Cardinal Health, Inc. (CAH) Q3 2008 Earnings Report, Transcript and Summary

Good day ladies and gentlemen, and welcome to the Third Quarter 2008 Cardinal Health Inc. Earnings Conference Call. My name is Erica, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. [Operator Instructions]. I will now like to turn the presentation over to your host for today’s call Ms. Sally Curley, Senior Vice president of Investor Relations. Please proceed.

Thank you, Operator. Good morning everyone and welcome to Cardinal Health Fiscal 2008 Third 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 in attached financial table. If any of you have not yet received a copy of our earnings release to the financial attachment, you can access it over the internet at our investor page at www.cardinalhealth.com. Additionally there are handful of slides that we’ll be reviewing which can also be found on the website. After the formal remarks, we will open the phone line to your questions. As always, we ask that you limit yourself to one question at a time. During the course of this call we may 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 the 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 Health’s investor page. At this time, I would now like to turn the call over to Chairman and CEO, Mr. Kerry Clark. Kerry?

Thanks Sally and good morning everyone. With me today are Jeff Henderson, our CFO; George Barrett, Vice Chairman and CEO of our Healthcare Supply Chain Services Sector; and Dave Schlotterbeck, Vice Chairman and CEO of our Clinical and Medical Product Sector. The results we announce today are consistent with the perspective I shared last quarter. We continue to have three 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 segments, but these are healthy businesses delivering industry-leading products and services to our core hospital customers. It shows in our results this quarter, with all three delivering solid growth. Within our Healthcare Supply Chain Services, Pharmaceutical Segment, we continue to manage through the challenges I outlined last quarter. We’ll talk more about that in just a minute. For the 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 and non-GAAP EPS is up 11% from last year to $2.83. For the full fiscal year, we expect to be in the middle of our EPS guided range of $3.75 to $3.85, excluding the potential impact of the Enturia acquisition. Enturia is expected to close in the fourth quarter, and the acquisition will likely be $0.01 to $0.02 dilutive 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 as I talked about quarter. I want to reference from the gains as they will affect Q4. We have highlighted slower overall pharma 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 had a larger share of national chains in our book of business, so it is good to get these renewals behind us. But as these older contracts were brought to current pricing levels, they have had an impact on our segment profit. In Q3 that impact was $45 million. Second, we have been working to implement new control substance anti-diversion measures and to reinstate our licenses to distribute controlled substances at three of our distribution centers. This disruption cost approximately $15 million this 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 to be about 3% higher than the second half of last year. This growth rate is lower than we forecasted at the time of our Q2 call in January, and will have an impact on segment profit. The change is due in part to a lack of momentum in our DST business as we work through the enhancements to our anti-diversion controls. So while the measurable cost associated with our enhanced controls haven’t changed this last quarter, we are seeing a slowing of progress as we try to grow the business; and its having an effect on the second half of the year. Our revenue outlook has also changed because of some incremental business with Walgreens that we had expected to ramp up in Q4, but will now begin in Q1 of fiscal ‘09. Also on the segment profit line, we have further scrubbed our generic launch forecast and made additional adjustments to even more conservative. This is the approach we are going to take going forward. As a results of these factors, our second half profitability in this business will 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’ve said throughout this fiscal year, we expected this segment to return to profitable growth in the second half, and it did that in Q3. There is still more work to do, but I’m pleased with our results for quarter, especially in our core Hospital Supply business where we had very strong results. We continue to manage some issues in the Presource kitting business, where we are focused on improving our efficiency and execution to return it to profitable growth as well. Now let me talk about our clinical and medial product sector, where we another good quarter, with revenue increasing 26% to $1.4 billion and profits grew 43% to $207 million. We continue to make great progress on the integration of VIASYS, and remain ahead of our internal schedules for the year. I’ll remind you that we expect to deliver $85 million to $100 million in synergies from the acquisition by fiscal 2010. Enturia will add support to our infection prevention offerings. As you may know, in the Deficit Reduction Act of 2008, Congress addressed concerns about reimbursements for hospital acquired conditions and preventable medical errors. As a result, the centers for Medicare and Medicaid services will no longer provide reimbursement for eight conditions beginning October 1, 2008 including several infection categories. A more recent proposal by CMS would broaden this list. So Enturia and our core CMP products along with their acquisition last year of MedMined all support a clear trend amongst providers and payors to reduce preventable medical conditions. We have strong businesses across the sector to support the shift especially in the areas of infusion, dispensing, infection prevention and respiratory. I do want to mention the status of our Alaris recalls. We’ve done a lot of work to strengthen our quality processes during the past year, and as a result, we are addressing potential issues earlier in the process. This was the case when we made the decision to voluntarily institute additional corrective actions to the Alaris systems. With an additional $6.5 million reserve taken this quarter, we are fully reserved for the recall and still plan the complete remediation by the end of the calendar year. In the process, we’re working to minimize any disruptions to our customers. We remain very optimistic about the CMP market and our position in it. About one-third of our profits now come from this sector and we continue to diversify our offerings, all with the focus on the major pain points affecting our customers. These include medication errors and hospital acquired infections. As I’ve said before, many forward-looking hospital CEOs are using improvements in quality as a strategy to lower their costs, and Cardinal Health is an important partner in this effort. Before I turn the mike over to Jeff, let me address fiscal 2009 guidance. We plan 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 a change 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 work through the issues I’ve discussed. However, as we move into calendar ‘09 and beyond, I see a lot of positive drivers. In addition to the momentum we have in CMP, there are several important factors within the supply chain pharma segment. We will lap the major replacements we undertook this year. We expect to have much stronger anti diversion controls in place with stability around those controls for our customers. We have new offerings in the works that we expect will gain traction within our various customer 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 2009 and beyond and will provide 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?

Thanks Kerry, good morning. Thanks for joining us. Today, I am going to talk about our consolidated and segment results for the quarter, update you in our key financial drivers and then I’d like to spend more time going through our outlook for the remainder of fiscal 2008. Lets start with the consolidated results for the quarter. Please not that my comments reflect the financial 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, reacting by the same issues in HSCS-P that have challenged us in the recent past. Earnings from continuing operations for the quarter were $390 million, flat versus the prior year. Diluted non-GAAP EPS was up 13% to $1.08, reflecting the leverage we’re able to deliver via our capital deployment strategy. Operating cash flow for the quarter was $897 million, primarily from earnings and contribution from working capital with year-to-date operating cash flow to just over $1.3 billion. Return on equity was 21.3%, up 40 basis points over the same period last year. Now, turning to next slide: During the quarter, special items totally approximately $36 million, which negatively impacted GAAP EPS by $0.06. $36 million was comprised predominately of litigation-related charges of $23 million associated with several losses; restructuring related charges of $8.5 million; and acquisition integration related charges of $4.4 million. Impairments and other totaled about $1 million in the quarter. Now I’d like to switch to the performance of the individual business segments on a year-over-year basis. Within Supply Chain pharma revenue for the third quarter increased 3% to $19.9 billion. Total revenue growth has been negatively affected by several factors, some macro and some Cardinal specific. The overall pharma market slowdown certainly affected us from a macro perspective. With respect to Cardinal and perhaps more impactful are the issues in our direct to store deliveries or DSD business. Revenue from bulk customers was up 8% on increased volumes from existing customers. Non-bulk revenue was flat and was negatively affected by two primary factors, first by the previously discussed DSD losses that occurred in FY’07 but haven’t yet anniversaried and second lost revenue from the controlled substance anti-diversion activities. Segment profit was down 21% to $300 million, primarily driven by the ongoing impact of previously announced customer re-pricings, the effect of the anti-diversion activities and a unique comparative to last year with respect to last years Q3. Specifically, as it was called out last year, in Q3 of FY’07 we recorded incremental fees of $15.8 million from one specific supplier contract, after we received confirmation of successful achievement of 2006 performance metrics. It was incremental to that quarter and did not repeat this year, getting the year-over-year benefit of an otherwise strong quarter for pharmaceutical price appreciation. Of note as we stated in the Q2 conference call, we anticipate that the measurable impact of anti-diversion efforts on the P segment will be at least $30 million for fiscal 2008. This includes expenses for increased delivery cost related to our license suspensions, as well as the losses in customers that can be directly attributed to these efforts. On a positive note, we continue to see progress in our effective use of capital. We are pleased that our tangible capital is down approximately 1% over Q3 of last year; and in fact days of inventory on hand decreased over two days versus last Q3. Turning to Slide 8, as Kerry mentioned we turned a corner in Supply Chain - Medical this quarter. Segment revenue growth continue to be strong with an increase of 8% over the prior year, primarily on increased sales for existing customers where we are aligned with fast growing hospitals and have increased penetration within our customer base. Segment profit for the quarter was 93 million, up 5% over Q3 of FY ‘07.This profit improvement was driven by the increase in revenue, and offset by refined corporate cost allocation, which negatively effected growth in the quarter by approximately 6 percentage points, and continues softness within our surgical kitting business, which negatively affected segment profit growth by 11 percentage points. Now, turning to the CMP sector and first the medical products and technology segment. Revenue increased 48% to $679 million with 38 percentage points of growth in the VIASYS acquisition and 10 percentage points related to the legacy business; of which 4 percentage points was due to foreign exchange. Segment profit was up 72% to $80 million, with the addition of VIASYS contributing 52 percentage points and 20 percentage points coming from the legacy business of which 11 are related to foreign exchange. So the legacy business, excluding foreign exchange, contributed 6 percentage points to revenue growth and 9 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 past nine months, IPS training provides for VIASYS sales rep took place, the [inaudible] and corporate offices closed and we announced the upcoming consolidation and rationalization of some manufacturing activities in the UK in to a facility in Gort, Ireland. We are delivering on our commitments and are on schedule to achieve to our $85 million to $100 million synergy target by FY’10. Moving on to Slide 10, Clinical Technologies and Services had another great quarter. Segment revenue was $747 million, up 11% over the prior year, driven by strong installation for our Pyxis and Alaris products. Growth was dampened by a slowdown in pharmacy services. Excluding this business, CTS revenue was up 19%. Segment profit was a $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 the quarter, related to the voluntary recall of integrated circuits and connectors on certain Alaris system modules. As Kerry mentioned, we anticipate that the recall announced in December and its recent voluntary one are now fully reserved and we expect to have both results by the end of calendar 2008. CTS continues to perform very well with great margin expansion. In fact, segment profit margin increased 240 basis points over Q3 of ‘07. Now I would like to turn to the key financial levers, we focused 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. Days inventory in hand improved by two days versus the prior year, with the improvements in HSCSP I referenced previously driving the improvement. Also as we previously mentioned, we continue to review our portfolio of assets, and have classified certain assets in the MPT segment as held for sale in the balance sheet, as we look to complete our divestiture. Return on invested capital was up 5 basis points versus Q3 of last year. For the quarter, we purchased approximately $150 million in shares, bringing our FY ‘08 repurchase to approximately $1.1 billion through the first nine months. We anticipate closing fiscal ‘08 having executed share repurchases of approximately $1.2 billion. Similar to the last quarter, we are operating with our debt-to-total capital ratio at the upper end of our target range at approximately 34%. The desired outcome of our financial strategy is enhancing returns and we’re able to deliver on that goal with a non-GAAP return on equity in Q3 of 21.3%, we’ve seen increase of 40 basis points over last year and 190 basis points of our non-GAAP ROE last quarter. Now moving on to our outlook for the remainder of FY ‘08. As Kerry noted, we expect to be right both in the middle of previously announced $3.75 to $3.85 range, excluding the impact of the Enturia acquisition which will be $0.01 to $0.02 dilutive to the fourth quarter. I would like to take you through our view of the fourth quarter in a little bit of detail, to help you better understand our expected results. As we mentioned, it will quite difficult HSCSP to grow revenue much faster than the overall pharma market rate of the growth, due to the impact of prior year DST losses and the anti-diversion efforts. All in all, we think Q4 HSCSP segment profit will be down approximately 15% versus a year ago, driven by the same general factors that affected Q3. In fact, we anticipate segment profit will be similar to our Q2 of this year, the December quarter. Within the HSCS sector, we anticipate similar sequential earnings trends as we have seen in past years, with segment profit dollars lower in the fourth quarter than in the third. As we’ve seen historically HSCSP segment profit margin will be meaningfully lower than Q3 on a sequential basis, driven by the timing of branded price increase which 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 is the change in HSCS-P, which we spoke to you last.. We had experienced slower growth in our DSD business and have now brought on additional volumes from Walgreens, as quickly as originally been expected. Although, we have not raised our formal estimate of the cost for anti-diversion efforts, we believe its further disruption in growing our DSD businesses related. In addition, and to a lesser extent, we have further risk adjusted our generic launch expectations. George will talk more about our current approach and forecasting in this area. Now turning to CTS, Q4 historically has been a strong quarter and will again this year, with sequential improvement from Q3. But I would like to remind you that Q4 last year was an exceptional quarter for the segment, so we wouldn’t expect the sequential improvement of anywhere near the magnitude we saw last year. More specifically, we added a large number of installers to our workforce towards the later half of FY’07 as we worked to clear very large backdrop of orders, particularly MedStation 3500 orders that accumulated. As such we experienced a pretty large boost in installations in Q4 of last year. We do expect CTS segment profit for the year will end up towards the upper end of the segment profit guidance range we’ve given previously of 20% to 25%. More generally, we also anticipate an overall increase in SG&A versus Q3, driven by some key product related investments and the impact of the Enturia acquisition within MPT. On the net interest expense line you may have noticed that our Q3 level was relatively low. There were foreign exchange benefits that lower this expense line, which we don’t expect to repeat in Q4. We expect Q4 return to a normalized level, which would be around the $50 million or so we saw in Q2 of this year. And finally, we expect Q4 average diluted shares to be slightly lower than our Q3 figures of just over $360 million. So in summary in the final slide, this all adds up to FY ‘08 outlook as follows: We now expect overall company revenue growth to be in the approximately 5% this year, based on market trends and slower than anticipated transition of the additional Walgreens volume. EPS range remains unchanged, we expect to cull at the middle of this range excluding the impact of Enturia, which would be $0.01 to $0.02 dilutive. And segment guidance remains unchanged. As we previously mentioned, we’ll be providing a comprehensive update on a Q4 FY ‘08 and FY ‘09 guidance call in August. With that I’d like to turn over to George, to provide a few comments on HSCS. George.

Thanks Jeff and good morning everyone. I last spoke with you three months ago in my second at Cardinal. I spent much of my time since assessing our HSCS business both on the pharma side and on the medical side and I’d like to share with you a bit of what I’ve seen. As Kerry and Jeff mentioned, our medical surgical business is making raw progress. Although kitting business will need to better adjust to the dynamics of the market, the rest of our medical businesses are showing marked improvement. In particular, I’d like to highlight the progress being made on our hospital supply business. I’ll devote more time our medical side during the future call but I will add that the work we’re in the category management should help us achieve a more profitable mix of business but also a substantial improvement in service and efficiency. The turnaround in pharma distribution is my top priority and clearly we have work to do. We’ve been dealing in a number of issues some of which were systemic but most of which are specific to our business mix and our execution. We’ll need to focus on fewer things and do them incredibly well, we have already revisited our priorities to determine, not only what is critical, but also what is less important at this time, so we can better execute and do it faster. Here are few of the key themes which will be the foundation of our path forward. Much of this is already in motion. First, from pushing the organization, to regain its passion, with the blocking and tackling of our core business. Superior territory or through maintenance execution may seem boring to some, but it is at the core of our customer offer. Second, we need to complete our ongoing segmentation of our customer base, both, downstream and upstream, which began earlier this fiscal year. This will help us tailor our offerings more specifically to the unique needs of various customer groups. This involves 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 these programs into our overall offerings by segment, in a way which helps our customers compete. We’ve been a very strong company in the buying side and on the sourcing side. We need to and will match this on the downstream commercial side. Finally, we need to better adapt to the enormous and rapid changes in the Pharma landscape, as well as in the retail landscape. This requires that we revisit our value proposition to both our branded manufacturing partners and to major retail customers to make sure that each of us is getting the right value and the appropriate rewards. This is not an easy task when everyone is under pressure. However, we must tackle this. We will do so with a spirit partnership, but with a real discipline. I believe that we are building the right leadership team, and placing Mike Kauffman to lead our Pharma segment is a key step. Mike has a strong track record in our pharmaceutical business as its former CFO and Head of Sales and Marketing. Well, recently Mike built a strong team in Medical, and set the turnaround in motion before accepting the Pharma role. I’ll work closely with Mike in the coming months on HSCS, again while maintaining a focus on the MedSearch side of the house to ensure that the business continues to improve. I am working with our executives to identify strategies for us to ensure that we have the right tools to execute. I have been meeting with customers, with suppliers, and with our own people on the field as much as possible to get first hand knowledge of 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-diversion program and our efforts to ensure security of the supply chain. We are working tails off to restore our reputation with DEA and gain back the ability to distribute controlled drugs from all of our facilities. Our early efforts dictated that, at times we use something of a blunt tool to ensure that no diversion was occurring, rather than a precision instrument. We know that this has caused some disruption to our customers, particularly in the retail independent stage. We regret that and truly appreciate their support through a tough time. Having said that, we have lost some independent retail share over this and we’ve certainly made it a challenging environment in which to grow. But we are making progress on implementing the necessary systems and getting our service levels back to where they belong. It is difficult to predict at this time a firm date where all of our facilities will be shipping controlled drugs, nor would it be prudent to comment on discussion with DEA. We can say that we are work with the utmost diligence to bring this matter to close. Second, I know that many are curious about market growth. We will not try to predict the future. We can say that recent IMS view is an overall market growing at 2% to 3%, and our recent data shows a corresponding slowdown versus earlier in the year. Third, a number of you have asked about forecast for generic activity, and we can say that the years between 2009 and 2012 look like relatively strong years for generic, with the caveat that some lumpiness is natural. Further, most of you are aware that many of the launches we see on the horizon are subject to legal and patent issues, making forecasting quite challenging. We will take the following approach going forward, as it relates to what is in our guidance. We will risk adjust all at-risk launches or take them out of our guidance completely depending on the nature of the case, the size of the product and the level of information available through dialogue with the manufacturers. Finally a few words on margins. It’s clear that the impact of our re-pricing has been margin dilutive. We will need to revisit the way in which we look at these programs. Further, our mix of business and our relatively smaller base of independent and non-warehousing chains has limited our ability to improve margins by growing valuable programs for these customers. Our anti-diversion effort has only made this more challenging. As I mentioned earlier, we are actively working to create the offerings which will better allow these customers to compete and this should be margin positive for us. As we come to our anti-diversion activities, our opportunities to grow will only improve. And with that, I will turn the call back to Kerry.

Thanks George, and operator I think we are ready to open the floor for questions. Question and Answer

[Operator Instructions]. Our first question comes from the line of Lisa Gill from JPMorgan. Please proceed.

Hi Thanks its Atif Rahim in for Lisa. I think we just have a couple of questions on distribution margins. I know George you just commented that the re-pricings have been margin-dilutive. But if you exalt some of the items that are non-recurring such as the anti-diversion measures and include some of the ones that are going to be recurring, such as the re-pricings. Where do you see your margins for the distribution business over the longer term?

Jeff, would you mind to taking a step at that?

Sure. First of all it’s hard to make some of those adjustments you spoke about, because repricings are 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 margins over the medium to longer term and recent activities aside such as diversion and a fairly substantial reprising we’ve had due to the hordes [ph] of larger national accounts that have come up over the past nine months or so, I’d expect that statement to hold relatively true.

I think the past statement was something like 150 basis points to 200 basis points.

No. Our most recent statement over the past 12 months or so has really been about maintaining stable margins.

Stable margins okay. Secondly on CTS, I know there has been a strong… you guys have strong results, but just in terms of the marker environment and some of the hospital liquidity issues, have you seen any of those effecting you or are hospitals just more focused on spending on items they absolutely need and perhaps some of the other areas where we’re seeing some of the weakness in hospital spending.

This is Kerry. I’ll just take the very first one. I think basically looking at our results across this quarter; we could say that we have not seen impact on changes in hospital spending affecting our business; however I would like to turn this over to Dave to make a few broader comments about the CTS business. Dave.

Thanks Kerry. Actually before I address that question, I’d like to say that I’m very enthusiastic about the Enturia acquisition and adding a new dimension in growth opportunities to our infection prevention efforts. Additionally, on the Alaris pump recall and this latest voluntary recall of sockets, components and connectors; we do expect to be completed by the end of the calendar year. That really applies to units that were manufactured before 2005 and reflects a proactive approach by Cardinal Health in examining the time period even before Alaris was acquired. And then last, while we are never satisfied with our performance and always strive to get more growth out of our business, I was pleased with the performance of CMP, CTS and MPT in the quarter. And to your specific questions, with respect to some of the comments that competitors and others have been making around the credit markets, I’d remind the audience that one of Cardinal Health’s competitive advantages is to provide leasing for owned equipment and it dampens any negative credit market impact. That’s particularly true in the dispensing market segment and added that both in the ventilation market and in the infusion market that these products really are necessities for a hospital to operate.

Okay, Thanks. I appreciate the color.

Next question please, Operator.

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

I had a coupe of quick questions regarding the guidance, you mentioned Jeff that the entire dilution in the fourth quarter would be about a penny or two. Can you give just give us sense on, how we should think about the dilutions as we move to the rest of the year? Are there just some specific charges as the acquisition comes on, that we should think about 4Q that might not come on later on?

Yeah, Q4 is relatively unique, Charles. Thanks for the question by the way. Yes, Q4 is relative unique depending on the actual timing of the close of the deal which is not definite yet. As you know when we make purchase like this there are certain purchase accounting adjustments that flow through the income statement during the initial weeks and months after the close of the deal such as the inventory, rate etcetera. So, we would expect most of those to flow through in Q4. As we said previously, heading into FY ‘09, we actually expect the acquisition to be accretive to earnings growth.

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

That’s not in special items, its included in the normal segment operating profit that we report.

Okay. And then in my last question has to do with the pharmacy management business. Revenues again were down this quarter, perhaps not as down as much as last quarter. Can you give us your thoughts on your rationale for keeping this business, it seems to be sort of underperforming and maybe give us a sense why the revenues have been week for the last two quarters.

Kerry, would take that question please.

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

Thanks, Dave. Next question please.

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

Thank you very much. I appreciate the color, I guess first question, you had talked a few times about the impact of the contract renewals on this year and then most renewals are done I guess all for fiscal ‘09, obliviously CVS is on the horizon. I don’t expect you to say much in terms of detail on that one, but can you sort of maybe at a high level comparing interest, maybe the timing of when that one was last renewed and your perception at least on where it is relative to market pricing compared to maybe some of ones that have been renewed in the last year that are really having a very negative impact on results.

Hey, Tom. Kerry here. That was summer ‘07 and yes I think that really brought us fairly close to current market pricing, so I think that’s important perspective as we head into the next round.

Okay, good and then on the DEA, I guess disruption, I guess realistically you probably lost some of the independent business for 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 will come back on line or how much of it do you think is more permanent in terms of customers that have found the new source at this point.

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

Hey, Tom. We certainly have challenges, the patients and some of our customers and as I said particularly in this independent space and we have seen some drop of that business. Most of whom have really signaled to us that they consider themselves to be Cardinal customers and will stay with us. We again have to work hard to bring back some of the customers I think who’ve fled during this challenge, I don’t think it’s a large group but we’ll…. again that’s going to take a little time and we’ll have to work back with them.

Thanks George, next question please.

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

Yeah, I just had a follow-up question on the margins, Kerry based on guidance that you gave, the comments like that the margins in the pharmaceutical distribution segment will be down another 25 to 30 basis points in the June quarter relative to the March quarter. Is that primarily just explained by the seasonality and maybe the timing of price increases or is there is something else that’s changing next quarter that’s driving those margins lower?

I think the primary driver, this is Jeff, by the way and thanks for the question Glen. Primary drivers is really the seasonality that we see every year as the Q3 price increase have a much greater impact in that quarter than on Q4. So obviously that’s a primary driver.

Okay. And then I just had one follow-up question on the supply chain medical segment, obviously you had a very strong quarter from the revenue and a margin perspective and I think if I heard George correctly he sort of suggested that that was increased sales to existing customers. Where were those sales prior to you winning them, was it those customers going direct or is that kind of market share gains you’re winning in the market.

Yeah, obviously its probably coming from, this is George by the way, I think primarily coming from other distributors, so we’re seeing some market share movement here.

Do you think there is more to go in that front?

Well, I’m encouraged by what I’m seeing, of course we already have a declared victory but we’re seeing some good numbers coming at our med service business.

Thank you.

Thanks, next question please.

[Operator Instructions] And next question comes from the line of Ricky Goldwasser from UBS, please proceed.

Hello?

Ricky, are you there?

Yeah, I’m here. Can you hear me?

I guess we can. Thank you.

Good morning. Thanks of taking the question. Just to know... one question around pricing….

Ricky, I’m sorry. You’re now fading out. Can you speak a little more loudly, please? We can’t quite hear you here.

Can you hear me now?

I guess we can, thank you.

Okay. My question relates to sort of, your outlook for the price inflation, and you talked about the seasonality that we’re going to see in the June quarter but, what was that kind of like, what’s your outlook for the second half of ….

Ricky, you were kind of breaking up. This is Jeff. I’m going to try to figure out what your question was. I think you were asking about our outlook for price inflation. I’m sorry. We’re having some feedback, so I’m just going to pause for a second. Ricky, I think it’s coming from your phone. Maybe, if you could put it on mute, that would help. Well, first of all, Q3 was a relatively healthy quarter for price inflation, and I think that’s been echoed by other sources as well. You know, going forward, we see price inflation in the 6% to 7% range. Now obviously, as we approach the election next year, there could be some volatility around that regarding exact timings, so it’s going to be a little bit difficult to project, but our expectations are pretty consistent with what other predictors are saying as well.

Thanks, Ricky. Next question please.

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

Hey. Thanks for the question. Jeff, I understand there’s a lot of moving parts in Pharma distribution in general. In the last conference call, you talked about working through some of the long-term guidance over the next three to four months, and we’re sitting here three months later, so I’m just curious, when we’re going to get timing on the update on long-term outlooks for that segment, and do you still see the current long-term outlook is in the realm of achievability, and then I have a follow up?

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

Okay. Let me ask maybe a related question to George, you made a comment in your prepared remarks about revisiting the value proposition. I guess maybe could you expand. My question is that… would that include contract renegotiations or could they conclude broader strategic changes that we haven’t seen yet in the business?

Yes, well, I think its sort of… it comes along two dimensions, one is downstream whether our major customers and the other is upstream. As I said, I think we are looking to it carefully at the kind of value that we offer relative to the compensation for that. And I think as we work through our segmentation strategy, we will able to, at least on the downstream side, more affectively do that, thinking about simply more end-to-end solutions with our major retailers for example, where we look at collectively eliminating cost from the system is a kind of model that we need to look at, we are so highly connected as very large enterprise and this is an area that we can look at. As it relates to the upstream side and our relationship with pharma, obviously this has been a long and rich history for us in terms of these relationships and again its another place where we look at the possibility of using some, thinking about end-to-end solutions to create value in eliminating sort of inefficiency from the system. Having said that, the value of assuring the pedigree of products and of securing the supply-chain, and of moving products throughout the system with world prices escalating, just to name a few. These are significant value and we really do not intend to give it away. So we are going to take a very discipline look at that but we are optimistic that all of our partners will respect that.

Is this a current process that your having, discussions you’re having, going about the review that your going to able in the position to come out and talk about that in the context of the broader outlook in August?

I couldn’t comment on that.

Okay.

I am sorry.

Thanks Randall. Next question please.

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

Thanks good morning everyone, a few questions for George and just a clarification for Jeff on the FX. I just want to make sure that I heard correctly are you saying you and Mike are now kind of sat with your management team or is that still a work-in-process and did you say exactly now many facilities are not shipping control substances. Is it still I think four?

I will do the second question first, there are four facilities that are today not shipping controlled substances. Yes I think as it relates to the management structure we are always in a process of refining it but we really developed a strong team, a group that Mike had been overseeing in the medical with David Anderson, Steve Inacker, Lisa Ashby, Kenny Wilson all people with many, many years of experience on the hospital business with Cardinal, with firms like Pepsi and other companies. We’ve got really a strong team there, so I’m really pleased that with the group we’ve got, we will always look as this business evolves and whether or not there are tools that we need to supplement and we’ve made some key moves organizationally with HSCS-P, we’ll continue to do the refining of 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…kind of before you just sort of talk about the benefits, starting July with Cardiolite going generic are you in a position to comment at this point George.

Yeah, I can give you a bit of color on this. You may have also know that we’ve made some key moves in the last month there is so do solidify our position in the nuclear pharmacy area. We announced recently that we had expanded our relationship with GE Healthcare

Right.

And through that extended partnership my view will now be more widely available across our network, which now allows us again to offer the radiology and cardiovascular community both leading MPI agents for nuclear cardiac imaging. So that’s a real positive step for us as you mentioned the time for Cardiolite starts in July and we’re still hopeful about offering low cost alternative about that time but there are number of issues still to be resolved in order to first to make that happen. You may know that there is Citizen Petition has been filed by the innovator which could delay launch. In addition the contract manufacturer of our generic system may be filed. We had received a warning letter related to GMP issues and that could delay our approval from that side. There are manufacturing partners working to resolve this and we’re involved in that process. So the timing of the resolution is not completely clear and we’re actively exploring both the sub-manufactured solution as well all of the available option to be able to use our powerful network and our scale to bring a low cost product to the market.

Great very good. Thank you so much. And then Jeff the FX benefit is something you are seeing about roughly $20 million in the quarter was that exactly and why wouldn’t that be recurring?

Yeah it was between 50 and 20, you are talking about the FX benefit on the interest expense line. I assume.

Yes.

Yes between 50 million and 20 million and it relates to two items, a inter company loans that we had outstanding as well as some overseas cash balance that were held in non-functional currency and both of those had since disappeared, both the cash balance and the loan itself, so that will replicate itself in Q4.

Great, Okay. Thank you.

Thanks a lot. Next question please.

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

Hi. There had been a go from you folks about dividends equaling 20% of net income, are we making any progress on that front? I can say over the past couple of years that we aren’t seeing much there in terms of hikes?

Hello Bob it’s Jeff. Well I guess this depends on perspective but we stated a few years ago that our goal was to get to 20% payout within a reasonable period of time. Over the three year period since that announcement we’ve raised the dividend 100%, 50% and 33% respectively over three years, which brings our payout approximately to 12% range. We have a Board meeting next week which is the usual annual Board meeting where we reassess our dividend for the following year and we’ll be discussing that in the context of all of our other capital plans and that longer term 20% payout. So, I would say we’ve made good progress towards that and have every intention to continuing to work towards that goal.

And to get to 20% payout, I mean I’m basically assuming the dividend amounts… essentially has to double here. Does it not?

If we are going to do it all one year, we’d have to effectively double it, 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 are currently clarified as held for sale on our MPT balance sheet. We are continuing to work through discussions with potential buyers and given that sensitivity of those discussions, we really don’t want to comment any further on those at this time, Bob.

All right. Thank you.

Thanks, Bob. Next question please.

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

Thank you for the question, I just have one, a brief one left and that was, George you had mentioned changing the way that you go about forecasting generics and specifically that was one issue that would be a change in the fourth quarter and I am just wondering, given your background, if part of that was related to a more conservative view on the availability of generic Protonix in the fourth quarter after the initial Folix [ph] that was launched into the trade at the beginning of the year?

Yes, thanks Barbara. Actually, the change in policy or my approach to guidance really is unrelated to Protonix issue.

Right.

Its really more about an industry in which the predictability is very challenging and so, there are various tools to do that, and our feeling is the most effective way to do that is to do some heavy careful risk adjustment and then in certain cases literally pulling products out of guidance when we just don’t have the kind of the transparency that would give us insights and taking more cautious approach.

Okay, thanks. And then the fourth quarter on Protonix. Specifically is that one of the components.

I don’t think I’ll comment specifically on Protonix..

Okay, thank you.

Thanks Barbara. Next question please?

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

Hi, good morning. I’m sorry if I missed this. But Jeff, did you quantify the interest expense contribution from Forex this quarter, how much of the upside was from that specifically?

Yeah, between 15 and 20, John.

$15 million and $20 million?

For the quarter, yes.

Okay, great. And then secondly, just sticking to two questions, could you all address where you are from a portfolio evaluation standpoint, and if it’s a reasonable expectation over the next 12, 18 months that you guys may look to make some portfolio changes in your business, or is it a poor time given the state of the capital markets? Thanks.

John, this is Kerry. And as Jeff mentioned, we do have some assets we are looking at now. I think we’d say we’re continually reviewing our portfolio and making sure they are supporting our mission of safety and productivity and that there each asset is helping each sector become as good as they can be. And so that process is ongoing, and I don’t really want to comment any further at this time.

But is it fair to say that, Kerry that the... at least the appetite for considering options maybe higher than it was a year ago, is that fair?

I really can’t comment on that, John, thanks.

Okay. Thank you.

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

Hi, thanks. Question for George. George, you mentioned a bit of falloff from the smaller chain customers relating to the anti-diversions effort. Can you give us an update on where are your customer mix stands today within supply chain pharma, and are you happy with that mix or will there be any particular categories that you like to emphasize in the coming years?

Yeah. Thanks for the question. I can’t give you the exact.... I don’t think I’m comfortable giving the exact breakdown of mix, but I think I can show you that I’d love to see some change in that mix. As you know we’ve very strong business with some of the major national retailers and that is a very important part of our business. but I think balancing that out with a broader position in the independent market and in the non-warehousing chain for us I think would be very beneficial, I think we’ve got the tools to do that and that will be an area that we’re looking at very carefully.

Great, thanks.

You’re welcome.

Next question please.

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

Thanks, good morning. You talked about the $45 million impacts from renewed accounts, I just wanted to understand that a little better, is that reflective fully of the sort of reprising of those accounts on the renewals or does that include any one-time transition or other costs that you might not expect to recur longer term?

Hey, John its Jeff, thanks for the question. First of all, since we’re renewing accounts that we already have, transition cost and I’m not sure exactly how you define those but since they’re accounts we already have transition cost really aren’t an important part of....

You talked about an expansion of the Walgreens relationship for example, so I’m wondering is that 45 sort of ongoing or does that include some non-recurring things, the reduction going forward would be less or that you recover some of it from the expansion of relationships?

Okay. I understand your question. Depending on the nature of the renewal and I don’t to comment on any specific one but some renewals have done with upfront payments etcetera and every one is slightly different, but to the extent if there are upfront moneys given those are then amortized over the life of the agreement. So that$ 45 million that Kerry referred to, I would to I would say is purely representative of an ongoing run-rate, unless, until we laps those renewals.

Yeah. And question number two is just on the... sort of a big picture, if have gotten any reaction from your customers or from your marketing folks on the Alaris recall specifically to what extent it might complicate your marketing campaign around promoting air reductions in hospitals?

Dave would you like to take that please.

Yes. Well as I had stated on probably last two calls, customers.... we do see a bit of hesitation with new customers and that’s really driven by their desire to understand the details of the existing recalls and so we do see some movement from one quarter to a next in their committed contracts. The good news is that ultimately they come to understand that the issues that 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.

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

Thank you very much. I just want to make everybody aware to feel free to call Cardinal Health Investor Relations and we’ll be available to answer any questions we didn’t get to answer in today’s call. I wanted to also make you aware of some upcoming events. Tomorrow actually George Barrett will address investors on a conference call, you can this find this information, in fact all of this information will be available on our website under the investor event section at www.cardinalhealth.com. On May 13th George will actually be presenting Banc of America Conference in Los Vegas. On May 19, Dave Schlotterbeck will actually be participating in a conference call to talk about Cardinal Health’s CTS segment and that again will be on May 19 On May 22, Kerry Clark will be addressing investors at the Citigroup Healthcare Conference in New York. On June 11, Jeff Henderson will actually be addressing investors at the Goldman Sachs Conference on June 11 again. And on June 12, the next day, we will be hosting a Med Tech day at our San Diego facility and for those that are unable to make it we are web casting that, so we invite you to participate by webcast if you can’t make the live demonstration. With that I will thank that our operator, thank everybody on the call and please feel free to get to us or any of you have any other questions.

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