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Executives

Carol Cox - SVP, IR

Kieran T. Gallahue - Chairman and Chief Executive Officer

James F. Hinrichs - Chief Financial Officer

Analysts

Lennox Ketner - BofA Merrill Lynch, Research Division

Amit Bhalla - Citigroup Inc, Research Division

David H. Roman - Goldman Sachs Group Inc., Research Division

Matthew Taylor - Barclays Capital, Research Division

Katherine Davis - Stifel, Nicolaus & Co., Inc., Research Division

Kristen M. Stewart - Deutsche Bank AG, Research Division

Joanne K. Wuensch - BMO Capital Markets U.S.

Jonathan J. Palmer - Credit Agricole Securities (USA) Inc., Research Division

Joshua Zable - WJB Capital Group, Inc., Research Division

David Turkaly - Susquehanna Financial Group, LLLP, Research Division

Kimberly Weeks Gailun - JP Morgan Chase & Co, Research Division

James Francescone - Morgan Stanley, Research Division

CareFusion (CFN) Q1 2012 Earnings Call November 7, 2011 5:00 PM ET

Operator

Good day, ladies and gentlemen. And welcome to the First Quarter 2012 CareFusion Corp. Earnings Conference Call. My name is Melanie, and I'll be your coordinator today. [Operator Instructions] I would now like to turn the call over to Carol Cox, Vice President, Investor Relations. Please proceed.

Carol Cox

Thank you, Melanie. And thank you, everyone else for joining us on today's call as we provide an overview of CareFusion's results for the quarter ended September 30, 2011, and provide updated guidance for our fiscal '12. Our press release with details of the first quarter results was issued today at 1 p.m. Pacific time posted on our website at www.carefusion.com and filed on Form 8-K with the Securities and Exchange Commission. We also filed and posted several slides to accompany today's webcast, which may be found on the Investors home page with our earnings materials. While we will not review each slide on today's call, these slides should be used as a reference guide by investors. The slides include comparisons of the results for the quarter ended September 30, 2011 to the prior-year period, a financial outlook for full-year fiscal '12 and definitions of our non-GAAP items and reconciliations to GAAP. Joining me on today's call are Kieran Gallahue, our Chairman and CEO; and Jim Hinrichs, our Chief Financial Officer.

Before I turn the call over, I'll just make a few, quick remarks. On today's call, we will discuss some non-GAAP financial measures, including financial results on an adjusted basis. A reconciliation to GAAP measures can be found in today's release, our slide deck and on the Investors section of our website. We believe that these adjusted financial measures can facilitate a more complete analysis and greater transparency into CareFusion's ongoing results of operations, particularly in comparing underlying results from period to period.

Additionally during today's call, we will be making statements that are forward-looking, including statements about our fiscal '12 guidance. Our actual results could differ materially from those expressed in our forward-looking statements due to risks and uncertainties, including the risk factors set forth in today's release and our filings with the SEC. We ask that you please refer to these materials for a more detailed explanation of the inherent limitations of such forward-looking statements. With that, I will turn the call over to Kieran.

Kieran T. Gallahue

Thanks, Carol. Well, we had a solid start to our fiscal year with good performance on a number of dimensions. We had some offsets too, but that's the nature of business and we were able to meet our commitments in the quarter and stay right on track for the year. We'll talk about this in some detail on today's call. Jim will also do a detailed walk across from our former reporting segments to the new segments, so you'll have plenty of color to understand the changes and the drivers.

Now on to the results. First quarter revenue grew 4% to $844 million. Adjusted income from continuing operations rose 19% and adjusted EPS for the quarter was up 14% to $0.33. Revenue growth was led by a 9% increase in our new Medical Systems segment.

Medical Systems includes our dispensing, infusion and ventilation equipment, where we continue to execute very well particularly in Dispensing and Infusion. We had a successful quarter installing many of the Pyxis and Alaris systems booked during the strong back half of fiscal 2011. We also had the benefit of our Rowa acquisition in the quarter, which is smoothly integrating into CareFusion and complementing our Dispensing business outside of the United States.

We introduced our first CareFusion Rowa product during the quarter, the SMART SYSTEM, which will bring high-end dispensing technologies to smaller and midsize retail pharmacies in Europe and in Asia.

In the Procedural Solutions segment, revenue declined 2%. However, excluding sales in the prior Q1 from our former OnSite Services business, which we divested in March 2011, segment revenue increased by 1%.

Procedural Solutions includes our Infection Prevention, Medical Specialties, Specialty Disposables and Diagnostic businesses. Across both segments, the environment continued to look similar to the second half of last year with a slightly weaker picture in Europe. Hospitals in the U.S. continued to prioritize their capital investments based on those products necessary to their operations. And fortunately, we sell many of those products.

We continue to make good progress with ChloraPrep and chlorhex largely because we are taking share or converting markets, somewhat offset by the softness we are seeing in procedural volumes. Outside the U.S., we experienced additional weakness in Western Europe. But recall, we are still growing our international presence and therefore, the impact is relatively minor.

During the quarter, we took a $12 million charge related to an increase in our recall reserves, all of which we offset through our operating performance and a lower tax rate. As a regulated company, addressing product quality on an ongoing basis is an integral part of our operations. What's important to us is that we have the systems, monitors and controls in place to identify the issues early. It allows us to take the necessary steps as quickly as possible as we did with the voluntary recalls we initiated during the quarter. This is evidence that our quality system is working when we are identifying and taking control of the issues.

During the past 5 years, we have invested well over $100 million in our quality system because patient safety is core to our mission and because we believe it can and should be a reason customers do business with CareFusion. Despite all of this, we stay diligent everyday. We cannot become complacent with something so critical to our business.

Last quarter, I told you about plans to reorganize into 2 new segments: Medical Systems and Procedural Solutions. We started with our customers and are working inward, focusing on changes that simplify the business, reduce costs in a targeted way, and importantly, reinvest those savings in growth initiatives. Our approach is to group like with like, putting like products and customer call points together to take advantage of our scale, improve the customer experience and leverage the synergies.

Though it is early, we are already seeing opportunities in the white space with collaboration among our sales reps and value-creating product bundles for our customers. We'll talk about this in greater detail in coming quarters as we begin to realize new benefits from these changes.

Our organizational changes fit within 3 phases of transformation I talked about since April. Those changes include: Phase I, stand-up, which was related to our spinoff from Cardinal Health and full separation from the associated transition service agreements; Phase II, foundation building, which is the phase where we simplify and rationalize our systems, infrastructure and businesses and a way that enables growth; and finally, the third phase, accelerating growth, the ultimate goal.

I am pleased to say we have exited our stand-up phase, reaching a key milestone during Q1 with our first quarterly close on CareFusion's financial systems. We have entered Phase II, where we are building a foundation to accelerate our growth. A big part of building that foundation is reducing the complexity of the organization. This simplification work is the next step towards continuing to expand our margins and importantly, freeing up resources to invest in our future.

During the first quarter, we completed much of the necessary planning and moved to the action phase of Phase II. We have prioritized our core IT initiatives, undertaken a large-scale project to harmonize our customer and supplier data, launched procurement initiatives and streamlined parts of our organization. Outside the U.S., our new global commercial operations team has started its work to refine our go-to-market strategy to both strengthen our businesses in core markets and establish our presence in emerging markets.

We have teams across the business working on improvement initiatives that deliver near and longer-term benefits. No doubt, we'll have bumps along the road as we go through this process, but we have good plans in place for each transition and we'll keep you updated as we bring more of these initiatives online.

So to summarize, our simplification work is on track and ongoing. It is all heading us in the right direction, getting us closer to Phase III, where our investments begin to accelerate top line growth.

These investments, which we, initiating in Phase II, include innovation projects, the addition of sales resources to our key growth markets and accelerating our geographic expansion where we expect revenues to grow faster than in the United States.

All this work delivers value as we move through it, expanding margins and enabling the reinvestment that will take us to the third phase where we expect to have the top line expanding more rapidly.

Last quarter, I raised expectation for margin enhancement to a 20-plus percent range as we exit fiscal 2014. Around this time, we also expect revenue to outpace the growth rates of our traditional market segments, targeting mid-single digit plus revenue growth over the long term. As I've said consistently, our businesses today operate in segments of the market growing in the low single digits. In the short term, we expect to do slightly better than that as we continue to drive the expansion of our operating margins.

For the longer term, we intend to move the top line faster with a cost structure that puts greater investment in R&D and provides for good leverage to the bottom line. There is no change in our revenue or EPS guidance for the year. We had some nonoperating upside during the quarter that helped us cover some of the recall related expenses while not slowing the pace of our investments in the business. This keeps us on track for adjusted EPS this year of $1.80 to $1.90, an increase of 9% to 15% over fiscal 2011. I'm looking forward to taking your questions but first let me turn it over to Jim for his comments on the quarter.

James F. Hinrichs

Great. Thanks, Kieran. Good afternoon, everyone. Today, I've got 3 things that I want to talk about. First, I'm going to review our new reporting segment, that's Medical Systems and Procedural Solutions, spend a little bit of time going over which businesses are in each segment just to get you oriented. Second, I'll provide an overview of our quarterly results, and then finally, I'll provide update to our guidance for fiscal '12.

Before I do any of that, I want to take a minute, though, to summarize what I think are the 3 key headlines from today's press release. First off, our top line came in as we expected, driven by strong growth in our biggest businesses, Dispensing Technologies and Infusion Systems. Second, our adjusted EPS of $0.33 per share was in-line with our expectation, although the components of how we got there was actually a bit different than we expected. I'll discuss the drivers in more detail later, but the takeaway is that growth in our big businesses combined with a lower tax rate provided us the flexibility to absorb an unexpected $12 million charge related to voluntary recalls in our Medical Systems segment.

And then finally, third headline, we are reiterating our top and bottom line guidance for fiscal '12. And while we do expect the bottom line to benefit slightly from a lower tax rate, we are also planning to modestly increase investment in a couple of our higher growth businesses, specifically ChloraPrep and chlorhex.

Okay, so first as I mentioned, let me start with our new reporting segment. Last quarter, we told you we had realigned our businesses into 2 new operating segments. The driving force behind that change was to reduce complexity and provide clear direction for our investments and then make it easier for our customers to do business with us.

So beginning with this quarter, the current quarter, we have realigned our reporting segments and replaced our former Critical Care Technologies and Medical Technologies and Services segments with our Medical Systems and Procedural Solutions segments, respectively. Last week, we filed historical segment financial data reflecting these changes on Form 8-K, our filing included new quarterly segment breakout for fiscal '11 and an annual breakout for fiscal 2010. So hopefully you saw that.

We have also filed slides to accompany today's call, so if you turn to Slide 7 in the deck today, you'll see how we've regrouped our businesses into the new segments. Our Medical Systems segment includes Dispensing Technologies, Infusion Systems and Respiratory Technologies. We are also now breaking out these business line revenues as well as in other line, which includes our MedMined businesses. So the question many will have is how does this new segment, Medical Systems, differ from our prior Critical Care Technologies segment?

So for Dispensing, it's exactly the same. All of our Dispensing sales are included in Medical Systems. For Infusion, we include sales of our infusion pumps plus our dedicated infusion consumable sets, while the nondedicated infusion sets including Medegen have been moved to Procedural Solutions as we plan to take advantage of similar go-to-market strategies. Respiratory Technologies includes our ventilators and associated dedicated consumables, however, our nondedicated respiratory consumable sets as well as our Respiratory Diagnostics business have been moved to Procedural Solutions.

Now moving to the Procedural Solutions segment. This segment includes our Infection Prevention, Medical Specialties and our Specialty Disposables business lines. Infection Prevention business line now includes contributions from our ChloraPrep products, our Legacy Prep products and our nondedicated Infusion consumables sets, which is a change. There are no changes to the Medical Specialties business, which continues to include our V. Mueller instruments and our interventional technology products and our Specialty Disposable business includes our nondedicated respiratory disposable products. The other line in the segment includes Neurocare and Respiratory Diagnostics.

Now turning to the results for the first quarter. Total revenue increased 4% compared to the prior-year period, 3% on a constant currency basis. Again, Dispensing technologies and Infusion systems were the key drivers of revenue growth for us in the first quarter.

Moving down the P&L, gross margins decreased by 30 basis points as favorable product mix in the quarter was more than offset by the impact of installing discounted infusion pumps, as we've talked about in the past, and by the unforecasted $12 million increase in recall reserves, which, on its own, drove down gross margin by approximately 140 basis points.

The gross margin decline in the quarter was in-line with our expectations despite the fact that we had to absorb the voluntary recall charge. I just want to be very clear here because there were some early confusion, I think. We did not back the $12 million recall charge out of gross margins. These are part of running the business and they are certainly not planned or forecasted but they are definitely in our operating earnings.

But I would like to say, commenting on overall gross margins, we continue to make progress expanding them. However, as we've mentioned in the past, we do expect continued discounted pump pricing to impact margins this year probably through our third fiscal quarter before we finish the lower margin installs and start to see the higher-margin disposable pull-through that we've been talking about.

Moving down the P&L to operating expense. Adjusted operating expense for the quarter was $308 million, that's 4% or $13 million higher than last year. This growth in expenses was due almost entirely to the Rowa acquisition and to foreign exchange, which combined with what we expect to be our lowest revenue quarter of the year, slightly skewed our expense ratios. So as we move into the second quarter, we do expect that our SG&A spend, as a percent of revenue, will be more in-line with our annual forecast.

If you exclude foreign exchange and Rowa, operating expenses were essentially flat year-over-year and within that flat expense line, we continue to successfully drive more of our spend towards revenue and growth generating activities such as sales marketing and R&D.

Moving down to the tax rate. Our adjusted rate for the first quarter came in lower than we expected at 19.8%. That was versus our 28% to 30% guidance and the benefit there was about $0.04 per share compared to our expectations.

The lower rate was driven primarily by a discrete onetime $5 million tax refund in the U.K. that related to historical periods prior to the spinoff from Cardinal Health, as well as favorable income mix. And although this is a good thing, the timing and the amount of this item were different than we've predicted and so we're lowering our full-year tax rate guidance by 1 point to reflect it. So we now expect our adjusted tax rate to be in the range of 27% to 29% for the full year. Again as I said in the past, we are continuing to work very hard to optimize our tax structure and replan our forecasting. Our estimate of 27% to 29% for the full-year tax rate does not include any additional discrete items that may pop up during the course of the year that are unpredictable, nor does that include the impact of any of the incremental planning work that we're doing that could potentially lower the tax rate.

Finishing up on the P&L. Adjusted EPS from continuing operations increased 14% to $0.33 for the quarter, right in-line with what we were expecting. Again, I want to be very clear here, we did not adjust or back out that $12 million recall charge from adjusted EPS. If you did choose to back that out and apply the first quarter tax rate, earnings per share would have been between $0.37 and $0.38 per share.

Now moving to the results of our segments. Medical Systems revenues for the first quarter came in at $509 million, that's an increase of 9% on a reported basis compared to last year, that's driven by increased sales in our Dispensing Technologies and Infusion Systems businesses. The growth in those businesses partly offset by lower sales in Respiratory Technologies. Looking at each of the businesses, Dispensing Technologies' revenue grew 16%, that's driven by organic growth in the business as well as the Rowa acquisition.

Infusion Systems grew at 7%, as we continue to install additional channels related to the COLLEAGUE opportunity and other competitive wins. In Respiratory Technologies, we continue to experience softness, particularly in our ex-U.S. capital sales, which contributed to the overall 8% decrease in Respiratory Technology sales year-over-year.

Looking at our Procedural Solutions segment, revenues were $335 million, that's down 2% on a reported basis compared to last year. The decline was driven primarily by the lost sales from divesting OnSite Services last year, which contributed $11 million in the first quarter last year.

The net of that divestiture, segment revenues actually grew by %1 in the first quarter compared to the prior year. Digging a little deeper, during the first quarter, our Infection Prevention business sales grew 2% as we continue to take share and convert end-user to our ChloraPrep product line as well as our nondedicated Infusion Disposables. The growth in the quarter was muted as procedure volumes in the U.S. were somewhat weaker than we expected and as purchases from our distributor customers seem to be lower than what our conversions and our end market customer demand would imply.

As you'll hear later, we continue to be optimistic that this business is still on track for strong growth for the full year. Our Med Specialties business was flat year-over-year, driven by the same trends that we've seen for several quarters, which is an increase in our Interventional Specialties products, particularly chlorhex and a decline in our V. Mueller instrument business.

The Specialty Disposables business, which as I mentioned earlier is primarily nondedicated respiratory disposable product, was down 6% in the quarter due in part to buying patterns as well as tough competition in this category.

Moving to cash flow. Our operating cash flow from continuing operations for the 3 months ended September 30 was $1 million, which is $5 million more than last year but below our expectations. A couple of factors contributed to this. First, the result of strong equipment installs in the first quarter and anticipated installs in the second quarter, we built inventory and carried more receivables over the end of the quarter. This is actually a good thing, of course.

On a less positive note, the recalls that we were dealing with created a situation where incremental inventory needed to be built and shipped as part of the remediation and that hurt cash flow. And finally, our progress on collecting a longer dated receivable and trimming inventory that resulted from last year's systems conversions moved a little more slowly than we anticipated. However, to be clear we are absolutely making progress on all of these fronts. We still expect to hit our full-year operating cash flow guidance of $600 million to $650 million.

Just rounding up the cash flow discussion. Capital Spending totaled $24 million; depreciation and amortization was $50 million, of which $19 million or approximately $0.07 per share was intangible amortization related to acquisitions. At September 30, we had $1.2 million in cash and $1.4 billion in debt.

Now switching gears and moving to my third topic, the Fiscal 2012 guidance. If you turn to Slide 14 through 17 in the investor deck, you'll see the key P&L items that we're guiding through this year. I did want to take a couple of minutes to walk you through some of the information on the slide. Our plan is, as always, to continue to provide annual guidance on certain P&L items and the assumptions at the reporting segment level. This quarter, we are also updating our assumptions on the 2 segments and down to the business lines because we've regrouped some of these businesses into our new segment structure since we provided our guidance in August.

So first on the top line, we continue to expect revenue to grow 3% to 5% over last year on a constant currency basis and that'll be driven by mid-to high-single-digit increases in Medical Systems revenues and low- to mid-single-digit revenue increases in Procedural Solutions.

Now let me dive a little bit deeper and walk you through each of the business lines to help you model out the year. In Dispensing Technologies, we continue to target high-single to low-double-digit growth including contributions from the Rowa acquisition. Infusion Systems is expected to grow in the mid-single-digit range. That's the combination, if you remember of very strong double-digit volume growth offset by pricing discounts on the pumps.

Respiratory Technologies, we expect to be flat as stabilization in the U.S. offset some softness in Europe. We expect Infection Prevention revenue to grow high-single digits as we build market share and our ChloraPrep business and our nondedicated infusion disposables, and to be clear, this guidance does contemplate the slower procedural volumes we talked about earlier. We continue to expect Medical Specialties to grow low- to mid-single digits driven by higher growth rates in our Interventional Specialties products, where we continue gain share and lower growth in our surgical products.

And then finally, Specialty Disposables, we expect to be down mid-to high-single digits year-over-year. In the long run, we expect this business can return to growth but will require investment and turnaround activities on our part and we'll keep you updated on our process.

From an earnings standpoint, we really don't have any change in our guidance. We're maintaining our adjusted EPS range of $1.80 to $1.90 per share. We continue to expect results to be weighted through the second half of the year and we're picking up a modest benefit from a lower tax rate forecast.

The recall charges that I mentioned, we included in adjusted operating earnings and we are also marginally increasing investments to support future growth in the second half of the year.

Finishing our guidance for fiscal '12, we continue to expect our adjusted operating margin to be approximately 18% for the year. We're bringing down our capital expenditure expectations from the range that we set in August of $150 million to $160 million, to $130 million to $140 million primarily as a result of lower CapEx on IT related projects.

So in summary, I just want to conclude by saying it was a solid quarter. We had a few unusual, but offsetting items. Underlying all that noise, though, are operating results that reflect continued execution on driving efficiency, while reallocating our resources to customer-facing and growth-generating activities. Before I close it and turn it back to Carol for questions, I just like to make one final comment. I want to acknowledge the fact that this is Carol Cox's final call with us. She's leaving CareFusion, as you all know, to run Investor Relations at Lake Technologies.

I really want to thank Carol for all her hard work in building our IR capability from nothing to really world class in a very short time. She leaves really big shoes to fill and we're going to definitely miss having her around. I also want to welcome Jim Mazzola as he assumes the role of lead IR person for CareFusion. I'm sure all of you will get to meet Jim in the coming months and will enjoy working with him as much as we do. So with that, I'll turn it back to you, Carol.

Carol Cox

Great. Thanks, Jim. And I just like to acknowledge everyone at CareFusion, too. I really have enjoyed my time here and certainly I'm going to miss the team. So best of luck to everybody. So now we'll open up to Q&A and just -- since it's my last call, [Operator Instructions] Melanie, if you could turn it over to Q&A?

Question-and-Answer Session

Operator

Operator Instructions] And our first question comes from the line of David Lewis with Morgan Stanley.

James Francescone - Morgan Stanley, Research Division

This is actually James in for David. First question, just a perspective on gross margin. If we add back -- if we were to add back the recall charges, we get to gross margins that are over 52%, which seems pretty impressive in light of the Infusion discounting. I guess 2 issues here. One, could you give us some color on how much the Infusion discounting actually cost from GM; and two, as you look ahead through the rest of the year, how sustainable do you think profitability would be at those levels?

James F. Hinrichs

That's a great question. A couple of things. One is we installed a slightly lower volume of the heavily discounted pumps than we expected and they were replaced actually with installed slightly higher margin pumps. So the impact in Q1 of those discounted installs actually was not as intense as we thought it would be. And I don't have exact numbers to give you specifically what the impact on it was, but it did have a slightly lower impact than we thought. With respect to the rest of the year, I think it's a reasonable again, netting out that $12 million recall charge, which puts your gross margins, as you mentioned, over 52%. Netting that out it's reasonable to expect that we would probably see lower margins in the middle part of the year, again, as I mentioned, through the third quarter and then accelerating into the fourth quarter. Again consistent with what we had set at the beginning of the year, but just a slight timing change here for with the first quarter into the second and third.

Operator

Our next question comes from the line of Amit Bhalla with Citi.

Amit Bhalla - Citigroup Inc, Research Division

Just a quick question. Just want to understand like the split again of some of the businesses, especially Infusion and Respiratory. Can you just tell us, in terms of Infusion, if you take the prior way you reported Infusion, what's the split between medical and procedural? I'm getting roughly like 80-20. And then the same for respiratory. Respiratory's now split into 3 different places, is the amount that's still in the Medical business roughly about 40% or so? What was in there prior?

James F. Hinrichs

So if you take the Infusion business, what we've done is we've taken pumps and dedicated disposable, and that stayed with the Medical Systems business. And then the nondedicated disposables sets, which include the old Alaris SmartSite, as well as the Medegen business that goes with the new Procedural Solutions segment. So it's not 80-20, it's probably -- I don't have exact numbers directly in front of me, but it's less than that. It's probably more like -- we can get these exact numbers, but Carol can get them but it's probably more like 60-40 or 70-30. It's not quite as high as that on the capital side. On the respiratory side, it is really -- if you think about ventilation and disposables as being roughly similar in size. And so each -- that got split roughly down the middle into Medical Systems and Procedural Solutions, so those are pretty similar -- Respiratory Diagnostics, the smaller business in the range of $100 million all went to Procedural Solutions. Does that help?

Amit Bhalla - Citigroup Inc, Research Division

That's helpful. And just the other question I had for you was -- you talked about the weakness in the capital side in Europe on Respiratory. Any sense of how weak that really was?

James F. Hinrichs

Just from our standpoint, it was down more than the 8%, the overall revenue line was down I don't know care of [indiscernible] on the capital side.

Kieran T. Gallahue

So on the capital side, it was really not a lot of change from last quarter when we so basically continued weakness. Obviously there were some additional emphasis that you saw coming out of countries like the U.K. where they put a hold on quite a bit of the capital expenditures. So I'd say it was similar, maybe a little bit more aggressive than we saw last quarter.

Operator

Our next question comes from the line of Matt Taylor with Barclays.

Matthew Taylor - Barclays Capital, Research Division

Just one clarification point on the gross margins, I guess, you said that the mix was partially lower, priced system -- higher priced, why wouldn't that recur I guess why would that be worse in the next coming quarters? And just general commentary around Dispensing would be great because that was really strong.

James F. Hinrichs

Yes, the reason -- what happened in the first quarter with Infusion is we had scheduled out -- the way we saw the year when we guided for, at the beginning of the year, was that we saw a lot of lower margin installs in the first quarter. Customer needs and demands change and so we pushed out some of those lower margin installs from Q1 into the second and into the third quarters and backed all them with frankly installs at a slightly higher margin. So you didn't see as big an impact in the quarter from these lower margin installed, as we initially thought when we entered the year. Those low lower margin installs will be put in place in Q2 and Q3. And so you'll see a slightly bigger effect, bigger negative effect on gross margins from the Infusion pump installs.

Kieran T. Gallahue

And one of the things you would ask is “why you wouldn't see that going forward again?” Just to remind yourselves we enter the year with a certain number of committed contracts. And the way , that Infusion business works is that you have the committed if you have committed contracts, you get a day 1 and then you install that 30, 60 sometimes -- I should say 1 quarter out sometimes 2 quarters out, basically is when the install occur. Sometimes it happens faster, sometimes a little bit slower, so we knew what the pool we were working with, it just happened the way it worked in some of the higher-margin ones installed first that means we know we're going to do the installs the others, which means, by its nature, it has to hit Q2 or Q3.

James F. Hinrichs

That's right. Yes, just to mix through the year, this kind of shift happen a lot. Second question is on Dispensing we had a great -- as you remember in the fourth quarter we had a terrific committed contract, record committed contract quarter in the fourth quarter. That was great for installs organically. So if you look at that 60% growth, without getting down to the last decimal point, about half of it is organic growth, about half of it relates to the Rowa acquisition. And so good organic growth, high single-digit and then helped out with some nice growth from our Rowa acquisition.

Kieran T. Gallahue

And just sort of highlight that Rowa acquisition has come out of the great's crate. The team is integrating very, very well with the CareFusion team. We’ve been integrating at the appropriate pace and they are just doing a stellar job. So far, so good and very pleased with that acquisition.

Operator

Our next question comes from the line of Mike Weinstein with JPMorgan.

Kimberly Weeks Gailun - JP Morgan Chase & Co, Research Division

This is Kim here for Mike. So I guess our first question is on the Infection Prevention piece in the quarter so that came in a little bit below what we were expecting and you guys cited some procedural weakness offset by the continued strength of, I think, ChloraPrep and I think you also cited the Infusion disposables. Can you give us a sense of what did ChloraPrep grow in the quarter maybe even what the Infusion disposables grew in the quarter? And then where you get the comfort that -- for the year you can still grow that line item kind of in the high single digits?

Kieran T. Gallahue

Yes, why don't we start with sort of baselining. If you look at that Infection Prevention, let's remember what it includes. So part of it is the ChloraPrep, part of it's the Legacy Prep. It has the Medegen for the nondedicated consumables as well, SmartSite. So you have a mixture within that of some of the newer, faster growing areas as well as some of the legacy products, which for their nature are pretty much flat, in some cases even down a little bit. So it's a blended rate which you get in the total Infection Prevention area. If we look at last year's number, that 23%, just again remind ourselves that, that includes the year-over-year impact of Medegen, which was about 13 points out of the 23, which means that category grew at about 10% last year. And that's the category that you're absolutely right as we came out of the gate, it grew in the low single digits and we think we're going to get to the high single digits low double digits by the end of the year. So just sort of baselining those 2 things you can see that those numbers sort of get a lot closer. As we look through the rest of year, we're still encouraged by the progress that we're making in each of those categories. The development of the Procedural Solutions business allows for a substantial amount, more communication between our commercial units, between our sales forces in the training side of the business. All of those things, which we believe will be extremely beneficial in not only helping to continue to stimulate new conversions of business, remember that's what our growth is really based off is new conversions. But will also allow us to identify white spaces to fill-in product categories and fill out the bag of these reps. So we've got a couple of good things happening all at once. You're absolutely right, there was some headwind that we experienced with the procedural volumes being down. And in that case, we think that total year probably a couple of percentage points or so is going to be carved off of what the possible was in that area but beyond that it still driven by the fundamentals of conversions.

Kimberly Weeks Gailun - JP Morgan Chase & Co, Research Division

Okay, great and just a follow-up on the gross margin side, are you guys expecting any continued impact into next quarter from the ventilator efforts?

James F. Hinrichs

From the recall charges? Kim, are you asking about the recall charges, will we see anything in the second quarter? If that was the question, which I believe it probably was, the answer is no, we wouldn't expect to see any incremental charges for these particular recalls. We estimate what we think to be is the full charge and we take it during quarter.

Operator

Our next question comes from the line of Joshua Zable with WJB Capital.

Joshua Zable - WJB Capital Group, Inc., Research Division

I have a couple ones and I'll try and sneak them in before I get cut off here. Jim, I think you mentioned sort of that the underlying business we're doing a little bit better than you're expecting and you were going to increase investments in ChloraPrep and something else. I just want to make sure I'm clear on that so just my question is sort of what else were you increasing investments in and did I hear you properly? And the second question I'll sneak in before I get cut off was I know you guys are rejiggered [ph] around the segment categories. I know Respiratory you were expecting to be down but that was sort of a function of 3 different segments and the new segment Respiratory was flat. I know obviously the one respiratory segment you called out Europe. So maybe just help me understand if anything actually has changed better or worse? Or just a function of the different segmentation?

Kieran T. Gallahue

Okay. So with the investment in growth, I think the best way to baseline is to say our objectives here during Phase II of our growth, stimulated by CareFusion simplification, that should be CSI, is to take monies from the back office and put it to the front office. In other words, to reallocate where we're spending our money to those areas where it can have the greatest impact on customers and on patients. And so that takes many forms. And I can tell you, there's a number of different places in the business some of which we mentioned that we are working on in order to stimulate efficiencies and be able to improve the allocation of resources towards where the growth is. Now some of that is going to take place behind the scenes, in research and development. So we'll be investing more in the Procedural Solutions side of the business. We think we are investing about the right amount in our Medical Systems businesses and there it's more about continuing to improve efficiencies and the effectiveness of how we spend and I can talk more about that. On the other side on Procedural Solutions, it is a mixture of effectiveness and the absolute investment. And so we'll be increasing that. We'll be working with our commercial organizations to optimize the way that we communicate with our customers. And so that's something that we'll be developing over time. We're also going to continue to invest in clinical resources that can be used in the field to help educate our clinicians and our customers about the clinical differentiation and downstream also the financial benefits that therefore come from the use of our products and there is many benefits that come on the different avenues not just in Procedural Solutions side. I will say these business segments that we have created are really already paying dividends. I'll give you an example. We had some business reviews last week where over the course of 2 days met with each of the parts of the business within the Medical Systems group. The 3 new leaders underneath Tom Leonard, as well as with his other leaders in that whole segment that run the Enterprise Solutions and Service. And I can tell you that they are operating not only individually very well but across the different business units in a way that we had never been able to do before and that is much more customer centric and that is much more solutions centric. So as we develop into these segments, we are finding opportunities to invest wisely and to take what we've invested and make it more efficient. So that's the goal, that's where we're heading in and that's -- we've seen early returns on that. As far as the Respiratory side of it, what you're pointing to on that flatside is the equipment side of the business, the Ventilation business that is underneath of the Medical Systems side. Remember that in the old way we defined it, we also have the Disposable segments and we have Diagnostics. Disposable is still a business that's under pressure that would have been where you'd see most of the negative pressure coming from whereas relatively neutral in the small diagnostic side.

James F. Hinrichs

To finish that out, I would say no, I mean, it's the way we split out the businesses, the growth rates are going to look little different but if you sort of add up the component parts you end up with the same guidance we gave earlier or under the old system which was down a couple of points. That's -- all these sort of adds up to same kind of guidance.

Operator

Our next question comes from the line of Dave Turkaly with SIG.

David Turkaly - Susquehanna Financial Group, LLLP, Research Division

I know you haven't had these division segments too long. But as we look at them today, big part of the story has been kind of this operating margin expansion ahead. Medical Systems and Procedural Solutions, call it something like 19 and 7 as the operating margin in the quarter. Can you give us a long-term target for each of them? Help us a little bit in terms of modeling. Where do you think each of those go and which can you move, which has the most low hanging fruit, which can you move the fastest?

James F. Hinrichs

I mean this is kind of a tough question to ask. If first quarter reviews numbers out here, you know obviously the Procedural Solutions business is the easiest one to move. It's just smaller numbers. And so therefore, a few million dollars can make a big difference in the sell adds we sort of invest in the business, what we did in the first quarter and driving OUS launches and looking across the bordered areas where we can invest now to simplify and take out costs later. Any investment in that business, even to the tune of a few million dollars have a big effect on the operating margin and a big effect on the growth rate. So I think the short answer is the one that's easier to move is Procedural Solutions. Having said that, I don't think I'd be inclined to give specific targets for each business outside of the overall operating margin target that we've set for ourselves, 3 years down which is 20% plus. And using each of these 2 businesses and growing the higher-margin products faster than the slower margin product will be a major contributor to that growth and to that improvement in operating margin.

Operator

.

Our next question comes from the line of Jonathan Palmer with CLSA.

Jonathan J. Palmer - Credit Agricole Securities (USA) Inc., Research Division

Jim you had mentioned some tax work that you're doing is not included in the guidance in the opening remarks. Can you give us some color on these efforts, the timing and perhaps quantify what your savings ultimately.

James F. Hinrichs

Yes, I can certainly tell you a little qualitatively what kind of the things we're working on. And we're launching a number of products OUS, some of the higher-margin products are being launched like ChloraPrep and others. And as we drive more income -- as we derive, I should say, more of our income from outside the U.S., that gives us an opportunity to set up in a way that we can lower our overall tax rate. I wouldn't want to be pinned down to a number. I think it's possible that some of these efforts could kick in this year. If things go as we hoped and so potentially go been substantially there's some of that in the tax rate were not suck about big gigantic jump to the tax rate multiple percentage points. But smaller moves than that in over the course of time and the multiyear period we could potentially even move it more than that. So again I just want to make sure I leave open the fact that we are continuing to work and perhaps there will be some upside if things go as we planned and these product launches go well and all things continue as we hope they will.

Operator

Our next question comes from the line of David Roman with Goldman Sachs.

David H. Roman - Goldman Sachs Group Inc., Research Division

Want to start with one operational question then follow-up with Kieran, something you brought up in your prepared remarks. Firstly, maybe on pumps. It looks as though your other competitor in the United States had a very tough quarter. Obviously trying to get the ship in order there. You touched a little bit about Households prioritizing CapEx and also most of the surveys that we've done do put Infusion pumps pretty high on their prioritization list as it relates to households, maybe you could sort of go into a little bit more detail to what you were referencing, whether you actually think there was a step down in the Infusion pump market this quarter. And then maybe more broadly speaking in that context, what the opportunity is for you beyond just taking share from Baxter, what is there on the Hospira side?

Kieran T. Gallahue

Great. So -- the Infusion side of the business is one where it is essential within our customers operations. I mean it's intimately involved in their patient care. It's intimately involved in protecting patients and providing the utmost in safety for those patients. So it's an area where, in times when there is maybe a pullback in certain investments, it's an area that still gets a lot of time and attention out of our customers and we're quite fortunate to have that situation. As far as, from a competitive perspective in the marketplace, I'd say nothing much has changed in that setting. We, I think, had a pretty good last year and not only against Baxter but against other competitors. We feel like we are still well-positioned in the marketplace, and will continue to execute on our plan and would like to think of it because we have an excellent sales force. We have an excellent service infrastructure and we support our customers, we think, better than anybody else in the industry and that's certainly what we drive to do. So I think it's really about fundamentals and continuing to focus on those fundamentals. I think, David, you had that another question I guess you're getting cut off.

Operator

.

Our next question comes from the line of Lennox Ketner with Bank of America.

Lennox Ketner - BofA Merrill Lynch, Research Division

Just wanted to focus on pricing for a minute. I know there's been a lot of talk about the pricing that you're seeing on the pump side. But I was wondering, either JIm or Kieran, if you can just talk a little bit about what you're seeing in terms of pricing, in some of the other businesses, if there's been any change there lately. And then, I'm not sure if you mentioned it on this call, but I think last call, Jim, you talked about some of the -- about potentially changing your approach to strategic pricing overall, if you could maybe talk just a little bit more about what you're hoping to do there and kind of where you are in those initiatives?

James F. Hinrichs

Yes, sure. I would say that, in general, we operate in a highly competitive markets, as you all know, and in general, pricing in these markets tends to be biased downward rather than upward, which is why we want to invest more in that capability. Putting aside -- couple of things to say, first of all, putting aside what we talked about in terms of discounting pumps for this near-term opportunity, the overall pricing environment, it varies by business. In areas where we're highly differentiated, we are able to maintain price in areas where we're less differentiated. Clearly price is tougher to maintain. I would say, overall, pricing in the businesses and again there is no one single theme you can make about them, has been reasonably firm over the past couple of quarters particularly, in our larger businesses, again, putting aside the capital equipment part of Infusion. And certainly in that Infusion business we're trying to bring price back to the marketplace and we're seeing some early signs that we've been reasonably successful in doing that. But I would say no major change in pricing trends, we are absolutely investing in pricing capability, we believe there is opportunity because we do believe that our products provide significant value to our customers and we're not always getting the value that we provide. So that's a concerted effort in our part. Too early to say that there's been any proof from that yet but certainly we're investing in the capability.

Operator

.

Our next question comes from the line of Joanne Wuensch with BMO Capital Markets.

Joanne K. Wuensch - BMO Capital Markets U.S.

A couple of times on the call you've mentioned some lower procedural volumes. We hear this frequently from a number of the company's management you work with. But for your businesses, can you tease out what's happening on that topic in the U.S. and outside the United States and then in your new reporting structure, which segment is most exposed?

Kieran T. Gallahue

Sure. I think let me start with your last question first. Certainly in Procedural Solutions side of the business would be more impacted by positive or negative changes in procedural volumes over time. That's the nature of the business. One of the reasons why we separated out those businesses because of the nature of how you serve those customers, in a way that the products are used, are very different. On the Medical System side of the business, it tends to be much more about infrastructure of these health systems. And so it's not impacted on any short-term variations in procedural solutions to any great degree. I'll say in the Med Systems there are some impact on the dedicated consumables, as an example so it's not scot free. But it is relative balance, one versus the other. As far as the overall we are seeing how it is impacting, it's more of a soft feel that we get the sense -- we're certainly hearing from our customers. We are in conversation with them on a very regular basis. We are probably feeling a little bit more in the U.S. at this point on the procedural volume side than outside the U.S., that maybe a function of the size of our businesses by the way, and the nature of our businesses because the medical systems portion of our business is much larger OUS than the other parts. So by its nature, it would again suggest that we would feel the impact a little bit more in the U.S. and be more sensitive to it. But that being said, again a couple of points we see overall other than that we continue to drive the businesses that are really more conversion related.

Operator

.

Our next question comes from the line of Kristen Stewart with Deutsche Bank.

Kristen M. Stewart - Deutsche Bank AG, Research Division

I was wondering if you could give any sort of organic growth in the quarter because I know there's some moving parts between on-site and Rowa and some others, just wanted to kind of get that number from you. And then also if you could just give an update on some of the restructuring programs and just kind of where savings or tracking because SG&A just seemed to be a little bit higher this quarter and I know you mentioned effect in Rowa but maybe just an update there would be great.

James F. Hinrichs

Yes, so organic revenue growth in the quarter, if you back out FX which added a little less 1 point, or a little more than 1 point, and you back acquisitions which added right around 1 point ended up being around 2%, 2.3% to be very precise. And so -- and then the second question around SG&A, yes, so Rowa and FX basically was almost all of the growth in operating expenses. We also invested in some of our businesses. We invested in some of the acceptance work and some of the preliminary work that needed to be done in order to drive savings from our simplification initiative. We also invested and are continuing to invest heavily in internal and external resources on creating and starting to implement a growth strategy. That investment involves moving resources into R&D, starting to drive, hopefully, more sales and marketing expenditures on our higher growth products, getting more push behind those products where we actually think there's organic headroom to grow the business. And so we did -- it was, expenses were as I mentioned flat, if you net out, essentially flat, if you net out FX and Rowa, and within that flat expense line, there was quite a bit of investment and quite a bit of shift from what we would describe as the back-office to the front office into areas where I can drive revenue growth, whether it's R&D, sales and marketing, or just preliminary work that's designed to either drive growth or drive savings in future periods. So net-net from my standpoint, it was actually exactly what we had hoped would happen on the operating expense line. I don't know, Kieran, if you have something to add.

Kieran T. Gallahue

I think one of the realities here is that, as we make huge progress within the company, as we move to simplify, as we organize around these new structures, not all that flows into the financial statements right away. A lot of it, some of that work is being done behind the scenes. But I can tell you that we are just moving very quickly. I am very optimistic about the progress that the team is making, the focus that they have on simplifying the business, the focus that they have on trying to drive more assets towards of those areas that can stimulate growth. So it's been, I'd say, a very, very positive period for CareFusion and one that I have all intentions of seeing move through the financial statements, as we move forward.

Kristen M. Stewart - Deutsche Bank AG, Research Division

And the restructuring savings, those are tracking as expected from what you...

James F. Hinrichs

Yes, from last year's plan restructuring savings are basically tracking exactly where we expected.

Kristen M. Stewart - Deutsche Bank AG, Research Division

Okay and the lower CapEx that you're expecting for the year, what was that driven by again?

James F. Hinrichs

Primarily driven by lower expenditures on IT projects, so some of the IT projects that we're working on, some of the capital expenditures has either lowered or recapped as expense. And so that's just driving lower capital expenditures.

Operator

Our next question comes from the line of Thomas Kouchoukos with Stifel Nicolaus.

Katherine Davis - Stifel, Nicolaus & Co., Inc., Research Division

This is Katherine in for Tom. I guess my question was about the Rowa acquisition. So Rowa reported about $70 million to $80 million of revenue last year. Do you foresee any revenue slowdown due to the ongoing economic issues in Europe? And then the second question is, you mentioned last quarter about having a formal plan for what you're going to do with your excess cash. Do you have any plan for the excess cash deployment at this point?

James F. Hinrichs

So first off, with respect to Rowa, as we said I think last call, we would do -- we expected Rowa to do or guiding that Rowa do somewhere between $60 million and $65 million for the 11 months that we have them this year, which is -- does imply a slight slowdown and a level of conservatism in our guidance to anticipate a potential slow down in Europe. So 60 to 65 for the 11 months is what we were guiding to and continue to think will be the reality in that business. With respect to formal plans for use of excess cash, again I go back to what we said last quarter, which is for the moment, we are working -- using excess cash to shore up our balance sheet. We have a goal of improving our credit rating, we see opportunities to invest organically and, also importantly, inorganically, both in the U.S. and outside the U.S. So at this moment I would say no change from what we said last quarter. We continue to use excess cash again to shore up our balance sheet, improve our credit rating, improve our credit ratio and drive organic and inorganic growth.

Carol Cox

Okay. Great. Well, thank you, Melanie. I think Kieran has a couple of words.

Kieran T. Gallahue

Just the final words here. So I just want to thank everybody for joining us on the call today. I want to thank the team members from the CareFusion team members throughout the globe. They've been just outstanding as we go through the exit of Phase I into Phase II and as we simplify the business and as we move towards acceleration of growth, the team has just done an outstanding job, very proud of them. And I look forward to updating you on future calls. And I'd like to add my thanks and best wishes to Carol along with a big welcome to Jim to this new role although he's certainly not new to CareFusion. Thanks, everybody. We look forward to updating you on the next quarter call.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. That does conclude the presentation. You may disconnect. Have a wonderful day.

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