卡地納健康 (CAH) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen, welcome to the Second Quarter, 2008, Cardinal Health Inc.

earnings conference call.

My name is Eric, and I will be your coordinator for today.

(OPERATOR INSTRUCTIONS) I would now like to turn your presentation over to your host for today's call, Bob Reflogal, Vice President of Investor Relations.

Thanks, Eric.

Good morning everyone and welcome to Cardinal Health fiscal 2008 Second Quarter conference call.

Our remarks today will be focused on the company's consolidated and business segment results for the quarter which are included in the press release and attach financial tables.

If any of you have not yet received a copy of our earnings release or financial attachment, you can access it over the internet at our investor page at www.cardinalhealth.com.

Additionally, there are a handful of slides that we will be reviewing which can also be found on the web site.

After the formal remarks, we will open up the phone lines for your questions.

As always we ask that you limit yourself to one question at that time.

During the course of this call, we may make forward-looking statements.

The matters addressed in the statements are subject to risk and uncertainties that could actual results to differ materially from those projected or implied.

Please see our press release and SEC filings for a description of those risk factors.

In addition we will reference non-GAAP financial measures.

Information about these non-GAAP measures is included at the end of this presentation and posted on Cardinal Health's investor page.

At this time I would like to turn this call over to Cardinal Health's Chairman and CEO, Kerry Clark.

Kerry.

Thanks, Bob.

Good morning, everyone.

With me today are Dave Schlotterbeck, Vice Chairman and CEO of our clinical and medical products sector, Jeff Henderson our CFO and outgoing interim CEO of the Healthcare Supply Chain Services Sector and George Barrett our newly appointed Vice Chairman and CEO of Healthcare Supply Chain Services who joined the company yesterday.

I want to start today's call by talking about our earnings outlook for all of fiscal 2008.

Then Jeff will provide some detail about the second quarter.

I think it is important to note that we have three of our four segments performing on track.

These segments are Supply Chain Medical, Clinical Technologies and Service and Medical Products and Technologies.

All three are enjoying strong revenue growth and margins that are are expanding.

These businesses will account for almost 50% of our operated earnings this year and collectively, we expect they will grow profit about 20% for the year.

All are shaping up for a strong second half and of course these segments remain a strength for the company.

But as I said last quarter, we are facing a number of challenging in our Supply Chain Pharma business.

Despite revenue growth of 5% versus a year ago in the first half of the year, operating earnings were down 9% from year ago.

Q2 was generally in line with what with we advised three months ago.

The issues affecting the Supply Chain Pharma business in the first half are the same as we talked about on last quarters call, the timing of new launches and deflationary environment in the generics market.

Branded price increases a year ago in Q2, the impact of repricing some of our larger contracts last spring which with had an impact on our first half results and some supply and pricing challenges in our radio pharmaceutical business.

And of course, poor execution in winning new DFE business, generic penetration, and reducing our SG&A expenses remain the same as we talked last quarter.

This latter point is important to understand-- understanding our first half results, because, while we had forecast the impact of contract renewals, we were unable to offset the effects of these renewals in other parts of the business.

We discussed all of these factors in our call last quarter so there should not be any surprises about the first half.

Turning to the second half; however, we believe we need to make some significant changes to our forecast for Supply Chain Pharma, and that is why we are.

taking our guidance down at this time.

While we expect to see a moderation in the rate of decline, segment profit will now be below year ago for the full year in Supply Chain Pharma.

This is the primary reason for our guidance revision to a range of $3.75 to $3.85.

Let me explain why.

Over the last nine months, we have renewed all our large contracts.

KMart, Kroger and CVS last spring, and we just renewed our Walgreen's contract earlier than expected.

All of these renewals were long standing contracts and all have been renewed at what we would consider current market rates.

Having these renewals at hand, puts a lot of stability under our business going forward for at least the next 12 months.

However, collectively, they will have an impact of more than $140 million on fiscal 2008.

As I said earlier, our prior expectation was that a vast amount of last springs renewals would be covered through improved business in the balance of our customers and certain expectations on the impact of branded price increases and generics activity.

However, we have just completed an in-depth review of the prior forecast and have determined we need to reduce that forecast to now-- what we now think is most likely.

And of course, the impact of the Walgreen's renewal is net extra.

In addition, we were affected by suspensions of our controlled substance licenses at three facilities that led to remediation actions that we are taking across the entire network.

These steps will strengthen our anti-diversion controls for all customers.

I want to emphasize how important this work is to our mission.

The safety and security of the pharmaceutical supply chain is core to our business and its protection is an important public policy priority for all of us.

This matter will result in additional expenses on some lost business.

We are forecasting a $30 million reduction in operating earnings for the year, more than half of which are expenses.

While we continue to engage in discussions with the DEA it is not possible to say exactly when this matter will be resolved.

Now I will turn to our go forward plans for Supply Chain Pharma.

Let me start by level setting on the current environment.

We expect to see mid single digit revenue increases over the balance of the fiscal year.

I want to underscore the stability we expect among our large customers over at least the next 12 months.

Second, we do not expect-- excuse me-- Second, we do expect a mid single digit average increase in branded Pharma prices over the next 12 months.

And third, while with we have also reduced our generics forecast, we expect the next 12 months will be good for generic merchandising margin.

Increasing our generic business is one of our most important priorities.

As you know we've been working to build out our capabilities in this area.

With that as background, here are the steps we have taken to improve our execution.

We have a strong sector in segment leadership team now fully in place.

In addition we have removed layers of management to flatten the organization and put our leaders closer to our customers.

This is a more efficient and customer-focused structure.

Our generic programs for retail independents and hospitals are being well received including a new program we launched earlier in the fiscal year.

As a result, our generic unit sales to retail independent pharmacies and hospitals are up 10% to 15%.

We expect to increase momentum as we move through the next 12 months and new generic products are launched.

As we enter the second half of the year, we are now seeing the benefits of our SG&A controls, and we will be below our budget for the year.

We are also coming to completion of an extensive industry SG&A bench market study with an outside firm and expect this work to guide us on identifying new opportunities as we move into fiscal '09.

Before I leave Supply Chain Pharma, let me make a few comments on nuclear which is included in this segment.

Some of the supply problems experienced around the holiday season have pretty much cleared up.

We have also been able to make some pricing, supplier and cost adjustments.

But there still may be some additional volatility in the business leading into next year's important generic event.

Looking at the company as a whole, I want to emphasize that we have a very strong business model and a vibrant and growing health care industry.

We need to make some adjustments, but that does not change our view that we are in great businesses with excellent market potential.

We are differentiated by our portfolio of high growth and high margin clinical and medical products in one sector.

And our supply chain services in the other sector delivers excellent cash flow, outstanding returns and is well positioned to prosper as demand for healthcare products and services continues to grow.

Now, let me turn to our results for second quarter.

Revenue increased 7% to $23 billion and non-GAAP EPS was up 8% to $0.90.

This is consistent with what we had expected and communicated.

In health care, supply chain services sector, revenue rose 6% to $22.4 billion but profits declined 19.5% to $330 million.

I have already talked about the major factors that have contributed to the profit decline, so I won't say anymore here.

The clinical and medical products sector was an exceptional value driver and continues to differentiate us in the market.

In Q2, CMP accounted for 36% of our profit, so it plays a substantial role in our overall results.

We have a leadership position in patient safety and infection prevention products, both essential and rapidly growing segments of healthcare.

A strong position has reflected a gain in our Q2 revenue growth for the sector which increased 24% and profits which rose 32%.

Now I will turn it over to Jeff to discuss our segment results in more detail.

Thanks, Kerry.

Good morning everyone, and thanks for joining us.

Today we're going to talk about our consolidated and segment results for the quarter, update you on our key financial drivers and I would like to spend more time going through our outlook for the remainder of the year.

Let's start with the consolidated results of the quarter.

Please note that my comments will reflect the financial results from continuing operations on a non-GAAP basis.

Consolidated revenues were up 7% to 23.3 billion, and operating earnings were down 3% to $526 million which, as expected, reflects the Pharma segment challenges we highlighted during our Q1 call.

I will discuss this in greater detail later.

Earnings and continuing operations for the quarter were $329 million also down 3% over prior year.

Diluted non-GAAP EPS was up 8% to $0.90 reflecting a leverage we were able to deliver via our capital deployment strategy.

Operating cash flow for the quarter was negative $26 million.

The negative cash flow this quarter was driven primarily by unique quarter end [and] timing of payments at that impacted our cash flow by approximately $250 million.

Return in equity was 19.4% up 420 basis points over the same period last year.

Now, turning to the next slide.

During the quarter, special items totaled $30 million which impacted diluted EPS by $0.05.

The $30 million was comprised predominantly of restructure-related charges including $14 million associated with the [Magob] Park transition.

The $23 million gain on sale of steak in OTN is included in impairments and other.

Now I would like to switch to the performance of the individual business segments.

Within the Supply Chain Pharma, revenue for the second quarter increased 6% to $20.4 billion.

Revenue from bulk customers was up 12% and non-bulk revenue was up 1%.

Non-bulk revenue growth was effected by previously discussed ESP losses, which occurred in Q2 and Q3 of last year.

Segment profit was down 21% to $258 million, largely consistent with what I had spoken about during our Q1 call.

Primary drivers were generic market conditions, timing of brand price increases and the on-going impact of previously announced customer repricings.

We continue to see progress in our effective use of capital.

We are pleased that our tangible capital was down approximately 14% over Q2 of last year.

However, due to the profit decline, economic profit margin decreased 27 basis points versus last year.

Turning to slide eight, we continue to make great progress in Supply Chain Medical.

Segment revenue was $2 billion, an increase of 8% over the prior year.

Continue the momentum from Q1 providing further confidence that our turn around is on track..

Total segment profit for the quarter was $72 million, down 13% over Q2 of '07.

Profit in the quarter was impacted by the refined corporate cost allocation, which negatively affected growth in that quarter by approximately seven percentage points and softness within our surgical kitting business.

We have also substantially completed the first wave of our business transition from Illinois to Ohio.

As we look forward, there's real momentum in the business, we continue to expect to return to positive year-over-year growth in the second half.

Now, turning to the CMP sector and first the medical products and technology sector.

Revenue increased 47% to $667 million, on strong sales of infection prevention products and surgical instruments and the VIASYS acquisition.

Segment profit was up 46% to $69 million with the addition of VIASYS and improved operating leverage in the legacy business.

There is good momentum established in our infection prevention line.

We saw growth in the quarter from our Converter drapes and gowns and our Esteem gloves.

There is good momentum established in our infection-prevention line.

We saw growth in the quarter from our Converter drapes and gowns and our Esteem gloves.

We have now converted 100 hospitals exclusively to our proprietary latex-free, Esteem micro surgical gloves.

I am happy to report that the integration of VIASYS continues to go extremely well and synergy capture for FY '08 is ahead of schedule.

VIASYS was a substantial contributor to MPT in Q2 and we are very optimistic about our pipeline of 13 new VIASYS product introductions planned for this calendar year.

On top of all this, the team has been able to lower days of inventory in the business by 13 days since last quarter.

All in all, the MPT did wonderful job integrated VIASYS and driving growth and value enhancement across their businesses.

Moving on to slide number ten, clinical technology and services had another great quarter.

Segment revenue was $715 million up 8% over the prior year, driven by strong double digit for our Pyxis and Alaris products.

Growth was dampened by a slow down in pharmacy operations.

Excluding this business, CTS revenue was up 19%.

Interestingly we saw a nice pick up in our Canadian operations where sales of Pyxis and Alaris products rose 65%.

We are seeing very good traction in this market for CTS products through relationships we have in the hospital distribution side of our business, continued validation of the impact of one Cardinal Health on the customer side.

Segment profit was $115 million up 26% driven by a favorable mix of higher margin products and improved operating leverage.

This was somewhat dampened by the additional $10 million charge we took in the quarter related to the Alaris pump module voluntary recall.

This brings a total reserve to $14 million including the $4 million we reserve in Q1.

Overall, the Alaris voluntary pump recall is moving forward.

We continue to work with the FDA and have started the pump inspection process.

We have identified an additional 5,000 to 6,000 pumps that we believe should be inspected as part of this voluntary recall and are currently in discussion with the FDA on this.

We believe our current reserve is adequate to support the recall as planned.

Overall we are very happy with the performance of CTS and the execution we're seeing.

Segment profit margin continues to expand with a 2 percentage point improvement over Q2 of FY '07.

Now I would like to turn to the key the key financial levers we focus on to drive both growth and returns for the business and our shareholders, which are balance sheet management, capital deployment and our capital structure.

We again made meaningful progress among all these dimensions in the quarter.

Return on invested capital was up 156 basis points versus Q 2 of last year.

For the quarter we repurchased almost $350 million in shares, bringing our total repurchase for the first half of FY '08 to $942 million.

Similar to last quarter we were operating with our debt to total capital at the top end of our target range with a ratio of 36%.

Clearly the desired outcome of our financial strategy is enhancing returns, and we were able to deliver on that goal with a non-GAAP return equity in Q2 of 19.4% which is an increase of 420 basis points over last year and almost 200 basis points over the non-GAAP ROE last quarter.

Moving on to our outlook for the remainder of FY '08.

As Kerry noted, we are lowering and narrowing our guidance for non-GAAP deluded EPS from continuing operations to $3.75 to $3.85 driven by continued challenges in our Supply Chain Pharma segment.

While we are clearly disappointed in this action, many positives remain.

Three of four segments are expected to perform in line or better than our expectations.

As such, current segment profit guidance for CTS, MPT, and Supply Chain Medical remain unchanged and we continue to expect a strong second half across those three segments.

And, overall our updated guidance still represents double digit EPS growth for shareholders.

Now, let me build on Kerry's comments regarding our revised outlook for Supply Chain Pharma.

As he noted there are four primary factors that, when combined, effectively reduced our outlook in Pharma by 110 to $120 million.

First is the increased cost and impact of our controlled substance anti-diversion efforts.

Currently we're estimating this to have at least a $30 million impact on segment profits for the full fiscal year.

Much of this cost relates to the investment we are make to put in place, enhanced controls to address the diversion of controlled substances.

In addition, efforts rectifying this issue have created a distraction with the organization that has slowed some of the momentum we gained in Q2.

The remaining factors include a revised outlook for our generics business, branded fees and price increases and the impact of more recent customer repricings.

Together these accounted for approximately 80 to $90 million of forecast revisions.

I have worked with a new management team over the past several months to take a hard look at results to date, trends, and market conditions to come up with these revised assumptions.

Generics and branded margin, we felt we were too optimistic based on events of the last several months and our latest intellegence on the remainder of the year.

So, we have adjusted the forecast to actively reflect our current and best view of reality.

Now I would like to turn to our financial goals.

I have mentioned much of this on prior slides, but I do want to highlight a few key points.

First for fiscal 2008, with the changes I just discussed, we now expect overall company revenue growth to be 7% this year.

EPS is being lowered and narrowed to $3.75 to $3.85 per share.

As always, this guidance excludes any potential impact from the ongoing portfolio optimization reviews.

As you can see from the left side of the financial goals slide we have not formally made any changes as we review and update our long-term goals annually.

Our organization is still working and incented toward achieving these aspirations.

However, we will be entering our planning cycle soon, and as we do annually, we will need to review a few of our long-term growth expectations in light of the revised FY '08 forecast for Supply Chain Pharma.

So with that, I would like to take a minute as a former interim CEO of CHCS to recognize George Barrett.

Welcome to the team and I will turn the call over to him to make a few comments.

George.

Thanks, Jeff, and, good morning everyone.

As you have heard this morning, we've got some challenges which will no doubt occupy my attention in the short term.

We are in the business where execution is critical, and we need to do a better.

job of it.

Having said this, let me tell you something about why I am excited about being here.

Because of the scale and the significance of our position in multiple segments, we have a unique opportunity to implement the delivery of health services and products throughout the system.

Particularly at that time when change is the rule of the day.

I will try to focus on two basic issues, first, improving our operational execution, and second, creating a single-minded commitment to value creation for our customers and our center business partners.

Although I come out of a different part of the health system I am hopeful my experience in addressing these very things will serve us here.

I look forward to getting a chance to meet those of you I don't know and reconnecting with many of you with whom I have worked over the years.

I think I'll turn the call back to Bob for Q and A.

Eric, we're ready for questions.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Glen Santangelo, Credit Suisse.

Please proceed.

Kerry, just a couple of quick questions on the drug distribution business.

You said earlier in the call, you renegotiated the CVS business last spring.

Can you remind us what some of the terms of that renegotiation are and it is my understanding you had to renegotiate that in fiscal '09, is that not true.

What we did-- I can't give you the terms of the contract.

We did receive an increased allocation of business during that renewal, and yes, it is our understanding in summer '09 there will be another round of discussions with CVS at that time.

Okay.

Then the $30 million that you are suggesting that, the cost related to the DEA how much of that have you already recognized in fiscal '02, the fiscal second quarter versus what's going to have to be recognized in the back half.

There's only about-- just a-- really a very small amount in Q2.

These numbers are all directed towards the back half.

Okay, and then just my last question and then I will jump off.

Regarding your revenue growth in mid-single digits.

For several quarters now, we have seen your bulk revenues growing at a double digit pace while your DSD revenues are basically very low single digits, and you cited a couple of customer losses last year.

Is there any sort of shift going on within your customer base like with CVS, Kroger, K-Mart,?

Some DSD sales shifting to bulk or is there something else going on.

No.

We don't see any shift within our contracts with our bigger customers on DSD to bulk, but, we have had, as we have said before, some lost DSD business in the retail (inaudible) small chains which we addressed last quarter.

That still persist through now.

But clearly, a lot of the focus on the DEA has -- as with the anti-diversion issue, has really had our folks in the fields working on that while our customers-- we haven't been able to make as much progress in recovering that as we thought.

Okay, thank you.

Next question.

Your next question comes from the line of Tom Gallucci, with Merrill Lynch.

Please proceed.

Good morning, thank you\.

Just about the guidance, either for Kerry or Jeff,.

It sounds like Walgreens is incremental to what you were thinking about before, the $30 million on the DEA but I think, Jeff, you said on branded and generics you were sort of too optimistic, I think, in prior guidance.

Can you give us a little more granularity on both the generic and the brands where maybe you were too optimistic or what's changed and what your new expectations actually are in those areas?

Sure, Tom.

Good morning.

Thanks for the question.

Clearly over the last two to three months since I have been the interim CEO of CHCS, I have had an opportunity to dive more deeply, with the new management team, into our current results, trends, and assumptions for the last six months of FY '08 as we have gone through that, particularly as we have gone through sort of the critical December to January period where a fair amount of activity happens particularly on the branded side.

It became clear that some of our assumptions regarding both generics and branded were too optimistic based on that latest data.

And, let me just give you a couple of examples.

First of all, there was one fairly significant branded manufacturer that did not do a price increase anywhere near the size we had anticipated in December or early January.

It is doubtful we will see that for the remainer of fiscal '08.

So that was a specific piece.

And then I would say, just more generally as we look at our entire portfolio of branded manufacturers and expected price increases, it was clear that based on the trends we saw in December and January, although still relatively healthy, they were not going rise at a level we had been anticipating earlier in the year.

On the generics side, our assumptions for generic launches include both sort of the very well known public launches, such as Fosamax which remains intact.

But also included is other at-risk launches that, we assess based on our confidential discussions with generic manufacturers, and we base our forecast on those discussions.

And, the intelligence we gain from them and others regarding the likelihood of launches or at-risk launches or delays in launches.

Again, based on what we saw in November, December and early January, and based on updated discussions with those manufacturers, it was clear that a few of those, including at least one two fairly substantial generic launches, were not going to-- were not likely to happen for the remainer of FY '08.

Those were sort of at risk launches you were guessing at before?

Generally, yes.

Okay, I just want to clarify one thing, you had said K-Mart, Kroger, CVS, Walgreens, say collectively that's $140 million impact.

And, is it proper to characterize K-Mart as being out sized relatively given the unique circumstances for that contract?.

Tom, that is correct.

The impact of our repricings which primarily is driven by the four major accounts that you mentioned, does have an FY '08 negative impact of $140 million.

I don't want quantify the individual pieces but, you know, with respect to your question, on K-Mart, it is clearly that our original contract with K-Mart was done several years ago when they were in a different situation.

We renegotiated in the spring of last year at essentially current market prices.

Okay.

Thank you so much, Tom

Next question.

Next question comes from the line of Ricky Goldwasser with UBS.

Please proceed.

Yes, good morning.

One question.

As you were going through the guidance for the second half of year, did George have a roll in revising expectations and providing some insight as to the generic landscapes?

No, he did not, Ricky.

Okay.

So as far really it is kind of like looking at expectations are we expecting George to take more of the role when you provide a fiscal year '09 guidance or do you think there's still potential some revisions ahead?

You are referring to FY '09, Ricky.

Good morning, by the way.

This is Jeff.

Morning, Jeff.

Clearly over the next three or four months we are going through our long term and short term planning processes.

As the new CEO of our biggest sector, clearly George is going to have a very important input and say into what our realistic expectations are for the next several years, so, yes, he will play an important role.

So, I guess the question is, is George's role really kind of kicks in when you are going through the fiscal year '09 guidance.

Yes, but by the time we issue guidance for fiscal '09, George will have been here plenty of time by then, and I'm sure will have a very significant input into that.

Operator, next question.

Your next question comes from the line of Ross Muken, Deutche Bank.

Please proceed.

(lost sound) -- changes that have happened over the last several months, do you think the team that you currently have in place with George now joining and Scott having joined a bit of time ago, rounds out, at least the supply chain piece of the business and this is sort of the team to go forward with?

Yeah, Ross, hi good morning.

Kerry here.

You just kind of kicked off.

We didn't get your opening comments but yes we now feel that we have got the leadership team in place.

And, throughout the organization, and you know, obviously we are going to look for opportunities to continue to strengthen where we have outages, but by and large the team is in place.

And, in term of the clinical business on the brighter side of things, obviously performance there has continued very strong.

Could you talk about some of the key trends you are seeing in both just Alaris and sort of the momentum you have entering into the back half of the year?

Ross, thanks a lot.

I will ask Dave to make a few comments on that, if you don't mind.

Certainly can.

Continue to see strength in Alaris particularly in the (inaudible) market.

Texas continues a strong path.

We are seeing a lot of strength in our basic MPT businesses and VIASYS continues to perform above our expectations.

I think we have mentioned that we do see a number of new product introductions coming out of VIASYS and these are really designed in the ventilator space to begin to create a razor-- razor blade business.

One of these products was shown at a conference in December.

It was called the Palm Top ventilator.

This product is the first of its kind.

It's the smallest, it's the lighter ICU-type product designed also to follow the patient into the home.

So, overall in momentum I am very, very positive about where this sector is going.

Thanks, Ross.

Operator, next question.

The next question comes from the line of Randall Stanicky, with Goldman Sachs.

Please proceed.

Great.

Thanks a lot.

And, George, I'm not sure if you're there, but if you are, welcome to the services side of the world.

Jeff, can I just follow up on a previous question?

As you think about the components to outlook, it is not clear what has changed.

If we think about the branded price, inflation is down, you are thinking a mid single digit outlook there, is there a potential timing issue if you think about the fiscal versus calendar year and then on the generic side, can you characterize, maybe more conservatism in the outlook, relative to before or would you-- are there specific launches, I know you mentioned at-risk launches that have been pulled from the forecast, but It is not clear there's a lot of movement in the generic pipeline outlook for the year.

Good morning, Randall, thanks for the question.

First of all, on branded side, it really relates to the specific brand increases that we are seeing for the companies that we still have the viable model with.

And so it's less of a-- the overall complete portfolio of branded price increases that we are seeing and more about the specific companies that, we are still contingent-- still have contingent fees related to.

As I said, there was one large manufacturer that did a very minimal price increase.

We were expecting something more substantial for FY '08.

And then just generally across the portfolio of companies that we still have contingent arrangements with, we did not quite see the pick up in December and January that at least we were anticipating.

That all said we still view the overall branded price increase portfolio as being relatively healthy.

It was just as our specific portfolio reflects itself in our financials, we were not seeing the type of increases that we were counting on for a full fiscal year.

May some of that happen next fiscal year?

Sure.

I mean it is now a possibility that some of this is timing, but I think the current forecast is a realistic view, at least our view of the world based on our portfolio.

On the generic side, yeah, there were a couple of very specific, relatively large launches that we had anticipated based on our discussions with generic manufacturers and for various reasons including the status of patent challenges et cetera, they no longer appear likely in our FY '08.

Could they still happen?

Sure.

Could we be wrong on the down side and be positively surprised?

Yes, that's always a possibility.

One of the things about this business is that, your forecast is only good for about half an hour sometimes until you get the latest data from the courts or from the generic manufacturers regarding what they're going to go at-risk with.

I suspect some of the things that we pushed out of our FY '08 will happen in FY '09 and we will have to watch those closely and continue our discussions and see how those show up in our numbers eventually.

I know you are not giving fiscal '09 guidance at this point, but as you look and extend, there's obviously a lot of time and discussion here, as you look to the back half of calendar '08, do you feel like the momentum is at least turning around?

Can you characterize for us, what inning with George coming in here as you look at the Pharma distribution.

Obviously this is the third revision outlook now, in a certain number of months.

Do you feel like we are into the late innings in terms of what you need to do to get that business turned around.

Randall, Kerry here, good morning.

I think we underneath all of this noise of the repricings,we really just need to, as much as I don't like where we are, in the sense of-- we have gone through a lot of major repricings and frankly, we thought we would have enough puts and calls to offset those.

Clearly in putting together our approach, we ended up getting a little too far ahead of ourself on thinking about the impact of branded price increases and generic activity.

Now we've got that back down to-- what should I say, it's probably fairly close to what the industry consensus-- what we read in all your materials and so forth.

So.

I think there's the core elements going forward are pretty much aligned with how a lot of people see the market going forward.

But underneath that, there's a lot of good stuff because we are with customers who are growing and growing their market share.

We are winning with the winning customers.

That's important,.

Number two is-- it is very clear that our customer facing organization is starting to create connections that we've not had before and through that we are learning about new business opportunities and how we can do better work with each of our customers.

George talked about the importance of doing a better job of creating value for our customers and value for our vendors.

We have made changes in generic program which we started to get some traction on.

Of course the anti-diversion issue has distracted us.

But, if we can look beyond the repricings and the anti-diversion, I think we are going to enter a base period of a fair amount of stability with the big contracts behind us, with the opportunity to work on improving our generic penetrations.

the opportunity of creating better value for our customers and for our vendors.

So, I look beyond the noise, and plot out how you see those things coming sort of quarter by quarter.

I think underneath it, there's nothing that's really-- suggests that the business is on a downward trajectory on its core basic elements.

It feels like we have a level of stability and how we are going to market and that ought to get better.

I know it's a long, convoluted way and I didn't give you any of the specific numbers you were exactly looking for, but I do feel that underneath all of this noise, there's a lot of things, we are winning with winning customers, we have got a lot t of improvements when we go to market.

We have a better go to market program in our generic program and as these other issues start to anniversary, we should be on a much more solid footing.

It is fair to say, George is entering a late innings game if you will?

I guess you can characterize it as that, but no, I think that there's no-- I don't want to be glib on anything.

We have our work cut out for us on many fronts.

George is going to bring a lot of value on many fronts.

George is going bring enormous value, not only to what we do with the Supply Chain Pharma but also our Supply Chain Medical.

He's bringing a tremendous amount of breadth and dept and skills that are going to affect the entire supply chain business.

We are look not just only for him to make an impact here.

He's got skills and capables, but we are looking for George to be impacting much more broadly across the whole supply chain part of our business.

Thanks, Randall.

Operator, next question.

Your next question comes from the line of Larry Marsh with Lehman Brothers.

Please proceed.

Thanks, and good morning.

A guess a quick question for George and maybe Kerry.

I need a clarification for Jeff on Walgreens.

George, you talked about the opportunity of Cardinal and Kerry elaborated on this with operation and value proposition.

Would you describe a major value opportunity to be a much more robust and scaled generics offering overtime from Cardinal given your experience from the supply world?.

Hey Larry, it Kerry.

It is a very legitimate question, but it is not really something that is fair to ask George today.

We know we have opportunities in this area but we have not embarked on nor are we foreshadowing a major change in what we're doing in generics.

We want to do what we are doing better.

We know we have opportunities to be more-- to provide more value to our manufacturers and to our customers but we are not sitting here today getting ready to unveil a big new change in generics.

I would like to answer that on George's behalf here, which is, we are going to do better, execute better, we are going to have better programs, but at this point in time we are, it is continuing what we have launched.

Okay.

Just to clarify that and then with Jeff, has there been any changes in your management in the generics program at Cardinal yet?

Well we still have Frank Segrave who leads that business for us and he has got a good team under him.

Obviously, we want to continue to grow our capabilities in that place.

We have a team in place with some respected people in the industry leading it.

Okay, thank you.

Just a clarification, I guess for Jeff.

When did the repricing of Walgreens go into effect specifically and then on slide 7, you know you illude to substantial new business with this early renewal, can you elaborate on that and how we reconcile that with the revenue take down to 7% that you gave us versus what you said in November?

Yeah, Larry.

First of all, for competitive reasons, I don't want to get into the specifics of the Walgreen renewal.

All I will say is that our previous contract came due in the summer of '08, we have announced an early renewal, for competitive reasons I don't want to give you the exact date of that effective date of the renewal but it has a significant impact on our FY '08 financials or we wouldn't have highlighted it today.

In terms of substantial business, the reality, it is going to be a transition period for that over the next six months.

So, I wouldn't expect all that to materialize in FY '08, that will transition as we head into FY '09.

I do want to highlight, though, that this was a very significant event for us and Walgreens and they gave indication that we are very strong partners.

We are their primary distributor now for the U.S.

and I think having this long-term contract under both our belts gives us a great source of stability to grow our partnership from and we're very pleased to be able to serve Walgreens.

Thanks, Larry.

Operator, next question.

Your next question comes from the line of Lisa Gill with JPMorgan Securities.

Please proceed.

Thanks very much.

Good morning.

Just as a clarification on what you just said around Walgreens.

Does that mean that you took some of this business from another distributor or is it some of the business that they were doing themselves just so we understand that.

Yeah, again I don't want to go into too much detail.

But, the additional business we are taking on is not coming wholly from Walgreens itself.

I expect there is a slight market shift there.

Okay.

Great.

I just had two follow up questions.

First, you touched a little bit, I think, Kerry on nuclear pharmacy, and where you were in there.

Can you just talk about the expectations around the generic launch of Cardiolite and what's currently in your expectations it seems like a fiscal '09 event and just secondly, Dave Schlotterbeck, I think you're still on the phone, Baxter on their most recent quarterly call talked about their pump coming back to the market in the next couple of months.

I am wondering if you can comment on your expectations from a competitive standpoint, as they've been out for a long time.

Okay, Lisa.

The the pediatric extension was granted, so this now takes the event into the summer.

So, that's that point.

And I think the second point is at this point in time, Vista is a new player in the marketplace.

We are in active negotiations with them and other people regarding the generic event.

Our expectation is that it will be a very positive event for us next fiscal year.

And, for the balance of this year we are expecting stability to descent growth depending on the volatility we see in the second half.

So.

I think everything seems to be unfolding as expected there.

To your question, Lisa, on Baxter, competitively their practice has been-- and they have been very good at focusing on smaller hospitals, typically 150 to 200 beds or less and so I would expect that they would continue their efforts there, which would have, in my view, a very modest effect on the growth that we have been seeing in Alaris which has focused on the primarily the larger hospitals and the aging institutions and the large IBMs.

So this is not something that gives me any pause and my expectations are that we will continue to take market share.

Thank, Lisa.

Eric, next question.

Your next question comes from the line of Robert Willoughby with Banc of America.

Please proceed.

Thank you.

George, is it possible to comment on your incentive compensation, what metrics it is actually tied to and any sense of maybe Kerry, if that compensation program is any different than George's predecessors.

Bob, George is tied into the same incentive plan that all the senior leadership is at Cardinal.

There are are short-term incentives which are based on our ability to deliver return on tangible capital and operating earnings performance and our longer term incentive is a three year plan recently introduced that is exclusively on the ability to grow economic profit for the company.

So George and Dave and Jeff and I and many others of the leadership team are tied into that plan.

So Grege is on line with everybody's program.

Okay.

And Jeff, did you comment on a tax rate going forward?

Yeah, it is basically what we said previously, Bob, we're going to have quarterly fluctuations but I think a rate for the year in the 32 to 32.5% range is still pretty much what we are expecting for FY '08.

Great.

Thank you.

Thanks, Bob.

Operator, next question.

Your next question comes from the line of Charles Boorady with Citigroup, please proceed.

Thanks.

Morning.

With Walgreens, it sounds like a bit of a mixed message in terms of substantial new business yet it was repriced.

So.

we get a sense for margin trends.

Can you just put the two together and give us a sense of whether going forward recognizing the new business is going to take some time to ramp up.

But going forward, when you put together the top line pressure with the substantial new business, is this relationship going to be better for you on the bottom line going forward or neutral or slightly negative?

Charles, thanks for the question but hopefully you understand, it is really difficult for us to comment on specific contract renewals for competitive reasons.

All I can say is, it was priced at market.

I think both Walgreens and ourselves are very happy with the new agreement and we will go forward, serve them well and continue to drive value on both sides.

I don't want to get more specific than that.

The only thing I would throw in on that, Charles, is first of all, we, while no question, there was an opportunity for Walgreens to reprice the contract, the fact that they chose to do it with Cardinal, the fact that they want to do it, I think is also-- is a sign that they feel that we can execute and meet their needs and feel that we have a lot of capabilities that we can work with them to help grow their business and add value in new places.

So, I see it.

It was much more than just an economic deal.

I think it was a resealing and growing of the partnership and that creates opportunities down the road for us as well.

Can you give an example of what some of the substantial new business is in terms of new services you will be providing or just taking more share of existing services that some others were involved in as well?

There are some just projects we have identified with the company that they're anxious to work with us on.

I have to leave it at that.

Thanks, Charles.

Operator, next question.

Your next question comes from the line of Steve Halper with Thomas Weisel Partners.

Please proceed.

Yeah, hi, good morning.

With NCTS, what's the problem with the pharmacy services business because it appears as though it is kind of marred and otherwise a pretty solid quarter at Alaris and Pyxis.

That's yours, Dave

Yes.

I wouldn't say it is a problem.

It has been a relatively flat business for a number of years now.

We consider it to be strategically valuable because of the insights that it provides us to around the pharmacy and clinical operations of the hospital.

And the issue is that being the size that it is of nearly a billion dollars in revenue and relatively flat, that it does temper the top line and the bottom line growth rates for CTS.

Now, none the less, CTS still recorded a 26% increase in operating earnings over a year ago and I think that, I think that's a pretty darn good performance.

Just to follow up, you know, is there any way for you to actually try to grow that pharmacy services business?

We have some new offerings that we think overtime will catch on that we have been seeing some nice growth in, and it is a remote pharmacy review service which allows smaller hospitals to essentially have a pharmacist review their physicians' medication orders on a 24 hour a day basis through a centralized facility that will handle a number of hospitals.

So, this is something that we have seen a very good response from the marketplace.

We think this will help us get the top line moving in that business as opposed to the traditional approach which has basically been to send in folks and take over the actual pharmacy of the hospital.

So, yeah, we are working a number of avenues there.

Thanks, Steve.

Operator, next question.

Next question comes from the line of John Ransom with Raymond James and Associates.

Please proceed.

Hi, good morning.

In your drug distribution business, I know one of the goals was to increase the generic recapture, and one of the tools you have now is an IT system that helps you measure profit by customer..

To use the baseball analogy, where do you think you are in that process of recapture and as the tools and incentives, have you seen any measurable return yet from having new tools in the (inaudible).

Hey, John, good question.

Thanks.

Since Kerry and I have Canadian we will express in terms of hockey periods.

I would say we're in the second period of that right now-- beginning the second period.

Let me tell you what we've done so far.

We have run detailed account by account profitability now for our retail independents and in hospital customers.

We have now sat down and shared that with the sales teams.

We identified close to 100 accounts that were questionable in terms of profitability.

As we've gotten through that with the sales teams, we have given specific direction to address those accounts and we will be monitoring that over the next couple of months.

and seeing the progress that we make.

We will expand that profitability analysis to our entire chain of customers and set up a regular program of review of the progress against that.

So, again, start of the second period, we are off to a great start.

And then I am glad you didn't do a curling analogy.

That would have been tough.

The other thing.

I know you don't want to talk about wag, but is it safe to assume at least the wag is in there for the full back half of the fiscal, at least a January 1 time frame as an assumption.

Again, John, for competitive reasons and confidentiality, I can't comment on that.

I am trying to understand why the timing is a Kremlin secret.

That doesn't seem to be anything that would be unusual to announce.

John, Kerry here.

This is really, we are, respecting Walgreens' wishes on this specific detail.

Thanks, John.

Okay.

Next question.

Your next question comes from the line of John Kreger with William Blair and Company.

Please proceed.

Hi, thanks very much.

Two quick questions on the drug distribution side.

Kerry, you mentioned a few times on the call that you think execution has been an issue, Can you just be a little more specific on where you think the execution is lacking and then, I guess a question for Jeff, can you give us a sense within the drug distribution business, the percent of the books that is now on contingency basis, versus the traditional by hold?

Morning John.

So, these are things we mentioned the last time, but they would include in the retail independent and the hospital space is insuring that we have a profitable business on each of our customers which is one as we just talked about in the previous-- a lot of it has to do with, generic penetration and following up to make sure that we are in line with contract compliance and I think there's a broader issue, too, even on our larger national (inaudible).

It is really working follow on plans and making sure we continue to develop the business as we go forward.

So, in essence, it has to do with really, a more robust sales process, throughout the organization, that keeps the contracts from just being contracts but becoming a place, a beginning point to develop strong, deep customer relationships where we can grow our businesses and mutually and identify new areas.

These are the areas we are really focusing on.

What we did primarily just to again summarize, was we flattened the organization to make sure particularly Scott and his channel leadership are very in touch with customers.

We are trying to reach out to them.

That has been implemented and is underway as well.

I will also just reinforce, that we have had some-- as we have been working on the anti-diversion issue, this has slowed our traction there because we've had to work control issues with every single customer.

So we are a little behind where we would really like to be on that.

But, those are the key things: flatter organization, stronger sales process, in depth and continual growing and focusing on growing our business with each of our customers, insuring that we have them also the right amount of generics business.

Those are the key parts.

Thanks.

John, a response to your second part of your question, about 20 to 25% of our branded margin is still on a contingent basis.

I was going to give you an exact number today, 22%.

Thanks very much.

Operator, next question.

Your next question comes from the line of Eric Coldwell of Robert W.

Baird Please proceed.

A couple of quick questions I will handle them distinctly.

First off, I think (inaudible) channel checks it appears as though if [F.

Doman] integration did not go as well as perhaps would have been expected and maybe a substantial amount of that acquired revenue went away.

I guess my question is what did you learn from that process and what did those smaller community pharmacies tell you they wanted from Cardinal as they were perhaps shifting to other suppliers?

It is Jeff.

Thanks for the question.

I would say generally, we retained the customers we expected to retain.

So, I'm not sure there's a huge our Doman acquisition is on track.

We did lose one large account which we anticipated at the time that we did the deal.

Other than that, I would say generally we retained the customers we expected to retain, So, I'm not sure there's a huge lesson learned here other than obviously it is important before you do deals like this that you have a good understanding of which customers you are going to be able to keep and which ones you can't.

And, obviously maintain stability in the sales force to the maximum extent possible because particularly for some of these regional accounts, the accounts are very much linked to the sales people.

So insuring we have a smooth transition and treat employees well is critical for all our acquisitions.

Also point out this was a relatively small tuck-in.

So, although any time you lose a customer, it is a significant event because we want to keep 100% of them, overall, it is not having a huge impact on our business one way or the other but generally it is on plan.

Jeff, during your prepared comments, you mentioned that guidance is obviously exclusive of any new portfolio optimization initiatives.

Are there any specific things you are targeting right now.

Are you working on any portfolio events that maybe we will see news on in next few months.

Eric, I would say part of the process here at the company is always to be looking at it.

So, no matter when you ask me that question I would say we would be looking at things.

You always want to look at businesses that perhaps are not giving us the return or adding the strategic fit that we need for the overall portfolio.

And, that will be a continual process.

At this point, sure there's a couple of businesses we are looking at closely, we are not prepared to talk about those specifically.

Other than you shall not expect anything that really stuns or surprises you.

There's a whole host of businesses that sort of a fall out of our core businesses, Obviously, the market-- there are some businesses that I would describe as-- they're not strategic, but you've got to have the right conditions and you've got to have a buyer and a seller and it works out.

But, I would say, we continue to work that, but there are a few things that are on our docket but nothing you would find in the category of really big or surprising.

Thank you, and just one more final question if I might.

We have talked a lot about the management change and SDS Pharma.

You've also mentioned the distractions with the DE A and other issues.

We've seen some headlines that perhaps there's more union activity, more teamsters activity around warehouse and delivery personnel.

I am curious whether Cardinal is facing any issues with employee relations or any changes in the makeup of perhaps union related employees or union activities.

There's obviously a good question to ask.

We have had some union activity at a handful of supply chain medical facilities.

Although on the other hand we just recently won a big vote where the union was not accepted.

So we have a handful of places but nothing that I don't think we can work through and it is in-- in the supply chain medical area.

As I said we are also making progress.

We had one where the union was not ratified by the employee.

So, I don't think it is anything to worry about.

Operator, next question.

Your next question comes from the line of Charles Ryee, with Openheimer.

please proceed.

Thanks for taking my question.

Actually just one quick question here on the medical distribution.

Actually, you made some comments about expecting year-over-year growth.

to improve as we move into the back half.

Does that include the change in the cost allocation?

Yeah.

The comment was that we expect a return to positive growth in the second half of the year for Supply Chain Medical That would include the corporate cost allocation (inaudible).

Operator, we have time for one more question.

I think we -- Are there anymore in the queue, operator?

We are showing no more questions in the queue at this time.

Okay.

Thank you.

Well, I know we are past our time I'll just make a few quick comments as we wrap up.

I just want to reiterate that the gain.

That we have three of the four segments which are on track, Supply Chain Medical, Clinical Technology Services, Medical Products and Technologies, these businesses do account for 50% of our operating earnings for the fiscal year on an average basis and they are going to grow about 20% for the year.

We are feeling very good about those businesses.

Supply Chain Pharma, we fell the need to reduce our second half forecast but I do believe we have a very strong core business.

We have completed contract renewals with our biggest customers.

The market dynamics are looking favorable going forward.

We made or are in the process of making the changes to improve execution that will begin to show improvement in the second half.

The revised EPS while down, still it represents 10 to 13% on the fiscal year.

I think, more importantly, we are feeling very good about operating in a growing industry, we are very strong fundamentals, especially when the broader markets are are becoming volatile.

We also feel very positive about our outlook for the mid and longer term, the diversity of our health care products and services is a strength that differentiates Cardinal and we are looking forward demonstrating that as we return both sectors to performance levels we expect.

So thank you very much for joining us this morning.

And, operator, this concludes our call..

Thank you for your participation in today's conference.

You may now disconnect.

Have a good day.