Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

CareFusion Corporation (CFN)

F2Q10 (12/31/09) Earnings Call Transcript

February 9, 2010 5:00 pm ET

Executives

Carol Cox – VP, IR

David Schlotterbeck – Chairman and CEO

Ed Borkowski – CFO

Dwight Winstead – COO

Analysts

David Lewis – Morgan Stanley

Eric Schneider – UBS

Ben Andrew – William Blair & Company

Tao Levy – Deutsche Bank

Taylor Harris – JP Morgan

Rick Wise – Leerink Swann

Lenox Kettner [ph] – Banc of America

Kristen Stewart – Credit Suisse

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2010 CareFusion earnings conference call. My name is Alicia, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will break periodically to answer your questions toward the end of the call. (Operator instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's conference, Ms. Carol Cox, Vice President of Investor Relations. Please proceed.

Carol Cox

Thank you, Alicia, and good afternoon, everyone. Thank you for joining us on today's call as we provide an overview of CareFusion's results for the quarter and six months ended December 31, 2009 and an update on our outlook for full year fiscal 2010.

Our press release was issued today at 1 P. M. Pacific Time or 4 P. M. Eastern Time, posted on our website at www.CareFusion.com and filed on the Form 8-K with the Securities and Exchange Commission.

We also filed and posted several slides to accompany today's webcast. While we will not review each slide on today's call, these slides should be used as a reference guide by investors. Slides include comparisons of the results for our second quarter ended December 31, 2009 to both the prior year period and to our first quarter ended September 30, 2009; as well as an updated financial outlook for the full year and definitions of our non-GAAP items and reconciliations to GAAP.

Joining me on today's call are David Schlotterbeck, CareFusion's CEO; Ed Borkowski, our CFO; and Dwight Winstead, our Chief Operating Officer. Before I turn the call over, I would like to make a few remarks.

In today's call, we will be presenting our results on a GAAP and on an adjusted basis. Our adjusted results exclude restructuring and acquisition integration charges, one-time spinoff-related costs, nonrecurring tax items, and discontinued operations. We believe that the adjusted financial measures can facilitate a more complete analysis and greater transparency into our ongoing results of operations, particularly in comparing underlying results from period-to-period. Our management team utilizes adjusted financial measures internally and financial planning to monitor business unit performance and in evaluating management performance. We have included reconciliations of these non-GAAP measures with today's release.

I would also like to remind investors that during today's call, we will be making statements that are forward-looking and consequently are subject to risks and uncertainties. Examples of these statements include statements regarding our fiscal 2010 guidance, our expectations regarding hospital capital spending, our expected stand-up costs and other costs related to the separation from Cardinal Health, and other statements regarding matters that are not historical facts.

You should be aware that certain factors may affect us in the future and could cause actual results to differ materially from those expressed in these forward-looking statements. Such factors include the risk factors set forth in this afternoon's press release and those set forth in our Form 10-K and in our other filings with the SEC. We urge you to consider these factors and remind you that we undertake no obligation to update the information contained on this call to reflect subsequent events or circumstances.

With that, I will turn the call over to Dave.

David Schlotterbeck

Thank you, Carol. Before I talk about our Q2 results and the outlook for the balance of the fiscal year, I would like to say a few words about the business community’s admirable response to the disaster in Haiti. I am particularly proud of our CareFusion employees. Across our global operations, we mobilized within a 48-hour period, worked with our customers to reprioritize orders and had a $3.1 million donation ready to go with Infusion pumps, ventilators, and water purification products purchased from another local company. We were not alone. Many other healthcare companies did their part to collectively pledge millions of dollars in cash and products during the first two weeks following the disaster. The people of Haiti need our help and I am proud of the way our industry has responded.

Now, let me turn to our Q2 performance. As we discussed during our Q1 call, the first half of fiscal 2009 was very strong for us, as the capital spending slowdown was in the early stages. We believe we were the first med tech company to call the slowdown back in November of 2008. At that time, our order pipeline was full, and we were efficiently installing this backlog through the end of our Q2 of last year. It wasn't until Q3 of fiscal 2009 that the slowdown showed in our financial results.

Now against this backdrop of a very strong Q2 in the prior year, we executed particularly well this quarter and continued to grow our business. Top line revenue grew 5%, with strong performance in our Infusion and Respiratory businesses within the Critical Care Technologies segment, and from our Interventional Specialties in surgical products businesses within our Medical Technologies and Services segment. Our Dispensing business performed exactly as we expected. Equally important were order rates, which were strong across Critical Care Technologies, including in our Dispensing business, where we continued to expand our book of business.

Recent customer wins across the segment include Tenet Healthcare, and ten-year agreement to upgrade Infusion pumps across Tenet’s 50 affiliated hospitals. This is one of the largest Infusion contracts in history. The Cleveland Clinic, where we are completing a sole source agreement to upgrade and expand our Pyxis medication Dispensing technology. CHRISTUS Healthcare, a five-year sole source agreement to upgrade and expand Pyxis Perioperative Dispensing technology across this 25 hospital network. And of course, we continue to fill ventilator orders for the CDC as part of our contract for the national strategic stockpile.

Competitively, we are in a great position across this segment. For example, in the Infusion business, we have won 95% of the 74 new contracts where we completed, of which 80% were competitive displacements. We continue to take market share.

In summary, this was a good quarter. We executed well. We delivered adjusted EPS of $0.39, which gives me confidence to raise our guidance for the year to the upper end of our previously-provided $1.35 to $1.45 range. I expect we will finish the fiscal year in the range of $1.40 to $1.45. This guidance assumes no further material improvement in hospital capital spending during this fiscal year.

Now, while I am pleased to be at the upper end of our prior guidance range, we are executing against a long-term strategy and we have important investments to make in the second half of our fiscal 2010 that I will not compromise. These investments will govern earnings growth somewhat in Q3 and Q4. In total, we are investing nearly $30 million in the second half of our year in increased R&D, expanded sales coverage, and new product launches. I will provide you examples of where we are investing shortly, what let me first address the hospital capital spending environment.

As I said during our Q1 call, we are seeing a gradual thaw in hospital spending. I have characterized orders as improving about 10% to 15% beyond the 10% to 15% improvement we saw beginning in April of 2009. We saw this modest momentum from Q1 continue in Q2, and as an example, I believe orders within our Infusion business are now running at about 65% to 70% of where they were during the first half of calendar 2008. We remain disciplined in our tracking of deal flow and still see about $250 million in capital orders on hold. While this is modest progress, it remains encouraging. I remain very comfortable with our long-term goals to grow revenue in the mid-single digits and earnings in the 11% to 15% range. Strategically and competitively, we are in an enviable position.

I want to say a few words about our long-term strategy and investments we are making in the second half of the fiscal year. We are delivering clinically proven products that will lower the cost of healthcare for generations to come. This focus has initially been supported through our work to eliminate medication errors and hospital acquired infections, because addressing these two issues could eliminate more than $20 billion of excess costs in the United States alone. We are now making additional investments that will expand our portfolio into adjacencies that continue this theme of lowering healthcare costs.

Let me give you some recent and near-term examples of how we are innovating to reduce healthcare costs. First, you may have read about a groundbreaking study published in January in the New England Journal of Medicine, proving the superiority of 2% chlorhexidine-alcohol in skin preparation prior to certain surgeries. Using our ChloraPrep product, the study showed a 41% reduction in surgical site infections over traditional povidone-iodine. Based on these results, proper skin preparation using 2% chlorhexidine-alcohol has the potential to remove as much as $4 billion in healthcare costs in the US alone. Some hospitals are already declaring it the standard of care for certain surgical procedures. We have long believed ChloraPrep should be the standard of care in preparing nations prior to surgery or catheter insertions. To drive our growth, we are making investments to increase our sales force in the US and in key geographies worldwide.

In March, we will launch an innovative product to hold a laparoscopic video camera during minimally invasive procedures. There are 3 million laparoscopic surgical procedures annually, and in 95% of them, a surgeon, clinician, or surgical intern now holds the camera for up to two hours. Can you imagine trying to hold a camera steady for two hours? This device allows the surgeon to easily manipulate the camera with greater control and stability. We believe this could reduce procedure times by 10% and free 1 person using minimally invasive surgeries to perform higher value duties. These are high-value procedures, and we estimate the time saved will enable larger hospitals to add one or two more procedures every day. With the scarcity of clinical resources and the need for greater efficiency, we believe the economic impact of this product will be substantial.

Finally, we are investing in another important segment of the market for spinal surgery, by expanding our product platform to better address compression fractures. We are in limited release with a new product and based on early feedback, we are increasing our investment to drive its growth. This is a $500 million to $600 million segment that is rapidly growing because 50% of women and 25% of men over the age of 50 will experience one of these painful fractures.

There are two primary approaches, both of which deliver bone cement to vertebrae to stabilize the fracture. One approach is vertebroplasty, delivering bone cement with specialized needles. We have a system that has been widely adopted in this space. The other approach is kyphoplasty, where a small balloon is first inserted to open the space prior to delivering the bone cement. We will offer a highly-differentiated value proposition, with our new kyphoplastic offering, that I think will become another example of lowering the cost of healthcare for generations to come. Not only will our products be very competitively priced, we believe the features of these products will make them safer and more effective for surgeons and interventional radiologists to use. CareFusion will be the only company in the industry to offer a full line of products that address both vertebroplasty and kyphoplasty.

Of course, we also continue to invest in our core brands. In December, we announced six new Pyxis products at the largest annual conference for hospital pharmacists. These products continue our leadership in improving safety and lowering costs by supporting care communication in the hospital. Within the Alaris line, we implemented an important customer installation to automatically document Infusion data to the hospital’s electronic medical record. This closer integration of our devices with the hospital’s IT system frees nurses from tedious and error-prone manual documentation and allows them to spend more time caring for patients.

I will close by re-iterating that the long-term fundamental drivers of our business remain very positive. We have scale in our key product lines with growth opportunities in all geographies, a robust innovation pipeline with resources and opportunities to further differentiate through innovation. We expect to see R&D investments increase in the second half of FY10 and I remain committed to our long-term goal of investing 6% to 7% of sales on innovation. I want to clarify one point about this metric.

When I talk about the percentage of our sales invested in R&D, I am referring to our product businesses. Remember, we also have a large distribution business outside the United States that has no associated R&D investments and therefore, its sales are not included in the calculation of this metric. While I haven't defined that specifically before, I think this makes the most sense, given the composition of our business. In the future, we will also look to provide you with more color around the capitalized portion of our R&D investments. For those businesses that have R&D spending, we expect to exit the year with our R&D spend approaching 5% of sales.

And finally, we are uniquely focused on measurably improving the safety and efficiency of healthcare, reducing the cost of healthcare for generations to come. We have an experienced management team with a proven track record of success that is highly motivated to grow our business.

Now, let me turn it over to Ed.

Ed Borkowski

Thank you, Dave; and good afternoon, everyone. I will review our results in more detail and provide some additional commentary on our expectations for the second half of the year. But first, let me provide a brief recap of the quarter. Our strong results for the second quarter were led by a significant increase of sales in our Respiratory products related to flu preparedness and H1N1, and better-than-expected sales in our Infusion business. Our product mix for the current quarter came in differently than we had forecasted, with Respiratory sales making up a larger proportion of overall sales. This change in mix impacted both our gross margins and our tax rate. Our adjusted tax rate for the quarter was higher due to this change in product mix and the jurisdictions where these sales occurred.

As I take you through the details of our second quarter results on a year-over-year comparison, I will also highlight some of the sequential improvements we made from the first to the second quarter, which may be more relevant.

Total revenue for the second quarter increased 5% to $1 billion compared to the prior year period, or 2% on a constant currency basis. Sequentially, our revenues increased by $96 million or 11%. For the second half of the year, we expect our top line to grow over the first half revenues of $1.9 billion, with a slight weight into the fourth quarter. With this upward revenue trend, we are raising our full-year revenue guidance to be in the range of $3.95 billion to $4.05 billion, up from the previously provided range of $3.85 billion to $4.00 billion. We continue to expect a moderately positive impact from foreign currency on the full year.

Moving on to our segments, I would like to remind you that our fiscal 2010 results include higher SG&A expense related to standing up as a public company than the historical comparisons.

In our Critical Care Technologies segment, which includes our Dispensing, Infusion and Respiratory business lines, revenues were $682 million, and adjusted segment profit was $126 million, a 1% and a 15% decrease respectively from the prior-year period. Sequentially, revenue increased 11% and adjusted segment profit increased 13%. The growth in our second quarter top line was driven by the significant increase in sales in our Respiratory products that I mentioned previously.

We performed better than expected in our Infusion business during the quarter as our business gained momentum following the ship hold that was lifted in July of 2009 and we continued to increase our competitive wins. Our Dispensing business remains on track and in line with our estimates. As expected, second-quarter sales were down compared to the prior year period, but were up sequentially. As we said last quarter, we expect Dispensing sales to be flat year-over-year due to delays in hospital capital spending. For the second half, we expect the Critical Care Technologies segment top line growth rates to increase versus the first half, due to increased sales in our Dispensing and Respiratory businesses.

In our Medical Technologies and Services segment, which includes our Infection Prevention and Medical Specialties businesses, revenues were $337 million, a 15% increase over the prior-year period. Results were driven primarily by increased sales from our International Surgical Products business, formerly known as our international distribution business; and our Interventional Specialties business. Adjusted segment profit decreased 19% to $23 million, primarily related to corporate overhead costs of operating as a public company, which were partially offset by increased profitability in our Interventional Specialties business.

On a sequential basis, MTS revenues increased 10% and adjusted segment profit increased 6%. For the second half, we expect MTS sales to increase from the $643 million of revenue we recorded in the first six months, driven by the sales of our ChloraPrep product.

Gross margins for the second quarter were 47% compared to 49% in the prior-year period, due to product mix. As I said earlier, we had higher Respiratory sales this quarter. Recall that our Respiratory gross margins are somewhat lower than gross margins in our other capital equipment businesses and positively offsetting this impact was our continued cost management and manufacturing efficiencies realized during the current year quarter. For the full fiscal year, we expect our gross margins to be approximately 48% and in line with our previously-provided guidance of 47% to 48%. Product mix will affect gross margins as Respiratory sales increase over the first half levels.

Adjusted operating expenses, including SG&A and R&D totaled $329 million or 32% of total revenue, in line with our expectations. Adjusted SG&A expense of $292 million increased 14% over the prior year period, as the incremental operating costs related to standing up as a public company impacted our spend. This spend was positively offset by the previously announced March 2009 restructuring. R&D for the quarter totaled $37 million, down from the $41 million invested in the prior year period, impacted by the timing of product development.

As we look to our adjusted operating expenses for the remainder of the year, I would like to reiterate what Dave said about executing on our longer-term strategy and making necessary investments. In the second half of the year, we will be increasing our investments to support the sales of our ChloraPrep product in the United States to support upcoming launches of our ChloraPrep product internationally, and to build a sales force to support the launch and promotion of our kyphoplasty product. We are also expecting R&D to increase in the second half, as we ramp up product development. Together, these additional investments will increase our operating expenses by approximately $30 million beyond our initial plan. We expect these investments to provide incremental returns in fiscal 2011 and beyond, including contributing to top line growth and margin expansion.

For the full year, we expect our adjusted operating expenses to be between 34% to 35% of total revenue, within the range previously provided, driven by the investments I just mentioned, and the timing of the spend for our stand-up costs, which are somewhat weighted to the second half of the year.

Interest expense and other totaled $24 million for the second quarter of fiscal 2010, primarily driven by interest on our $1.4 billion of debt, which carries a yield to maturity interest rate of 5.8%. Our adjusted effective tax rate of 30.2% for the second quarter was higher than our previous guidance, primarily driven by the increase in our Respiratory product sales and compares to a rate of 20.6% for the prior year period. The period-over-period increase in the tax rate is primarily driven by a shift in the mix of pre-tax income to higher tax jurisdictions. We expect that the shift in the mix of pre-tax income to higher tax jurisdictions we saw in the second quarter will continue to impact the remainder of the fiscal year, and as a result, we now expect our adjusted tax rate to be approximately 28% for the full year, an increase over the range we had previously guided. The higher tax rate will have an approximate $0.04 impact to our earnings for the year.

Moving to operating cash flow, for the six months ended December 31, 2009, our operating cash flow from continuing operations was approximately $351 million. Capital spending totaled $67 million and depreciation and amortization was $84 million. At December 31, we had $970 million in cash. For the full year, we expect our capital spending to be approximately $160 million to $170 million, down from the $180 million we had previously guided to, driven by the timing of projects. We continue to expect that depreciation and amortization will be approximately $170 million.

Our financial condition continues to strengthen, and we now expect our operating cash flow will be in the range of $500 million to $550 million, up from the range of $400 million to $450 million we had previously provided.

Our adjusted net income for the quarter totaled $88 million, compared to $110 million a year ago. Our fully diluted adjusted earnings per share for the second quarter was $0.39, compared to $0.50 a year ago, and flat compared to our first quarter ended September 30, 2009. Excluded from adjusted earnings in the second quarter of fiscal 2010 are $22 million in one-time pre-tax expenditures or $0.07 per fully diluted share.

Based on our results for the first half of fiscal 2010 and the investments we intend to make in the second half of the year, we are raising the lower end of our full year adjusted EPS guidance by $0.05, and are now projecting EPS to be between $1.40 and $1.45. This narrowed guidance range implies an adjusted EPS range of $0.61 to $0.66 for the second half of the year, a decline over the $0.79 recorded in the first half, most of which is driven by the additional commercial and R&D investments we plan to make in the second half of the year to support long-term growth as well as the timing of the spend for our stand-up costs.

Turning to currency, we have previously indicated that currency will provide a benefit of about $0.01 per share per quarter. Even with the recent strengthening of the dollar, we did not see a material change from that impact.

Before we move into the Q&A, I would like to reiterate that our management team’s commitment is to make investments we believe will allow us to continue to grow our business. Looking beyond fiscal 2010, we remain committed to growing our top line in the mid-single digits and our earnings in an 11% to 15% range. We still have a lot of work to do over the next several years as we stand up the company, exit the transition service agreements with Cardinal Health, and drive margin improvements throughout our business. We are pleased that our strong results for the first six months as a public company allows us to continue on with our priorities of investing in our long-term strategic plans.

I will now turn the call over to Carol for questions.

Carol Cox

Great. Thanks, Ed. We would like to open it up for the question-and-answer period. And I would just politely like to remind everyone we have a long list of people who would like to ask questions and if you could limit it to one or two questions, I am sure everyone would appreciate that. Thank you.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of David Lewis from Morgan Stanley. Please proceed.

David Lewis – Morgan Stanley

Good afternoon.

David Schlotterbeck

Hey, David.

David Lewis – Morgan Stanley

So just two quick ones here, in light of Carol’s guidance here. First off, David, it is hard to ignore this quarter and the amount of attention that kyphoplasty got. Just give us a sense here the strength that you are seeing with the product and the product launch. Can you differentiate between OUS and US, and specifically as it relates to the US, your confidence in the IP position for the product?

David Schlotterbeck

We do intend to launch globally. It will be staggered, with outside the United States occurring after we launch in the US. Our plans are to launch in April and we expect that this is an area we will be very successful in. I would add on the IP front, we have done our homework. We feel very confident that either the patents that had been in play are expired or we do not infringe any other existing patents. So, we are entering this marketplace to win.

David Lewis – Morgan Stanley

Okay. And can you quantify, Dave, in terms of revenue, kind of how large this product is this quarter or can be this year?

David Schlotterbeck

Well, you know, as we have said before, we tend not to give specific revenue targets or contributions by product line. I will tell you that the market is $500 million to $600 million on a global basis.

David Lewis – Morgan Stanley

Okay. And maybe just switching over real quick on the financial side here. Just in terms of the quarter, obviously GMs were a little lower than you would have expected, and it sounds like mix is the principal driver of that. If mix is going to continue to work against the (inaudible) the remainder of the year, can you just give us the components, how mix or GM can improve sequentially across the quarters, given your comfort in that upper end of the GM range?

Ed Borkowski

Well, I think couple of things. One is, what we are seeing from the orders right now and what we sort of see in the pipeline that we feel we have better visibility between now and the end of the year in terms of what is in play. So based upon that, I think that is what we are basing our projections on. As you can imagine, as we get a little closer, we do have a little better visibility in terms of what is going to be installed over the next several months and gives us confidence in that and to be able to project what that is.

David Lewis – Morgan Stanley

And Ed, just one last quick one and I will jump back in the queue. Obviously, the strength in MTS this quarter, I am assuming, was the recent launch in spine. And I am also seeing kind of reduced profitability versus our expectations. So should I assume that is really a launch effect of this significant launch in spine and we should see a significant improvement in profitability throughout the year in that segment? Thank you.

David Schlotterbeck

David, to be clear, the spine kyphoplastic products have not launched yet. We are launching those in April. And so, there is absolutely no contribution at this moment of any revenue at all, and you know, I suspect it will be deminimus in Q4, because we are just going to be starting in the marketplace. What has really driven that business has been Enturia, and the tremendous response to ChloraPrep and the realization that this is a product that can really make a difference.

Next question?

Operator

Your next question comes from the line of Eric Schneider from UBS. Please proceed.

Eric Schneider – UBS

Good afternoon. Just to revisit the kyphoplasty already, with that launch coming in April, just so I understand, are you looking at ancillary or support products of the existing procedures or are you looking at direct head-to-head displacement of existing products used for existing procedures?

David Schlotterbeck

This is a head-to-head strategy. And as I said in my prepared remarks, we won't be the only company in the world to offer both vertebroplasty and kyphoplasty. I think it is important to recognize that not only are we able to reduce the time for the procedure with our product offering, but it is safer for the radiologists to use it. They can stay outside of the radiation field, so they have no accumulated effects of radiation poisoning along the way. And you know, we are going to be very aggressive when it comes to pricing.

Eric Schneider – UBS

And then, if it is ChloraPrep/Enturia driving MT&S growth, why is the operating margin slipping a little bit there, given what we think is substantially higher than segment average margin contribution in that business?

Ed Borkowski

Well, at this point, Enturia, although having a positive impact, is still a small piece of the whole, and just remember the distribution business that we have is obviously not a real profitable piece of that business as a whole. So essentially it makes very little money.

Eric Schneider – UBS

So that is mix then driven by the also relatively substantial growth of that distribution business.

Ed Borkowski

Right.

Eric Schneider – UBS

And do you have a – have you put a timeline out when you expect to exit the transitional service agreement with Cardinal, just as you look forward to eventual operating leverage in that part of the business?

David Schlotterbeck

Sure. You know, what we have been talking about, most of the service agreements are over a 24 month period, and most of them expire at the end of that 24 months. There are some smaller ones that occur within 12 months, and then most of them occur in that second year of drought. So what we have been projecting is that impact won’t be felt until after that second year.

Eric Schneider – UBS

Thank you.

Operator

Your next question comes from the line of Ben Andrew from William Blair & Company. Please proceed.

Ben Andrew – William Blair & Company

Can you hear me okay?

David Schlotterbeck

We can hear you fine, Ben.

Ben Andrew – William Blair & Company

Great. Just a couple of questions. First, just following up on the operating margin question on MTS, can you size the international distribution business for us a little more precisely? Is it still around $500 million total and is that reasonably evenly split by quarter so we can just sort of back that out, and is your calculation about R&D and SG&A spending for the back half, that 34%, 35% kind of goes through for the full year, does that include the adjusted calculation or the gross calculation?

Ed Borkowski

The first question, on MTS, you are in the right range in terms of that business. I don't know if there is any real seasonality to that business, but it is definitely in that $0.5 billion range. And on your second question, that 34% or 35% is an adjusted number.

Ben Andrew – William Blair & Company

Okay, great. And then, this is my second question I guess, Dave, you talked about the competitive Infusion contracts that you are winning in head-to-head situations. How was pricing in those, given the overall environment, have you seen that to be sharper with people being maybe in a little bit weaker position or is pricing holding up?

David Schlotterbeck

Generally, I would say pricing is holding up. The places where we find that we give a bit on price is when we are dealing with elephant deals. These deals are huge and you know, it is basically a volume discount. And so there is no denying that. Now, I have heard some of our competitors say that they have seen their customers moving to lower-priced in the Infusion world and frankly, when I look at the 74 deals that we have participated in and we won 95% of those and 22 of those, we displaced our competitors lower-priced products. And so, there may be some misinterpretation of what is going on in the marketplace, because as you know, we price our product at a premium.

Ben Andrew – William Blair & Company

Great. Thank you.

Operator

Your next question comes from the line of Tao Levy from Deutsche Bank. Please proceed.

Tao Levy – Deutsche Bank

Good afternoon. Can you hear me okay?

David Schlotterbeck

Yes.

Tao Levy – Deutsche Bank

So I will just start first again on the kyphoplasty, because that is some news to me. Is your product approved already in the US?

David Schlotterbeck

A portion of the product is approved. We are waiting on final approval on the other portion of the product line.

Tao Levy – Deutsche Bank

And is there any risk on the reimbursement front that – you know, it is not deemed the same as the kyphoplasty –

David Schlotterbeck

It is the same as kyphoplasty.

Tao Levy – Deutsche Bank

Okay.

David Schlotterbeck

That is why we are calling it kyphoplasty. I don't see any risk on reimbursement, other than the risks that every manufacturer has when they have a reimbursed product.

Tao Levy – Deutsche Bank

And then just lastly, on the tax rate, as you know Respiratory starts to get, you know, maybe slowed down as a – or becomes smaller as a percentage of sales, should we expect the tax rate to dip down lower and sort of is your guidance on the tax rate assuming that Respiratory stays where it is at for the rest of the year?

Ed Borkowski

Yes, Tao, that is basically our – we believe and from what we see is that Respiratory will continue to be strong in the second half and that is why we believe we needed to take up that tax rate because of that mix.

Tao Levy – Deutsche Bank

Okay, great.

Ed Borkowski

Our visibility is that – leaving the tax rate at the 28% because of that.

Tao Levy – Deutsche Bank

Okay, thank you.

Operator

Your next question comes from the line of Taylor Harris from JP Morgan. Please proceed.

Taylor Harris – JP Morgan

Thanks a lot. Just wanted to start with your revenue guidance for the rest of the year, which implies a very good second half of the year growth rate. So by my math, it implies 20% year-over-year growth in the second half of the year. And obviously you have got easy comp in Alaris. Maybe just help us understand the composition of that 20% growth, is it stronger in Critical Care versus MTS and are there any other big items besides the Alaris easy comp that we should consider?

Ed Borkowski

I would say there are a couple of pieces that are going to that. One is from MTS, obviously Enturia is there as we see that gaining momentum, that certainly is a driver for MTS in the second half versus the first half. Also, I think as you look at the Critical Care segment, I think you see a couple of things. One is obviously what we just talked about, which is Respiratory being stronger in the second half. Infusion continues to do well. We have talked about that, first to second quarter continues to build, even with the (inaudible) that went in the first quarter continues to grow. And I think we see Dispensing doing better in the second half, just as traditionally, that business has done better in the second half, particularly the fourth quarter of our fiscal year traditionally.

Dwight Winstead

Yes, Ed. Dwight Winstead here, Taylor. The other thing is, as Dave and Ed commented earlier, we are seeing Dispensing right on target and really with plan year over year, even with the economic changes. And some of the recent wins that Dave announced with Cleveland Clinic and the Perioperative side seems to be doing pretty well for us also.

Taylor Harris – JP Morgan

Okay, great. And then specifically in Infusion, are you done shipping the backlogged pumps from the ship hold and about what was the impact this quarter?

Dwight Winstead

Yes, let me answer that, Taylor. As we indicated in all previous call, we had about $60 million to $65 million of backlog that was part of the ship hold. We indicated on our last quarterly call that we cleared most of that in Q1. I think if you really pressed on it, maybe $5 million to $10 million of that showed up in Q2, but a very minimal amount.

Taylor Harris – JP Morgan

Okay. And so, year over year, is Infusion growing if you exclude that backlog fill or is it still flat to down?

David Schlotterbeck

My recollection from our forecast, I think it is growing slightly versus the prior year on a complete year basis with the bonus.

Taylor Harris – JP Morgan

Okay, great. And then, let me ask my obligatory kyphoplasty questions as well. So, one is, I assume you already sell to the radiology community vertebroplasty. What are you going to do for the spinal surgeon community? Is that going to be a sales force you build yourself or not? And then, secondly, on the pricing front, sounds like you are ready to be aggressive there. Can you give us a ballpark range of what that means?

David Schlotterbeck

Well, we are establishing a separate sales force as part of the investments we are making in the second half to call on not only radiologists, but spinal surgeons. And these will be people that are well-schooled and already have relationships with these customers. Second, we really haven't settled on the pricing yet for the product. All I can tell you is conceptually, it is going to be aggressive.

Taylor Harris – JP Morgan

Great. And I want to just ask one final classifying question on the earnings growth you talked about 11% to 15%. Is that operating earnings growth as you talked about back at the Analyst Day or is that your net EPS earnings growth?

Ed Borkowski

You know, what we said, that was operating earnings growth. That does tend to translate right down to EPS as well. So we hadn’t anticipated anything else to, let us say, accelerate that.

Taylor Harris – JP Morgan

Okay. But, I mean, you should have a benefit from below the operating line I would think going forward or not. You think operating profit grows the same rate as earnings?

Ed Borkowski

That was our assumption. We didn't really plan in, let us say, any share repurchases or the like at this point.

Taylor Harris – JP Morgan

Okay, thanks a lot.

Operator

Your next question comes from the line of Rick Wise from Leerink Swann. Please proceed.

Rick Wise – Leerink Swann

Good afternoon. Can you quantify the impact on this quarter – you highlighted the – I think it was a $30 million CDC order, just how did it fall this quarter and are we done with that now?

David Schlotterbeck

No, by no means are we done with that. Let me answer a slightly different question.

Rick Wise – Leerink Swann

Okay.

David Schlotterbeck

And that is really the impact of H1N1 on the ventilation business. In the quarter, it was somewhere between $20 million and $25 million. For the year, we expect it will be somewhere between $60 million and $65 million. I will say that the EnVe has had a deminimus contribution, just as we planned, and for those of you who don't know about the EnVe, it is a nine pound ventilator that does the same things that a ventilator weighing 10 times that much being used in the ICU. It has a full range of benefits and we believe ultimately can help reduce ventilator-associated pneumonia. Now I want to mention that we recently discovered an electromagnetic sensitivity, which led us to recall the first six units that we had shipped. We are targeting to resume customer shipments next quarter, and no impact on full year performance.

Rick Wise – Leerink Swann

Okay. And two other really quick ones. You highlighted the order rates have strengthened a bit. I think, if I heard you correctly, they are improving 10% to 15% beyond the April 2009 quarter, if I understood you. Is that what you expected; was it a little better, little worse, about what you thought? Is that what we expect to see in this couple of quarters? Is that what your guidance assumes?

David Schlotterbeck

Yes, our guidance assumes that that is going to continue. We frankly did not expect that and, you know, we are really using the Infusion business as the parameter here, because the Dispensing business is a different financial model and the Respiratory business is very distorted because of national stockpile and H1N1 and all of that. Infusion is doing a bit better than what we had anticipated, but remember, in perspective, it is still running at a 65% to 70% of where it was in the first half of calendar 2008. So, by no means has it fully recovered.

Rick Wise – Leerink Swann

Okay. And last, the ChloraPrep study from the New England Journal; you know, you clearly continue to be excited about the potential impact on healthcare costs, et cetera. What kind of impact have you seen so far, and if you haven’t seen a big one, what is it going to take, is it a larger sales force to get out there and tell the story, you know, just give us a little perspective there, thanks.

Dwight Winstead

Rick, Dwight Winstead here. I would say that for the January timeframe, we haven’t seen a lot of the impact. We are beginning to see some improvement in February, but as Dave indicated, part of our investment for the second half or a part of the $30 million is to build out a separate sales force for the vascular side of our business, thereby allowing our most seasoned representatives to focus on the surgical side sales, which will drive the Enturia product line, we believe, and will also reinforce, you know, what the study actually demonstrated.

Rick Wise – Leerink Swann

Thanks so much.

Operator

Your next question comes from the line of Lenox Kettner [ph] from Banc of America. Please proceed.

Lenox Kettner – Banc of America

Thanks so much for taking the question. Can you hear me okay?

David Schlotterbeck

Yes.

Lenox Kettner – Banc of America

Great. Just to go back to gross margins for a second. I think you talked about the gross margins being down highly sequentially, in part because of the higher Respiratory sales. I am just wondering if you could quantify what exactly or in the ballpark what you think the drag was on gross margin from the higher Respiratory sales in the quarter. And then also, it sounds like you are expecting those sales to continue to be strong for the remainder of the year. So I am just a little bit confused what the product mix is that is going to drive the gross margin improvement in the back half of the year if Respiratory continues at these levels.

David Schlotterbeck

Yes, I think what we talked about, Lenox, was also when you look at the first quarter to second quarter, that decline, you know, we had a lot of the orders from that ship hold had come in and those contracts having done anywhere from maybe six to nine months earlier and we are done at slightly higher maybe margins than what we may have gotten in with more recent sales. Then with the mix with Respiratory being somewhat below let us say the corporate average, it does have a weighting when you look at mix in total relative to our gross margins. I think as we look forward into the next half, even though Respiratory is growing, so is, you know, the Infusion business continues to gain momentum and Dispensing continues to grow since the back half of the year is our strongest half for Dispensing. So when you look at all that mix, that is why we are guiding where we are with the margins.

Lenox Kettner – Banc of America

Okay, great. And then, just one question on the tax rate. I know the expectations have moved around a little bit there, but if you are guiding to 28% I think for the year now, should we be modeling that in the out years as well or do you think you can bring that down over time?

Ed Borkowski

Well, great question. I think, right now, given the visibility we have, I would use – I don't know that I would use other than 28%. We are continuing to work on our tax structure and strategy. It is something we are diligently working on, but as you can imagine, something we are intensely focused on. But at this point in time, I would use the 28% and we will update you, obviously every quarter as to where we are and as we get into our guidance later this year for the following year, we will have even better ability to update you.

Lenox Kettner – Banc of America

Great. Thanks very much.

Operator

(Operator instructions) Your next question comes from Kristen Stewart from Credit Suisse. Please proceed.

Kristen Stewart – Credit Suisse

Thanks for taking the question. Sorry for the background noise. Just again, going back I guess to the kyphoplasty launch, will you be launching the product with any clinical data at all; what sort of data might you have at the time of launch?

David Schlotterbeck

Well, this has already been in trials and being used by radiologists and spinal surgeons and so, I think the answer is yes.

Kristen Stewart – Credit Suisse

Okay. Has it been published anywhere or is it just kind of warm trials?

David Schlotterbeck

If you are asking have there been clinical studies done, the answer is no.

Kristen Stewart – Credit Suisse

Okay. And then I guess just going back on the tax rate, I know that you guys have had along with Cardinal some outstanding issues with the IRS with some of the audits. Is there any sense as to when some of that might be concluded and better visibility on kind of longer-term tax rate?

Ed Borkowski

You know, I think that issue continues to be under review. I would say that it is probably a – as dealing with this type of matter, they don’t resolve themselves very quickly. I would say that you are in a probably 18 month to 24 month window, at the earliest, I would say.

Kristen Stewart – Credit Suisse

Okay. And lastly, and I apologize if you already addressed this, but the change in CapEx guidance for the full year, should we think about that in terms of just lower cost of outstanding offer or is it a timing issue from additional CapEx expenditures expected to fall into 2011? Thanks.

Ed Borkowski

It is more of a timing issue, I think, as we see as we get closer to the end of the year relative to some of the purchases of some of the capital equipment, and especially IT equipment related to you know, some of the things that we are doing, they are just timing that is falling out relative to one year versus the other.

Kristen Stewart – Credit Suisse

Okay, thanks very much.

Carol Cox

All right, great. Alicia, I think that is our last question. So I think if you could repeat the information at the end of the call, I think we are done.

I am sorry. Dave has one more thing to say. I apologize.

David Schlotterbeck

Let me just close the call by saying that our results in Q2 were right in line with where we guided during our Q1 call. We executed well, which gives me confidence in moving to the upper end of our guidance range for the year, while we continue to make investments that will drive our growth over the long term. Thank you; and we look forward to talking to you again when we report our third quarter results.

Carol Cox

Thanks. If we could have the replay information, Alicia, thank you. Thanks everyone.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: CareFusion Corporation F2Q10 (12/31/09) Earnings Call Transcript
This Transcript
All Transcripts