卡地納健康 (CAH) 2009 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Cardinal Health third quarter fiscal year 2009 earnings conference call.

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

(Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

And I would like to turn the presentation to your host for today's call, Ms.

Sally Curley, Senior Vice President of Investor Relations.

Please proceed.

Thank you, Michelle, and welcome to Cardinal Health third quarter fiscal 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 results to differ materially from those projected or implied.

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

In addition, we will reference non-GAAP financial measures and information about non-GAAP financial measures is included at the end of the slide.

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

Before I turn the call offer to Kerry, I would like to mention a few upcoming events.

Representatives from Cardinal Health and/or CareFusion will be presenting and answering questions during several conferences during May and June.

The Bank of America conference on May 13; the Robert Baird growth conference on May 14; Deutsche Bank conference on May 18 and the Goldman-Sachs in mid-June.

Also, on June 2 Cardinal Health and CareFusion will be hosting back to back events.

For more information, please contact the IR department.

Just as a side, also given tight time constraints, the large number of investor conferences in May and our own analyst and investor events on June 2, we will actually not be conducting any meetings -- one on one meetings at the May conferences.

Details of most of these events are or will be posted on the investor events section of our website at cardinalhealth.com.

Please make sure to visit that site often for updated information.

Now I'd like to turn the call over to Kerry Clark, Cardinal's Chairman and CEO.

Thanks, Sally.

Good morning, everybody, and welcome.

I'm going to keep my comments brief today.

Jeff, George and Dave will go into more detail.

Overall, I am encouraged with our third quarter performance.

We posted 9% overall revenue growth driven by strong top line performance from health care supply chain services.

The strength of this segment during tough economic times gives us comfort that we are making progress.

As previously forecasted, clinical and medical products continue to see impact of the deferral in hospital and capital spending and experienced head winds from Alaris-related issues as well as foreign exchange.

But we did experience a slight positive increase sequentially in customer orders in a couple of our capital equipment product areas.

While this is still very preliminary, it may suggest the negative trends are moderating.

As in past quarters, we continue to exercise discipline over total company operational expenses.

In addition, we continue to monitor our separation costs related to the plan spin-off very carefully and believe they're reasonable and in line with benchmarks for comparable transactions.

We reached a major milestone in Q3 with the filing of CareFusion's Form 10 in March.

We are moving forward internally by organizing along the lines of the two separate companies.

Our target remains for the planned spin-off to become effective this summer, subject to the Form 10 being declared effective by the SEC, a favorable ruling from the IRS, investment grade credit ratings for both entities and securing adequate financing.

In the meantime, we are still very focused on delivering our financial and operational goals this year.

As I mentioned last quarter, excellence in execution is key.

Now, I'll turn this over to Jeff to provide you with more details of our Q3 fiscal performance.

Jeff.

Thanks, Kerry.

Good morning, everyone, and thanks for joining us.

Today I'm going to take you through the consolidated and segment results for the quarter, update you on some key financial drivers, then spend some time going through our outlook for the remainder of the year.

First, let me build on Kerry's comments regarding the status of the spin.

As you know, CareFusion filed its Form 10 on March 31 thanks to some tremendous efforts from our team.

Everyone continues to work hard to get ready to spin off CareFusion as target for this summer from an organizational, business, legal and systems perspective.

We are making great progress in those areas.

Our treasury teams are working diligently to complete the necessary financing arrangements and complete our discussions with rating agencies.

I'll touch more on that later in my talk.

Finally, we're also preparing the pro forma CareFusion financials and the pro forma [recast] financials for Cardinal Health and expect to have them available to you in the next month or so.

I plan to walk many of you through them during our June 2 investor day in Boston.

In summary, we feel very good about our spin preparations and readiness plans.

Now on to the third quarter results and a bit about our outlook.

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

Consolidated revenues were up 9% to $24.9 billion.

Operating earnings were down 10% to $553 million reflecting stability in our HSCS segment but dampened by the previously disclosed deferral in hospital in capital spending, negative impact of foreign exchange and costs associated with remediation reserve on ship hold on certain Alaris infusion products.

We continue to exercise very good discipline regarding operating expenses, reporting total SG&A less than last year's Q3.

Head count is down materially since the beginning of the year and will continue to decrease as the CMP reduction in force is fully implemented.

All other expenditures are being watched extremely closely.

Strong costs and capital management will be a key focus moving forward both before and after the spin for Cardinal Health.

Net interest expense and other was $60 million for Q3, an increase of almost $30 million versus the prior year.

This is primarily driven by the negative impact of foreign exchange in the third quarter as well as the favorable impact we experienced last year.

Interest expense and other did end up higher than we had previously anticipated due in large part to FX movements during the quarter.

Our non-GAAP tax rate for the quarter was 29% versus just over 33% last year which reflects a favorable discrete adjustment in the current quarter that relates to a tax refund claim.

This lowered the current quarter tax rate by roughly 5 percentage points.

Non-GAAP diluted EPS was $0.97 for the quarter, down 10% from the prior year.

I'd like to pause for a moment on the EPS number.

I recognize there are a few unusual items in our quarter so let me try to call them out for you.

The unusually low tax rate contributed about $0.06 to $0.07 of benefit in the quarter.

We were also able to offset a headwind of approximately $0.06 related to ship hold and reserves for the Alaris products as well as $0.02 of bed debt expenses related to the bankruptcy of a few regional pharmacy chains.

We report solid operating cash flow of $821 million which reflects good working capital management including sell-through of excess inventory from one of our large customers that we mentioned on our last earnings call.

In addition, we repaid $450 million draw on our accounts receivable sales facility in Q3 which has shown us an increase in accounts receivable on the cash flow statement during the quarter, but year-to-date has a neutral impact to operating cash flow.

Year-to-date we generated almost $740 million of operating cash flow.

And, as indicated last quarter, we anticipate ending the year at around $1 billion.

Now, let's dig down into a few working capital metrics.

Sequentially days sales outstanding was flat from prior year, increased by almost two days from our Q2 really due to our Q2 utilization of the AR facility and subsequent paydown in Q3.

Absent that, it was roughly flat.

Days inventory decreased two days on a sequential basis, largely due to the one large customer inventory issue I noted earlier.

Days inventory on hand was flat compared to the prior fiscal year.

Our balance sheet remains strong.

At quarter end, total debt to capital was 30%, well within our target range of 28% to 35%.

And we had $1.4 billion of cash on the balance sheet.

Overall, management of working capital and a strong focus on our balance sheet will be of paramount importance as we move forward.

We are also executing important work on the balance sheet to position the company for the planned spinoff.

We recently amended our core $1.5 billion revolving credit facility and expect to complete an amendment of the $850 million accounts receivables facility shortly which will include an increase in capacity of $100 million for total AR facility of $950 million.

While on the topic, I wanted to quickly mention that we're currently doing significant work around finalizing capital structure and with that capital deployment the two organizations following the completion of the planned spinoff.

For those of you who participated in recent investor interviews with third party firms, we truly appreciate you taking the time to provide us with your input and feedback as it is helpful to our decisions with capital structure and deployment.

We plan to share some of our thinking in this regard on June 2.

Turning to the next slide.

During the quarter, special items totaled approximately $52 million which negatively impacted GAAP EPS by $0.11 with the biggest contributor of this amount being costs associated with the planned spinoff.

Impairments and other totaled about $3 million in the quarter and positive impacted GAAP EPS by $0.01 due primarily to some tax benefits associated with the past divestiture of PTS.

The net of all this was negative $0.10 impact to GAAP EPS.

As a reminder, guidance range of $3.50 to $3.60 doesn't include costs we will incur associated with the planned spinoff and separation of the two companies which was $39 million in the quarter and totaled approximately $50 million pretax year-to-date.

Before I get into the details of the segment performance, I want to give a brief update on the critical investments we plan to make in both segments that we originally referenced with total up to $100 million in this fiscal year.

As the year has unfolded, we stated we would be prudent in our spending to offset challenges we would be facing.

In this regard, we announced specific actions to respond to current economic reality, including reduction in the workforce of our CMP businesses and additional cost control measures implemented across the organization.

However, importantly, we continue to maintain the majority of our planned investment spend for this year.

Specifically, we are continuing to invest in those IT and R&D projects most important to the future success of both segments going forward.

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

Please recall that the following segment results reflect the current operating and reporting structure for the company and that some of the businesses currently included as part of the CMP segment, such as gloves, converters and fluid management, will remain with Cardinal Health following completion of the planned spinoff.

With HSCS, revenue for the third quarter increased 9% to $24 billion driven by strong sales growth in the pharmaceutical supply chain business.

In the pharma business we are able to continue the trend of good growth in a number of areas.

Revenue from both customers was up 19% on increased volumes from existing customers.

Revenue from non-bulk customers was up 3% driven primarily by organic growth across multiple channels and the acquisition of Borschow in Puerto Rico, offset by the shift of certain DSD business to bulk with a large customer.

HSCS segment profit increased 2% to $384 million.

This is primarily driven by solid revenue growth, cost controls and a strong quarter in nuclear pharmacy where profit was up more than 30% over last year.

These are partially offset by the impact of customer mix and incremental bad debt reserves for approximately $15 million.

Since I mentioned bad debt a few times now, I can spend a little more time on this.

Unfortunately, we had three regional chain customers declare bankruptcy during the quarter which make up the bulk of our incremental bad debt expense in Q3.

However, our monitoring process remains very vigilant and overall we're pleased with the payment situation of the majority of our customers, given the environment.

In fact, our delinquency trends as a percent of overall trade receivables stayed relatively stable sequentially in Q3 and our DSOs adjusted for the AR facility remain effectively flat.

Turning to CMP, revenue was down 6% primarily driven by sales declines from the previously mentioned deferral in hospital capital spending as well as change in foreign exchange rates year over year which negatively impacted growth by almost 4 percentage points.

During Q3 the interior acquisition contributed approximately 4 percentage points of sales growth.

Segment profit was down 22%, primarily due to the deferral in hospital capital spending, the reserve associated with remediation efforts for certain Alaris infusion products and impact on the ship hold.

In total during Q3 there was a total of $18 million of reserves made for Alaris remediation plans and about $13 million of lost profit due to the ship hold.

In addition, the change in foreign exchange rates negatively impacted the growth by about 8 percentage points.

The overall decline was partially offset by the acquisition of Enturia which contributed approximately 9 percentage points of growth.

Now just a quick comment on guidance.

Even with additional impact from the Alaris remediation reserve and ship hold, we are maintaining our previous guidance range of $3.50 to $3.60 per share but expect to be at the low end of the range.

As per our usual practice, this guidance does not include special items, impairments or other costs associated with the spinoff of CareFusion nor does it reflect any decisions to divest any of our businesses currently being reviewed for strategic fit which could potentially go into discontinued operations at some point if a firm decision is made to sell any of them and they qualify for DO treatment.

We expect the tax rate to average in the 32% to 33% range, interest and other expense to be above $230 million, and fully diluted shares outstanding average about 361 million for the full year.

Let me also make a brief comment on LIFO expense since I know it has come up in other company's calls.

Right now we're forecasting in the year at a slight LIFO debit position which implies no LIFO charge in Q4.

It's clearly something we will be watching closely and it depends in part on brand and generic price movements during the remainder of the year.

Before I pass it over to George I'd like to take a moment to set expectations around the providing of our outlook going forward.

First, we expect to provide the long-term strategy and goals of both Cardinal Health and CareFusion during our investor day on June 2.

At that time, I'll also walk you through the pro forma and financials for both CareFusion and Cardinal Health and discuss in more detail some of the one-time costs and negative synergies associated with the spin for both companies.

Our expectation is to provide FY10 guidance for new Cardinal Health on our Q4 earnings call in August as we did last year.

CareFusion will provide FY10 guidance prior to the planned spinoff.

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

George.

Thanks, Jeff.

Good morning, everyone.

I'm pleased to report that our HSCS segment followed up on our positive Q2 performance with solid performance in Q3 and we did so in a very difficult environment.

As Jeff mentioned, our segment revenues grew by 9% and our segment profit grew by 2%.

We had excellent contribution from nuclear pharmacy, solid performance across a number of our medical operations and results in pharmaceutical distribution which point to a continuing stabilization of our business.

We remain focused on executing on our operating priorities, driving margin improvement and on showing discipline in managing operating expenses.

Let me take a few minutes to walk you through some of the highlights of the businesses for the quarter.

Our pharma distribution business continues its road to recovery.

Year-over-year growth was approximately 10% driven largely by growth from our large chain bulk customers.

Overall, bulk sales to customer warehouses grew by nearly 20%.

This bulk growth reflects some new volume we picked up earlier this year and as we mentioned in prior calls the movement of certain business to bulk from one of our large customers which last year was reported in DSD sales until Q4.

Of particular note, our retail and independent business grew by 4% in the period.

This is an encouraging piece of data in light of what IMS is reporting to be a flat to declining overall independent retail market.

We are beginning to see some signs of increased same-store sales and continue to build out our offerings to our more than 3,000 leader stores.

I'd like to highlight that the integration of the Borschow acquisition in Puerto Rico has gone extremely well and we retained 100% of our customers on the island.

Total DSD direct stores sales revenues were up 3%, a rate which was reduced by 3 percentage points by the movement of the same business of DSD to bulk which I just mentioned.

We did see the economy take its toll in a few pharmaceutical distribution customers.

As you heard Jeff mention, three of our original chains filed for bankruptcy protection during Q3, negatively impacting our pharmaceutical operating margins by 6 basis points.

Overall, our pharmaceutical distribution operating margins were down 13 basis points reflecting the impact of these three bankruptcies as well as the very high rate of growth in our lower margin bulk business.

While I have highlighted in the past some of the challenges presented by our customer mix, I will say that our partnerships with some very solid growing and well positioned customers provides additional stability to our business during turbulent times.

It was a solid, but unspectacular quarter for our generic business.

Although we made progress with independent retailers where we saw some improvement in compliance rates, the uplift from generic business was dampened by the competitive position of a few of our regional chain customers who have been reducing store count.

Our year over year generic growth for the quarter was in the low single digits.

Generics remain a high priority for us.

While our base is strong with over 4,000 customers benefiting from our Source generics program, we are repositioning our generic Source program along two dimensions.

First, we are moving our program away from a transactional to a more strategic orientation, one that creates more sustainable value for us and for our vendor partners.

Second, we are working on our downstream program creating an offering which directed the very needs of a very diverse pharmacy market and sold by a sales organization specifically trained to articulate the value of our offering.

As I've told you in the past, this is a building process.

I don't expect every move to gain immediate traction.

We are laying a very critical foundation for transforming our generic business.

Our branded pharma distribution had a solid quarter with good performance in our fee for service business.

As many of you know, the March quarter tends to be a relatively high quarter for price inflation and this was true for this year as well with comparable numbers to last year.

It has been a period of extraordinary merger activity and we will be working closely with our branded supplier partners to ensure that as we go forward our service fees reflect the value we bring and the real cost of supporting the unique product lines of each of these newly combined branded suppliers.

Our nuclear pharmacy business add an outstanding quarter, our team has executed extremely well, maintaining extraordinary service levels while expanding our product line and managing through product shortages.

Our contribution of profit grew by over 30% versus prior year and although the presence of a generic Cardiolite dampened revenues, pricing is generally stable and both of our major brands are performing well.

The shortage of the raw material Molybdenum seems to be resolving and this will help us as we move forward.

Overall, it was a really strong quarter for our nuclear pharmacy team.

Our medical supply chain businesses continue to show good results in spite of some very challenging market conditions.

Collectively, these businesses contributed double-digit growth year-over-year in profit in Q3.

This is particularly noteworthy given the pressures in the top line resulting from the slow down in hospital admissions, elective surgeries, physician visits and lab testing.

It is something of an accomplishment that revenues across these businesses was essentially flat.

With this as a backdrop, we see the growth and profit contribution as a positive sign.

This reflects our focus on product mix, purchasing economies and continued expense management.

Once our spinoff is complete, these medical businesses are likely to contribute over a third of our new Cardinal Health profits and we see significant upside as we look to the future.

We believe that we offer a product range, a vertical scale, a channel coverage and industry experience that gives us a competitive advantage.

We are refocusing on these businesses and making the moves to drive value.

We continue to look at ways to use our footprint across channels and, in particular, leverage our access to data.

We have taken recent steps to enhance our position in the operating room.

For example, we've entered into partnerships which help prevent the potential for retained foreign objects in surgery.

We have upgraded our category management tools and, finally, our investments in transforming the operational and IT footprint of thee businesses will put us in a great position to improve our margins over time but just as important will give us the tools to help customers become more cost effective.

Ultimately, our ability to bring efficiency to health care will be valuable as healthcare reform takes shape.

While it is still early to predict the exact direction healthcare form will take, it is clear the spotlight will remain bright.

We expect that we will see congressional committee meetings and hearings on various aspects of healthcare through the spring and the summer and there will be significant pressure for legislation.

We will be engaged as this unfolds.

Let me conclude by saying that we are excited about getting to the completion of the spinoff of CareFusion and the launch of new Cardinal Health.

While we know that the work of putting this business in the right trajectory is far from done, we feel very positive about our mix of businesses which uniquely positions us to support the health system with a wide range of products and services across the continuum of care.

We believe that this is a particularly important factor as the historical distinction between retail and institutional channels continues to blur.

We're refocused on our core and on our customer needs.

We believe that we are pulling in the right operational and strategic levers, managing the power of our balance sheet and showing discipline in operating expenses and, most important, drawing on the talents and the renewed enthusiasm of our people.

We look forward to seeing many of you at our June 2 investor day where these topics will be covered in greater detail.

With that, I'll turn the call over to Dave.

Thank you, George.

As I mentioned during last quarter's earnings call, we did expect a decline in revenue and profit in the second half of the fiscal year due to the ongoing deferral of hospital capital spending.

This was indeed what happened in the third quarter.

It was compounded by the recall of ship hold we currently have on certain Alaris products as part of the amended consent decree.

To remind you, on March 12, we announced a ship hold and a $6 million reserve to correct a software issue in our Alaris point of care unit and the Alaris patient-controlled analgesia module.

We are working towards FDA clearance this quarter to implement this software fix within our manufacturing operations which would enable us to release the ship hold and install new units that were deferred from the third quarter.

In addition, last week we submitted our corrective action plan to the FDA.

This was a requirement of the amended consent decree that we disclosed in February and resulted in an additional $12 million reserve we announced today for the remediation of products in the field.

I won't speculate on the time frame to begin the remediation work on specific items in the plan or specific items in the plan, but I will say that we anticipate the FDA's response to our plan by early June.

In total, we recorded reserves of $18 million in the third quarter for our infusion products.

In addition, we have been on ship hold longer than we anticipated in March, and we'll see a greater impact on the full year than the approximately $14 million we previously mentioned.

For perspective, the Alaris system represents less than 10% of our segment revenue, but it is the main product in our infusion line and an important driver of our segment profit.

It also carries fixed costs that, when idle, further hurt our profitability.

The combination of these factors will have negative implications for our FY 2009 segment profit.

I now anticipate we will finish the fiscal year with segment profit down 7% to 11%, falling below our flat or better goal for the year.

This guidance does not include any new remediation items that FDA may propose under the amended consent decree.

While I'm disappointed to lower our segment guidance, there are clearly a number of factors that could not have been contemplated in January.

We have seen some modest softening of our business outside of the US, but the primary drivers of the guidance charge -- change and the reserves and the impact of the ship hold.

The range this guidance implies that Q4 is largely dependent on when we can lift the ship hold which will determine when we can install units with customers.

So what have we done to mitigate the downside?

As you know, we took action in the third quarter to substantially resize our infrastructure.

A small portion of the benefit from our restructuring will be realized in the current fiscal year, but we expect the majority of the benefit, more than 70%, to be realized in FY 2010.

As we reported on March 31, we expect ongoing annual savings within two years of $110 million to $130 million.

We did make progress in the quarter in meeting our requirements of the amended consent decree.

In addition to filing the corrective action plan, the third-party certification audit of our Alaris infusion pump operations was completed and submitted to the FDA.

This is an important milestone of the original consent decree and something that also meets part of the requirements of the amended consent decree.

As I've mentioned before, I believe our new quality systems will be a differentiator for us.

We have more work to do, but this is an opportunity and an obligation to bring to market products that are among the safest in the industry.

Now let me go through our business results from Q3.

As Jeff mentioned, CMP revenue declined 6% to $1.1 billion and segment profit was down 22% to $148 million.

Foreign currency exchange significantly dampened our results on the revenue and segment profit lines again this quarter.

Segment profit, for example, was lowered by 8 percentage points due to the impact of foreign exchange.

For the quarter, the overall trends remained fundamentally the same.

Our capital equipment businesses were affected by the deferral in capital spending while our businesses tied to admissions and procedures continued to hold their own.

Infusion continues to be the business most affected by the deferral and spending due to deal size and medication dispensing continues to be the least affected.

The capital portion of our respiratory business is also down, but this is not as large a business as infusion or dispensing.

Therefore, not as significant a contributor.

We are seeing recent strong interest in our respiratory products related to concerns about the swine flu that we are monitoring closely.

Overall, capital equipment orders were down from Q3 of last year, but they improved sequentially from Q2 and were strong in March.

Now, as a reminder, any pickup in customer orders would not have an impact on the income statement for a couple of quarters, given installation timelines.

In the infusion business we are not seeing any substantial competitive challenges or market share changes.

We won contracts in more than 80% of the accounts where we competed of which more than 50% were competitive displacements.

This win rate is consistent with prior quarters.

Our challenge was that the deal activity itself was down substantially from prior quarters by about 45%.

We had significant installations at Ohio Health Riverside Methodist Hospital of about 1,500 pumps and Harborview Medical Center in Seattle of nearly 1,100 pumps.

We also received an important certification for Alaris system from a group called Integrating the Healthcare Enterprise, or IHE.

IHE is a global initiative to implement data communication standards for devices and systems within the healthcare.

This is important to our customers and our strategy.

For clinicians, a higher level of data sharing helps reduce manual documentation, avoid medication errors, and enable faster response times through alerts and alarms.

In our dispensing business we achieved an important milestone by regaining a spot at the top of MD Buyline's quarterly customer service report.

We are now tied for number one.

As many of you may recall, we set a long-term goal several years ago to rebuild our advantage in customer service after it had fallen significantly.

This achievement reflects that multi-year commitment and is indicative of the focus we have on providing superior customer service.

In addition, just following the close of Q3, we were awarded one of our largest sole-source dispensing contracts for the year by Community Health Systems.

CHS is one of the nation's leading operators of acute care hospitals with more than 120 facilities in 29 states and approximately 18,000 beds.

The multiple year agreement displaces multiple competitors, and we expect to upgrade the majority of sites to our Pyxis MedStation 4,000 over the next 18 months.

In the respiratory business we remain on track to deliver our new Enve palmtop ventilator this summer.

This is an excellent example of the innovative products we will continue to bring to market.

At just 9-1/2 pounds, we expect that this will be the smallest intensive care ventilator in the world.

Most ICU ventilators weigh about 80 pounds.

So our product will make it easier for hospitals to transport ventilated patients for tests or other procedures within or outside the hospital.

And it can reduce infection rates because the ventilator moves with the patient, rather than being detached.

Hospitals do try to reduce the number of times they break the supply circuit from the ventilator to the patient because it opens a direct channel into the lungs for potential infections.

We really expect this product to be transformational because it will put the ICU wherever it needs to be.

Turning from capital equipment, I'll remind you that a meaningful portion of our business is from products tied to procedures and admissions.

Overall, these businesses continue to perform well led by ChloraPrep from the Enturia acquisition and the disposable products in our respiratory and infusion businesses.

We continue to deliver long-term measurable value to our global customers and have very clear opportunities for growth as an independent company.

We filed our Form 10 at the end of this quarter which was a major milestone on our path to spinoff as CareFusion later this year.

I look forward to going through those growth opportunities in more detail at our June 2 analyst meeting.

Now, I'll turn it back over to the operator for questions.

(Operator Instructions) Your first question comes from the line of Glen Santangelo of Credit Suisse, please proceed.

Yes, thanks a lot.

I just had a quick question with respect to CVS, you didn't comment at all on the upcoming renegotiation.

Kerry or George, maybe if you can give us a sense for where you are in that process and what you expect for timing, that would be helpful?

Yes, Glen, as you know, it is difficult for us to discuss that sort of during the course of the process.

So I'm going to have to just let you know that the conversations, obviously, have been ongoing, are very positive and beyond that I think it's difficult to share any more at this time.

Hey, George, is the contract up on June 30, and is there a chance we could go past the contract date?

Our contract, actually, I believe is July.

But I think it is -- it's unlikely that we go fast past the contract date.

Okay.

And then if I could ask one follow-up question, you suggested in your prepared remarks that the revenues were somewhat impacted by some store closures in mid--sized chains.

Can you maybe elaborate on that a little bit and maybe discuss how much that impacted you in the quarter?

I can't give you exact number.

It is not something I'm comfortable quantifying nor am I particularly comfortable talking about relative health of each of our customers, but there are a few regional chains that in their competitive markets have had to make some adjustments and are probably losing a little bit of share to some of the national players and so we see that dynamic in some of our markets.

Okay.

Thank you.

You're welcome.

Your next question of comment comes from the line of Lisa Gill of JPMorgan, please proceed.

Thanks very much and good morning.

George, just following up on that line of questioning.

Can you talk about when a customer does file for bankruptcy or closes stores and sales primarily move to someone else or in the case of Drug Fair in New Jersey where Walgreen's buys it, how much of that volume do you generally pick up?

Lisa, that is a good question.

The answer it that it would vary a lot case by case.

So in some instances, business may move literally from one pocket to the other and it also depends on the nature of that particular customer.

Are they a customer that buys generic directly from the manufacturer, for example, or are they a customer that buys generics through us or through the distribution channel?

So it is hard to give a categorical answer.

In the case you described, generally speaking if business is moving to one of our major customers who are buying generics directly, we would expect over time that they move it -- that they're likely to move in that direction.

And so in some cases it can be a negative to us and in some cases it is really neutral.

Do you have like some kind of percentage so, for example, in this kind of case which it sounds like those are the kind of players that are filing for bankruptcy, is it we lose 40% of those sales, 50% of those sales as it moves to a national player, just as we start thinking about more bankruptcies come about in the next couple of years?

This is Jeff.

As George said, it is a difficult question to answer because everyone is different.

Depends on the type of liquidation that they do.

In the specific case of Drug Fair, which has been very public and it's also very public that Walgreen's is buying the -- a significant portion of the assets, we have a pretty good window of that because as we sit on the credit committee as one of the major creditors of Drug Fair.

Those discussions are still being finalized, but expectation is that Walgreen's will buy the majority of the stores from Drug Fair, but exactly what that number will be still remains to be finalized.

Okay.

One follow-up.

George, you talked about healthcare reform, you kind of laid out the timeline, but you didn't talk about what your expectations are for Cardinal around healthcare reform.

Can you maybe just give us 30 seconds on how you think it would impact Cardinal?

Let's talk about probably the single most important issue is the inclusion of large group of Americans who are today either uninsured or underinsured.

So I think net the inclusion of those probably now 50 million Americans into the system is probably a good thing for us.

It is really hard to know exactly how this is going to take shape.

I think the question of access is largely being accepted as a fact now even though we don't know exactly how to do it.

I think the access issue is almost no longer a debate.

The issue really moves towards cost and how do you do that?

So we will be watching very carefully to make sure that our voice is heard in that discussion.

The good news for us is that our business is largely about cost efficiency and cost effectiveness, and we're not exactly the natural target as you look at the pools that you would attack in the system.

So I think we'll play an active role in this.

I think our focus on efficiency is going to be positive and we'll continue to reinforce that as we go.

Thank you.

You're welcome.

Your next question or comment comes from the line of John Kreger of William Blair, please proceed.

Thanks very much.

Question for both Dave and George about kind of your perspective on the macroenvironment.

Dave, I think you said in the past you survey your customers weekly perhaps.

Could you just give us an update on what those survey results are showing and sort of your perspective on when a turn in the capital equipment environment might happen and, George, similarly as you look across your network of customers, are you seeing any change in underlying pharma consumption in your opinion?

Dave, you want to go first?

Why don't I jump in and hopefully I didn't lose the connection on the other end.

John, from our standpoint, as you can see from our revenue numbers, consumption appears to be relatively robust, so the fundamental demand in spite of some of the market data continues to look good.

Part of that has to do with again our unique customer mix.

Each of us in the system is a bit different.

Clearly we're watching carefully the total utilization numbers and watching how Americans alter their behavior in healthcare behavior as it relates to economic conditions.

Right now I would say we're holding up relatively well.

The place of course where we see it a little more directly is in our hospital business and in our ambulatory business.

It is probably a more dulled impact than you would see in the pure capital business.

But we've seen certainly some data, as I mentioned in my comments, that hospital visits and discharges are down, elective procedures are down.

So we see some of that on our business.

We've done very well in this environment.

It's sort of a second order effect to us, but right now I don't see anything notably deteriorating at this stage and we feel like we're relatively well positioned across the channels to weather this.

Great.

Thanks.

You're welcome.

John , sorry for the technical issue, we do frequently survey our customers, and I think my summary would be they're indicating no change in their behavior at the moment.

The majority of them see the next 12 to 18 months as the time period when they will continue to defer their capital spending.

I will say that as we plan for the spin and we plan for FY 2010, we are taking that into account.

It's in fact one of the reasons that we did the restructuring announced at the end of March.

I think there was a report recently put out by the AHA which had some very recent data gathered in the month of March which indicated upwards of 80% of hospitals have become very cautious about their capital spends and I think that that correlates exactly with the customer feedback that we're

Operator, next question.

Your next question comes from the line of Randall Stanicky of Goldman Sachs, please proceed.

Great.

Thanks for the questions.

Just one again for Dave and George.

Dave, just follow-up to the last question.

How should we think about the P&L flow when orders start to pick up on the system side, how is that going to convert to the P&L in terms of timing?

The typical delay in the infusion and the dispensing business, which are reasonably large parts of our capital equipment offerings, typical delay is four to six months, and so we wouldn't really see any P&L impact until that kind of a time period went by after we saw orders began to grow.

Not true in respiratory, in the respiratory business.

The cycle from order to shipment and acceptance is very short.

Not only two weeks, and so that's going to make the respiratory business a leading indicator of the turnaround.

So consumables, understanding that they're higher margin in the meantime, is there a scenario where we would actually see profitability improve given mix of consumable versus system sales?

Well, theoretically it's possible, but really only if you address the fixed and variable costs associated with running the business.

And, frankly, that's part of what we tried to do in our March 30 or 31 restructuring.

Okay.

Understood.

And a quick one for George.

You talked about the generic growth, I think you said single digits.

Maybe you can just touch on competitively, what do you need to do to make the generic program or to drive better contribution from the generic program?

There are a couple of issues, one is a little bit about mix and that's part of the reason I wanted us to and we focused on driving our DSD business.

That is probably the ingredient that has the most powerful impact.

Those stores can be very effective generic players and for us important target customers.

It's part of the reason why coming out of the issues that we had in controlled drugs is very important to us.

So, again, it is all part of the same mix which is moving more heavily into that category, getting a higher percentage of their business, and making sure that as we come out of the -- this controlled drug issues that we had that our selling effort is very well directed, that we have got tremendous alignment, all the incentive systems designed to drive our generic programs.

So part of it is on that level.

I think part of it, Randall, is also the part I mentioned as it relates to the nature of our program on our sourcing approach.

In my view we have probably not taken full advantage of the position that we have in the market.

We probably had too many suppliers with not rich enough or deep enough strategic relationships, and we're working along that to mention as well.

So there are key ingredients, sales force effectiveness, penetration in the right mix and driving the right sourcing model and I think that probably, for us, is the primary focus.

That's great.

Thanks very much, guys.

Your Next question comes from Ricky Goldwasser of UBS, please proceed.

Good morning.

I have a couple of follow-up questions.

First of all on leaders, can you comment on what is the compliance rate, generic compliance rate?

Is it above or below the company average and does this group represent the most needed opportunity for up-selling generics from your perspective.

And then two other questions.

First, George, you commented that independents grew about 4% for you this quarter.

How does that compare to last quarter and what was the sequential growth?

Finally, just to confirm, you are saying no LIFO charge next quarter, does that mean that you're really not looking for much in terms of pricing action in the June quarter?

Thank you.

Ricky, let me see if I can capture all of those.

Jeff should probably take the third piece of it.

The Leader program is important to us.

We've not broken out quantitatively that program as it relates to compliance versus others, the rest of our business.

I'll say this, our leader customers are very good customers.

They tend to be customers that value the broad range of services that we offer from the generic program to our inventory management tools, to our reimbursement support.

So I would say on balance those customers are ones we clearly believe understand the value that we offer in our programs and we tend to do very well with them, and we're obviously on a regular basis trying to expand those offerings to them and expand the number of players in that program.

The second question was about -- I don't actually have the number in front of me.

I thought it was a retail versus -- independent retail versus Q2, which is what I thought the question.

And we're slightly favorable to the year-over-year comps that we showed you in Q2, Ricky.

Okay.

And do you have the data on the sequential basis?

We'll follow up with you on that.

I don't have it in front of me.

Sorry, Ricky, it is Jeff.

Let me answer your question regarding LIFO.

First of all, let me spend a few seconds to try to simplify how the LIFO is actually calculated.

Sometimes I do this for my own benefit because it is an incredibly complicated calculation.

I have to remind myself of all the key drivers.

Effectively, there are four major drivers in determining whether we have a LIFO charge or not.

To put it really simplistically, more brand inflation is bad for LIFO charge.

More branded inventory at the end of the quarter is bad for LIFO charge.

On the flip side, generic deflation is good for the LIFO charge and more generic inventory is good for the LIFO charge.

Again, to put it very simplistically.

We have to make four assumptions as we forecast our LIFO.

Two of them are more controllable and that is level of inventory we have for both branded and generic products at the end of the year, and the second set of assumptions we have to make which are obviously less controllable are branded inflation and generic deflation during any period.

I would say our expectations on those last two fronts for the remainder of the year are pretty much consistent with what we've seen so far this year.

Specifically answering your question, we've seen branded inflation in Q3 about in line with what we saw last year and we expect that general trend to continue in Q4.

Now, clearly if any of those assumptions differ, that can have an impact on LIFO during the quarter.

Ricky, I can follow up on that other question.

There were two parts to it.

As it relates to the compare three versus two on a year-over-year basis we are favorable to past period.

If we look pure sequential, we're roughly comparable to where we were last quarter.

Okay.

Thank you.

Your next question comes from the line of Larry Marsh of Barclays Capital, please proceed.

Thanks, three quick ones, hopefully.

First for Jeff, I just think you and Dave already touched on this but I just want to be clear.

On CMP you say down 7% to 11% versus prior flat, are you keeping the other components of your guidance the same for this year, both in supply chain and top line for CMP?

We didn't comment specifically on the top line for CMP but we're expecting it to be flattish for the year, Larry.

For HSCS, our guidance is unchanged.

Okay.

Great.

And then just maybe a quick follow-up then for Dave on assuming given the Alaris ship hold I assume that business could be down a good bit in the fourth quarter.

It sounds like you're saying that division would be down profits another 25% year-over-year in the fourth quarter.

Are the other pieces of the business, do we think of those as being down modestly or Enturia, Pyxis, VIAYSIS given the economy or not?

Well, respiratory and Pyxis are about where we had anticipated them to be, if not a little better in dispensing and maybe slightly worse in respiratory, and Enturia continues to exceed our expectations, Larry.

Okay.

Thanks.

Second on I guess for George, just the other topic of some broad commentaries in the last couple of months, sell side margin pressure, I think you're saying today a reasonable environment, some particular customer issues with bankruptcies, but any particular comments on the margin side of the equation from a pricing standpoint competitively?

As you know, Larry, obviously this is a competitive business, but I would not be able to point to a significant systemic decline in prices.

As you said on a case-by-case basis the competitive dynamic is unique.

Finally, I know you are going to talk a lot more about this on the June 2 analysts day, but you're calling out some negative synergies of two separate public companies.

Besides the obvious things, is there anything else we should think about as we model the two companies in the next couple of months?

Probably nothing that we haven't talked about before but maybe with can just remind everyone of what we have said.

Clearly, there will be some negative synergies, particularly early on as we separate the two companies.

There will also be one-time stand-up costs, some will be occurring before the spin, some will also occur after the spin as we complete the stand-up of CareFusion particularly related to systems.

Some of the systems requirement will be handled through a transition services agreement with Cardinal Health for the first couple of years and during that period we'll be spending some additional money to complete the totally independent stand-up of CareFusion in that regard.

Again, we'll provide more detail on that on June 2.

In terms of the capital structure, we've said before that we expect about 35% to 45% of the existing debt of Cardinal Health, which is about $3.6 billion, to eventually end up on CareFusion's balance sheet.

That remains the expectation and, again, we'll give you an exact number in that regard when we issue the pro forma financials over the next month.

But I think those are the some of the basic issues and, again, we'll go into a little bit more detail on June 2.

Okay.

Very good , I'll stop there, thanks,

Thanks, Larry.

Your next question comes from the line of Robert Willoughby of Bank of America, Merrill Lynch, please proceed.

Thanks.

The CMP spin already helps you in an already strong cash position for Cardinal on the distribution side and maybe it's just a question for George.

Can you tell us what near-term obligations you think you will have post the spin for the cash and then maybe just more broadly what is your philosophy on debt, do you repay or do you refinance, and just anything fundamentally different in your preference for dividends versus share repurchases?

Sure, those are great questions, Bob, and very timely because we're spending a lot of time on those exact topics.

First of all, in terms of capital deployment which I really think is your first question, we are spending a lot of time with our investors and internally sort of looking at our capital deployment strategy, matching it up with our business strategy and what we expect to be the capital structure of the business going forward and our clear desire to maintain investment-grade rating.

So those are all elements that are going to be key to it.

Just a couple -- touch on a couple of highlights and then I'll reserve the rest of it until we have our Board meeting next week and the June 2 analysts day.

First of all, we will continue to invest in capital expenditures in the business.

Right now we target about 25% of our operating cash flow to go to capital expenditures.

I expect it will be at least that in new Cardinal Health at least initially, in part because we have some major transformations that we want to undertake with respect to our systems and processes to really get a leg up on the competition.

So that will continue and that will be a big priority for us.

In terms of M&A, I'll let George comment further on that, but I don't expect initially there will be any primary focus, although we'll take a look at small tuck-ins that allow us to round out our portfolio and, George, you want to comment.

Bob, there's not a lot to add to that.

We'll talk about this in June, but obviously today our focus is really on revitalizing these core businesses.

Clearly, we'll continue to look at the environment, particularly with an eye on whether or not there is anything that we think, again, bolsters those core activities and so we'll deploy capital accordingly.

But, Jeff, the first part of what Jeff is saying is really important.

This is an important time for us to reach out to all of you to get a sense of how you see this and we'll share more about that in June.

And on the issue of share repo versus dividend, again, that's a very important question, something we'll be discussing with our Board and starting to share with you on June 2.

I've said before we expect to have a meaningful dividend payout.

Exactly what meaningful means still remains to be seen and subject to approval of our Board but I think that statement stands.

Bob, I know you asked a second question there but for the life of me I can't remember what it was.

Maybe you can repeat it for me.

No, you got most of it.

George, personally do you have a preference for dividends or share repurchases one way or the other?

I know the Board is obviously going to make a decision, but do you have a preference one way or the other.

Fair question.

I probably will not answer that at this point.

I would like this to be the one we first discuss with our Board and then, of course, we'll be talking with you.

Okay.

Thank you.

Your next question comes from the line of John ransom of Raymond James.

Please proceed.

Hi, one picky question and one macro.

It looks like D&A dropped $6.7 million.

Is that the new sustainable number or is there something in that number?

Yes, I can't think of anything unusual that happened in that regard.

We'll do some further research on that to see if there is anything particular there.

Nothing major comes to mind that would indicate that was an unusual event.

Okay.

And then the more in kind of following along Rob's questioning, having looked at your acquisition history it looks like on average you pay 13, 14 times EBITDA for your businesses and I think it is fair to say that it's been a mixed track record.

Going forward, is there a different way you're going to think about acquisitions, particularly as we look at the supply chain business it is going to be pretty deleveraged and pretty cash-rich, kind of a mature business.

If you look at strategic targets, are we going to continue to be looking to pay high multiples of fast growth businesses or is it going to be a different way of thinking about strategic targets in the future?

Yes.

Let me give you a very general and it will be very general at this point.

Of course.

We will take a very disciplined look.

I come from an environment where that is where I was trained and I know that that we have sort of as our primary focus right now, revitalizing a business that we really think has legs and that's going to be our focus.

As we look out there and we think about whether or not there are acquisition opportunities, we'll be very mindful of the way that those would be integrated, if we do that, the way it will build strategic value, and so you should assume that our approach will be with a rigorous and disciplined eye and on short-term really focused on the core activities.

John, this is Kerry Clark.

I just sort of would step back and say you should expect very different capital deployment strategies in both sides of the house.

And, in fact, that's one of the drivers in deciding to separate out in to two companies was that we did have different businesses with different needs and different requirements.

And so you can expect George and Dave to take very different approaches depending on the type of characteristics in their business.

I think that your comment on mixed track records, I would say depends on what time frame you've looked at.

I think we would have to say Alaris was one of our most successful acquisitions ever, and I think we're very comfortable with the long-term future of CareFusion, MedMined, and VIASYS in the CMP side, and we had on the distribution side really an absolutely terrific track record on distribution acquisitions over the years.

I think we made a lot of progress improving the accountability of the company's acquisitions to shareholders and we continue to be that way, and do expect different capital deployment strategies for both sides of the house.

And just -- is there any change in your thinking about post-spin what businesses will be retained at supply chain versus what businesses might be in a maybe better credit environment might be let go?

No, our decisions on what businesses are on which side of the house are clear, and we haven't made any changes on those since we talked to you about that in the past.

Okay.

Thank you.

Just I guess two things I'd like to add on that.

In the area of capital structure and capital deployment, our first and very significant priority is to ensure that we have both entities start with and continue with a strong capital structure and more than ample liquidity, and I think we all know in this environment that is very critical and maintaining investment grade ratings will also be very important for both entities.

So that will be a very high priority consideration for both management teams as we go forward.

Again, I think you would all agree in this environment this has to be a big consideration.

Just following on Kerry's comments about the portfolios of respective entity.

First of all, I'll second what he said that the portfolio of businesses in each entity remained what they said they were going to be six months ago.

The one thing I'll add to that, though, as we've indicated before, we'll continue to conduct a strategic analysis of certain businesses within the HSCS portfolio and to the extent that we decide at some point in the future they don't fit, they could be candidates for sale which I think maybe part of the question you were asking.

Operator, I think we have time for probably one more question.

Your next question comes from the line of Michael Cherny of Deutsche Bank, please proceed.

Hi, it's actually Ross.

So as we think about the transition here, obviously now you started to communicate the two strategies pretty elegantly, and if we think about the work force, and I have asked this sort of before, in terms of developing a corporate identity and kind of reinvigorating everyone after several years of being under a little bit of a malaise performance probably wasn't what everyone wanted it to be.

Where would you say where we are right now in terms of getting people internally kind of buying into the new strategy, really trying to grasp this sort of new direction you're going in, and have you seen kind of a change heading into the spin in terms of productivity or morale relative to the business and, in turn, something that's helped with execution, particularly on the supply chain side?

Ross, Kerry here, good morning.

I'm feeling very good about how the organizations are not only physically aligning up behind the two businesses but also on a morale basis.

We do conduct on an annual basis a voice of employee survey that allows us to get a good insight into how people are feeling about their level of engagement with the business, how they're feeling about manager effectiveness, how they're feeling about their alignment to business goals.

And we've recently completed that study sort of reflecting the full knowledge of where the company is going, and we had a significant increase in employee engagement this year which tells us that our employees are more engaged than they have been for a while.

They're very much behind where we're going, they're engaged behind the leaders of both businesses, they're engaged in the mission.

We've got a lot of internal communication by George and Dave to organizations, and I think I would describe it, I think people around here are walking with a new spring in their step on both sides of the house.

Great.

Thank you very much, Kerry.

That concludes the question-and-answer session, I'll now turn it back to management for closing remarks.

I'd just like to say, it's Kerry again, thank you very much for joining us and we look forward to seeing you over the next couple of weeks and particularly June 2.

Thanks for sticking with us on this extended call.

Thanks.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Have a great day.