Cardinal Health, Inc. (CAH) Q2 2008 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2008 Cardinal Health Incorporated Earnings Conference Call. My name is Eric, and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will facilitate the question-and-answer session towards the end of the conference. [Operator Instructions]. I would now like to turn your presentation over to your host for today's call, Mr. Bob Reflogal, Vice President of Investor Relations, please proceed.

Thanks Eric. Good morning everyone and welcome to Cardinal Health's fiscal 2008 second quarter conference call. Our remarks today will be focused on the company's consolidated and business segment results for the quarter, which are included in the press release and attached financial tables. If any of you have not yet received a copy of our earnings release or the financial attachment, you can access it over the Internet at our Investor page, at www.cardinalhealth.com. Additionally, there are a handful of slides that we will be reviewing, which can also be found on the website. After the formal remarks, we will open up the phone lines for your questions. As always, we ask that you limit yourself to one question at a time. During the course of this call, we may make forward-looking statements. The matters addressed in these statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected or implied. Please see our press release and SEC filings for a description of those risk factors. In addition, we will reference non-GAAP financial measures. Information about these non-GAAP measures is included at the end of this presentation and posted on Cardinal Health's Investor page and posted on Cardinal Health's Investor page. At this time, I will like to turn the call over to Cardinal Health's Chairman and CEO, Kerry Clark. Kerry?

Thanks Bob. Good morning everyone. With me today are Dave Schlotterbeck, Vice Chairman and CEO of our Clinical and Medical Products sector; Jeff Henderson, our CFO and outgoing Interim CEO of the Healthcare Supply Chain Services sector, and George Barrett, our newly appointed Vice Chairman and CEO of Healthcare Supply Chain Services, who joined the company yesterday. I want to start today's call by talking about our earnings outlook for all of fiscal 2008, then Jeff will provide some detail about the second quarter. I think it's important to note that we have three of our four segments performing on track. These segments are Supply Chain Medical, Clinical Technologies and Services and Medical Products and Technologies. All three are enjoying strong revenue growth and margins that are expanding. These businesses will account for almost 50% of our operating earnings this year, and collectively we expect they will grow profit about 20% for the year. All are shaping up for a strong second half and of course these segments remain a strength for the company. But as I said, last quarter, we are facing a number of challenges in our Supply Chain Pharma Business. Despite revenue growth of 5% versus year ago in the first half of the year, operating earnings were down 9% from year ago. Q2 was generally inline with what we advised three months ago. The issues affecting the Supply Chain Pharma business in the first half, are the same as we talked about on last quarter's call. The timing of new launches and deflationary environment in the generics market, branded price increases, although a year ago, in Q2, the impact of repricing some of our larger contracts last spring, which had an impact on our first half results. And some supply and pricing challenges in our radiopharmaceutical business. And of course poor execution in winning new DSP business, generic penetration and reducing our SG&A expenses, remain the same as we thought last quarter. This latter point is important to understand... to understanding our first half results, because while we have forecast the impact of contract renewals, we were unable to offset the effects of these renewals in other parts of the business. We discussed all of these factors in our call last quarter, so there should not be any surprises about the first half. Turning to the second half, however, we believe we need to make some significant changes to our forecast for Supply Chain Pharma, and that is why we are taking our guidance down at this time. While we expect to see a moderation in the rate of decline, segment profit will now be below a year ago for the full in Supply Chain Pharma. This is the primary reason for our guidance revision to a range of $3.75 to $3.85. Let me explain why. Over the last nine months we have renewed all our large contracts, K-Mart, Kroger and CVS last spring. And we just renewed our Walgreens contract earlier than expected. All of these renewals will have long standing contracts, and all have been renewed at what we would consider current market rates. Having these renewals in hand puts a lot of stability under our business going forward for at least the next 12 months. However, collectively, they will have an impact of more than $140 million on fiscal 2008. As I said earlier, our prior expectation was that a vast amount of last spring's renewals would be covered through improved business and the balance of our customers, and certain expectations on the impact of branded price increases and generics activity. However, we have just completed an in-depth review of the prior forecast and have determined, we need to reduce that forecast to now what's enough to what we now think is most likely. And of course, the impact of the Walgreens renewal is net extra. In addition, we were affected by suspensions of our controlled-substance licenses at three facilities that led to remediation actions that we are taking across the entire network. These steps will strengthen our anti-diversion controls for all customers. I want to emphasize how important this work is to our mission. The safety and security of the pharmaceutical supply chain is core to our business, and its protection is an important public policy priority for all of us. This matter will result in additional expenses and some lost business. We are forecasting a $30 million reduction in operating earnings for the year, more than half of which are expenses. While we continue to engage in discussions with the DEA, it is not possible to say exactly when this matter will be resolved. Now, I will turn to our go-forward plans for Supply Chain Pharma. Let me start by level setting on the current environment. We expect to see mid single digit revenue increases over the balance of the fiscal year. I want to underscore the stability we expect among our large customers over at least the next 12 months. Second, we do not expect... excuse me, second, we do expect a mid single digit average increase in branded pharma prices over the next 12 months. And third, while we have also reduced our generics forecast, we expect the next 12 months will be good for generic merchandising margin. Increasing our generic business is one of our most important priorities. As you know, we have been working to build out our capabilities in this area. With that as background, here are the steps we have taken to improve our execution. We have a strong sector and segment leadership team, now fully in place. In addition, we have removed layers of management, to flatten the organization and put our leaders closer to our customers. This is a more efficient and customer focused structure. Our generic programs for retail independents and hospitals are being well received, including a new program, we launched earlier in the fiscal year. As a result, our generic unit sales to retail independent pharmacies and hospitals are up 10% to 15%. We expect to increase momentum as we move to the next 12 months and new generic products are launched. As we enter the second half of the year, we are now seeing the benefits of our SG&A controls, and we will be below our budget for the year. We are also coming to completion of an extensive industry SG&A benchmarking study with an outside firm and expect this work to guide us on identifying new opportunities, as we move in to fiscal 09. Before I leave Supply Chain Pharma, let me make a few comments on nuclear, which is included in this segment. Some of the supply problems experienced around the holiday season have pretty much cleared up. We've also been able to make some pricing, supplier and cost adjustments, but there still may be some additional volatility in the business, leading into next year's important generic event. Looking at the company as a whole, I want to emphasis that we have a very strong business model and a vibrant and growing Healthcare industry. We need to make some adjustments, but that does not change our view that we are in great businesses with excellent market potential. We are differentiated by our portfolio of high growth and high margin clinical and medical products in one sector, and our supply chain services in the other sector delivers excellent cash flow, outstanding returns and is well positioned to prosper, as demand for healthcare products and services continues to grow. Now let me turn to our results for the second quarter, revenue increased 7% to $23 billion and non-GAAP EPS was up 8% to $0.90. This is consistent with what we have expected and communicated. In Healthcare Supply Chain Services sector, revenue rose 6% to $22.4 billion, but profits declined 19.5% to $330 million. I have already talked about the major factors that have contributed to the profit decline. So I won't say anymore here. The Clinical and Medical Products sector was an exceptional value driver and continues to differentiate us in the market. In Q2, CMP accounted for 36% of our profit, so it plays a substantial role in our overall results. We have a leadership position in patient safety and infection prevention products, both essential and rapidly growing segments of healthcare. This strong position is reflected again in our Q2 revenue growth for the sector, which increased 24% and in profits, which rose 32%. Now let's turn it over to Jeff to discuss our segment results in more detail.

Thanks Kerry. Good morning everyone and thanks for joining us. Today I'm going to talk about our consolidated and segment results for the quarter, update you on our key financial drivers. And then I would like to spend some more time going through our outlook for the remainder of the year. Let's start with the consolidated results for the quarter, please note that my comments will reflect the financial results from continuing operations on a non-GAAP basis. Consolidated revenues were up 7% to $23.3 billion, and operating earnings were down 3% to $526 million, which as expected, reflects the Pharma segment challenges we highlighted during our Q1 call. I will discuss this in greater detail later. Earnings from continuing operations for the quarter were $329 million, also down 3% over prior year. Diluted non-GAAP EPS was up 8% to $0.90, reflecting a leverage we are able to deliver via our capital deployment strategy. Operating cash flow for the quarter was negative $26 million. The negative cash flow this quarter was driven primarily by unique quarter and timing of payments, that impacted our cash flow by approximately $250 million. Return on equity was 19.4%, up 420 basis points over the same period last year. Now turning to the next slide, during the quarter, special items totaled $30 million, which impacted diluted EPS by $0.05. The $30 million was comprised predominantly of restructuring related charges, including $14 million associated with the McGaw Park transition. The $23 million gain on sale of our stake in OTN is included in impairments and other. Now, I would like to switch the performance of the individual business segments. Within the Supply Chain Pharma, revenue for the second quarter increased 6% to $20.4 billion. Revenue from bulk customers was up 12% and non-bulk revenue was up 1%. Non-bulk revenue growth was affected by previously discussed DSP losses which occurred in Q2 and Q3 of last year. Segment profit was down 21% to $258 million, largely consistent with what I had spoken about during our Q1 call. Primary drivers were; generic market conditions, timing of brand and price increases and the ongoing impact of previously announced customer repricing. We continue to see progress in our effective use of capital. We are pleased that our tangible capital was down approximately 14% over Q2 of last year. However, due to the profit decline, economic profit margin decreased 27 basis points versus last year. Turning to slide 8, we continue to make great progress in Supply Chain Medical. Segment revenue was $2 billion, an increase of 8% over the prior year. This continues our momentum from Q1, providing further confidence that our turnaround is on track. Total segment profit for the quarter was $72 million, down 13% over Q2 of 07. Profit in the quarter was impacted by the refined corporate cost allocation, which negatively affected growth in the quarter by approximately 7 percentage points, and softness within our surgical kitting business. We have also substantially completed the first wave of our business transition from Illinois to Ohio. If you look forward, there is real momentum in the business. And we continue to expect a return to a positive year-over-year growth in the second half. Now, turning to the CMP sector and first, the Medical Products and Technologies segment. Revenue increased 47% to $667 million on strong sales of infection prevention products and surgical instruments and the VIASYS acquisition. Segment profit was up 46% to $69 million with the addition of VIASYS and improved operating leverage in the legacy business. There is good momentum established in our infection prevention line. We saw growth in the quarter from our Convertors drapes and gowns and our Esteem glows. We have now converted 100 hospitals exclusively to our proprietary latex-free Esteem Micro surgical gloves. I am happy to report that the integration of VIASYS continues to go extremely well and synergy capture for FY08 is ahead of schedule. VIASYS was a substantial contributor to MPT in Q2. And we are very optimistic about our pipeline of 13 new VIASYS product introductions planned for this calendar year. On top of all this, the team has been able to lower date of inventory in the business by 13 days since last quarter. All-in-all, the MPT is doing a wonderful job integrating VIASYS and driving growth and value enhancement across our businesses. Moving on to slide number 10, Clinical Technologies and Services had another great quarter. Segment revenue was $715 million, up 8% over the prior year, driven by strong double digit sales growth for our Pyxis and Alaris products. Growth was dampened by a slowdown in pharmacy operations. Excluding this business, CTS revenue was up 19%. Interestingly, we saw a nice pickup in our Canadian operations, where sales for Pyxis and Alaris products rose 55%. We are seeing very good traction in this market for CTS products, through relationships we have in the hospital distribution side of our business, continued validation of the impact have won Cardinal Health on the customer side. Segment profit was a $115 million, up 26% driven by a favorable mix of higher margin products and improved operating leverage. This was somewhat dampened by the additional $10 million charge we took in the quarter related to the Alaris pump module voluntary recall. This brings the total reserve to $14 million, including the $4 million we reserved in Q1. Overall, the Alaris voluntary pump recall is moving forward. We continue to work with the FDA and have started the pump inspection process. We've identified an additional 5,000 to 6,000 pumps that we believe should be inspected as part of this voluntary recall, and are currently in discussions with the FDA on this. We believe our current reserve is adequate to support the recall as planned. Overall, we are very happy with the performance of CTS and the execution we are seeing. Segment profit margin continues to expand with a 2 percentage point improvement over Q2 of FY07. Now I would like to turn to the key financial levers we focus on, to drive both growth and returns for the business and our shareholders, which are balance sheet management, capital deployment and our capital structure. We again made meaningful progress along all these dimensions in the quarter. Return on invested capital was up 156 basis points versus Q2 of last year. For the quarter, we repurchased almost $350 million in shares, bringing our total repurchase for the first half of FY'08 to $942 million. Similar to last quarter, we are operating with a debt-to-total capital at the top end of our target range with a ratio of 36%. Further, the desired outcome of our financial strategy is enhancing returns and we were able to deliver on that goal with a non-GAAP return on equity in Q2 of 19.4%, which is an increase of 420 basis points over last year and almost 200 basis points over our non-GAAP ROE, last quarter. Moving on to our outlook for the remainder of FY08, As Kerry noted, we are lowering and nearing our guidance for non-GAAP diluted EPS from continuing operations to $3.75 to $3.85, driven by continued challenges in our Supply Chain Pharma segment. We are clearly disappointed in this action many positives remain. Three or four segments are expected to perform inline or better than our expectations. As such current segment profit guidance for CTS, MPT and Supply Chain Medical remained unchanged and we continue to expect a strong second half across those three segments. And overall, our updated guidance still represents double-digit EPS growth for shareholders. Now, let me build on Kerry's comments regarding our revised outlook for Supply Chain Pharma. As he noted, there are four primary factors, that when combined, effectively reduced our outlook in Pharma by $110 million to $120 million. First is the increased cost and impact of our controlled-substance anti-diversion efforts. Currently, we are estimating this to have at least a $30 million impact on segment profit for the full fiscal year. Much of this cost relates to the investment we are making to put in place, enhanced controls to address that diversion of controlled-substances. In addition, efforts rectifying this issue have created a distraction for the organization that has slowed some of the momentum we gained in Q2. The remaining factors include our revised outlook for our generics business, branded fees and price increases and the impact of more recent customer repricings. Together, this account for approximately $80 million to $90 million of forecast revisions. I worked with a new management team over the past several months to take a hard look at our results to-date, trends and market conditions to come up with these revised assumptions. Generics and branded margin, we felt we were too optimistic based on events of the last several months and our latest intelligence on our reminder of the year. We have adjusted the forecast to accurately reflect our current and best view of reality. Now I'd like to turn to our financial goals. I have mentioned much of this on prior slides, but I do want to highlight a few key points. First, for fiscal 2008, with the changes I just discussed, we now expect overall company revenue growth to be approximately 7% this year, and EPS is being lowered in near to $3.75 to $3.85 per share. And as always, this guidance excludes any potential impact on the ongoing portfolio optimization reviews. As you can see from the last slide of our financial goal slide, we have not formally made any changes, as we review and update our long term goals annually. Our organization is still working in the sense towards achieving these aspirations. However, we will be entering our planning cycle soon and as we do annually we'll need to review a few of our long term growth expectations in light of the revised FY'08 forecast for Supply Chain Pharma. So with that, I would like to take a minute as a Former Interim CEO of HSCS to recognize George Barrett. Welcome to the team and I'll turn the call over to him to make a few comments. George?

Thanks Jeff and good morning everyone. As we you've heard this morning, we've got some challenges which will no doubt occupy my attention in the short term. We are in a business where execution is critical and we need to do a better job of it. Having said this, let me tell you something about why I am excited about being here. Because of the scale and the significance of our position in multiple segments, we have a unique opportunity to influence the delivery of health services and products throughout the system, particularly at a time when change is the rule of the day. I'll try to focus on two basic issues, first, improving our operational execution; and second, creating a single minded commitment to value creation for our customers and our vendor business partners. Although I come out of a different part of the health system, I am hopeful that my experience in addressing these varied themes will serve us here. I look forward to getting a chance to meet those of you I don't know and reconnecting with many of you with whom I've worked over the years. I think I'll turn the call back to Bob for Q&A

Eric, we are ready for questions. Operator? Question And Answer

[Operator Instructions]. Your first question comes from the line of Glen Santangelo from Credit Suisse. Please proceed.

Yes Kerry, just a couple of quick questions on the drug distribution business. You said earlier in the call, you renegotiated the CVS business last spring. Could you maybe just remind us maybe what some of the terms of that renegotiation are? And it is my understanding that you had to renegotiate that in fiscal 09, is that not true?

Well Glen we did, I can't give you the terms of the contract. We did receive an increased allocation of business during that renewal and yes it is our understanding, in summer 09, there will be another round of discussions with CVS at that time.

Okay. And then the $30 million that you are suggesting that... the cost related to the DEA. How much of that have you already recognized in fiscal '02... the fiscal second quarter versus what's going have to be recognized in the back half?

Glen there is only about just... a really, a very small amount. In Q2, these numbers are all directed towards the back half.

Okay. And then just one last question I'll jump off, regarding your revenue growth in mid-single digits for several quarters now. We've seen your bulk revenues growing at a double digit pace, while your DSP revenues are basically very low single digits and you cited a couple of customer losses last year. Is there any sort of shift going on within your customer base like with CVS, Kroger or K-Mart, some DSP sales shifting to bulk or is there something else going on?

No, Glen we don't see any significant shift within our contracts with the bigger customers on DSP, the bulk, but we've had, as we've said before, some loss DSP business in the retail and in the small chains which we addressed last quarter, and that still persist through now. But clearly a lot of the focus on the DEA has... and not the anti-diversion issue has really had our folks on the field working on that with all our customers. So we haven't been able to make as much progress from recovering that as we thought.

Okay. Thank you.

Thank you Glen.

Next Question.

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

Good morning, thank you. Just about the guidance either for Kerry or Jeff. Sounds like Walgreens is incremental to what you were thinking about before the $30 million on the DEA. So I think Jeff you sort of said on branded and generics you were sort of too optimistic, I think in prior guidance. Can you give us a little bit more granularity, both the generics and the brand where maybe you were too optimistic, or what's changed, and what your new expectations actually are in those areas?

Sure, Tom and good morning. Thanks for the question. Clearly over the last 2 to 3 months as I have been the Interim CEO of HSCS, I have had opportunity to dive more deeply with the new management team, into our current results, trends and assumptions for the last six months of FY08. And as we've gone through that and particularly as we have gone through sort of the critical December to January period where fair amount of activity happens, particularly on the branded side. It became clear that some of our assumptions regarding both generics and branded were too optimistic based on that latest data. I know I just gave you a couple of examples. First of all, there was one fairly significant branded manufacturer that did not do a price increase anywhere near the size we had anticipated in December or early January, and it's doubtful that we'll see that for the remainder of fiscal 08. So that was a specific piece. And then I would say just more generally as we look at our entire portfolio of branded manufacturers and expected prices increases, it was clear that based on the trends that we saw in December and January, although still relatively healthy, they were not going to rise the level that we had been anticipating earlier in the year. On the generic side, our assumptions for generic launches include both sort of the very well-known public launches such as Rotomax [ph] which remains intact, but also includes other risk launches that we assess based on our confidential discussions with generic manufactures. And we based on our forecast on those discussions and the intelligence we gain from them and others regarding the likelihood of launches or at-risk launches or delays in launches. And again based on what we saw in November-December and early January and based on updated discussions with those manufacturers. It was clear that few of those including at least one or two, fairly substantial generic launches were not likely to happen for the remainder of FY08.

And those were sort of at-risk launches that you were guessing out before?

Generally yes.

Okay. And I just want to clarify one thing you had said K-Mart, Kroger, CVS, Walgreen is it collectively that's a $140 million impact. And is it property characterized K-Mart is maybe being outsized relatively given the unique circumstances for that contract?

Yes that is correct. The impact of our repricings which primarily is driven by the four major accounts that you mentioned that's have an FY08 negative impact of a $140 million. I don't want to quantify the individual pieces, but with respect to your question on K-Mart its clearly that our original contract with K-Mart was done several years ago when K-Mart was in a different situation and then we renegotiated that's in the spring of last year essentially preferred market prices.

Okay.

Thank you so much, Tom. Next question?

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

Yes, good morning. One question: as you are going through the guidance for the second half of the year, did George had a role in revising expectations and providing some insight as to the generic landscape?

No, he did not, Ricky.

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

You are referring to FY09, Ricky; and good morning by the way. This is Jeff.

Good morning Jeff.

Clearly, over the next three or four months, we are going to be through our long-term and short-term planning processes. And as the new CEO of our biggest sector, clearly George is going to have a very important input and say into what our realistic expectations are for the next several years. So yes, he will play an important role.

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

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

Operator next question.

Your next question comes from the line of Ross Muken [ph]. Please proceed.

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

Yeah, Ross. Hi, good morning, Kerry here. You just kind of kicked off, we didn't quite get your opening comments. But yes, I mean I think we now feel that we have got the leadership team in place, and throughout the organization and obviously we are going to look for opportunities to continue to strengthen, where we have some outages, but by in large the team is in place.

And in terms of the Clinical business on the brighter side of things obviously, performance there has continued to be very strong. Could you talk about some of the sort of key trends you are seeing in both Pyxis and Alaris and sort of the momentum you have entering into to back half of the year?

Ross thanks a lot. I am going to ask Dave to make a few comments on that if you don't mind.

Certainly, I can. Continue to see strength in Alaris, particularly in the rest of market. Pyxis continues a strong path. We are seeing a lot of strength in our basic MPT businesses and VIASYS continues to perform above our expectations. Like we mentioned that we do see a number of new product introductions coming out of VIASYS and these are really designed in the ventilator space to begin to create a razor blade business. One of these products was shown at a conference in December, it is called the Palmtop Ventilator. And this product is the first of its kind. It's the smallest, it's the lightest ICU-type product designed also to follow the patients into the home. So overall in momentum, I am very, very positive about where the sector is going.

Thanks, Ross. Operator, next question?

Question comes from the line of Randall Stanicky with Goldman Sachs. Please proceed. Randall Stanicky - Goldman Sachs & Co.: Great, thanks a lot. George, I am not sure if you are there, but if you are, welcome to the services side of the world. Jeff, just... can I just follow-up on a previous question? As you think about the components to outlook, I am just... it's not clear what's changed. So if we think about the branded price inflations it sounds like you are thinking about a mid single digit outlook there. Is there a potential timing issue? As you think about our fiscal versus calendar year. And then on the generic side, I mean could you characterize? Is it... maybe more conservatism in the outlook relative to before or would you... are there specific launches? I know you mentioned at risk launches that have been pulled from the forecast, but is it... it's not... clearly there has been a whole lot of movement in the generic pipeline outlook for the year.

Good morning, Randall; thanks for the question. First of all on the branded side, it really relates to the specific brand increases that we are seeing for the companies that we still have the buy and hold model with. And sort of to talk about the overall complete portfolio of branded price increases that we are seeing and more about the specific companies that we are still contingent... still have contingent fees related to. And as I said, there was one large manufacture that did a very minimal price increase and we are expecting something more substantial for FY08. And then, just generally, across the portfolio of companies that we still have contingent arrangements with, we did not quite see the pick up in December and January that at least we were anticipating. That all said, I think we still view the overall branded price increase portfolio is being relatively healthy it is just as our specific portfolio reflects itself in our financials. We were not seeing the type of increases that we are counting out for a full fiscal year. Will some of that happen next fiscal year? Sure. I mean it's... now there is a possibility that some of this is timing, but I think the current forecast is a realistic view, at least our view of the world-based on our portfolio. On the generic side, yes, there were a couple of very specific relatively large launches that we had anticipated based on our discussions with generic manufacturers and for various reasons including the status of patent challenges etcetera, they no longer appear likely in our FY08. Could they still happen? Sure. Could we be wrong on the downside and be positively surprise? Yes, that's always a possibility. And one of the things about this business is that your forecast is only good for what happened sometimes until you get the latest status from the core sort from a generic manufactures regarding what they are willing to go at risk with. I suspect some of the things that we pushed out of our FY08 will happen in FY09 and we will have to watch those closely in your discussions to see how those show up in our numbers eventually. Randall Stanicky - Goldman Sachs & Co.: I know you are not giving fiscal 09 guidance at this point. But as you look in extent, I mean there is obviously lot of timing discussion here. As you look to the back half of calendar 08, do you feel like the momentum is at least turning around? And can you characterize for us maybe what inning was George coming in here as you look at the pharma distribution? Obviously this is the third revision to outlook now and certain number of months. Do you feel like we are getting into the late innings here in terms what you need to do to get that business turnaround?

Randall, Kerry here, good morning. I think we... underneath all of this noise of the repricings, we really just need to as much as I don't like where we are in the sense of we have gone through a lot of major repricings and frankly, we thought we have enough puts and calls to offset those. And clearly in putting together our approach, we ended up getting a little too far ahead of ourselves on thinking about the impact of branded price increases and generic activity. Now we have got that back down to what should I say is probably fairly close to what industry consensus what we read in all your materials and so far. So I think there is a... the core element is going forward are pretty much aligned with how long people see from that going forward. But underneath that, there is a lot of good stuff, because with customers who are growing and growing their market shares, so we are winning with the winning customers; that's important. Number two is it is very clear that our customer facing organization is starting to create connections that we have not had before and through that we are learning about new business opportunities and how we can do better work with each of our customers and George talked about the importance of doing better job of creating value for our customers and value for our vendors. We have made some changes in generic program, which we start to get some traction on and of course the anti-diversion issue has distracted us. But if we will look beyond the repricings and the anti-diversion, I think we are going to enter a base period of a fair amount of stability with the big contracts behind us. With the opportunity to work on improving our generic penetrations, the opportunity in creating better value for our customers and for our vendors. So if I look beyond the noise, and plot out how you see those things coming sort of quarter-by-quarter. I think underneath that, there is nothing that's really to suggest that the business is on a downward trajectory on its core basic element. It feels like we have a level for stability and how we are going to market, and that ought to get better. So I know it's a long complicated way, and I didn't give you any of the specific numbers you are exactly looking for. But I do feel that underneath all of this noise, there is a lot of things, which we are winning with winning customers. We've got a lot of improvements on a go-to-market; we've got a better go-to-market program in our generic program. And these other issues start to anniversary, which should be on a much more solid footing. Randall Stanicky - Goldman Sachs & Co.: So it's fair to say George is entering a late innings game if you will.

I guess you could characterize that as that. But no, I think that there is no... I don't want to be grip [ph] on anything. We have our work cutout for us on many fronts, and George is going to bring a lot of value on many fronts. George is going to bring enormous value, now that what we do in Supply Chain Pharma, but also on our Supply Chain Medical. He is bringing a tremendous amount of breadth and depth of skills that are going to affect our entire supply chain business. And we are looking not just only for him to make an impact. He has got skills and capabilities, but we are also looking for George to be impacting much more broadly across the whole supply chain part of our business.

Thanks Randall. Randall Stanicky - Goldman Sachs & Co.: Great, thanks.

Operator, next question.

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

Thanks and good morning. I guess a quick question for George and maybe Kerry, and then just a clarification for Jeff on Walgreens. Because George, you talked about the opportunity of Cardinal, and Kerry elaborated on this with operation and value proposition. Would you describe a major value opportunity to be a much more robust in scale generics offering overtime from Cardinal given your experience from the supplier world?

Hey, Larry, it's Kerry. That is a very legitimate question, but it is not really something that it's fair to ask George today. We know we have opportunities in this area, but we have not embarked on nor are we foreshadowing a major change in what we are doing in there. We want to do what we are doing better. We know we have opportunities to be more supply more value to our manufacturers and to our customers. But we are not sitting here today getting ready to unveil a big change in generics. So I would like to answer on George's behalf here, which is we are going to do better. We are going to execute better, we are going to have better programs. But at this point in time, we are... it is continuing what we have launched.

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

Well, we still have Frank Segrave, who leads that business for us. And he has got a good team under him. And obviously we want to continue to grow our capabilities in that place, but we have a team in place with some expected people in the industry leading it.

Okay, thank you. And then just a clarification for Jeff. When did the repricing of Walgreens going to affect specifically? And then on slide 7, you alluded to substantial new business with this early renewal; can you elaborate on that? And how we reconcile that with a revenue take down to 7% that you gave us versus what you said in November?

Yes, Larry, first of all, for dependent reasons, I don't want to get into the specifics of the Walgreens. All I will say is that we knew that that our previous contract in due [ph] in the summer of 08. We have announced them early renewal. For competitive reasons, I don't want to give you any exact date of that... effective date of the renewal, but clearly it has a significant impact on our FY08 financials. We wouldn't have highlighted that today. In terms of substantial business, the reality is it is going be a transition period for that over the next six months. So I wouldn't expect follow that to materialize in FY08 a lot of transitions as we head into FY09. I do want to highlight those as this was a very significant event for us and Walgreens. I think it's an indication that we are very strong partners; we are their primary distributor now for the U.S. And I think having this long-term contract in our both our belts gives us a great source of stability to grow our partnership from and we are very pleased to be able to serve Walgreens.

Thanks Larry. Operator, next question.

Your next question comes from the line of Lisa Gill with J.P. Morgan Securities. Please proceed.

Hi, thanks very much and good morning.

Hi, Lisa.

Good morning. Just as a clarification on what you just said around Walgreens; does that mean you took some of this business from another distributor or is it some of the business that they were doing themselves just the way we understand that?

Yes. Again, I don't want to go into too much detail, but the additional business we were taking on is not coming wholly from Walgreen itself. I expect there is a slight market shift there.

Okay, great. And then I just had two follow-up questions. First you touched a little bit, I think, Kerry on nuclear pharmacy and where you were there. Can you just talk about the expectations around the generic launch of Cardiolite and what was currently in your expectations? It seems now like it will be a fiscal 2009 event. And then just secondly, Dave Schlotterbeck, I think you are still on the phone; Baxter on their most recent quarterly call talked about their pump coming back to the market in the next couple of months. I am just wondering if you can comment on your expectations from a competitive standpoint as they have been out for a long time?

Okay, Lisa. The pediatric extension was granted so this now takes the event into the summer. And so that point, and I think the second point is, this point in time, Avista is a new player in the marketplace and we are in active negotiations with them and other people regarding that the generic event, our expectation is that it will be a very positive event for us next fiscal year. And for the balance of this year, we are expecting stability to decent growth depending on the volatility that we see in the second half. So I think everything seems to be unfolding as expected there.

To your question Lisa, on Baxter, competitively their practice has been, and they have been very good at focusing on smaller hospitals, typically 150 to 200 beds were less. And so I would expect that they would continue their efforts there, which would have, in my view a very modest effect on the growth that we have been seeing in Alaris, which was focused on primarily the larger hospitals and the teaching institutions and the large IDNs. So this is not something that gives me any pause. And my expectations are that we will continue to take market share.

Thanks, Lisa. Eric, next question.

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

Thank you. George, is it possible to comment on your incentive compensation? What metrics it is actual tied to and any sense, maybe Kerry, if that compensation programs any different than George's predecessors?

Bob, George is tied into the same incentive plan that all the senior leadership is at Cardinal. There are short-term incentives, which are based on our ability to deliver return on tangible capital and operating earnings performance. And our longer-term incentive is three-year plan recently introduced that is exclusively on the ability to grow economic profit for the company. And so George and Dave, Jeff and I and many others of the leadership team are tied into that plan. So George is online with everybody's program.

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

Yes, basically what we said previously Bob. We are going to have quarterly fluctuations, but I think our rate for the year in the 32% to 32.5% range is still pretty much what we are expecting for FY08.

Great, thank you.

Thanks Bob. Operator, next question.

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

Thanks, good morning. With Walgreens it sounds like a bit of a mix message in terms of substantial new business, yet it was repriced, and so we get a sense for margin trends. Can you just put the two together and give us sense of whether going forward recognizing the new business can take some time to ramp up? But going forward, when you put together the top line pressure with the substantial new business, is this relationship going to be better for you on the bottom line going forward or neutral or slightly negative?

Hey Charles, thanks for the question. But hopefully you understand it's really difficult for us to comment on specific contracting renewals for competitive reasons. All I can say is that it was priced at market. I think both Walgreens and ourselves are happy with the new agreement and we will go forward to serve them very well and we'll continue to drive value on both side. So we don't want to get more specific in that.

I think the other thing I would just throw it on this Charles is first of all, well, no question there was an opportunity for Walgreens to reprice the contract. The fact that they chose to do with Cardinal, the fact that they want to do it, I think is also is the sign that they feel that we can execute and meet their needs and feel that we have a lot of capabilities that we can work with them to help grow their business and to add value in new places. So I see it and it was much more than just an economic deal. I think it was receiving and growing of the partnership and that creates opportunity down the road for us as well.

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

There are just some new projects we have identified with the company that they are anxious to work with us on, and I will leave it with that.

Thanks, Charles. Operator, next question.

Your next question comes from the line of Steve Halper form Thomas Weisel Partners, please receive.

Yes, hi, good morning. Within CTS, what is the problem with the pharmacy services business, because it appears as though it kind of marred [ph] and otherwise pretty solid quarter at Alaris and Pyxis?

Yes, I wouldn't say it's a problem, it's been a relatively flat business for a number of years now. We consider it to be strategically valuable because of the insights that it provides to us around the pharmacy and clinical operations of the hospital. And the issue is that being the size that it is of nearly $1 billion in revenue and relatively flat that it does tamper the top line and the bottom line growth rates for CTS. Now, nonetheless, CTS still reported a 26% increase in operating earnings over a year ago and I think that that's a pretty darn good performance.

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

Yes. We have some new offerings that we think overtime will catch on. One of those... that we have been seen some nice growth and is a remote pharmacy review service, which allows smaller hospitals to essentially have a pharmacist review their physicians medication orders on a 24-hour a day basis through a centralized facility that would handle a number of hospitals. And so this is something that we have seen a very good response from the marketplace. We think that this will help us get the top line moving in that business. As opposed to the traditional approach, which has basically been to send in folks and takeover the actual pharmacy of the hospital. So we are working in a number of avenues there.

Thanks Steve. Operator next question.

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

Hi, good morning. In your drug distribution business, I know one of the goals was to increase the generic recapture and one of the tools that you have now is an IT system that helps you measure profit by customer. To use the baseball analogy, where do you think you are in that process of recapture? And at the tools and incentives, have you seen any measurable return yet from having new tools and incentives there?

Hey John, good question, thanks. And since carrying our Canadian, we are going to express it in terms of hockey periods. I would say we are in the second period of that right now, beginning the second period. Let me tell you what we have done so far. We have run detailed account-by-account profitability analysis for our retail independent and hospital customers. We have now sat down and shared that with the sales teams. We identified close to 100 accounts that were questionable in terms of profitability as we have gone through that with the sales team. We have given specific direction to address those accounts and we will be monitoring that over the next couple of months, and seeing the progress that we make. And it will expand that profitability analysis to our entire chain of customers and set up a regular program of review of the progress against that. So again start of the second period... but I think we are off to a great start.

And then say, I am glad you didn't do a curling analogy as that what would have been tough. The other thing I know you don't want to talk about WAG. But is it... is it safe to assume at least the WAG is in there for the full back half of fiscal 08 year that at least kind a January 1 timeframe as an assumption.

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

I guess I am just trying to understand why the timing is a Kremlin secret. That seems to be anything that would be unusual to announce.

John, Kerry here. This is... we are really respecting Walgreens wishes on this specific detail.

Thanks John.

Okay. Thank you.

Operator, next question.

Your next question comes from the line of John Kreger with William Blair & Company. Please proceed. John Kreger - William Blair & Company, L.L.C.: Hi, thanks very much. Two quick questions on the drug distribution side; Kerry, you mentioned a few times on the call that you think execution has been an issue. Can you just be a little bit more specific on where you think the execution is lacking? And then, I guess a question for Jeff, can you give us a sense within the drug distribution business the percent of the books that is now on contingency basis versus the traditional by hold?

Good morning, John. These are things we mentioned the last time, but they would include and the retail independent and the hospital space is ensuring that we have a proper book of business on each of customers, which is one as we just talked about in the previous. A lot has to do with generic penetration and following up to make sure that we are inline with contract compliance. And I think there is a broader issue to even on our larger national accounts is really working follow on plans and making sure that we continue to develop business as we go forward. So I mean in essence that it has to do with really a more robust sales process throughout the organization that keeps the contracts... has been just being contracts becoming a place... beginning point to develop strong, deep customer relationships, where we can grow our businesses mutually and identifying new areas, and these are the areas that we are really focusing on. And what we did primarily, just to kind of again summarize what... we flatten the organization to make sure, particularly, Scott and his channel leadership are very in touch with customers, and we are really kind of reach out to them. And that has been implemented and is underway as well. I will also just reinforce that we have had some... as we were working on the anti-diversion issue, this has slower attraction there, because we've had to work control issues with every single customer, so we are a little behind where we would really like to be on that, but those are the key things, flatter organizations, stronger sales process, in-depth and continual growing and focusing on growing our business with each of our customers, ensuring that we have also the right amount of generics business. Those are the key parts. John Kreger - William Blair & Company, L.L.C.: Thanks.

John, in response to your second part of your question, about 20% to 25% of our branded margin is still on a contingent basis, those can give you the exact number today, its about 22%. John Kreger - William Blair & Company, L.L.C.: Great. Thanks very much.

Thanks John. Operator, next question?

The next question comes from the line of Eric Coldwell with Baird. Please proceed.

Thank you. A couple of quick questions, I will handle them distinctively. First off, based on our channel checks, it appears as though the F-domain [ph] integration did not go as well as perhaps would have been expected and maybe a substantial amount of that acquired revenue went away. I guess my question is, what did you learn from that process and what did those smaller community pharmacies tell you they wanted from Cardinal as they were perhaps shifting to other suppliers?

Hi, Eric, it's Jeff. Thanks for the question. I would say generally our domain acquisition is on track. We did lose one large account, which we anticipated at the time that we did the deal. Other than that, I would say generally we retained the customers we expected to retain. So I am not sure there is a huge lesson learnt here other than obviously it is important before you deal... you do deals like this that you have a good understanding of which customers you are going to be able keep and which ones you can't. And obviously, maintain stability in the sales force to the maximum extent possible, because particularly for some of these regional accounts, the accounts are very much linked to the sales people. So ensuring that we have a smooth transition and treat employees well as critical for all of our acquisitions. I also point out that this was a relatively small tuck-in. So although any time you lose a customers' significant event because we want to keep 100% of them overall not having a huge impact on our business one way or the other, but generally I would say it's on plan.

Jeff, you... during your prepared comments, you mentioned that guidance is obviously exclusive of any new portfolio optimization initiatives. Are there any specific things you are targeting right now? Are you working on any portfolio events that maybe we will see news on in the next few months?

Eric, I would say part of our process here at the company is always to be looking at it. So no matter when you ask me that question, I would say we would be looking at things I always want to look at the businesses that perhaps are not giving us the return or adding the strategic fit that we need to the overall portfolio and that will be a continual process. I would say at this point that sure that there always is going to be a couple of businesses that we are looking at closely and we are not really prepared to talk about those specially.

Okay.

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

Right.

But there is... our homes [ph] businesses that sort of fall out of our core businesses and obviously the markets... there are certain businesses that I would describe as they are not strategic, but you've got have the right conditions and you've got have a buyer and a seller that works out and so... but I would say, we'll to continue work that... there are a few things that are on a docket but there will be nothing that you would find in the category of really big or surprising.

Thank you and just one more final question, if I might. You've talked a lot about the management change and SCS format. You've also mentioned the distractions with the DEA and other issues. We have seen some headlines that perhaps there is more union activity, more teamsters' activity around warehouse and delivery personnel. I'm curious whether Cardinal is facing any issues with employee relations or any changes in the makeup of perhaps union related employees or union activities?

Yes obviously a good question to ask. We have had some union activity at a handful of our Supply Chain Medical facilities. Although on their hand we just recently won a big vote, where the union was not accepted. So, yes, we have a handful of places, but nothing that I don't think we can work through and it is in the Supply Chain Medical area. But as I said, we're also making progress. We just had a one where the union was not ratified by the employees. So, I don't think its anything you need to worry about.

Okay. Thank you.

Thanks Eric. Operator, next question.

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

Thanks for taking my question. Actually just one quick question here on medical distribution. Actually you made some comments about expecting a year-over-year growth to improve, as we move in the back half, did that include the change in the cost allocation?

Yes. The comment was that we expect a return to positive growth in the second half of the year for Supply Chain Medical and that would include the corporate cost allocation impact.

Okay, great. Thanks.

Thanks Charles.

Operator, we have time for one more question.

Anyone in the queue, operator.

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

Okay, thank you. Well, I know we are past our time, lets make a few quick comments as we wrap up. I just want to reiterate that the gain that we have three of our four segments which are on track, Supply Chain Medical, Clinical Technologies Service and Medical Products Technology. These businesses do account for 50% of our operating earnings for the fiscal year on an average basis and they are going to grow about 20% for the year. So we are feeling very good about those businesses. Supply Chain Pharma, we felt the need to introduce our second half business... excuse me our second half forecast, but I do believe we have a very strong core business. We have completed contract renewals with our biggest customers. The market dynamics are looking favorable and forward. We've made or are in the process of making the changes to improve execution that will begin to show improvements in the second half. The revised EPS, well down still represents 10% to 13% on the fiscal year. And I think more importantly, we're feeling very good about operating in a growing industry with very strong fundamentals, especially when the broader markets are becoming volatile. We also feel very positive about our outlook for the mid and longer term. The diversity of our healthcare products and services is a strength that differentiates Cardinal and we're looking forward to demonstrating that as we return both sectors to performance levels we expect. So thank you very much for joining us this morning and operator this concludes our call.

Thank you for your participation in today's conference. This concludes our presentation. You may now disconnect and have a good day.