cardinal health q3 2008 earnings transcript

F I N A L T R A N S C R I P T

CAH - Q3 2008 Cardinal Health, Inc. Earnings Conference Call

Event Date/Time: May. 01. 2008 / 8:30AM ET

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C O R P O R A T E P A R T I C I P A N T S

Sally CurleyCardinal Health, Inc. - Senior VP of IR

Kerry ClarkCardinal Health, Inc. - Chairman/CEO

Jeff HendersonCardinal Health, Inc. - CFO

George BarrettCardinal Health, Inc. - Vice Chairman/CEO of Healthcare Supply Chain Services

Dave SchlotterbeckCardinal Health, Inc. - Vice Chairman/CEO of Clinical and Medical Products

C O N F E R E N C E C A L L P A R T I C I P A N T S

Atif RahimJPMorgan - Analyst

Charles RhyeeOppenheimer - Analyst

Tom GallucciMerrill Lynch - Analyst

Glen SantageloCredit Suisse - Analyst

Ricky GoldwasserUBS - Analyst

Randall StanickyGoldman Sachs - Analyst

Larry MarshLehman Brothers - Analyst

Bob WilloughbyBanc of America Securities - Analyst

Barbara RyanDeutsche Bank - Analyst

John RansomRaymond James and Associates - Analyst

John KregerWilliam Blair & Company - Analyst

Charles BooradyCitigroup - Analyst

P R E S E N T A T I O N

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2008 Cardinal Health, Inc., earnings conference call. Myname is Erica, and I will be your coordinator for today. (OPERATOR INSTRUCTIONS) We will be facilitating a question-and-answer

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May. 01. 2008 / 8:30AM, CAH - Q3 2008 Cardinal Health, Inc. Earnings Conference Call



session towards the end of this conference. (OPERATOR INSTRUCTIONS)

I would now like the turn presentation over to your host for today's the call, Ms. Sally Curley, Senior Vice President of InvestorRelations. Please proceed.

Sally Curley - Cardinal Health, Inc. - Senior VP of IR

Thank you, operator. Good morning, everybody, and welcome to Cardinal Health fiscal 2008 third quarter conference call. Ourremarks today will be focused on the company's consolidated and business segment result for the quarter, which are are includedin the press release and attached financial table. If any of you have not yet received the earnings release or the financialattachment, you can access it over the Internet at our Investor page at www.Cardinal Health.com. Additionally, there are ahandful of slides that we will be reviewing, which can also be found on Web site. After the formal remarks, we will open thephone lines for your questions. As always we ask you limit yourself to one question at that time.

During the course of this call we may make forward-looking statements. The matters addressed in these statements are subjectto risks and uncertainties that could cause actual results to differ materially from those projected or implied. Please see ourpress release and SEC filings for a description of those risk factors. In addition, we will reference non-GAAP financial measures.Information about these non-GAAP financial measures is included at the end of this presentation and posted on Cardinal HealthInvestor page. At this time, I would now like to turn the call over to Chairman and CEO, Mr. Kerry Clark. Kerry?

Kerry Clark - Cardinal Health, Inc. - Chairman/CEO

Thanks, Sally, and good morning everyone. With me today are Jeff Henderson, our CFO, George Barrett, Vice Chairman and CEOof our Healthcare Supply Chains Services Sector, and Dave Schlotterbeck, our Vice Chairman and CEO of our Clinical and MedicalProducts Sector. The results we announced today are consistent with the perspective I shared last quarter. We continue to havethree of our four segments performing according to our expectations. These segments are Healthcare Supply Chain Medical,Clinical Technologies and Services and Medical Products and Technologies. I see puts and takes in each segment, but these arehealthy businesses delivering industry-leading products and services to our core hospital customers. It shows in our result thisquarter with all three delivering solid growth. Within our Healthcare Supply Chain Services Pharmaceutical, segment we continueto manage through the challenges I outlined last quarter. We will talk about that in just a minute.

For third quarter, consolidated revenue increased 5% to $23 billion, and non-GAAP EPS was up 13% to $1.08. Year-to-date,revenue has increased 6% to $68 billion dollar, and non-GAAP EPS is up 11% from last year to $2.83. For the full fiscal year, weexpect to be in the middle of our EPS guidance range of $3.75 to $3.85, excluding the potential impact of the Interior acquisition.Interior is expected to close in the fourth quarter, and the acquisition will likely be $0.01 to $0.02 diluted to the quarter. Now,let me say a few words about the Supply Chain Pharma business. The issues affecting our business this quarter are the same asI talked about last quarter. I want to reference them again since they will also affect Q4. We have highlighted slower overallPharma growth for several quarters now, but, more importantly, there are a couple of factors that are specific to Cardinal Health.First, as we have talked, we have now renewed all major contracts that will expire through fiscal '09. As you know, we have alarge share of national chains in our book of business so it is good to get these renewals behind. But, as these older contracts,were brought to current pricing levels they have had an impact on our segment profit. In Q3 approximate, that impact was $45million. Second, we have been working to implement new controlled substance anti-diversion measures and to reinstate ourlicenses to distribute controlled substances at three of our distribution centers. This disruption cost approximately $15 millionthis quarter. And George is going to talk more about this before we go to Q&A.

I also want to make a couple of points about the second half of the year for this segment. First, we now expect our revenue tobe about 3% higher than the second half of last year. This growth rate is lower than we had forecasted at the time of our Q2call in January and will have an impact on segment profit. The change is due in part to a lack of momentum in our DSD businessas we work through the enhancements to our anti-diversion controls. So while the measurable costs associated with our







enhanced controls haven't changed since last quarter, we are seeing a slowing of progress as we try to grow the business andis it is having an affect on the second half of the year. Our revenue outlook has also changed because of some incrementalbusiness with Walgreen's we had expected to ramp up in Q4, but will now begin in Q1 of fiscal '09. Also, on the segment profitline, we have further scrubbed our generic launch forecast and made additional adjustments to be even more conservative.This is the approach we are going to take going forward. As a result of these factors, our second half profitability in this businesswill be approximately even with the first half. We previously forecasted our profitability to slightly improve in the second half.

Now, turning to Supply Chain Medical. As I said throughout this fiscal year, we expected this segment to return to profitabilitygrowth in the second half, and it did that in Q3. There's still more work to do, but I am pleased with our results for the quarter,especially in our core hospital supply business, where we had very strong results. We continue to manage some issues in thepre-source kitting business, where we are focused on improving our efficiency and execution to return it to profitable growthas well. Now, let me talk about a Clinical and Medical Products Sector, where we had another good quarter with revenueincreasing 26% to $1.4 billion profits grew 43% to $207 million. We continue to make great progress on the integration of VIASYSand remain ahead of our internal schedules for the year. I will remind you that we expect deliver $85 million to $100 million insynergies from the acquisition by fiscal to 2010. Interior will add support to our prevention support offerings. As you may know,in the Deficit Reduction Act of '08, Congress addressed concerns about reimbursements for hospital-acquired conditions andpreventable medical errors. As a result, the centers for Medicare and Medicaid will no longer provide reimbursement for eightconditions beginning October 1, 2008, including several infection categories. A more recent proposal by CMS would broadenthis list. So, Interior and our core CMP products, along with our acquisition last year of MedMined, all support a clear trendamong providers and payors to reduce preventable medical conditions. We have strong businesses across the sector to supportthis shift, especially in the areas of infusion, dispension, infection prevention and respiratory.

I do want to mention the status of our Alaris recalls. We have done a lot of work to strengthen our quality processes during thepast year, and, as a result, we are addressing potential issues earlier in the process. This was the case when we made the decisionto voluntarily institute additional corrective actions to the Alaris system. With an additional $6.5 million reserve taken thisquarter, we are fully reserved for the recalls and still plan to complete remediation by the end of the calendar year. In the process,we are working to minimize any disruption to our customers. We remain very optimistic about the CMP market and our positionin it. About a one-third of our profits now come from this sector, and we continue to diversify our offerings all with the focuson the major pain points affecting our customers. These include medication errors and hospital-acquired infections. As I havesaid before, many forward-looking hospital CEOs are using improvements in quality as a strategy to lower their costs, andCardinal Health is an important partner in this effort. Before I turn the mike over to Jeff, let me address fiscal 2009 guidance. Weplan to provide guidance for '09 on our Q4 call in August, which we will extend to allow plenty of time for Q&A. I know this is achange from our past practice of providing guidance in late, June but, frankly, it is consistent with common industry practices.What I will say today about our outlook is that we expect the remainder of calendar year '08 to be very challenging as we workthrough the issues I have discussed. However, as we move into calendar '09 and beyond, I see a lot of positive drivers. In additionto the momentum we have in CMP, there are several important factors within the Supply Chain Pharma segment. We will lapsethe major repricing we undertook this year. We expect to have much stronger anti-diversion controls in place with stabilityaround those controls for our customers. We have new offerings in the works that we expect will gain traction within our variouscustomer segments. The industry should have a better pipeline of generic launches, and, of course, we still have approximately$1.3 billion left in our share repurchase authorization. Again, these are drivers we see for calendar '09 and beyond, and we willprovide a lot more detail on our August call. Now, I will turn it over to Jeff to discuss our segment results in more detail. Jeff.

Jeff Henderson - Cardinal Health, Inc. - CFO

Thanks, Kerry. Good morning. Thanks for joining us. Today, I am going to talk about our consolidated and segment results forthe quarter, update you on key financial drivers, and then I would like to spend more time going through our outlook for theremainder of fiscal '08. Let's start with the consolidated results for the quarter. Please note that my comments will reflect thefinancial results from continuing operations on a non-GAAP basis. Consolidated revenues were up 5% to $22.9 billion. Operating







earnings were up 1% to $613 million, which reflects strong performance in three segments, dampened by the same issue andHSCSPs that is have challenged us in the recent past.

Earnings from continuing operations for the quarter were $390 million, flat versus the prior year. The diluted non-GAAP EPSwas up 13% to $1.08, reflecting the leverage we were able to deliver via our capital deployment strategy. Operating cash flowfor the quarter was $897 million, primarily from earnings and contribution from working capital, bringing year-to-date operatingcash flow to just over $1.3 billion. Return on equity was 21.3% up 40 basis points over the same period last year.

Now, turn to go the next slide. During the quarter special items totaled approximately $36 million, which negatively impactedGAAP EPS by $0.06. $36 million was comprised predominantly of litigation related charges of $23 million associated with severallawsuits, restructuring-related charges of $8.5 million and acquisition integrated -- integration-related charges of $4.4 million.Impairments and other totaled $1 million in the quarter.

Now, I would like to switch to the performance of the individual business segments on a year-over-year basis. Within SupplyChain Pharma, revenue for the third quarter increased 3% to $19.9 billion. Total revenue growth has been negatively affectedby several factors, some macro and some Cardinal specific. The overall pharma market slow down affected us from a macroperspective. Specific Cardinal and perhaps more impactful are the issues in our directive store delivers or DSD business. Revenuefrom bulk customers was up 8% on increased volumes from existing customers. Non-bulk revenue was flat and was negativelyaffected by two primary factors first by the previously discussed DSE losses that is occurred in FY '07 and have not yet anniversaries,and second loss revenue from the control substance anti-diversion activities. Segment profit was down 21% to $300 million,primarily driven by the ongoing impact of previously announced customer repricings, The affect of the anti-diversion activitiesand a unique compared to last year with respect to last year's Q3. Specifically, as was called out last year, in Q3 of FY '07, werecorded incremental $15.8 million in fees from one specific supplier contract. After we received confirmation of successfulachievement of 2006 performance metric. It was incremental to that quarter and did not repeat this year, dampening theyear-over-year benefit from an otherwise strong quarter from pharmaceutical price appreciation. Of note, as we stated, weanticipate that the measurable impact of anti-diversion efforts on the P segment will be at least $30 million for fiscal '08. Thisincludes expenses for increased delivery costs related to our license suspensions as well as the losses of customers that is canbe directly attributed to these efforts. On a positive note, we continue to see progress in our effective use of capital A. We arepleased that our tangible capital is down 1% over Q3 of last year. And in fact, days of inventory on hand increased over twodays versus last Q3.

Turning to slide eight, as Kerry, mentioned we turned the corner in Supply Chain Medical this quarter. Revenue growth continuedto be strong with an increase of 8% over the prior year, primarily on increased sales to existing customers, where we are alignedwith fast growing hospitals and have increased penetration with our customer base. Segment profit for the quarter was $93million up 5% over Q3 of FY '07. This profit improvement was driven by the increase in revenue and offset by the refined corporatecost allocation, which negatively affected growth in the quarter by six percentage points. And continued softness within oursurgical kitting business, which negatively affected by 11 percentage points. Now, turning to CMP Sector, and, first, the MedicalProducts and Technology Segment. Revenue increased 48%, which is $679 million, with 38% of growth in the VIASYS acquisitionand 10% to legacy business of which four percentage points was due to the foreign exchange. Segment profit was up 72% to$80 million with VIASYS contributing 52 percentage points and 20 percentage points coming from the legacy business, which11 related to foreign exchange. So the legacy business excluding foreign exchange contributed six percentage points to revenuegrowth and nine percentage points to segment profit growth.

The integration of VIASYS continues to go extremely well with synergy capture for FY '08 ahead of schedule. During the pastnine months, IPS training for VIASYS sales reps took place, the Conshocken corporate office is closed, and we announced theupcoming consolidation and rationalization of some manufacturing activities in the U.K. into a facility to [Gore], Ireland. We aredelivering our commitment and on schedule to achieve our $85 to $100 million synergy target by FY 10. Moving on to slide 10,Clinical Technology and Services had another great quarter. Segment revenue was $747 million up 11% over the prior year,driven by strong installations for our Pyxis and Alaris products. Growth was dampened by a slowdown in pharmacy services,excluding this business, CTS was up 19%. Segment profit was $127 million up 29%, driven by a favorable mix of higher margin







products and improved operating leverage. This was somewhat offset by the additional $6.5 million charge we took in thequarter related to the voluntary recall of integrated circuits and on certain Alaris modules. As Kerry, mentioned we anticipatethat the recall announced in December and recent voluntary one are now fully reserved and we expect to have both reservedby the end of calendar '08. CTS continues to perform very well with great margin expansion. In fact, segment profit marginincreased 240 basis points over Q3 of '07.

Now, I would like to turn to the key financial levers to drive both growth and returns for the business and our shareholders,which are balance sheet management capital deployment, and our capital structure. We again made meaningful progress alongall of these in the quarter. Days inventory on hand improved by two days versus the prior year with the improvement in HSCSPdriving the improvement. Also, as we previously mentioned, we continue to review our portfolio of assets and have classifiedcertain at assets in the MPT Segment as held for sale as we work to complete divestiture. Return on invested capital was up fivebasis points versus Q3 of last year. For the quarter, we repurchased approximately $150 million in shares bringing our FY '08purchase to approximately $1.1 billion through the first nine months. We anticipate closing fiscal '08 having executed sharerepurchases of approximately $1.2 billion. Similar to the last quarter, we are operating with debt-to-capital at the upper-endour our target range at approximately 34%. The desired outcome is enhancing returns, and we are able to deliver on that goalwith a non-GAAP return equity in Q3 of 21.3% which is an increased of 40 basis points over last year and 190 basis points aboveour non-GAAP REO last quarter.

Now, moving on to the outlook for the remainder of FY '08. As Kerry noted, we expect to be right above the middle of thepreviously announced $3.75 to $3.85 range, excluding the impact of the Interior acquisition, which will be $0.01 to $0.02 dilutedfor the fourth quarter. I would like to to take you through our view of the fourth quart near a little detail to help you betterunderstand our expected results. As we mentioned, it will be quite difficult for HSCSP to grow revenue much faster than theoverall pharma growth due to the prior year DSD losses and anti-diversion efforts. All in all we, think Q4 HSCSP Segment profitwill be down approximately 15% versus a year ago driven by the same general factors that affected Q3. In fact, we anticipatesegment profit will be similar to our Q2 of this year the December quarter. Within the HSCS Sector we anticipate similar sequentialearnings trends as with have seen in past years with segment profit lower in the fourth quarter than in the third. As we haveseen historically, HSCSP Segment profit margin will be lower that Q3 on a sequential basis driven by the timing of brand priceincrease, which is typically impact the March quarter more than the June quarter.

At the risk of repeating some of Kerry's earlier comments, now let me talk briefly about what has changed in HSCSP since wespoke to you last. We have experienced slow growth in our DSD business and have not brought on additional volumes fromWalgreen's as quickly as originally been expected. Although we have not raised our formal estimate for the cost anti-diversion,we believe this further disruption in growing our DSD business is related. In addition, and to a lesser extent, we have furtherrisk adjusted our generic launch expectations. George will talk more about our current approach of forecasting in this area.

Now turning to CTS. Q4 historically has been a strong quarter, and it will again this year as we had the sequential improvementfrom Q3. But I would like to remind you that Q4 last year was an exceptional quarter for this segment, so we wouldn't expect asequential improvement of anywhere near the magnitude we saw last year. More specifically, we added a large number ofinstallers to our work force towards the end of '07 as we work to clear a large backlog of orders, particularly MedStation 3500orders that had accumulated. As such, we experienced a pretty large bulge in installations in Q4 of last year. We do expect CTSSegment profit for the year will end up toward the upper own testify the profit guidance range we given of 20 %to 25%. Moregenerally, we also anticipate an overall increase in SG&A versus Q3, driven by some key product related investments and theimpact of the acquisition within MPT. On the net interest expense line, you may have noted our Q3 level was relatively low.There were foreign exchange benefits that is lower this expense line that we don't expect to repeat in Q4. We expect Q4 toreturn to a normal levels level around the $50 million range or so we saw in Q2 of this year. And finally, we expect Q4 averagediluted shares to be slightly lower than our Q3 figure of just over $360 million.

So, in summary on the final slide, this all adds up to an FY '08 outlook as follows. We expect overall company revenue growthto be in the approximately 5% this year, based on market trends and slower than anticipated transition of the addition ofWalgreen's volume. The EPS range remains unchanged. We expect to come in. in the middle of this range, excluding the impact







of Interior, which will be $0.01 to $0.02 dilutive. And segment guidance remains unchanged. As we previously mentioned, wewill be providing a comprehensive update on our Q4 FY '08 and FY '09 guidance call in August. With that I would like to turn itover to George to provide a few comments on HSCS. George?

George Barrett - Cardinal Health, Inc. - Vice Chairman/CEO of Healthcare Supply Chain Services

Thanks, Jeff. And, good morning, everyone. I last spoke with you three months on on my second day at Cardinal. I have spentmuch time since assessing our HSCS business, both on the pharma and medical side. I would like to share with you a bit of whatI have seen.

As Kerry and Jeff mentioned, our medical-surgical business is making real progress. Although our kitting business will need tobetter adjust to the dynamics of the market, the rest of our medical businesses are showing marked improvement. In particular,I would like to highlight the progress being made in our hospital supply business. I will devote more time to the medical sideduring a future call, but I will add the work we are doing in category management should help us achieve a more profitablemix of business and a substantial improvement in services and efficiency. The turnaround in pharma distribution is my toppriority, and, clearly, we've work to do. We have been dialing a number of issues, some of which are systemic, but, most of which,are specific to our business mix and our execution. We will need to focus on fewer things and do them incredibly well. We havealready revisited our priorities to determine, not only what is critical, but also what is less important at this time so we can betterexecute and do it faster. Here are a few of the key themes, which is will be the foundation of the path forward, much of this isalready in motion. First, I am pushing the organization to regain its passion for the blocking and tackling of our core business,superior or through remittance execution may seem boring to some, but it at the core of our customer offering. Second, weneed to complete our on going segmentation of our customer base -- base, both downstream and upstream, which beganearlier this fiscal year. This will help us pair our tailor offerings more specifically to the unique needs of various customer groups.This will involve some different go-to-market approaches by segment.

Third, while we have continued to improve the attractiveness of our generic programs, we need to better integrate theseprogram into our overall offerings by segment in a way which helps our customers compete. We have been in the buying andon the sourcing side, we need to and will match this on the downstream commercial side. Finally, we need to better adapt tothe enormous and rapid changes in the pharma landscape as well as the retail landscape. This requires that we revisit our valueproposition to both our branded manufacturing partners and to major retail customers to make sure that each of us is gettingthe right value and the appropriate rewards. This is not an easy task when everyone is under pressure. However, we must tacklethis. We will do so with the spirit of partnership, but with real discipline.

I believe that we are building the right leadership team in placing Mike Kaufman to lead our Pharma Segment. Mike has a strongtrack record in our pharmaceutical business as its former CFO and Head and Sales of Marketing, where recently Mike built astrong team in medical and set the turnaround in motion before accepting the pharma role. I will work closely with Mike in thecoming months on HSCS, again, while maintaining the the focus on Medsearch-side of house to ensure that that businesscontinues to improve. I am working with our executives to identify strategies for us to ensure that we have the right tools toexecute. I have been meeting with customers, suppliers and our people in the field as much as possible to get first handknowledge of the issues and how to address them.

I would like to make a few specific comments around items about which I know you will be asking. First, our anti-diversionprogram and our efforts to ensure security of the supply chain. We are working our tails off to restore our reputation with DEAand gain back the ability to distribute controlled drugs from all of our facilities. Our early efforts dictated that at times we usedsomething of a blunt tool to ensure no diversion was rather than a precision instrument. We know that this has caused disruptionto our customers, particularly in the retail independent space. We regret this and truly appreciate their support during thistough time. We have lost retailer share over this and have made it a challenging environment in which to grow. But, we'remaking progress on implementing the necessary systems and getting our service levels back to where they belong. It is difficultto predict at this time a firm date where all facilities also be shipping controlled drugs nor would it be prudent to comment on







discusses with DEA. We can say that we are working with the utmost diligence to bring this matter to a close. Second, I knowthat many are curious about market growth. We will not try to predict the future. We can say that recent IMS -- IMS view is anoverall market growing at 2% to 3%, and our recent data shows corresponding slow down versus earlier in the year. Third, anumber of you have asked about forecast for our generic activity. We are can say the years between 2009 and 2012 look likerelatively strong years for generic with the caveat that some clumpiness is natural. Further, most of you are aware that manyof the launches we see on the horizon are subject to legal and patent issues making forecasting quite challenging. We will takethe following approach going forward as it relates to what is in our guidance. We will risk adjust all at-risk launches or take themout of our guidance completely depending on the nature of the case, the size of the product, and the level of informationavailable through dialogue with the manufacturers.

Finally, a few words on margins. It is clear that the impact of our repricing has been margin dilutive. We will need to revisit theway in which we look at these programs. Further, our mix of business and our relatively smaller base of independent andnon-warehousing chains has limited our ability to improve margins by growing valuable programs for these customers. Ouranti-diversion efforts have only made this more challenging. As I mentioned earlier, we are actively work to go create the offering,which will better allow these customers to compete, and this should be margin positive for us. As we come to our anti-diversionactivities, our opportunities to grow will only improve. And with that, I will turn the call back to Kerry.


Thanks, George. Operator, I think we are ready to open the floor for questions.

Q U E S T I O N S A N D A N S W E R S

Operator

(OPERATOR INSTRUCTIONS). Our first question comes from the line of Lisa Gill from JPMorgan. Please proceed.

Atif Rahim - JPMorgan - Analyst

Hi, thanks. It's Atif Rahim in for Lisa. I think -- we have a couple of question on distribution margins. I know, George, you justcommented that the repricing have been margin dilutive, but if you X out some of the items that are non-recurring, such as theanti-diversion measures, and include some of the one that is are recurring, such as the repricing, where do you see your marginsfor the distribution business over the longer term?


Jeff, would you mind taking a stab at that.


Sure. First of all, it is hard to make some of those adjustments you spoke about because repricings are a part of our business,and they're going to happen from time-to-time. But, I think what we said in the past that we expect relatively stable marginsover the medium to longer term and recent activities aside, such as diversion and the fairly substantial repricings we have haddue to the bolus of large national accounts over the past nine months or so, I would expect that statement to hold relativelytrue.








I think the past statement was like 150 to 200 basis point. No, that's our most recent statement over the past 12 months or sohas been really about maintaining stable margins.


Stable margins, okay. Secondly, on CTS, there has been a strong -- you guys had strong results, but just in term of the marketenvironment and some of the hospital liquidity issues, have you seen any of those affecting you or hospitals just more focusedon spending on items they absolutely need and, perhaps, some of the other areas is where we are seeing some of the weaknessin hospital spending.


Well, this is Kerry. I will just take the very first one. I think basically looking at the results across the quarter we could say we havenot seen any impact on changes and hospital spending affecting our business. However, I would like to turn this over to Daveto make a few broader comments about the CTS business. Dave.

Dave Schlotterbeck - Cardinal Health, Inc. - Vice Chairman/CEO of Clinical and Medical Products

Thanks, Kerry. Actually, before I address that question, I'd like to say that I'm very enthusiastic about the Interior acquisition andadding a new dimension in growth opportunities to our infection prevention effort,. Additionally, on the Alaris pump recall andthis latest voluntary recall of sockets and and components connectors, we expect to be completed by the end of the calendaryear, and that really applies to units that were manufactured before 2005. It reflects a proactive approach by Cardinal Healthin examining the time period even before Alaris was acquired. And, then last, while we are never satisfied with our performanceand always strive to get more growth out of our business, I was pleased with the performance of CMP, CTS and MPT in thequarter.

To our specific questions, with respect to some of the comments that competitors and others have been making around thecredit markets, I'd remind the audience that one of Cardinal Health's competitive advantages is to provide leasing for ownedequipment, and it dampens any negative credit market impact. That's particularly true in the, in dispensing market segment.And add that, both in the ventilation market and in the infusion market, that these products really are necessities for a hospitalto operate.


Okay. Thanks. Appreciate the color.


Next question, please, operator.

Operator

Our next question comes from the line of Charles Rhyee from Oppenheimer. Please proceed.







Charles Rhyee - Oppenheimer - Analyst

Yes. A couple of quick questions, regarding the guidance. You mentioned, Jeff that the Interior dilution in the fourth quarterwould be about $0.01 or $0.02. Can you just give us a sense on how we should think I about the dilution as we go through therest of the year? Are there just some specific charges as the acquisition comes on that we should think about in 4 Q that mightnot come on later on?


Yes, Q4 is relatively unique, Charles. Thanks for the questions by the way. Q4 is relatively unique depending on the actual timingof the close of the deal, which is not definite yet. As you know, when we make a purchase like this, there are certain purchaseaccounting adjustments that flow through the income statement during the initial weeks and months after the close of thedeal, such as the inventory write up, et cetera. So, we would expect most of those to flow through in Q4. As we said previously,heading into F Y '09, we actually expect the acquisition to be accretive to earnings.


Okay. Then, just a quick clarification, the Alaris reserve that you took for -- for this recall, was that included in the numbers forspecial items or is that separate?


That's not in special items. It is included in the normal segment operating profit that we report.


Okay. My last question has to do with the Pharmacy Management business. Revenues again were down this quarter, perhapsnot as much as last quarter. Can you give us your thoughts on rational for keeping this business? It seems to be sort ofunderperforming, and maybe give a sense for why the revenue versus been weak the last two quarters?


Dave, would you take that question, please?


Yes. It is -- it is a tough market, number one. Number two, we are seeing more hospitals elect to manage their own pharmacies,and that means some turn in the customer base. The customer base really is -- really has not grown over the past several years,so the market is not expanding. We do feel that this business does give us, however, some very unique insights into the medicationmanagement and process that hospitals have. That without it, we would not have. And, we can take those insights and playthem back into the Alaris and Pyxis business, so it does provide some strategic benefits for us.


Thanks, Dave. Next question, please.







Operator

Our next question comes from the line of Tom Gallucci from Merrill Lynch. Please proceed.

Tom Gallucci - Merrill Lynch - Analyst

Thank you very much. I appreciate the color. I guess first question, you had talked a few times about the impact of the contractrenewals on this year, and that most of your renewals are done, I guess, all for fiscal '09. Obviously, CVS is on the horizon. I don'texpect you to say much in terms of the detail on that one. But can you sort of, at a high level, compare and contrast maybe thetiming of when that one was last renewed and your perception of where it is relative to market pricing compared to maybesome of the one that is have been renewed in the last year that have really had a negative impact on result?


Tom, Kerry here. That was summer '07. And, yes, I think that really brought us fairly close to current market pricing. So, I thinkthat is important perspective as we head into the next round.

Tom Gallucci - Merrill Lynch - Analyst

Okay, good. And then, on the DEA, I guess disruption, I guess realistically you probably lost some of the independent businessfor good, given some of the disruption. But, can you maybe add some perspective on how much of the disruption is temporary,and, as you fix the system, things can come back on line? Or how much of it do you think is more permanent in terms of customerthat is found a new source at this point?


Yes, Tom, I will ask George to take that, please.


Yes. Hi, Tom. We certainly have challenged the patients of some customers, and, as I said, particularly in the independent space,and we have seen some drop off of that business. Most of whom have really signaled to us that they consider themselves to beCardinal customers and will stay with us. We are going have to work hard to bring back some of the customers, I think, whohave who have fled during this challenge. I don't think it's a large group. We'll again -- it's going to take a little time, and we'regoing to have to work back with them.


Thank, George. Next question, please.

Operator

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







Glen Santagelo - Credit Suisse - Analyst

Yes, I had a follow up on the margins. Kerry, based on the guidance you gave, it kind of looks like the margins in the PharmaceuticalDistribution segment will be down 25 to 30 basis points in the June quarter relative to the March quarter. Is that primarily justexplained by the seasonality and maybe the timing of price increases? Or is there something else that's changing next quarterthat's driving those margins lower?


I think the primary driver -- This is Jeff by the way, and thanks for the question, Glen. primary driver is really the seasonality thatwe see every year as the Q3 price price increase have a much greater impact in that quarter than on Q4. I would say that's theprimary driver.


And then, I just had one follow-up question on the Supply Chain Medical Segment. Obviously, you had a very strong quarterfrom a revenue and margin perspective. I think if I heard George correctly, you sort of suggested that was increased sales toexisting customers. Where were those sales prior to you winning them? Was it them going direct, or is that kind of market sharegains you are winning in the market?


Yes, I would say it is probably coming from -- this is George by the way. I would say primarily coming from other distributors,so we are seeing some market share movement here.


Do you think there's more to go on that front?


Well, I am encouraged by what I am seeing. Of course, it is early to declare victory, but we are seeing good numbers comingout of med-surge business.


Thank you.


Next question, please.

Operator

Ladies and gentlemen, we do ask that you limit your questions to one question and one follow-up. Our next question comesfrom the line of Ricky Goldwasser from UBS. Please proceed. Had hello.








Ricky, are you there.

Ricky Goldwasser - UBS - Analyst

Yes, I'm here. Do you hear me?


Yes, we can. Thank you.


Good morning. Thank you for taking the question. Just one question around pricing.


I am sorry, you are now fading out. Can you speak a little more loudly, please> We can't quite hear you here.


Can you hear me now?


Yes, we can. Thank you.


My question relates to your outlook for price inflation, and we talk about the seasonality that we are going see in the Junequarter. But what are kind of like, what's your outlook for the second half of calendar year '08 with the effect of the presidentialelections?


Yes. You were kind of breaking up. This is Jeff. I am going to try to figure out what your question was. I think you were askingabout our outlook for price inflation. I'm sorry. We are getting some feedback. So, I am just going to pause for a second. Ricky,I think it is coming from your phone. If you could put it on mute maybe that would help.

First of all, Q3 was relatively healthy quarter for price inflation. That has been echoed by other sources as well. Going forward,we see price inflation in the 6% to 7% range. Now, obviously, as we approach the election next year, there can be some volatilityaround that regarding exact timing. So, it will be a little difficult to predict, but our expectations are pretty consistent with whatother predictors are saying as well.








Thanks, Ricky. Next question, please.

Operator

Our next question comes from the line of Randolph Stanicky from Goldman Sachs. Please proceed.

Randall Stanicky - Goldman Sachs - Analyst

Great. Thanks for the question. Jeff, I understand there's a lot of moving parts in pharma distribution in general. And, lastconference call, you talked about working through some of the long-term guidance in the next three to four months. We aresitting here three months later. So, I'm just curious, when we will get timing on the updated long-term for that segment? And,do you still see the current long-term outlook in the realm of achievability? And then I have a follow-up.


Yes, as we stated in the last call, and, as we spoke -- Kerry spoke about earlier today, first of all, we need to finish going throughour planning process. Clearly with George's arrival, we want to make sure that he has ample time to assess the business andfully understand the various levers going forward, and we are still going through that process as we speak. Now, as Kerry said,our goal still is to provide FY '09 guidance during the Q4 earnings call in August, and most of that call will focus specifically onFY '09 But,,t we will supplement that with some longer-term views of where the various businesses are heading. I really don'twant to comment on prior long-term guidance. That was developed last year's planning cycle, and, until we go through thiscurrent cycle, it would be premature to provide any comments on that.


Let me ask maybe a related question to George. You made a comment in your prepared remarks about revisiting the valueproposition. I guess, maybe, could you expand --? My question is that -- would that include contract renegotiations, or could itinclude more broader strategic changes that we haven't seen yet in the business?


Yes, well I think it is sort of it comes along two dimensions, one is downstream, where there are major customers, and the otheris upstream. As I said, I think we are looking very carefully at the kind of value that we offer relative to the compensation forthat. I think as we work through our segmentation strategy, we will be able to at least on the downstream side more effectivelydo that. Thinking about sort of more end-to-end solutions with our major retailers, for example, where we look at collectivelyeliminating cost from the system, is a kind of model that we need to look at. We are so highly connected as very large enterprises.This is an area that we can look at.

As it relates to the upstream side and our relationship with big Pharma, obviously, this has been a long and rich history for usin terms of these relationships. Again, it is another place we are l look at the possibility of using some thinking about end-to-endsolutions to create value and eliminating sort of inefficiency from the system. Having said that, the value of assuring the pedigreeof products and securing the supply chain and of moving products throughout the system with oil prices escalating, just toname a few, these are significant value and really do not intend to give it away. So, we are going to have to take a disciplinedlook at that, but we are optimistic all of our partners will respect that.








Is this a current process that you are having discussions and having and going with the internal review, you are going to beable -- to be in the position to come out and talk about that in the context of the broader outlook in August?


I just, I couldn't comment on that.


Okay.


Randall, I am sorry.


Thanks, Randall. Next question, please.

Operator

Our next question comes from the line of Larry Marsh from Lehman Brothers. Please proceed.

Larry Marsh - Lehman Brothers - Analyst

Thanks. Good morning, everyone. Quick question for George. Just a clarification for Jeff on the FX. George, just want to makesure I heard correctly, are you saying that you and Mike are now set with your management team? Or is that still a work inprocess? And did you say exactly how many facilities are not shipping controlled substances? Is it still, I think, four?


Yes. The second question first. Four facilities that are today not shipping controlled substances. Yes, as it relates to themanagement structure, I think we are always in the process of refining it, but we developed a strong team. The group that Mikehad been overseeing in the medical with David Anderson, Steve Inacker and Lisa Ashby and Kenny Wilson, all people with many,many years of experience in the hospital business with Cardinal with firms like Pepsi and other companies. We've got really astrong team there. So, I am really pleased with the group we've got. We will always look as if business evolves at whether or notthere are tools that we need to supplement, and we have made some key moves in the organization with HSCSP. We willcontinue to do this at the refining that organization and match the strategy as we go forward.


Great. And, did you -- are you positioned to comment on the nuclear pharmacy side, or is that because -- I know before othershave, sort of, talked about the benefit starting in July with going CardioWriter generic. Are you in a position to comment at thispoint, George?








Yes, I can give you a bit of color on this. You may also know that we have made some key moves in the last month or so tosolidify our position in the nuclear pharmacy area. We announced recently that we have expanded our relationship with G andA Healthcare.


Right.


And, through that extended partnership, Myoview will be more widely available across our network, which now allows us againto offer to the radiology and cardiovascular community both leading MPI agents for nuclear cardiac images. So, that's a positivestep for us. As you mentioned, the patent for CardioWriter expires at the end July, and we are still hopeful about offering a lowcast alternative at that time. But, there are still a number of issues to be resolved. As you may know, there is a citizens petitionthat has been filed by the innovator, which could delay launch. In addition to contract, manufacture of our generic system maybe filed. I have received a warning letter related to GMP issues, and that could delay our approval from that site although ourmanufacturing partners working to resolve this. And, we are involved in that process.

So, the timing is not completely, clear, and we are actively exploring both the self-manufacturing solution as well as all availableoptions to be able to use our powerful network and our scale to bring a low-cost product to the market.


Great. Thank you so much. And then, Jeff, the FX benefit, it sounds like you said roughly $20 million in the quarter. What wasthat exactly, and why wouldn't that be recurring?


It was between $15 and $20. You're talking about the FX benefit on the interest expense plan I assume, Larry.


Yes.


Yes, it is between $15 and $20 million, and it relates to two items, an intercompany loan that we had outstanding as well asoverseas cash balances that were held in non-functional currency, and both of those have since disappeared, both the cashbalance and the loan itself. So that won't replicate itself in Q4.


Great. Thanks.








Thanks, Larry.



Operator

Our next question comes from the line of Bob Willoughby from Banc of America Securities. Please proceed.

Bob Willoughby - Banc of America Securities - Analyst

Hi, there had been a goal from you folks about statement -- dividends equaling 20% of net income. Are we making any progresson that point? I can't say over the past couple of years we have seen much there in terms of hikes.


Hello, Bob. It is Jeff. Like I said, it depends on perspective. But, we stated a few years ago that our goal was to get to 20% pay-outwithin a reasonable period of time. Over the three-year period, since that announcement, we have raised the dividend 100%,50% and 33% respectively over three years, which is brings our pay out approximately to the 12% range. We have a BoardMeeting next week, which is the usual annual Board Meeting, where we assess our dividends for the following year, and we willbe discuss that in the context of all capital plans and then that longer-term 20% pay-out. So, I would say we have made goodprogress towards that, and we have every intention to continue to work towards that goal.


And, to get to 20% pay-out, I'm, basically, assuming the dividend amounts essentially has to double here, does it not?


If we were going to do it all one year, it would have to effectively double. That's correct.


Okay. And, you had mentioned some asset divestitures in a prior press release. Is there any sort of clarity on any programs ongoing there?


They're currently classified as held-for-sale on our MPT balance sheet. We are continuing to go work through discussions withpotential buyers, and, given the sensitivity of those discussions, really don't want to comment any further on those at this time,Bob.








All right. Thank you.


Thanks, Bob.



Operator

Our next question comes from the line of Barbara Ryan from Deutsche Bank.

Barbara Ryan - Deutsche Bank - Analyst

Thank you for taking this question. I just have one brief one left, and that was, George, you had mentioned changing the waythat you go about forecasting generics, and specifically that was one issue that would be a change in the fourth quarter. And Iam just wondering, given your background, if part of that was related to a more conservative view on the availability of genericProtonics in the fourth quarter after the initial bolus that was launched into the trade at the beginning of the year.


Yes, thanks, Barbara. Actually, the change in policy or my approach to policy is unrelated to --.


Right.


the Protonics issue. It is really more about an industry, in which the predictability is very challenging, and, so, there are varioustools do that. And, our feeling is the most effective way to do that, is to do some heavy, careful risk adjustment, and, in somecases, literally pulling products out of guidance when we just don't have the transparency that would give us insights and takinga more cautious approach.


Okay. Thanks. And, then the fourth quarter on Protonics specifically, is that one of the components?


Yes. I don't think I would comment specifically on Protonics.








Okay. Thank you.


Thanks, Barbara.



Operator

Our next question comes from the line of John Ransom from Raymond James. Please proceed.

John Ransom - Raymond James and Associates - Analyst

Hi, good morning. I'm sorry if I missed this, but, Jeff, did you quantify the interest expense contribution from Four X this quarter?How much of the upside was from that specifically?


Yes, it was between $15 and $20, John.


$15 and $20 million?


For the quarter, yes.


Okay. Great. And then, secondly, and, just sticking to the script of two questions, could you all address where you are from aportfolio evaluation standpoint? And, if it is a reasonable expectation over the next 12 to 18 months that you guys may look tomake some portfolio changes, or is it a poor time given the state of the capital market?


John, this is Kerry. As Jeff mentioned, we do have some assets we are looking at now. I think we would say we continuouslyreviewing our portfolio and making sure that they are supporting our mission of safety and productivity, and that their -- thateach asset is helping each sector become as good as it can be. And, so, that process is on going and I don't really want tocomment any further at this time.








Is it fair so say that though, Kerry, the -- at least the appetite for considering options may be higher than it was a year ago? Isthat fair?


I really can't comment on that, John. Thanks.


Okay, thank you.

Operator

Our next question comes from the line of John Kreger from William Blair. Please proceed.

John Kreger - William Blair & Company - Analyst

Hi, thanks A question for George. George, you mentioned a bit of a fall out from the smaller chain customers relating to theanti-divergence effort. Can you give us an update on where your customer mix stands today within Supply Chain Pharma, andare you happy with that mix? Or will there be any particular categories that you would like to emphasize in the coming years?


Yes, thanks for the question. I can't give you the exact. I don't think I can give an exact break down of mix, but I think I can sharewith you that I would love to see some change in that mix. As you know, it is a very strong business with some of the majornational retailers, and that is a the very important part of our business. But, I think balancing that out with a broader positionin the independent market and in the non-warehousing chains for us, I think would be very beneficial. I think we have the toolsto do that, and that will be an area we are looking at very carefully.

John Kreger - William Blair & Company - Analyst

Great. Thanks.


Your welcome.









Operator

Our next question comes from the line of Charles Boorady from Citigroup. Please proceed.

Charles Boorady - Citigroup - Analyst

Thanks. Good morning. You talked about the $45 million impact from renewed accounts. I just wanted to understand that alittle better. Is that reflective fully of the, sort of, repricing of those on the renewals, or does that include any one-time transitionor other costs that you might not expect to recur longer term?


Hey, John, it is Jeff. Thanks for the question. First of all, since we are renewing accounts that we already have, transition accounts-- transition costs, I am not exactly sure how you define those, but since they're accounts that we already have, transition costsreally aren't an important part.


You talked about expansion of the Walgreen's relationships, for example. So, I'm wonder if that $45 is ongoing, or does thatinclude some non-recurring things so that the reduction going forward would be less, or that you would recover some of itfrom expansion relationships?


Okay. I understand your question. Depending ton nature of the renewal, and I don't want to comment on any specific one, butsome renewals are done with up-front payments, et cetera, and everyone is slightly different. But to the extent there are up-frontmoneys, given those are amortized over the life of the agreement. So that $45 million that Kerry referred to, I would say is fairlyrepresentative of an ongoing run rate at least until we lapse those renewals.


Got it. And, question number two, is just on the, sort of, a big picture. If you have gotten any reaction from your customers orfrom your marketing folks on the Alaris recall, specifically, to what extent it might complicate your marketing campaign aroundpromoting error reductions in hospitals?


Dave, would you like to take that, please?


Yes. Well, as I had stated on probably the last two calls, customers -- we do see a bit of hesitation with new customers, and that'sreally driven by their desire to understand the details of the existing recalls. And, so, we do see some movement from onequarter to the next in their committed contracts. The good news is that, ultimately, they come to understand that the issuesthat we are addressing through these corrective actions really are not contained in any of the product that is currently shipping.And, so, that gives them some increased level of comfort as a result.








Thanks, Operator, I am now going to turn the call over to Sally to make some closing comments. Sally?

Sally Curley - Cardinal Health, Inc. - Senior VP of IR

Thank you very much. I just want to make everybody aware to feel free to call Cardinal Health Investor Relations. We will beavailable to answer any questions that we didn't get to on today's call. I wanted to also make you aware of some upcomingevent.

Tomorrow, actually George Barrett will address investors on a conference call. You can find this information, in fact, all of thisinformation will be available on our Web site under the Investor Events section at www.CardinalHealth.com. On May 13, Georgewill actually be presenting at the Banc of America Conference in Las Vegas. On May 19th, Dan Schlotterbeck will be participatingin a conference call to talk about Cardinal Health CTS Segment, and that again will be on May 19th. On May 22nd, Kerry Clarkwill address investors at the Citigroup Healthcare Conference in New York. On June 11th, Jeff Henderson will actually beaddressing investors at the Goldman Sachs Investors Conference on June 11th again. And, on June 12th, the next day, we willhosting a Med Tech Day at our San Diego facility. And for those unable to make it, we are Web casting that. So, we invite youto participate by Web cast if you can't make the live demonstration. With that, I would thank our operator. Thank everybodyon the call, and please feel free to give us a ring if you have any other questions.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Everyonehave a great day.

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cardinal health q3 2008 earnings transcript

Economy & Finance