卡地納健康 (CAH) 2009 Q1 法說會逐字稿

Good day, ladies and gentlemen and welcome to the 2009 first-quarter Cardinal Health Incorporated earnings conference call.

My name is Ann and I will be your coordinator for today's call.

(OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes.

At this time all participants are in a listen-only mode.

We will be facilitating a question and answer session towards the ends of the presentation.

I would now like to turn the presentation over to Sally Curley, Senior VP of Investor Relations.

Please proceed.

Thank you, Ann.

Welcome to Cardinal Health's first-quarter 2009 conference call.

Today we will be making forward-looking statements.

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

Please refer to our SEC filings in the forward-looking statements slide at the beginning of our presentation, which can be found on the Investor Relations page of our website for a description of those risks and uncertainties.

In addition, we will reference nonGAAP financial measures.

Information about nonGAAP financial measures is included at the end of the slide.

A transcript of today's call is also posted on our investor web page at www.cardinalhealth.com.

With that out of the way, now I would like to turn the call over to Cardinal Health's Chairman and Chief Executive Officer, Kerry Clark.

Good morning and welcome everybody.

I'm very pleased to report progress this quarter on a number of fronts.

The Company performed as we expected with double-digit revenue growth in HSCS and another solid quarter in Clinical and Medical Products with overall double-digit revenue and profit growth.

While successfully spinning off our CMP business as a top priority, we also remain very focused on delivering this year's numbers.

As I mentioned on the Q4, in late September conference calls that means focusing on excellent execution.

For Health Care Supply Chain, it means focusing on the right programs in the right channels at the right profitability and making the right investments for the future.

We are making progress here.

For Clinical and Medical Products, it means delivering clinically differentiated products that win in the marketplace.

We are pleased with the continued strength of this business.

The core business continues to enjoy industry leading positions and we have recently seen good signs from some of our investments.

We are making good progress towards the spin-off and still anticipate an effective date around the middle of calendar 2009.

We will likely file the private letter ruling request on the tax-free nature of the transaction by the end of the calendar year and still anticipate filing the Form 10 registration statement with the SEC during our Q3.

As a reminder, the Form 10 will include the spin-off companies financials.

Cardinal Health's pro forma historical financials reflecting the spin-off will be available separately, closer to the effective date of the spin.

We remain optimistic about the future of both of these businesses and continue to refresh their business models to be well positioned for growth.

Both organizations are truly energized about the spin-off and enthusiastic about the respective prospects.

Finally, we continue to be very sensitive to these extraordinary times we are now operating in and the impact they have had and could have on our retail and hospital customers.

For now, we believe that it is too early to the make financial adjustments but we are monitoring the situation very closely and are taking the necessary operational steps to be sure we are on solid footing for the balance of the year.

Now, I'll turn it over to Jeff to provide you with an overview of our Q1 fiscal 2009 performance and more commentary around the credit markets.

Jeff?

Thanks, Kerry.

Good morning, everyone and thanks for joining us.

This morning, I'm pleased to be reporting first-quarter consolidated results, at or above our expectations, despite the current challenging environment and the macro economy.

Truly, we are not declaring victory by any means but are making solid progress on our key initiatives.

As Kerry mentioned, Dave and George will discuss this in more detail in a few minutes.

Later, I will also update you for the outlook on the remainder of our fiscal year.

But first, given the credit markets issues we are all familiar with, I want to take a few minutes to propriety provide you with an update on our liquidity position.

We thought this might be top of line for all of you, so we would address it up front.

We finished Q1 with just under $700 million of cash on our balance sheet, of which approximately 400 million was overseas.

Cash was down from our FY '08 year-end balance due to some debt repayments made in Q1, as well as some normal variance in our quarterly operating cash flow, which I'll touch on later.

Outside of our US cash we have three primary sources to meet our short-term funding needs.

First, we have a $1.5 billion commercial-paper program, which is fully back stopped by a committee-credit facility led by Bank of America, JP Morgan, Chase and Barclays.

We have been able to issue commercial paper during the past several weeks albeit at higher rates.

Right now, we believe that about $200 million of available liquidity for us in this market, which we monitor and test frequently.

Second, is our $850 million committed accounts receivable sales facility.

We are in the process of renewing that facility, which expires in November.

We recently tested it with a short-term $300 million drawdown without issues.

Third, we can also utilize international cash on a temporary basis.

The government recently expanded a Safe Harbor for temporary loans of international funds to the U.S.

for 180 days without creating a tax liability.

So we can access those loans if the short term need arises without a significant tax cost.

From a usage standpoint, we do not have any significant debt maturities until the Fall of 2009.

As you know, we have downsized our share repo program in advance of the planned spin-off next year.

The bottomline, we have a strong balance sheet, good liquidity and continued access to capital.

Let's now discuss the consolidated results for the first quarter.

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

Consolidated revenues were up 11% to 24.3 billion.

Operating earnings were down 6% to 482 million, which reflects the challenging quarter we anticipate from HSCS, partially offset by the expected growth from the CMP segment.

Earnings from continuing operations were down 16% to 268 million driven by the segment results a year over year increased in interest and other and a significantly higher tax rate than last year.

Just a few more details about our net interest expense of $62.5 million at Q1.

This was an increase of almost $20 million versus last year driven by two primary factors.

Lower investment income and a swing in the impact of foreign exchange.

I'm happy to report that we had zero write-offs in our cash portfolio related to the credit crisis.

Our nonGAAP tax rate for the quarter was a little over 36%, versus about 32% last year.

Which in part reflects the one-time reserve adjustments related to some ongoing IRS controversy, as well as some mix changes and some expiring non-U.S.

tax incentives.

Diluted EPS was $0.74 for the quarter down 14% from the prior year.

Operating cash flow for the quarter was a use of 350 million, partly driven by an increase in working capital to service the significant increase in revenue in HSCS and partly due to normal fluctuations in working capital that arise on a day-to-day basis making an impact to reported numbers.

For example, Monday and Tuesdays are high-payment days.

So there is a negative impact of ending on a Tuesday, like we did this quarter, versus ending on a Friday, which is a high collection day.

Actually, we make good progress on our key controllable working capital metrics.

Days inventory on hands improved by one day versus the prior year.

And receivables days also improved almost a day versus the prior year.

We also made good progress in reducing our overall portfolio of customer delinquencies, which is particularly important during these times.

Now turning to the next slide.

During the quarter special items totaled approximately $35 million, which negatively impacted GAAP EPS by $0.10.

The 35 million was comprised mainly of severance and other employee costs associated with our July restructuring.

Impairments and other totaled about 17 million in the quarter and favorably impacted GAAP EPS $0.05 due to the relief of a tax reserve as a result of divestitures in that period.

The net of all this was a negative $0.05 impact to GAAP EPS.

Going forward, we are going to flush out this chart a little, so you can see which costs in the period were related to the CMP Spin-off.

In Q1 this number was under $1 million.

So we didn't break it out this time.

But going forward in the future you will have complete transparency to these costs.

Now, I'd like to switch to the performance of the individual business segments on a year over year basis.

Please recall that some of the businesses currently included as part of the CMP segment such as gloves, converter and fluid management will remain with Cardinal Health following completion of the plan spin-off.

However, the following segment results reflect the current operating and reporting structure for the Company, which is the reporting methodology we plan to use until the spin-off is executed.

Within HSCS, revenue for the first quarter increased 11% to $23.4 billion, which even with the extra billing day in the period which contributed a little under two percentage points of growth represents very strong growth in all core businesses, including both medical and pharma.

Specifically, in the pharma-business, we are able to achieve very good growth in a number of areas.

Revenue from bulk customers was up 20% on increased volumes from existing customers and customer wins.

Revenue from nonbulk customers was up 4% driven by growth in retail chain and hospital markets.

More work to do here but we are very happy with our progress in this area.

I should point out that our current mix of bulk and non-bulk revenue within the pharma-business is now about 50/50.

As expected, segment profit was down 16% to 293 million, primarily driven by the ongoing impact of previously announced customer repricing in Pharma.

The effect on anti-diversion activities and lower-branded price inflation for a basket of products in the prior year.

Partially offset by the strong revenue growth and increased profit dollars in generic products with the launches of [inaudible].

With regard to branded price inflation, I know there's been a lot of speculation as to the year over year change in inflation levels.

It is clearly lower for our basket of products.

Although, keep in mind that about 80% of our business is now fee-for-service.

So the most relevant price increases in any given quarter are the ones that impact the remaining 20%.

We are seeing some benefit versus our budget from lower fuel prices but as we mentioned before, within HSCS that is a relatively small part for of our overall cost structure.

Finally, I also did want to mention our Medical Supply Chain, which also had a strong quarter with revenue up approximately 8%.

Then last but not least and very importantly, we have also begun making the increased investments in IT and in HSCS, which will be critical to our longer term success.

I will turn to CMP.

Revenue was up 12% driven by installations of Pyxis products, growth in international, and the acquisition of Enturia which contributed approximately five percentage points of growth.

We have begun the important task of increasing our investment in R&D.

We will see R&D increases as the fiscal year progresses and expect to spend about 4% of FY '09 revenue in this area of spend.

Segment profit was up 15% on the revenue growth and the acquisition of Enturia which contributed approximately nine percentage points.

Partially dampened by the increased cost of raw materials.

Now, on the topic of commodities, I would like to briefly explain how they impact our CMP business.

There has been a lot of volatile in oil prices and some speculation as to how it impacts us.

Now for clarity, there are really three buckets of exposure to commodities within CMP.

Number one is fuel and on honestly, it's the smallest bucket and doesn't not immediately impact the P&L in most cases.

It's primarily absorbed into inventory and rolls into cost of goods sold as inventory turns.

Second category of commodity products of oil is one driver of the cost.

These include resins like polypropylene, polystyrene, polyethylene and PVC.

All of the prices of these raw material sources are generally linked to oil.

In most cases, they lag the movement in oil prices by a few months.

And in addition, our contracts are typically structured to adjust based on an index on a 30 or 90s day basis, which has a further delay in impact.

Then lastly, these costs are also absorbed into inventory and roll into COGS as well as inventory turns.

The last bucket is made up of commodity products where oil is not a driver of the cost.

An example of this would be the latex that we use in glove manufacturing.

Any change in these costs would also first be absorbed into inventory.

So all in all, it can take six to nine months for most commodity cost changes to impact the P&L, which means we are just now starting to feel the full impact of rising costs from earlier in the calendar year.

So I would caution you not to look for a dramatic near term benefit from falling prices given the time it takes to see those prices impact the bottomline.

However, all else being equal, we should start to see some benefit from current prices in the fourth quarter of this year and beyond.

Dave will obviously touch on CMP later and what he's seeing in the hospital market in a few moments.

Now, turning to slide nine and guidance.

Q1 did play out largely as we expected despite the various potential pressures created by the ongoing economic and credit conditions.

Looking forward it would be naive for to us assume our business is totally immune from a continuation of the overall negative environment.

We will see higher interest expense if credit spreads don't come in.

And we are keeping a close eye on bad debt expenses.

Although, I will point out that our bad debt reserve as a percent of receivables held pretty steady thus far.

On the business side, IMS is reporting slower scrip growth.

Although, we really haven't seen that come through on our supply chain revenue to date.

More importantly, we are seeing a pause in certain hospital capital spending which will effect our CMP business in Q2.

Specifically, although we expect Q2 segment profit for CMP to still grow significantly year on year versus Q1, it perhaps will not be at the rate of growth that we expect for the full year.

However, it's not clear how that will play out for the year so we are not changing full year guidance at this time but it is something we will be watching closely.

With regard to nonoperating items.

let me also provide some additional color.

For the full year tax rate, we still do expect to be on track to hit our guidance of around 34% but we anticipate the rate in the second quarter to be closer to the 36% or so realized in the first quarter.

We expect net interest expense to be only slightly lower in Q2 than Q1 and given our experience in Q1, as well as our expectation for higher borrowing costs and lower interest rates on investments, we now anticipate the full year net interest expense to be north of 200 million.

We expect shares outstanding to be slightly higher in Q2 than Q1 with average diluted shares outstanding for the full year in the previously indicated range of 361 to 362 million.

This reflects our plan to repurchase no more than the amount required to offset dilution from equity compensation issuance.

So there are some puts and takes but in summary our full year guidance remains unchanged at this time, despite fact that Q2 might be lighter than some expect due to CMP customer issues and certain below the line items.

However, Q3 and Q4 are expected to be stronger due to our usual quarterly profitability patterns and our previously indicated return to profitable growth for HSCS in the second half of the year.

We will continue to monitor all the environmental and market issues closely.

And to take the actions necessary to mitigate the impact as appropriate.

Now as we said before, our guidance does not reflect any incremental costs we will incur associated with the spin-off and separation of the two companies.

As I mentioned earlier, our plan is to separately identify and call out those costs on a quarterly basis.

With that, I'd like to turn it over to George to provide a few comments on HSCS.

George?

Thanks, Jeff.

Good morning everyone.

For those following the presentation, slide seven and eleven in the presentation will refer to my comments here.

I'm happy to report continued progress in our HSCS business.

We still have enormous work in front of us but we do see some positive signs.

Let me start by talking about our Medical Supply businesses which agree revenues by approximately 8%.

We continue to focus on three things.

First, reducing complexity in order to improve customer service and profitability.

Second, aggressively moving forward on our lien transformation in our presource kitting business.

And third, driving growth in key areas of opportunity.

As relates to the first producing complexity, we have been able to reduce our medical surgical product line by nearly 2000 SKUs without a reduction in value to our customers.

Although this does not translate to an immediate financial benefit, this SKU rationalization process will simplify our business and create value as we go forward.

Our lean transformation and our presource kitting business is progressing well as we push to reduce inventory, shorten cycle times, eliminate waste and improve the customer experience.

Finally, our efforts to target growth areas are bearing fruit.

As our Ambulatory business grew at double-digit rates and our Scientific Products business has recovered from last year's loss, of its largest customer and it's actually turned to profitable growth, this is a great accomplishment.

Our Nuclear Pharmacy business continues to lead the market in serving cardiac imaging and we were able to take advantage of the first launch of a generic Cardiolite through an improved cost position with our existing suppliers.

I'd like to turn to our Pharma Supply Chain business, our largest business.

Our year over year revenues increased 11% driven largely by the growth in our bulk customers.

Good news in what IMS is reporting as a particularly slow growth script environment.

We did see an uptick to our DSD business, our direct store business of 4%, a relatively modest number in absolute terms but encouraging given the fact that we grew in the face of the anti-diversion negative impact and reclassification of some [Walgreen] business from nonbulk to bulk, which we discussed last quarter.

In addition, although independent retail business was flat year over year, our performance looks more promising when you remember that our control drug issues resulted in lost business of roughly 1 billion on an annualized basis starting in Q3 of last year, most which have came from independent retailers.

As we announced a few weeks back, we did come to a settlement with CEA with regard to our distribution of controlled drugs and expect that our New Jersey, Florida, Washington and Texas facilities will be back on line by the end of November.

This is an important threshold for our customers and is a critical milestone in our effort to return our business to a positive trajectory.

Our Generic Programs also showed signs of progress.

Our source Generic Programs grew at about 10%.

Although, we saw modest growth in our overall retail generics, we experienced more dramatic double-digit growth in other segments, as we continue to tailor our offerings to specific customer needs and is included some effective use of telemarketing for our pharma operations.

Given the complexity of the generic environment, the heightened awareness of the important of access to low-cost pharmaceuticals and ongoing flow of drugs, which will lose patent protection in the coming years.

We will continue to focus on building our generic capabilities.

Our drive to achieve best -in-class speed and execution of generic launches was put to the test with the launch of lamotragine and the full roll-out of Respiradone which began at the end of last quarter.

Both of which were executed extremely well.

This is crucially important to our customers who gain from our ability to source efficiently and to our generic manufacturing partners who benefit from our ability to aggregate share.

In summary, we feel good about our progress and are well aligned around our priorities.

We have a strong focus on execution and are mobilized towards improving the customer experience, while maintaining a very disciplined approach to management in this extraordinary environment.

Getting the DEA settlement behind us is a big step for us and our team is energized and excited about the challenges and the opportunities in front of us, as we move toward the spinoff.

With that, I would like to turn the call over Dave.

Thanks, George.

As CMP delivered solid results in the quarter, we continue to set the standard in medication management and make progress on our goal to set the same standard in prevention.

The changes that CMS has made in its reimbursement for never events, including those related to hospital acquired in growing challenges for our customers, while we bring the industry leading expertise to health.

We continue to maintain or expand our market positions in infusion, respiratory and dispensing equipment.

While the landscape remains competitive, we continue to win with our products and Alaris continues to displace competitors and gain share.

We won more than 60% of deals in infusion where a competitor was the incumbent.

Some of our strategic investments are also making excellent progress.

For example, we closed more deals for our MedMined infection, detection and prevention service this quarter alone than we did in all the FY '08 and we gained more customers in Pyxis Supply in the quarter than we did in all of FY '08.

In addition, our Enturia acquisition performed very well.

Confirming our belief that ChloraPrep will continue to gain share as the preferred antimicrobial skin-prep solution.

Now as Jeff said earlier, we are seeing hospitals delay some purchase decisions.

It's not been a dramatic slow down at this point but we are seeing it have an impact on Q2.

Our committed contract run rate slowed at the very end of the first quarter and we are being somewhat cautious in looking forward.

The outlook is more difficult to determine in our business, since it's not obvious that purchases of our capital equipment products would be deferred over an extended period of time.

Let me highlight that our offerings such as ventilators and IV pumps are critical to providing care and that we do provide a leasing structure for dispensing equipment.

Our leasing provision is a key competitive differentiator for us.

In addition, many of our disposable products serve as an annuity stream for our business.

Not only do we have lines of disposable products in infection prevention like gloves, more than 50% of our infusion revenue comes from disposables and more than 35% of our respiratory revenue is from disposables.

So there are some revenue streams that should be relatively insulated from any slow down in capital spend.

We are also making great progress on product remediation and infusion.

We completed the recall work on the signature edition pump in the quarter as expected and currently anticipated we will be back in the market in the spring.

This is already factored but completing this remediation is a significant milestone for the business and for our customers.

We are also on track to complete the remediation on our flag ship product, the Alaris system by the end of the calendar year and I am pleased with the great progress we made on our overall quality system and will continue to work through the process with the FDA to resolve the consent decree.

Despite the challenges of the current economic landscape, we have a great business with industry leading products that make a clinical difference for patients.

We are increasing our investment in R&D.

In fact, R&D as a percent of sales historically has been in the 3% range and we expect that number to increase to about 4% in FY '09.

Our goal is to move it to the 5% to 6% range over time.

This is a blended rate which means that our investment needs will be lower in disposables be higher in capital equipment where we lead with innovation.

We continue to invest in an already strong innovation pipeline and to be well-positioned for the long term.

Now, I would like to open up the call for questions.

(OPERATOR INSTRUCTIONS) The first question comes from the line of Tom Gallucci from Merrill Lynch.

Good morning.

Thank you very much.

I had one each hopefully for Dave and for George.

David, just wondering, you gave some statistics there on consumables in individual product lines.

As you look at your whole segment, any idea what consumables are as a percent of revenue and what the margins are in that business?

And, then, for George, it seems like maybe, did you take market share or are your existing customers just doing very well.

Particularly in that independent business that you noted the DSD is up despite the loss of the independent?

Can you describe where that business is coming from.

Thank you.

Thanks for your question, Tom.

I will take the first one.

To the question of what percent of revenue for the overall segment disposables represent.

It's over 40%.

And as far as margins are concerned, disposables typically have fairly strong margins particularly where they are dedicated to the equipment like an infusion.

George?

Tom, it's really a couple of components.

You asked about the contribution to growth and what's happening.

I think it's a had I been of three components.

One is some improvement in capturing a higher percentage of our existing customer business.

The other is new business and I think we mentioned this in prior quarters that we've been picking up a little business along the way in spite of some of our challenges in the anti-diversion environment for us.

And then finally, we actually had some more unusual growth in certain segments in the health systems part of our business and ambulatory.

So it's really several components that are contributing to this and feeling like we are on the right path here.

George, have you had any major discussions with clients that were affected by the DEA issues and now that you are going to be out by the end of November, you think any visibility which have of those customers you may win back or not?

We've had plenty of conversations.

Probably, actually now for months about the future.

It is very difficult to give you a quantitative analysis on what's going to come back to us.

I think as I've said before, we are probably going to work out slowly but I'm optimistic that the things that we've been doing in recent months are a signal to them of our commitment and I think will take time but I think we are on the right path with them.

Thank you.

Next question, Ross Muken from Deutsche Bank.

I also have one question each.

As we look at sort of the commentary around hospital based spending, is there certain price points where you are seeing a bit of softness?

It certainly seemed on some of the CapEx side that you are, you saw a bit of softness at the end of the quarter.

Is there a certain price point that it's a break point for purchasing departments?

And then in turn, have you we seen sort of any sort of normalized reassumption of demand patterns in the early weeks of this quarter that maybe made you a little less cautious or potentially held you off from doing any sort of change to guidance?

Ross, I think the answer to your question is that I don't detect any particular price points that are driving hospital behaviors.

I think it's much more a function of the behavior of the individual Chief Financial Officer.

So the answer, the short answer to that question is no.

And we've continued here in the early weeks of our second quarter to see hospitals continue their cautious [inaudible] and I'm hoping that obviously that that turns around as governments around the world intervene in the credit markets.

Right.

And, George, how would you sort of characterize the morale of the sales force at this point?

There's been so much change in cardinal in the last few years but certainly even more recently, a lot of things put in place and certainly with the split off and now obviously with some of the DEA issues getting towards resolution.

Is there sort of any kind of change in the overall sort of behavior pattern of the sales force?

Do they feel a bit like the opportunities ahead of them now as you've been somewhat of a share loser the last few years?

That's a great question and it's delicate to speak for other people but the energy I see from the group at the moment is really high.

It's been interesting as we have announced the spin-off of another area in a sense of uncertainty and yet for individuals and yet people are extremely excited about it.

And I think the resolution of our agreement with the DEA., I think for some lifted a cloud.

We know that we've got a lot of work around that area to continued to do, but I think the sense of optimism has shown a significant uptick.

I'm excited about the way people seem to look and talk and feel about our business and where we are going today.

Great, guys.

Thank you very much.

The next question comes from the line of Lisa Gill from JP Morgan.

Please proceed.

Good morning.

George, as we look at the fact that IMS is now lowering the global forecast and the U.S.

forecast for pharmaceuticals.

How much of that do you think that -- clearly, it's a sales number that they are talking about but how much do you think is utilization towards the push towards generics?

You are talking about you pushing more generics into the channel or looking at a price point difference between a branded and a generic.

Are you seeing big shifts in actual utilization of pharmaceuticals or the actual buying patterns of your customer overall or do you think it's more of a shift from a brand to a generic?

And then secondly, Dave, I know that you talked about the fact that it's not a specific price point for the product but are there certain products that they are holding off on buying or is this just more of a credit crunch?

The CFO is concerned about borrowing to buy the product and therefore, we think that this will come back when things start to ease, perhaps in the early parts of 2009?

Thank you.

Yes, Lisa.

Let me comment a little bit about your question on the IMS.

That's a real good one.

I think right now there is no question that the shift from branded pharmaceuticals to generics continues.

Now, this is not a new trend.

Obviously it's getting a lot of play right now.

This is a trend that's been pretty heavily in motion for years.

So I can't say that we are suddenly seeing a dramatic swing but the trend is clear.

Generic utilization is going up .The conditions that we find ourselves in as a health system probably will continue to promote that.

So that does have some dynamics for the overall script data or the overall market data.

As relates to script, there is some data that suggests a slowing of utilization a bit and the way I say this to folks internally is that fundamentally the demands for what we do will not go down.

The population is aging.

We know that pharmaceutical treatment is an incredibly cost efficient treatment.

So whether there may be some delaying of doctor visits or other things.

There's been a lot of anecdotal reports about this.

We are seeing at least in the public data little bit of utilization is slowing but I think the interest that you raise which is the shift from the branded pharmaceuticals to generic is clear.

Are you hearing from your customers?

When you talk to your retail-based customers, you are saying, "You know, our volumes are down.

Utilization is down." Or we are not quite seeing that yet?

Not particularly.

I don't think I would say that sort of a loud voice coming from our customer base right now.

I think they are more aware of the economic climate as a driver of concern for them than particular script utilization.

Okay.

Great.

And then, Dave, any comments as to how you think this will rebound and if there are specific products and services that they are looking at?

Actually, I don't see this apply to any specific capital equipment purchase.

As you know, we have three lines of capital equipment.

The infusion line, the dispensing line and the ventilator line.

In dispensing, as I mentioned in my earlier comments, we do offer our own leasing option and so the decision that the customer would make is a decision to extend a capital lease, which would typically be five years.

And doesn't mean that they are not continuing to use the equipment that they already have and continuing to make lease payments on that -- on a monthly basis.

The size of the deals I think is more what drives the decision from the standpoint of the CFO and if you look at the size of the purchase decision that they'd be making across all three of these product lines, depending upon the size of the institution, it will range from roughly $0.5 million at the time of a purchase decision up to as much as $15 million.

And so these are numbers, obviously, that get the attention of the CFO and I think that they are simply wary about the availability of capital and I think that once we see the availability of capital clearly begin to free up that they are going to be in a different frame of mind.

Great.

That's very helpful.

Thank you.

The next question comes from the line of Charles Rhyee from Oppenheimer.

Please proceed.

Hi , a couple of questions for Jeff here regarding the guidance.

I think last quarter you guys mentioned that as part of the first quarter you were expecting a hefty amount of investment spending and I think it was roughly about 50 million for HCSC and also for the CMP division.

Looking at the results can you give us a sense on did you spend all that money in the current quarter?

Is there a little bit more of than investment spending, which we should see in the next quarter?

And also in regards to your interest expense guidance you expect over 200 million.

Clearly, you got hit a little bit in this quarter by the FX?

Can you give us a sense on what you are seeing currently in regard to FX and how you are accounting

Sure.

Thanks, Charles.

Good questions.

First of all, in terms of the incremental investment spend for FY '09.

What we said in the prior call was we expected it to be about 100 million in total for both segments, divided approximately equally between $50 million of expense for HSCS, mostly for IT related spend and about $50 million for CMP primarily related to product research and development.

Obviously, we are off to a good start in terms of the spend so far this year.

Despite the fact that we are scrutinizing every expense in the Company right now given the current macro environment.

There are certain expenses that we recognize -- investments that we recognize that we are going to need to make for the long-term future of this Company and those are two of them, Continuing to improve our IT investments in HSCS and building our product pipeline for the future in CMP.

I would say in Q1 we are pretty much on track with those investments and we still have every reason to believe that we will spend close to the $100 million for the full year.

It doesn't necessarily expect to come in the first quarter, all of it.

Is that correct?

No, it was not supposed to be in the first quarter.

That $100 million was spread over the year.

We said it would generally be front end loaded and I would say generally that in terms of the activity that's true.

Whether all the expenses themselves will be recognized in Q1 or Q2 or later remains to be seen.

It depends on the pace of some of the activity, particularly in the IT area, where it takes time to ramp up projects but those projects are all fully underway, including some very important customer facing projects that we commit to do that we are doing.

On the FX front, the net/net impact, if you look at the operating impact and the impact below the line for Q1.

It was a little over $10 million of negative impact for Q1.

Most of that actually was below the line related to some revaluation of inter-company receivables, et cetera, in light of the strengthening U.S.

dollar.

Overall for the year though I would say generally, Charles, FX isn't a big driver of our results.

We have a global Company but it's perhaps not as international as other companies you may cover.

And we are pretty well hedged both operationally and financially where appropriate.

So I don't expect FX to have a huge impact on the bottomline.

On balance right now, it's probably more negative than positive given the strength of the U.S.

dollar.

But we'll continue to put in place the appropriate hedges.

Again for Q1, it's about a $10 million negative impact.

Thanks.

If I could just ask one more here.

Obviously, had you a strong quarter in distribution on the topline, even if we back out the extra day in the quarter, but the full year guidance remains sort of greater than 6% topline.

Kind of implies that the growth rate slows a little bit.

Can you just give a sense on what are the dynamics that we should be thinking of as we move to the course of the year.

Well, I could touch a piece of it.

We got some particularly note worthy growth, some business that we had picked up on the bulk side from Walgreens that we talked about in the past.

That was one component of it.

Generally, I think that we feel comfortable with the kind of revenue guidance we provided.

Obviously, our hope is always as we start to build momentum coming out of our anti-diversion issues that we will start to see some noteworthy progress but I think we are comfortable with the kind of revenue forecast we provided.

Thanks a lot, George.

Thanks, everyone.

The next question comes from the line of Glen Santangelo from Credit Suisse.

Please proceed.

Yes, thanks.

George, I just want to do talk a little bit more specifically about your distribution margin.

You talked in your remarks pretty generally about the progress you're making and the fact that you're on the right path.

And clearly settling with the DEA was a major part of that.

Could you maybe talk a little bit more specifically about what ultimate the turns the margins in this division because the operating margins are down year over year, then down again sequentially but yet it sound like you're making progress.

I'm trying to understand is the DEA settling that issue going to be enough to turn the margins or is there something more specifically that we should be focused on?

And then, I just had a follow-up question on the nuclear pharmacy business.

Let me just give you a quick observation, a little bit comes back to some math exercise we did actually in the last earnings call and this is again sort of an interesting dynamic.

I mentioned in that call that because our bulk business and those customers are growing disproportionately fast, our margins are influenced by this mass exercise, which essentially is that the lower margin component is simply growing faster than what can happen realistically on the direct store side.

So part what have you're seeing is completely expected and in fact, I don't think it's unhealthy.

We are very happy to grow that bulk business.

What's really important to us though is to -- around that is to grow our direct store business, shifting that mix so we start to see some favorable direction in our margins.

But again, very important, this components of math is one that we just need to realistically understand.

So again, biggest issue is mix.

I would say first customer mix and second is actually product mix and again, that has to do with what we are doing in our category management and medical businesses, as well as, driving our generic programs.

So those to me are the single largest drivers of margin.

Coming out of the anti-diversion issues, no question that this will give us a better shot at capturing some of the business that we really believe can help get some margin to stick to the bones.

Hey, George, could you maybe just comment a little bit on the nuclear pharmacy business?

How big is that as part of your total business?

And now that there's a version of generic Cardiolite out there, can you give us a sense of the pricing and profitability on that product?

Where you thought a little better, a little worse than you thought?

Could that be something ultimately that can move the margins as well?

I think so in a very broad sense the nuclear business contributes about 100 million to our profitability.

Here's where I see this playing out.

I think at the moment for us the good news is that the generic launch that did occur, which triggered a provision of our existing suppliers which allowed us a better cost of goods going into the market.

Of course, there was a corresponding drop in price in the nuclear pharmacy business.

.

I would say that has played out.

Although, we won't provide exact margin direction to you.

I would say that has played out about as we expected in relation to pricing and we knew exactly what our acquisition cost was going to be in that events.

That's sort of a key components.

The other thing that's worth reminding you, we said probably going back a call or two, that we did not model in for this year access to our own manufactured generic Cardiolite.

So that is an assumption that we continue to stick by.

I hope, love to be wrong but at this point I think that's the appropriate

Okay.

Thank you.

Operator, can I just ask we have actually quite a few folks in queue that we are going to get to this morning.

So if people could limit their question maybe to one question and one follow up that would be helpful.

Thank you.

Okay.

The next question comes from the line of John Ransom from Raymond James.

Please proceed.

Good morning.

Looking at your initial guidance for fiscal '09.

Part of the issue was additional investment, particularly for the September quarter.

It didn't --how much of that investment was actually in the September quarter, versus how much is going to be for the rest of the year?

Thanks.

Hello, John, this is Jeff.

I would say in Q1 of the total, it was probably less than 20% of the expense that showed up on the income statement.

Now, that doesn't mean there wasn't a lot of activity and some capital investment, et cetera, but in terms of the actual expense, I would say it was less than 20% of the full year amount.

Now, I do expect that will ramp up in Q2 and particularly in some IT areas, where it will begin to recognize some expense, et cetera.

So I think will you see more of a bullous of it in Q2.

So less than 20% and what was the EPS impact of the 1Q investment approximately.

Let's say $0.03 to $0.04.

Okay.

Thank you.

The next question comes from the line of Ricky Goldwasser from UBS.

Please proceed.

Good morning.

Two questions and no follow up.

First of all for George.

What was the growth rate for your -- that you experienced this quarter -- for your generic program?

And then, David, if you could just elaborate further on what type of action are you entertaining on to mitigate the impact that you are seeing on the hospital side?

Ricky, our generic program grew about 10% for the period.

Thank you.

And to your question about actions on the hospital side .Well, obviously, we have already started our belt tightening when it comes to things like [inaudible].

It's primarily a focus on holding down SG&A and making sure that money that goes into investments would likely give us a faster return to help moving the business overtime.

The next question comes from the line of John Kreger from William Blair.

Thank you very much.

A question for George.

George, can you give us an update on the buy side part of the drug distribution business?

How are the -- your various fee contracts renewing?

Are you seeing any changing economics there?

And on the non-fee, I think you said 20% part of the business, are you seeing the forward buy opportunities go up or go down as you look out into the future?

I'd say the dynamic between us and our branded manufacturing partners is relatively stable at the moment.

As you know, we have the part of our business that is more inflation sensitive has been shrinking in recent years.

I think that direction, that trends will probably continue.

We do have some lumpiness throughout the year for this period, was probably a period just based on the timing of how we are compensated through brand manufacturers.

Probably , a little bit lower this period but I would say that would have been as we have modeled it based on the nature of price increases when that occurs and that's the mechanism that

And how would you say, you said relatively stable in terms of the fee portion.

Does that mean you are kind of hitting your general performance targets across the board?

Yes, at the moment I would say that's right.

Thanks.

Yes.

The next question comes from the line of Bob Willoughby from Banc of America Securities.

Jeff or George, does the guidance contemplate any change in Walgreens store openings and secondarily, is there any indication that Cardinal has provided yet the CMP dividend that it will pay to cardinal with the spin?

Good morning, Bob.

No, there's nothing specifically contemplated for store opening.

We obviously have some expected shift in the Walgreens business, which we knew when we renegotiated our contract but nothing specific.

Your second question.

I didn't quite get it.

I assume CMP will pay some sort of dividend to cardinal with the spin that they will lever up to some extend and they will pay a dividend to Cardinal.

Is that not the case?

Let me explain the way these sorts of transactions were typically structured.

The exact mechanics we are still working through and obviously, we want to make sure that it happens in the most tax efficient and cost-effective manner possible.

But typically what would happen is at the time of the spin, CMP would take out some sort of loan and then use the proceeds from that loan to transfer money to Cardinal Health.

And then, if that was a bridge loan for example, they would then replace it with bonds over time.

The net effect is CMP would borrow in order to transfer cash to Cardinal Health and that's effectively the way it would happen.

As we said before, we expect the debt that CMP will have on its balance sheet to be somewhere in the 35 to 45% range of what have Cardinal Health currently has on its balance sheet.

And that includes that loan, then?

Yes, that effectively, that loan would represent the debt it would take on.

That's great.

Thank you.

You're welcome.

The next question comes from the line of Leo Caprio from Harris and Company.

Please proceed.

Good morning, gentlemen.

Just a question on the hospital purchasing slow down.

Regarding the slow down, is this something that could be confined to particular specific market segments or is it an across the board phenomenon.

And the follow up question is, are [Pyxis cabinets being deferred, higher price points or lower price points items?

Thanks.

Generally speaking, I think as you listen to the earnings calls from other companies that are in the capital equipment business and selling to hospitals, it seems to be more across the board than anything else and the -- as a result, at least in the, there is a short term impact.

As far as and what was the second part of your question?

The second part of the question was regarding the Pyxis cabinet.

When your salespeople speak with the hospital CFO's, are they being -- are they telling them in terms of the list of priorities that they are looking out for CapEx spending or deferring them in favor of other more bigger ticket items or looking at smaller items in terms of where it falls in that hierarchy?

In terms of Pyxis cabinets, it really would not categorize the decision making of the hospitals as focusing on other items of those cabinets, whether it's higher priced.

Just not seeing that.

Okay.

Thank you.

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

Great.

Thanks for taking the questions.

Just two relatively quick ones.Jeff, firstly, we talked about this before but of the $100 million in investment spend that you guys talked about thus far on the call, how much of that continues post fiscal 2009?

And then secondly, to the extend that you can will or you want to comment on, can you give us a sense of quarterly distribution or some sort of way that you're thinking about quarterly distribution from the EPS perspective going forward?

Thanks, Randall.

Let me answer the first question and then I will need some clarification from you on the second one.

With respect to the first let me divide into two pieces.

For CMP, the R&D investment, as we said before, I view that as a permanent increase in the rate of R&D spend required to continue to replenish the pipeline and remain competitive.

So I would say it's a permanent edition.

And as Dave said, the goal here is to get to 4% of sales this year and then increase that towards the five or 6% so the bottomline is it's a permanent add.

With respect to HSCS, I would say there's going to be a particularly bolus in this year and FY '10.

There may be some diminishing of that amount in years to go forward once we get some of the major investments made.

But I don't actually believe that's going to go to zero.

I think we will be continuing to invest into IT really is the life blood of HSCS.

So we will continue to make sure that we spend an appropriate amount.

So I would say it's probably more of a bolus in this year and next.

Can you repeat your second question?

Just trying o get a sense if there's anything we should thinking about in terms of quarterly distribution that is abnormal relative to the distribution historically.

I know you guys have talked about a number of swing factors in that guidance and specifically that $0.15 range.

I think today you have probably better visibility around some of the commodity prices tax rate.

It sounds like, George, you have a better sense of where generic Cardiolite is.

So as you think about the other swing factors that are left.

I guess what are the major swing factors and how do we think about EPS distribution or is there anything that we should be thinking about?

Let me repeat some of the comments I made during my prepared remarks, specifically as it relates to Q2.

I do think Q2 will have a little bit of pressure due to the CMP hospital buying patterns that Dave alluded to.

And also, there's some below the line activity going on, particularly in the tax rate, where I indicated we expect it to be relatively high in Q2 as well.

And as we discussed before the entire first half for HSCS will still suffer the effects of the WAGs repricing that we did last year and the anti-diversion impact as we crawl back out of that hole.

So I think the first half of the year we have consistently indicated that there will be some pressure on our EPS and I think that holds and some of the unique factors that I mentioned for Q2 as well.

As we look to the second half of the year, a couple things happening, we have said before they were expect HSCS to get to profitable growth in the second half of the year and we continue to stand by that.

I think for CMP we continue to be optimistic but cautiously so because of the reasons that Dave cited and it's a little hard to have that much visibility into Q3 and Q4 just given the uncertainty of the credit markets.

I would say those are some of the major factors.

The next question comes from the line of Larry Marsh from Barclays Capital.

Thanks and good morning.

Just a clarification around that and I appreciate the discussions Jeff on the comments but CMP directionally is usually up a good bit second quarter to first quarter.

You did 167 in the first quarter.

Just broadly speaking, you are saying it's going to be flatter?

You think it's going to be flatter in the December quarter and you are going to make that up in the second half or is that not what you're saying?

No, that's not what I'm saying.

CMP will show good growth both versus last year and versus Q1 in Q2.

It might not be growth at the overall rates we expected a full year because of some of the issues that Dave mentioned but we still do expect to see good bottomline growth.

And we also expect to see the continued ramp up in the second half of the year, as we typically do with CMP where they generally have strong third and fourth quarter.

I would say the overall patterns for CMP generally looks as it has looked in the past with some slight dampening from prior expectations in Q2.

You said FX below the line 10 million?

Do you mean below the interest line or is that included in interest and other?

And as you think about it, it sounds like you are saying you anticipate a decent reduction second half versus first half on net interest expense?

Is that just a pattern of your cash flows or do you thinking that credit spreads will tighten or both?

First of all, the 9 million or $10 million or so that I mentioned that below the line, actually I meant that to be in interest and other.

I meant below the operating line.

In terms of the rest of the year, we do expect that Q1 and Q2 will be the heaviest in terms of net interest expense for the year.

We will see some lightning of that as the year progresses and that's due in part to the factor that we'll have higher cash balances as we build up operating cash flow in the course of the year and the fact that we don't have any major plans for that cash at this point.

Okay.

And a quick question for George.

Your largest customer you talked about is up for renewal in fiscal, middle of calendar '09, CVS.

Is there any updated timing, do we still anticipate that to be announced close to June of '09?

Do you still anticipate pricing that you already have is about in line and is there any difference in how you're thinking about it given now that Longs is in the mix and their commitment there?

I probably would say we don't have any update nor really change in expectations.

We again expect a renewal as we come towards the summer and again, I think, we continue to feel that as a newer contract it is a tighter fit to market conditions.

So we remain hopeful that it's going to be a relatively smooth transition but nothing really knew to update.

Okay.

Very good.

Thanks.

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

Thanks.

Good morning.

Typically distributors at least historically have built inventory in the December quarter for a number of reasons.

In front of the holidays, safety stocks with the weather, pricing inflation opportunities, what have you.

At the same time, we have in an environment where customers might be a little more willing to let inventories decline and not work a little closer to a just in time model given the spike in interest rates and the credit crisis.

I'm just curious whether you see any -- maybe Jeff if you can answer this -- if you see any potential in the quarter where perhaps your inventory days on hand would jump and we might see cash flow delayed until the March quarter or any themes on that front would be helpful?

Eric, a good question but at this point we really don't see any significant trends that would indicate that our inventory patterns in the December quarter will be much different that what we've seen in the past.

So I wouldn't expect a major change there in terms of days of inventory, et cetera.

And as a follow on, you've shown some continued improvement year on year in your days on hands specifically that's been the theme across the board .Do you still target showing a few days of additional improvement over time?

Is that still something that's on the horizon for you?

Yes.

What we've said in the past is we are not going to see the huge improvements that we saw back over the last three years where we were making a transition from the buy and hold model to fee for service.

That all said, we still do see opportunities to take a day or two out of inventory each year.

Really just do the hard work of operational excellence and getting much better about demands calibration and minimizing the amount that we need to carry.

So, yes.

I do think a day or two a year is a reasonable objective and one that we are very much driving for in our distribution center.

Operator, I think we've run over time.

I am going to ask that we actually conclude the call and turn the call back over to Mr.

Kerry Clark for some concluding comments.

And then, we are happy to take any comments or questions from folks a little bit later.

Thanks everybody for being with us today.

We look forward to seeing you at investor meetings in November and December and as Sally said, if any questions, please feel free to given the Cardinal Health Investor Relations team a call.

Operator, that concludes our call.

Thanks again, everybody.

Thank you, ladies and gentlemen.

And thank you for your participation in today's conference.

This concludes the presentation and you may now disconnect.

Have a good day