year.

Certainly our net earnings of $1.5 billion and earnings per share at $3.55 they were below our expectations set at the beginning of the year.

Our goal was a couple of percentage points higher for growth over prior year, and to finish with a much stronger second half.

We did achieve strong revenue growth of 15 percent, a very respectful 20.7 percent return on equity, and free cash flow generation of more than $2.1 billion, well in excess of our goal.

Most disappointing was the way we exited the year with less momentum than we entered.

The transition in the pharmaceutical distribution business has taken longer than we anticipated, and other segments are not meeting our growth goals.

But all this can change.

Was it a terrible year?

No.

But the fact is that it was below our expectation and yours, and that makes it not a great year, though we are committed to making the future great.

The second item I want to talk about is with respect to the accounting investigation.

The internal audit committee-- I'm sorry, the internal audit committee review is substantially complete with regard to the financial statement impact of the items identified to date.

The restatements resulting from this internal review are detailed in the 10K, and Mike is going to walk you through them in considerable detail -- but just a few high-level comments from me.

With respect to the next steps, it is the audit committee's role to address responsibility for the problems that have been found and implications for any individuals involved.

That is one of the issues the audit committee will be focusing on now.

While this internal review has been a long and difficult process, a lot has been learned and a lot of good has come from it.

We have been made aware of some things that we don't like, as reflected in the 10K.

For example, some management practices and judgments, control procedures, and documentation.

We've been under-resourced in some important areas.

This is not acceptable, particularly for a company that aspires to the quality levels that we do.

I'm here to tell you that there exists the right degree of humility and resolve to make changes that will allow us to do everything right, and that means totally right.

I've discussed with our board of directors my intention to put in place the following measures to deal directly with the issues identified by the audit committee's internal review.

First, we'll be creating an office of chief compliance officer, and the appointment of such officer to help ensure that the company is following best practices with regard to regulatory and compliance matters.

Second, to further strengthen our leadership by adding a role of chief accounting officer, separate from the controller, whose role it will be to keep us attuned to and current with contemporary accounting issues.

And third, to engage in a broad-based educational program for our personnel, at all levels, in the organization, in areas such as personal responsibility, ethics, corporate compliance, and disclosure.

And fourth is to commit the additional resources necessary to ensure that proper processes, procedures, and controls are in place to ensure that we meet the best practices in financial reporting.

My third general comment area is that while the last few months have been challenging as a result of the investigation, I want to assure you that management recognizes that its primary task is to grow the company and properly position it for the future.

Our 2004 results were below our internal operating expectations.

Cardinal's annual cash bonus plan payout is based on company performance and individual performance meeting internal expectations.

As you may have already seen in the 10K, total bonus payouts were significantly below targeted amounts for the entire company, and the executive officers received no bonus in fiscal 2004.

This may seem harsh but it reflects the reality of life at the top of the pay-for-performance organization.

When we meet high standards set, we will be amply paid throughout the company.

Shareholders suffered last year, and so did our team.

The fourth area I want to discuss is the developing business model in pharmaceutical distribution.

As I said earlier, the transition to an acceptable fee-for-service structure has taken longer than I expected.

But let me reiterate that the distribution system is very secure in its place in the supply chain in that we expect the profitability of our pharmaceutical distribution business to return to its historic levels, adjusted for less capital employed.

By that, I mean a return on sales of 2 percent to 2.5 percent.

Let me give you a little historic perspective on the pharmaceutical distribution industry by comparing it to how it looked in the early 1990s.

So we're going to compare it to the early 1990s.

Since then, the industry has grown nearly tenfold to be a $150 billion industry today.

At the same time, the industry has consolidated to where three distributors account for over 90 percent of the business versus 93 distributors at the beginning of this period.

Distributors today serve, on a daily basis -- this is on a daily basis -- distributors serve over 140,000 customer sites with a 12-hour order cycle, delivering 98-percent service level on pharmaceuticals.

The number of sites served has increased fourfold in this period.

Additionally, the number of products handled through a DC has increased two times.

These are some of the indicators of the increased complexity of the logistical task.

Additionally, we administer the pricing terms on over 100,000 contracts between manufacturers and providers.

The average pharmaceutical distribution center today is highly automated with annual sales exceeding $1 billion.

So in spite of the proliferation of products, the increased special handling requirements, dramatic growth in pharmaceutical sites and products handled, and the higher service requirements -- in spite of all that, the distribution industry's cost structure has been reduced by over 60 percent since the early 1990s.

The current costs today are below 2 percent of sales.

All of this is a reflection of manufacturers concentrating over 90 percent of their volume through the pharmaceutical distribution industry and providers acquiring generally all of their products from one wholesaler only.

This is the prime vendor model that uniquely exists in the pharmaceutical distribution industry.

This logistical system, combined with information and administrative support, is the most efficient channel with unparalleled level of customer service.

I'm not concerned about that.

Historically, manufacturers have paid for distribution services to get their products to market based upon their sales practices.

These sales practices include such items like cash discounts, promotional allowances, product return policies, and, in the most recent 20 years, the availability of product in advance of price increases.

We call this "buying margin."

So as the wholesaler reduced its selling price to the provider to reflect almost basis-point-for-basis-point, as we reduced our selling price to the provider to reflect this increased efficiency achieved through the prime vendor model and the consolidation within the industry, the buying margins that resulted from the manufacturer sales practices have become increasingly important.

So any reduction in manufacturer sales practices that affects the buying margin, either the amount of product available or the rate of product price increases, has a significant effect on the wholesalers' profitability.

So what has changed from this old model that makes it unworkable in today's world?

Well, the answer is really quite simple -- manufacturers have changed their sales practices, limiting our compensation opportunities.

By changing their sales practices, I simply mean that they have limited our ability to purchase product in ways that have been available to us for decades, and they've changed their product pricing policies.

Basically, our access to discounted product has been severely limited and at least over the past several quarters, product pricing increases have slowed.

The result is reflected in our financials in the fourth quarter of 2004, and what you'll see in our early 2005 results.

This is an industry-wide issue and, in fact, since we first revised our guidance in June of 2004, all three other publicly traded drug distributors have lowered their earnings expectations citing similar reasons.

Oddly, this change in sales practices isn't, in itself, a bad thing.

It's designed to help the manufacturer control the flow of product to the market.

For the manufacturer, it will give them more visibility to product movement all the way to the provider, along with real-time product movement data and a more balanced manufacturing process.

But in the process, margin has been moved upstream to the manufacturer.

This wasn't the primary objective of the manufacturer.

One of our other competitors said it was collateral damage suffered by the wholesaler.

I understand what he means, I just don't think we should just be considered collateral.

We're essential to the stream.

So our objective is to capture that margin but, at the same time, we intend to price our distribution services according to specific -- we tend to price our distribution services according to the specific cost to distribute each manufacturer's line, and we intend to be paid on a basis that is not contingent on inflation.

As a result, we have set a target date with most of our manufacture partners to have an agreement in place, which includes non-contingent, fair-market-value compensation for our services.

This phrase, which is our definition of a successful end state, is worth repeating -- non-contingent, fair-market-value compensation.

What does it mean?

It means adequate compensation based on market value of our services to that specific manufacturer, which is not contingent on anything other than our satisfactory performance of the distribution services.

These types of arrangements will allow us to have more stable and predictable compensation for manufacturers and therefore earnings in our distribution business.

Now, how is this end-state different from the current environment?

Let me break it down by component.

First, with regard to the non-contingent component.

The majority of our IMA agreements with our manufacture partners have compensation to us that is still contingent on their price increases.

While it could be adequate if the manufactured product pricing is right, it doesn't make sense in that we are providing day-in and day-out reliable service in exchange for the potential of price increases that may never come to be.

Incidentally, this may well be adequate for this year, but this is the middle-man mismatch that must be changed.

By "middle-man mismatch" I mean variable margins upstream but fixed discount to the provider downstream.

This unreliable compensation model is exactly the opposite of the reliable service that we must deliver for the manufacturer and ultimately the patient who uses these products.

Secondly, with respect to the concept of fair market-based compensation -- the old model does not differentiate between each manufacturer's specific product line service needs and costs.

As you might expect, each manufacturer's unique product line requires different levels of service and logistics.

So naturally each manufacturer's product line has a different cost of distribution including logistics in its administration and capital costs.

The old models did not account for these differences.

A small manufacturer with a complex product line requiring refrigeration or other special handling was not priced differently from large, high-volume manufacturer with simple handling costs nor was there a difference in a manufacturer's line extension, customer channel bias, or product concentration considered.

We have done an extensive analysis called "next-best alternative," we refer to it as NBA -- next-best alternative.

We've done an extensive analysis study that lets us objectively determine for each manufacturer the cost of their next-best alternative distribution method.

This, in turn, allows us to determine the appropriate level of compensation to us from each manufacturer based on their unique distribution needs.

What we've learned is that in the past some manufacturers pay too much, some too little, and the others are about right.

So we've looked at the cost to distribute each separate manufacturing line, and any next-best alternative.

Frankly, the efficiency of Cardinal and the industry allows fee-for-service pricing well below any other effective alternative for the manufacturer.

With that information in hand, we are able to sit down with each manufacturer, have a productive conversation on the right amount of compensation, and move into a discussion on how to make our compensation non-contingent.

We are now working our way through the list of our manufacturer partners with the objective of completing agreements for non-contingent, fair-market-based fee-for-service agreements by April 1, 2005.

So that brings us to the final question -- how are we doing in these ongoing negotiations with the manufacturers?

Well, since sending out our well-publicized letter to manufacturers in August, I am pleased to say we have signed a number of new, non-contingent, or fee-based arrangements with manufacturers, and progress has accelerated.

The bottom line is very simple -- we are working hard to be paid properly by the pharmaceutical manufacturer for the services we provide, and we can no longer afford to be dependent upon their sales practices for that compensation.

Incidentally, these sales practices, which includes the amount of product had been available to us to buy in advance of price increases, these sales practices were developed over the years to arm's length negotiation between manufacturers and distributors, and they will change again in the same way.

The process by which we get there may be time consuming, but it is really that simple when you cut to the chase.

We are making progress and look forward to providing a much more detailed update in some specifics on November 5th at our analyst meeting.

A brief comment on the sell-side environment -- we are seeing real evidence of stability in selling margins, although the market remains competitive.

We are reviewing customer contracts and are working to eliminate inefficiencies that current exist as well as instituting new pricing programs that improve returns in some areas.

We are focused exclusively on client-vendor relationships, as secondary relationships are unprofitable and a drag on the efficiency in our system.

The sell-side margin environment must improve over the long term.

We are taking the steps necessary to make that happen in our dealings with existing customer relationships and with potential new relationships.

We are selling on value delivered.

As I said, our goal in the pharmaceutical distribution is get back to the returns and margins that are commensurate with historic returns adjusted for the lower capital invested in the business.

Based upon our NBA studies, our ongoing negotiations with manufacturers in the sell-side environment that should develop, we believe, that goal is achievable.

Regarding the opportunities and challenges in our other segments, I'm going to defer talking about them to our analyst meeting following next week's first quarter earnings release.

The guidance that we gave you on September 13th remains unchanged.

We indicated that earnings per share versus last year we'd be down 25 percent in the first quarter, approximately, and we're down 10 percent to 15 percent in the first half.

Our EPS goal -- growth goal -- is still 10 percent for the full year.

We'll provide more color on our 2005 operating plan next week.

So let me turn this over to Mike to cover our fourth quarter, the full year, and our 10-K filing.

Let me say the following -- we've got a great company with wonderful market positions in a growth industry.

We are implementing changes to deal with the issues raised by the audit committee's internal review.

Our management, including me, is both near-term focused and up to the task and long-term oriented.

Now, while we don't like any low-scoring innings, we will be winning the ball game.

At this time, I'd like to turn the call over to someone I've known and respected for a long time, our new chief financial officer, Mike Losh.

Thank you, Bob, and good evening, everyone.

I look forward to meeting many of you at the end of next week.

I'm particularly pleased to report that the company has completed and filed its fiscal 2004 Form 10-K with the SEC earlier today.

Also, like Bob, I'd really like to acknowledge and thank the many individuals involved in this process and their hard work over the recent months to make this a reality, and I know a lot of you are listening to the webcast.

I really appreciate what you've done for this company.

In connection with today's filing, we have also issued our fourth quarter and fiscal year 2004 earnings release, along with the relevant financial table attachment.

All of these items will be referred to during my remarks this evening.

In fact, one of the things, for those of you who have had access to the charts that went out with the earnings release, if you've got those handy, you might want to follow along.

I think it makes it easier -- the high points are there.

I will refer to them periodically, in some cases, by number.

There's a number in the lower right-hand corner.

You should be on sheet 3 as I speak right now.

My goal tonight is to provide you with a quick run-through of the consolidated financial performance for the fourth quarter and fiscal year and to provide a high-level summary of the key points contained in the earnings release and particularly in the form 10-K filing.

I recognize the document is very long, and that it has just been issued, but the purpose of this call is to help you get focused on some of the key information that you may then want to review in detail and talk with us about in the future.

While many of the restatement items were explained in our Form 8-K filing back on September 13th, I want to try to pull all the pieces together as you begin to examine the 10-K.

I will also touch briefly on the outlook for fiscal 2005 and, at the very end, make a few comments on our liquidity position, since I know that got a lot of your attention last week.

First, the fourth quarter and the fiscal year pretty much came in the way we expected and communicated to you back on June 30th and then again on September 13.

Not a lot of surprises, and as I took the appropriate amount of time to go through the various accounts and items, I was really pleased with the way things did come together.

In fact, since we just formally closed the books on the fourth quarter, we had the advantage of two months of what would normally be hindsight.

This required us, actually, to record some items in '04 because of the facts that emerged during this passage of time.

An example -- just to cite one of the kind of thing that we made some adjustments for -- there were a couple of cases where we actually received cash for specific receivables that had been previously received as -- previously been reserved due to doubts about collectability.

That's one of the reasons that the fourth quarter actually looks a little bit better than you might have expected and that we previously forecast.

One thing that I think you will see as you read through the 10-K is that Cardinal Health is increasing transparency by providing you some fairly significant detail about one-time adjustments and other pertinent information to age you in your analysis of our results.

We hope the increased transparency and additional information is useful to you, and we're committed to continuous improvement of our disclosures, as we move forward.

Second, as disclosed in the 10-K, the audit committee's internal review is substantially complete with regard to any items identified to date that could have a financial statement impact.

The company has incorporated those conclusions in our financial statement, and Form 10-K by providing some expanded disclosures affecting certain revenue classification and restating financial results for the periods presented.

Now I'd like to talk and give you a few comments about the process that the audit committee has undertaken over the past six months.

As you may recall, the audit committee, along with their independent counsel, commenced its internal review in April of this year.

The process that they undertook included reviewing documents, interviewing certain company personnel, verifying documentation, disclosure, and accounting treatment of certain transactions and performing various other forensic accounting procedures during the periods under review.

The audit committee also requested that the company's independent auditor, the company's internal legal department and internal audit department, complete certain additional procedures in connection with this effort also.

During this process, the audit committee, through its independent counsel, has provided the SEC with periodic updates regarding the substance of the audit committee's review and conclusion.

In summary, and this is called out on Slide 5, the audit committee's findings, to date, is more fully discussed in footnote 1 of the company's financial statements, and while their work covered a lot of ground, I would classify their conclusions into four distinct categories, and I'll be talking about each of these individually.

The first is revenue classification, the second is disclosure of cash discounts, the third is the timing of revenue recognition within the automation and information services section -- and I should point out to you -- this is an item that was not discussed in our September 13th 8-K, and the fourth major item concerns balance sheet reserves and accruals.

While you may be familiar with several of these items, particularly if you talked with us at the time of the 8-K, I would like to briefly cover each of these.

The first, concerning revenue recognition, is highlighted on slide number 6 in your package.

For the past several years, the company reported two separate classes of revenue on the face of the income statement -- operating revenue and bulk deliveries to customer warehouses and other.

The company distinguished between these two categories based on how long the inventory was in the company's possession prior to being shipped to the customer.

Based on the results of the audit committee review, we concluded that certain bulk shipments were intentionally held beyond 24 hours so that pursuant to our internal policy, the shipment would be classified as operating revenue.

Today's 10-K includes disclosure of this practice and the impact on each revenue category for the periods affected.

For fiscal 2003 and 2002, and these amounts are detailed on Slide 7, operating revenues were overstated, and bulk revenues were understated by $813 million and $414 million, respectively, for those two years.

It should be noted that the improper classification had no impact on the company's previously reported total revenue or operating or net earnings for these periods.

Beginning with fiscal 2004, the company has changed its presentation to present a single revenue category and all periods presented have been reclassified to conform to this new presentation.

PDPS segment revenue will now include bulk sales, which we define as delivery to customer warehouses whereby the company acts as an intermediary in the ordering and delivery process.

Secondly, delivery of products to customers in the same bulk form as received by the company from the manufacturers.

A third characteristic is warehouse to customer warehouse, our process center deliveries, and a fourth characteristic is deliveries to customers in large or high-volume full-case quantities.

Disclosure of bulk sales, which totaled $18 billion in fiscal 2004, is presented in the MDNA in Form 10-K, and we will continue to present bulk sales in the MDNA, but it will not be on the face of the financial statement.

All growth rates and other financial metrics previously computed using only operating revenues have been recomputed and presented to conform to the new presentation.

In this case, I'd refer you to footnote 2 in the company's financial statements in the 10-K for a more fulsome discussion of this reclassification.

Slide number 8 talks about the accounting for cash discounts.

The company has historically recognized cash discounts as a benefit to cost of goods sold primarily when we pay the vendor's invoice.

As we originally disclosed in our 8-K filing and included in footnote 1 of the 10-K, the company also had a practice of periodically accelerating payment of vendor invoices at the end of certain reporting periods in order to earn cash discounts, which had the effect of increasing operating results for the reported period, and this practice and amount was not previously disclosed before we talked about it in the 8-K.

While we believe that this is and was an acceptable method under GAAP, we've decided to change our method of accounting for cash discounts effective as of the beginning of the fiscal 2004 year.

We now defer the cash discount benefit upon invoice payment and recognize the reduction in cost of goods sold upon sale of the inventory.

We believe that this new method is more objective and provides better matching of inventory costs and our revenues.

The cumulative effect of this accounting change for all fiscal years prior to 2004 reduce net earnings per diluted share by 9 cents a share -- as you can see, reported separately on the face of the income statement, and for 2004, the accounting method change resulted in an increase in net earnings per share of 3 cents a share.

And, once again, if you want to get into more specifics on this, it happens to be footnote 16 in the 10-K.

The next item is highlighted on Chart 9, and it concerns the timing of revenue recognition within automation and information services, and we're primarily, for this past year, talking about Pyxis.

That will be a broader segment this year, as you are all aware.

The revenue recognition policy for this segment is to recognize the revenue from sales-type leases, once the company's equipment installation obligations are complete, the equipment is functioning as specified, and that the customer has executed written acceptance of the equipment.

As part of the audit committee's internal review, an inquiry was commended, which concluded that some equipment confirmations, particularly in some sales regions, had been prematurely executed by customers at the request of some of our employees including some situations where inducements to the customer, such as deferral of payment, were offered to obtain premature execution.

While there is no evidence of any fictitious sales, this is clearly not an acceptable practice.

We recorded an $8.3 million reduction in revenue and a $5.3 million reduction of operating earnings during the fourth quarter of fiscal 2004 to adjust for premature revenue recognition that was determined to have occurred within that quarter.

While the financial statement impact of this practice was not material to the company's revenues or operating earnings for any quarterly or annual reporting period, disclosure of the impact as well as the corrective actions that are being taken and being implemented are included in footnote 1 of the company's financial statements in the 10-K.

This item was not included in our 8-K and thoroughly investigating this matter is one of the things that contributed to us being as delayed as we are in terms of filing the 10-K.

The last item that I'll talk about, and this is with regard to the investigation, concerns the balance sheet reserves and accruals.

This material is shown on Slide 10 and 11, first to talk about 10 -- the audit committee review included a comprehensive review of period-end adjustments to balance sheet reserves and accruals for recent past fiscal years.

Various financial statement errors and adjustments were identified during the review, representing situations where the amount and/or timing of reserve recognition or the timing of the release of the reserves was in question.

As such, the financial statements have been restated for certain prior periods.

The net impact of the restatement is to decrease earnings per diluted share by 3 cents for the first three quarters of fiscal 2004 and by 7 cents for fiscal year 2003 and, actually, to increase earnings per diluted share by 3 cents for fiscal year 2002.

If you look at Slide 11, if you've got access to that, that shows the amount in greater detail.

It's also greater detail than had been included in the 8-K at the time we did it, although we're still summarizing in much the same way.

One category is errors arising from misapplication of GAAP, and a typical example of this would be a situation where a reserve was examined; it was determined that an adjustment needed to be made, but that adjustment was not made until the subsequent period.

And then there's a column that you'll see that's headed up "Errors."

And "Errors" fall under the category that where errors were found, identified, and then appropriately corrected in the period in which they were discovered.

While these were not previously reported at the time of their discovery, because they were deemed immaterial, we have now decided to simply correct for these items and include them as part of our restatement at this time.

So we're correcting things that were a misapplication of GAAP and also correcting all other errors that we are aware of.

This category, the errors category, includes a refinement in the estimation methodology regarding vendor margins earned from generic and branded pharmaceuticals as well as health and beauty products.

Vendor margin for these three product categories has been and will continue to be recognized as the product is sold.

However, the changing business model has resulted in differing levels of inventory holding for each of these product categories.

As such, the company's approach of recognizing margin was refined by being based on -- it used to be based on total inventory turns for all of those products together, now we are segregating that inventory into three categories -- branded, generic, health and beauty products -- and each of those categories will carry its own merchandising margin while it's in inventory, and then that will be reflected when those products are sold, and they'll all have their own turn rates and own calculations.

Quite honestly, this results in a better matching of costs and revenues, and I think you'll hear that's a theme from us in several places.

This is, we believe, an improved way of keeping the books.

Lastly, and you've heard about this from us before -- the third category of restatement was our previous accounting estimated recoveries for vitamin manufacturers and instead of recognizing it on an estimated basis, we've restated so that it has now been recognized when the payment was received.

As I mentioned, we have incorporated these items in our financial statements, so I'd now like to continue with some observations on the results of the fourth quarter and the full fiscal year.

My comments primarily relate to results from continuing operations and exclude any impact of special items, and that's the way you're used to hearing your results from us on this kind of a call.

For the fourth quarter, revenues were up 11 percent to $16.9 billion as shown on Slide 12, with operating earnings up 3 percent to $622 million.

Positive interest expense and tax expense leverage delivered net earnings growth during the quarter of 8 percent to $423 million and diluted earnings per share growth of 13 percent to 97 cents a share.

For the full fiscal year, as shown on Slide 13, revenues were up 15 percent to $65.1 million with operating earnings up 7 percent to $2.4 billion.

Positive interest expense and tax expense leverage, again, delivered net earnings growth during the year of 10 percent to $1.6 billion and diluted earnings per share growth of 14 percent to $3.55.

As expected, our repurchase of 24.2 million of our outstanding shares during fiscal 2004 had a positive impact on overall earnings per share growth during the year.

Free cash flow for the year well exceeded our goal; was over $2 billion and return on equity for the year was 20.7 percent.

Our cash flow proceeds -- our cash flow includes net proceeds from the sales of certain automation lease receivables, and that had a positive impact on our cash flow of just about $100 million.

Now I'd like to provide you with a few insights into the segment performance for the quarter and fiscal year, but before I go into the numbers, I want to comment on a couple of additional segment disclosure items that you'll find included in the 10-K that we think will be helpful as we and you go forward in terms of analyzing performance of the individual business segments.

First, we have enhanced our MDNA discussion of each of the operating segments' performance by providing more qualitative information including information on revenue and operating segment growth, excluding the impact of acquired businesses.

We believe this information will help investors better analyze the performance of each of these segments, and I'll cover some of that in my comments later this evening.

Second, we've greatly expanded our discussion of corporate allocation of revenues and expenses to the segment both in MDNA and in footnote 18 in the 10-K.

While we have not made any changes during the fiscal years presented to the methods that used to allocate items to the business segments, we have decided that enhanced transparency of the amounts and categories of corporate allocations would be useful to investors, and I just want to take a few minutes to summarize some of the key improved disclosures.

As always, segment financial performance is presented after allocation of corporate administrative expenses, and the allocation is based on a reasonable basis -- comprehending revenues, operating revenues, employee base -- those are typically things that the companies use, and we do, as well.

We have made the decision not to allocate certain corporate expenses such as corporate HR, corporate finance, and corporate information technology, and, in addition special items and certain other corporate-directed costs are retained in the corporate sector.

Some specific corporate-directed costs that are retained include investment spending, and this shows up on Slide 15.

This is money that, as we're looking to grow businesses, develop business concepts, do things that aren't in the normal purview of a particular segment of the business, the money might be spent in the segment, but we retain the cost of that spending at the corporate segment, and for fiscal 2004, that investment spending was $48 million, down $10 million from the prior year but above what it had been in the 2002.

Also, another item that we want to make you aware of is something that's an interest income adjustment.

For the past several years, the direction of the corporation, automation and information services, executed sales of a portion of its lease portfolio, transferred the proceeds to the corporation for redeployment.

Since the proceeds were not reinvested in the automation and information services segment, beginning in fiscal 2004, a benefit associated with those sales was allocated to the segment by the corporation for the interest income that they would have earned associated with those leases, and we're disclosing the fact to you that that benefit amounted to $21 million during fiscal 2004.

Another area where we have made some adjustments that we're disclosing to you at this point is foreign exchange adjustment.

We assess the pharmaceutical and technology segment performance using a constant foreign exchange rate as it relates to translation.

For fiscal 2004, $11.2 million of expenses have been allocated to the corporation to recognize that and the PTS segment was, correspondingly, $11 million higher than it would have been, again, to reflect that policy on using constant exchange rates.

Now, one of the things I want to point out to you is that for fiscal year 2005 and beyond, the interest income allocation and the foreign exchange adjustment allocation to the segments that I just discussed will be discontinued, and they just won't be factors anymore, but as we report, as we go through this transition for fiscal '05, the reported results for the segments, we'll need to provide you some additional data so you'll be able to do apples-to-apples comparisons as we go through the translation -- or the transition.

Now I'd like to switch and talk about each of the sectors.

First, on Slide 16, pharmaceutical distribution and provider services is detailed.

PDPS, segment revenues for the fourth quarter were up 12 percent.

However, the flat earnings growth year-over-year clearly demonstrates the pressures, the pharmaceutical distribution business model transition is having on the sectors earnings and our earnings, in total, as Bob talked about.

For the year, PDPS segment revenues were up 15 percent, and operating earnings were down 1 percent.

The key factors negatively impacting this segment's operating earnings were the business model transition that we've talked about, and the impact of competitive pricing on the sale side.

In addition, changes in the accounting for cash discount actually contributed $20 million in additional gross margin during the year, along with favorable year-over-year LIFO benefit of just a little under $15 million, and this was partially offset by $15 million of operating earnings decline related to the change in how we estimate vendor margins specific to each of the inventory classes that I mentioned to you previously.

The next Slide 17, talks about medical products and services.

For the fourth quarter, revenues were up 10 percent and operating earnings up 12 percent and, for the fiscal year, revenues were up 11 percent, earnings up 13 percent.

For both the fourth quarter and the fiscal year the strong sales momentum and distribution, coupled with productivity enhancements and the benefit of lower incentive compensation expense, positively impacted earnings.

However, the increased mix of lower-margin distribution business, competitive pricing in the industry, and an increase in raw material costs used in manufacturing has dampened operating earnings growth of this segment.

We expect these conditions will continue and will actually intensify as we move through fiscal 2005.

Slide 18 talks about the pharmaceutical technology and services business unit.

It should be noted that the decision to reclassify revenues as a single category had a small impact on this segment's revenues as well.

There was a relatively small amount related to customer reimbursement of out-of-pocket expenses related to medical education business that is now included in gross revenues.

It previously was included as part of bulk sales just because it's out-of-pocket reimbursement.

There was no margin on it.

For the fourth quarter, in this segment, revenues were up 4 percent with operating earnings up 14 percent.

Acquisitions, primarily InterCare, in late calendar year 2003, positively impacted this sector's performance.

Excluding the impact of acquisitions, revenues would have been actually down 4 percent, and operating earnings growth would have been 5 percent for the fourth quarter.

For the full fiscal year, revenues were up 25 percent, and operating earnings up 26 percent excluding the impact of acquisitions, and, in this case, because it's a full year, both Syncor and InterCare impact this year's earnings versus the prior.

Revenue and operating earnings growth would have been 2 percent and 8 percent, respectively, if you take out the impact of those acquisitions.

Revenues and operating earnings growth for both the fourth quarter and the fiscal year were dampened by the previously reported delay in startup of commercial manufacturing of key sterile products in this segment.

And, lastly, to talk about automation and information services, on Slide 19, for the fourth quarter, revenues were down 12 percent with operating earnings down 21 percent.

For the fiscal year, both revenues and operating earnings were up 2 percent.

Overall segment performance in both periods was negatively impacted by the slowdown in customer demand with the full fiscal year itself actually having a little bit of a favorable impact from a reduction in receivables reserves of about $8 million due to improvements in customer-specific credit and collection matters.

As I mentioned earlier, the company has incorporated increased transparency in various disclosures presented in the 10-K filed this afternoon, and I just want to bring a few of those items to your attention.

First of all, you'll note that management's discussion and analysis includes a more expanded discussion within the risk factors that may affect future results.

While I don't think any of these items will be new to the investor group that's here, I do believe they provide a more comprehensive view of some of the major challenges and opportunities that we face today.

Secondly, as you are aware, along with the participation of the CEO and CFO, we are required to evaluate the effectiveness of disclosure controls and procedures as of the end of June in connection with the completion of their audit work including additional procedures undertaken in connection with the audit committee's internal review.

Our independent auditors have identified and communicated a material weakness related to the company's control environment including whether the overall tone set by the company clearly communicated a strong commitment to sound financial reporting practices.

Furthermore, the independent auditor has concluded that a material weakness existed related to revenue recognition practices within the automation and information services segment.

Item 9a in the 10-K outlines the measures that the company has adopted or is in the process of implementing to improve our internal controls and corporate governance.

Bob spoke about this.

This is an area that is very high on my personal list as well.

The detail is in the 10-K.

A number of these are spelled out on Slide 20 that's in your package.

Obviously, there is a new CFO and, in addition, as Bob talked about, we're going to create the office of the chief compliance officer.

We will be looking to appoint a chief accounting officer.

That job has gotten so important that we've decided to separate that from the controller's role.

The controller's job is still an extremely important job but in today's world, we have concluded that you need both.

We are also in the process of -- we've got a search underway as we look to hire a new treasurer.

So there will be quite a bit of new talent coming into the finance team here at Cardinal.

Also, some of the other improvements that we have adopted or are implementing include adoption of additional processes related to the operation of the company's disclosure committee.

We are developing written procedures for items such as unusual financial statement adjustment.

You heard me talk earlier about how we allocate costs to the business segments.

We are going to and already have implemented process improvements in the financial statement close process.

We will be undertaking significant improvement at automation and information services to make sure that we eliminate the problems that we have had with regard to revenue recognition there.

There will be additional financial and accounting training for our employees and not just our finance employees; other staff functions and operations people as well, and we have implemented an enhanced certification process to make sure that his operating decisions happen; that they're based on appropriate business considerations, and if they have an impact on accounting, we want to make sure that we understand them, and that they are accurate.

While these are starting points, we believe that implementing the enhancements outlined in item 9a will correct the weaknesses in future periods, and, quite frankly, we are committed to continuing to examining this issue and to further enhance our control environment and our control processes.

Now I would like to just talk with you a little bit about 2005.

The material related to that is on Slide 21.

As you read in the press release, the company reiterated our previously provided goals of expectations of first-half fiscal 2005 earnings per share growth will actually be down 10 to 15 percent, with the first quarter down approximately 25 percent and, obviously, we will be talking about that with you next week.

While the primary driver for the client is the ongoing business model transition in pharmaceutical distribution, as we'll get a chance to talk with you, that's not the only thing that's going on, and we have challenges in the other business segments, which will also contribute, and each of the segments, as you look at how do we get to being down 25 percent for the quarter, quite frankly, as we look at the numbers, each of the business units it's going to be down double-digit at the operating earnings level, and we'll be talking -- and I'm talking about the first quarter, and we'll talk with you about that in detail next week.

While the company maintains an earnings-per-share goal of at least 10 percent for fiscal 2005, achievement of this goal is dependent on operational progress and improvements, particularly in pharmaceutical distribution and successful execution of the previously announced restructuring plan that we've communicated to you.

One of the good things about this business is we continue to see good top-line growth with revenue expectation in the low to mid teens, a return on equity of at least 20 percent, and strong free cash flow of equal or greater than 60 percent of net earnings.

I'd now like to conclude my remarks with just a few comments on liquidity, and there is some material on this on Slide 22.

As you are aware from last week's Form 8-K filing and our press release, the company recently drew $750 million under our committee bank revolver to fund previously forecast working capital needs, and this is primarily related to investing in pharmaceutical inventory as we bring our new National Logistics Center online.

Including this borrowing at this point in time, we currently have more than $2 billion in cash and in addition to that we have incremental borrowing capacity of -- including recent commitments for additional borrowings, which total $750 million.

And at this point in time, we do not foresee any unusual cash need, and there are no immediate plans to execute on the additional $500 million borrowing capacity commitment.

The incremental need for inventory investment in the National Logistics Center is expected to be temporary, as the company sells existing backup stock at its Regional Distribution Center.

That said, we thought it was good to always stay out in front of things.

We wanted to make sure that we stayed in what I'll call a "virtuous" cycle so that we never ended up in any kind of a vicious cycle.

We believe that it's prudent to maintain a conservative and cautious course of action to put lines in place before you need them.

If you need waivers on dates, get them before they come due, because we always -- I figure one of my jobs is to take care of issues before they arise and so we're always ready to support our business operations from a financial standpoint.

That's all that was about last week, and that's how you should view it.

That concludes my remarks, and now I'm going to turn things back to Jim to open up the question-and-answer session.

Okay, thanks, Mike.

Thanks, Bob.

Before we open it up for questions, I just want to remind everyone of a couple of things.

First, because we are releasing fourth quarter results so late, the first quarter is actually over, and, of course, what that means is we're in a quiet period with respect to our first quarter results.

So we are not really in a position to answer any questions about our '05 performance and/or expectations beyond what is in the press release or was already in the formal remarks.

A second thing is, because we are still in the midst of an ongoing SEC investigation, please understand that we cannot give more detail beyond what in the 10-K about the status of or the next steps of the investigation.

So I appreciate everyone's consideration of this situation.

Now, Michael, we'd like to have our first question.

(OPERATOR INSTRUCTIONS)

Our first question comes from Tom Galluci of Merrill Lynch.

Good evening, thank you, and we do appreciate the thorough overview.

I guess I just was interested in trying to understand some of the nuances of a few of your comments, particularly related to the internal audit as well as the SEC investigation on one hand.

I think you mentioned that the audit is substantially done with respect to topics that have come up thus far.

I think there is a disclaimer in the 10-K filing that said the company is still responding to, obviously, the SEC investigation as well as the internal audit.

So is the internal audit still looking for new issues?

What exactly is going on there and how confident are you in the 10-K, the way it's been filed today in terms of the potential for future restatements in that regard as well as to the issue you mentioned before, in terms of weaknesses of internal controls?

I'll start on that and, you know, there are several aspects to your question.

I think, first of all, with regard to our confidence in what's in the 10-K, we're very confident in that.

We've taken the time to do it.

We believe we've done it right.

We believe that we have addressed all of the issues that have come up to date that have potential impact on the financial statements and fully addressed those.

That's why it took us as long as it took us to get here, and also that's why we're filing now, because we're very comfortable with where that stands.

But we can't really speak any further to the SEC investigation, but we certainly have addressed everything that they have brought to our attention.

Your next question comes from Robert Willoughby.

Thank you.

You broke out a number of $4.6 billion on capital deployed in fiscal '04.

Am I correct in assuming this is a number, Bob or Mike, gets cut in half this year?

Bob, I think -- I don't remember the exact number.

I think we said $4.6 billion, was it, and tried to outline that it was in really several areas.

One was capital expenditures in our business was the first area.

The second area was acquisitions, and the third area would have been what do we -- stock buyback, I'm sorry.

So I think I said earlier that you shouldn't expect us to be in the acquisition market right now.

I think there is nothing that we think is strategically important to us right now.

We've got plenty on our plate to see substantial opportunities to make improvements by integrating the companies together.

So I wouldn't expect any substantial acquisitions from us.

So that in itself answers your question that you've already cut it in half.

Our capital expenditure program, I don't think, is really any different than it has been in the past, and I would expect to be at about the same level.

Our next question comes from Kevin Berg.

Yes, Bob, you mentioned returning to previous margins of pharmaceutical distribution area.

Why should we expect you to return to those margins when the pharmaceutical industry is a very different industry now than it was five years ago, three years ago, in terms of their margins and in terms of the challenges the industry faces.

So why should you get to that same level of returns?

Kevin, the pharmaceutical distribution industry is quite different.

Obviously, I haven't seen their margins be cut in half.

If anything, the return on sales are very strong in the manufacture industry and probably 10 times what ours are.

Frankly, the reasons why we can command that kind of return, first of all, it is the type of return that is currently being earned around the world in pharmaceutical distribution.

It's the type of return that is driven by the economics of the industry here.

We need a return like that -- all of the current distributors need a return that's in the 2 percent to 2.5 percent in order to continue to sustain and build the kind of competitive distribution business that exists today in terms of not only of the provider but the manufacturer.

So at a 2 to 2.5 percent return, that provides the kind of return that our shareholders will demand and that is required for us to invest in capital in the business to sustain our growth.

Certainly, the manufacturer has no other way to go around us.

And so it's not like they can provide this service in some other way in a cheaper way.

So from a competitive standpoint, we'll be charging the manufacturer on a best-price basis, meaning it's the best price for the value, the service that can be delivered in the marketplace, and so it is a critical service we provide, and we'll be able to achieve those returns.

Our next question comes from Chris McFadden.

Yes, thank you, good evening.

On your talk in this forum and previously about a deadline at the end of the calendar first quarter, to begin to see manufacturers to conform to a fee-for-service or, as you said this evening, a non-contingent distribution agreement, what are you prepared to do to enforce that requirement for manufacturers who may not be on that same timeline?

Well, Chris, I took a lot of time to kind of outline how efficient the industry has become essentially and how critical we are of, first of all, how complicated it is what we do, and how we do it on a very efficient basis.

And so I think the manufacturer essentially has grown to depend on us, and so we're not -- this is not about picking a fight with any manufacturers without reminding them what they need to pay for the distribution services we provide them.

If, after a period of education, which we have been through -- a fairly long period of education -- one of our competitors reminds the market that this has been over a year of educating the manufacturer to understand what's going on.

After a reasonable period of education and negotiation, we are prepared to discontinue handling either a portion of a manufacturer's line or the entire line itself.

And I'm quite confident of our position there.

Frankly, you should do that in any business.

If you can't make -- you know, why would we let one manufacturer travel through our channel cheaper than some other manufacturer and some of the manufacturers I've talked to at the CEO level -- one of the main issues is they don't want to support a channel, which allows one of the competitors to go through it cheaper than the economics would dictate.

So we're prepared to discontinue a portion of the line, all of the line, or discontinue elements of services.

And we've already had some of those discussions, and fortunately, the manufacturers have understood that, and we haven't had a situation where we or the manufacturer that we were negotiating with walked away from the table.

Next question?

Our next question comes from Steve Halper.

Yes, this is George Sell (ph) sitting in for Steve Halper.

You and your competitors both spoke to the 2 percent to 2.5 percent operating margin target.

The number just seems kind of arbitrary.

Can you talk about what brings you to that number, and also it's kind of a wide margin, too -- it's a 25-percent spread.

What makes 2 percent to 2.5 percent the right number and not somewhere below that?

Okay, the question is what makes 2 to 2.5 percent the right number?

First of all, I realize that it is a range, and that, you know, that gives me an opportunity, over time, to get certainly at the top end of that range.

We historically have achieved that.

I think the industry today is every bit as valuable, if not more, to the manufacturer who pays for the distribution services.

So historically this is what we have earned -- that would be the first reason we have the right to it.

The second reason -- the manufacturers pay for distribution throughout the world.

I'm very familiar with what returns are throughout the entire world.

We are significantly more efficient in this marketplace than the distribution in other parts of the world, even considering the different methods of distribution.

And, in fact, I would tell you, U.S. versus Europe, the cost of distribution for the pharma manufacturer is almost two-and-a-half times what it is here.

So we are a bargain.

The third reason why we deserve that range of 2 to 2.5 percent is when you calculate the return on sales and then that drops certain dollars at the bottom line and look at what that return on capital is, that is a fair return on capital that will attract capital from shareholders.

And that's what drives the economic model.

So I'm quite confident that we will return to that.

We have enjoyed that, incidentally, as an industry, when we provide significantly -- when the manufacturers were significantly less dependent upon us.

We have enjoyed an average return in this industry on pharmaceuticals, which are in the 2 to 2.5-percent range.

And so I think history supports it, the international market supports it, and the return on capital required to sustain a critical industry support it, and it is affordable by the manufacturer, and there are not alternatives in place.

Next question.

Our next question comes from Eric Coldwell.

Thanks very much.

I had one housekeeping question.

First, in slide number 15, you talk about investment spending, and you point to incremental strategic business segment investments in the past of being between $30 million and $60 million.

I remember in numerous conference calls and management meetings that that number was typically referred to as $120 million to $125 million plus.

I'm curious, is there a definition change here or what am I missing about this new definition of past investment spending?

Eric, your memory is great, and Mike was really only referring to the investment spending portion that's captured at corporate, and when we defined investment spending before, we were referring to investment spending, which included what we would call "research and development" and investment spending ventures that are captured at the segment level.

When you total those things together, that you got to the number you talked about, and I think what we'll do is -- I'll remind Mike that at the analyst conference next week, that we will tie those facts out for you so that we can track our total investment spending, which you'd have to consider R&D as investment spending -- our total investment spending for the company, and we'll track that out for you a week from Friday.

Next question.

Our next question comes from Larry Marsh.

Just a clarification, Mike.

Could you just reconcile the slight differences between the restatements from the 8-K on the 13th and what you have on page 11?

You know, I can't get into it chapter and verse by specific item, but it really is (technical difficulty) the fact that time has gone by, and we continue to work on things and find things, and they all fall essentially in the area of errors, as we continue to look at things.

You know, we wanted to make sure that we had gotten everything.

We went down to items as small as -- the smallest one I can remember is, like, $300,000.

As time went by, we kept looking with more and more granularity.

And, again, when I talk errors, just to remind you, that's where we found something, and we corrected it, and, in this case, now, we've gone back and put it in the timeframe when theoretically we should have found it or should have known it.

So that would be the primary difference between what was in the 8-K and what's in the 10-K.

And then I think the other difference is, from a display standpoint, I believe in the 8-K we did not split errors from items related to mis-application of GAAP.

So that's a difference in display.

One more question.

Our next question comes from Ricky Goldwasser.

Bob, good evening.

You mentioned earlier that some manufacturers are starting to revise agreements post the August letter.

Can you quantify for us what percent of dollar volume is currently either fee-for-service or some form of revised IMA that provides you downside protection?

And also early on you mentioned that the audit committee will now focus on a CME kind of responsibilities.

When should we expect the audit committee to finalize its recommendations on that front?

Thank you.

I'll speak to the second part of your question and let Bob take the first part.

There's not a fixed timetable.

This is a process that you absolutely want to be a complete process, a thorough process, and you want it to be a fair process.

The audit committee of the board, you know, John Finn is the chairman, jeez, they have invested a tremendous amount of time, effort, energy, wisdom, counsel, in bringing it this far.

They will do the same, as they look at assigning responsibility.

So I think what you should expect is completeness, thoroughness, and fairness, and moving as quickly as possible, given those requirements.

Yes, on the second question, to give you some indication of where we are in magnitude with regard to IMAs and things like that -- one of our competitors, I think, did a really good effort, good job, effort, at trying to give some guidance on how many manufacturers, what percentage, and things like that, and it's complicated to tell you where it is.

What we will do at the analyst meeting, frankly, we will be developing some methodology to help you better track our progress.

And I'd rather really leave it 'til then so that we can report on that and give you a much more accurate method as we're tracking it.

I'm pleased with the progress we're making and confident about what our position will be.

Okay, so we'll wrap up.

We will have another conversation, as I said, our first quarter earnings will be reported.

As you can imagine, our financial group is busy.

The first quarter reported next Thursday night or Friday morning, and we'll have an analyst meeting, which we'll have an in-depth discussion of trends next Friday.

Thank you for participating in today's call.

You may now disconnect.