Cardinal Health F4Q07 (Qtr End 6/30/07) Earnings Call Transcript

Aug. 9.07 | About: Cardinal Health (CAH)
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Cardinal Health Inc. (NYSE:CAH)

F4Q07 Earnings Call

August 9, 2007 8:30 am ET

Executives

Bob Reflogal - VP of Investor Relations

Kerry Clark - CEO

Jeff Henderson - CFO

Mark Parrish - CEO of Healthcare Supply Chain Services

Analysts

Lisa Gill - J. P. Morgan

Tom Gallucci - Merrill Lynch

Ross Muken - Deutsche Bank

Larry Marsh - Lehman Brothers

Ricky Goldwasser - UBS

Randall Stanicky - Goldman Sachs

David Veal - Morgan Stanley

Charles Boorady - Citigroup

Steve Halper - Thomas Weisel Partners

Presentation

Operator

Good day ladies and gentlemen, and welcome to the Fourth Quarter 2007 Cardinal Health Incorporated Earnings Call. My name is Katina, and I will be your coordinator for today. At this time, all participants are in listen-only mode. (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 call, Mr. Bob Reflogal, Vice President of Investor Relations. Please proceed.

Bob Reflogal

Thanks Katina. Good morning, everyone and welcome to Cardinal Health fiscal 2007 fourth quarter conference call. I first want to start off by apologizing for the delay. I understand that there has been a problem with individuals getting connected to the call. And we'll try to work through those right at the beginning.

Our remarks today will be focused on the Company's consolidated and business segments results for the quarter and full fiscal year, which are included in the press release and attached financial tables. If any of you have not yet received a copy of our earnings release or the financial attachment, you can access it over the internet at our investor page at www.cardinalhealth.com. Additionally, there are a handful of slides that we will be reviewing which can also be found on the website.

Speaking on our call today will be Kerry Clark, CEO of Cardinal Health and Jeff Henderson, CFO of Cardinal Health. Also participating with us today for Q&A is Mark Parrish, CEO of Healthcare Supply Chain Services. After the formal remarks, we will open up the phone lines for your questions.

As always we ask that you limit yourself to one question at a time. During the course of this call, we may make forward-looking statements. The matters addressed in these statements are subject to risk and uncertainties that could cause actual results to differ materially from those projected or implied. Please see our press release and SEC filing for a description of those risk factors.

In addition, we will reference non-GAAP financial measures. Information about these non-GAAP measures are included at the end of this presentation, and printed on the Cardinal Health Investor page. At this time, I would like to turn the call over to Kerry Clark. Kerry?

Kerry Clark

Good morning everyone. Let me get started by providing my perspective on the quarter and the year. Then Jeff will walk you through the segment details. There are three thoughts I would like to share with you on the business. First, fiscal '07 was a very good year for Cardinal and marked a return to strong growth and a simpler, more focused business model that will provide a foundation for continued growth in the years to come.

Fiscal '07 non-GAAP EPS of $3.42 was up 20% from last year. This is great progress from a decline in EPS in fiscal '05, and single-digit growth in fiscal '06. Let me touch on the highlights.

Last winter, we divested PTS at an excellent price. This enabled the entire company to focus on our healthcare provider customers, and our mission to help make healthcare safer and more productive. Using proceeds from the sale we repurchased an additional $3.1 billion in shares for a total of $4.1 billion in fiscal ’07 and to date. We announced yesterday a two-year $2 billion repurchase authorization. So we are continuing our goal to return around 50% of our operating cash flow to shareholders in the form of share buybacks and dividends.

With the proceeds from the PTS sales we also made a $30 million contribution to the Cardinal Health Foundation, which is used to fund initiatives that are aligned with the company’s mission.

Last year, we also simplified and streamlined our business model for organizing around two sectors, Health Care Supply Chain Services which includes our pharmaceutical and medical products distribution businesses, and Clinical and Medical Products which includes our manufactured technology products. This design allows management of each sector to focus on the unique growth drivers to better serve customers and deliver operational efficiencies. While these two sectors have important differences, they are strategically connected to our common hospital selling organization which leverages our scale. Hospital sales now account for approximately $20 billion in annual sales for Cardinal, and more than 40% of our overall profitability.

Last spring, we acquired VIASYS Healthcare, establishing Cardinal as a leader in the $4 billion respiratory care market. The VIASYS acquisition also broadens our global reach and strengthens Cardinal’s small but growing international business. As you’ll hear later, the integration is going very smoothly. And just recently we've reached agreements to resolve the SEC matter and all other related securities litigation with respect to the company. So, financially and operationally, I believe fiscal '07 was a very good year.

Second, fiscal '07 was the year that our clinical and medical product sector emerged as a significant value creating growth engine for the entire company. This sector houses our clinical technologies and medical products segments and represented more than 25% of total company segment profits. Fiscal '07 revenue for this sector was $4.5 billion, up 11% from last year, and profits were $584 million and increased up 20% from last year. With an expanding profit margin of 13%, this sector will continue to be an important driver of consolidated operating margin growth.

When we look at this sector in Q4, the results are even more impressive, revenue increased 15% to $1.3 billion and profit grew 42% to $202 million. Clinical and medical products have a bright future at Cardinal.

Finally, our Health Care Supply Chain Services sector delivered strong results this year and did so despite the challenges in our medical supply business. This sector houses our pharmaceutical and medical supply segments which, combined, grew revenue nearly 9% to $84 billion and profit 11% to $1.6 billion. This sector is the core of the company and a substantial generator of operating cash flow. Our goal in supply chain services is to create a world-class distribution business and we're heading in that direction.

Regarding Supply Chain Medical we had good turnaround plans in place, and I remain confident that we’ll return to target growth rates in the latter part of fiscal '08.

As I said in our last call, this business is strategic to our broader hospital offerings, and I believe we are on the right path to turn it around. Of course, Supply Chain-Pharma is the core of the sector. In total for fiscal '07 this segment had a strong year with revenue up 9% and segment profit up 14%.We expect revenue growth in fiscal '08 to track with market growth, of course adjusted for our mix of generics and customers.

As we said in June, we expect fiscal '08 segment profits to be at the top end of our 7% to 10% long-term goals. In Q4, segment profit was down 3% primarily related to the timing of several items included in the fourth quarter of last year. This is what we communicated to you four weeks ago, so there is absolutely nothing new here. And we are on track for solid Q1 and to deliver our targets in fiscal '08 for Supply Chain-Pharma.

So, all in all, I am pleased with the progress we have made in the past year, the combination of a world-class distribution sector and a fast growing higher margin clinical and medical product sector, differentiates us from competitors and provides an advantage that will deliver value to customers and shareholders overtime.

And we intend to continue to extend this advantage. For example, in fiscal '08 we anticipate our clinical and medical products sector will account for more than 30% of our profits. Net-net, we are very focused on delivering our long-term growth goals and I believe, we have the right platforms and teams in place to do that again in fiscal '08 and beyond. So, now over to Jeff for details about our segment performance.

Jeff Henderson

Thanks Kerry. Good morning everyone and thanks for joining us. After my comments today, we'll open up the call for your questions. During my formal remarks, I planned to discuss our FY '07 fourth quarter consolidated and segment results. In addition, I will review our fiscal 2007 full year financial performance which, as Kerry mentioned, was very strong as we substantially exceeded our long-term growth targets in many respects.

Finally, I will provide an update on our acquisitions scorecard that now reflects our acquisition of VIASYS, and briefly review our outlook and assumptions for fiscal '08 that I discussed in detail back in June.

Now, let's turn to the fourth quarter results on slide 6. Please note that my comments reflect the financial results from continuing operations on a non-GAAP basis, and reflect the divestiture of our Pharmaceutical Technologies and Services segment. Consolidated revenues were up 5% to $22.3 billion and operating earnings were up 3% to $538 million as strong top and bottom line growth in Clinical Technologies and Services and Medical Products Manufacturing segments were somewhat offset by an expected and previously communicated weaker Q4 compare and our supply chain distribution business.

Net earnings for the quarter were $345 million up 5% of our prior year. And diluted EPS was $0.89 compared to $0.78 last year, up 14%. Operating cash flow for the quarter was negative $292 million due primarily to class-action litigation settlements. And return on equity was 17.3% up about 110 basis points over the same period last year.

Now turning to the next slide, during the quarter special items totaled $118 million or $108 million after tax, which impacted diluted EPS by $0.28, $88 million of the $118 million were merger-related costs, of which $84 million was in process R&D associated with VIASYS acquisition. The remaining $31 million was split between net litigation expenses of $19 million and restructuring costs of approximately $12 million.

The next slide is on impairment charges and other items. During the quarter, impairment charges had a minor net gain of $0.6 million that had negligible impact on diluted EPS. As a reminder, our Q4 FY'06 non-GAAP diluted earnings per share from continuing operations of $0.78, excludes PTS.

Now, I'd like to turn to the performance of the individual business segments. Let us discuss the results in each of our four segments. I want to remind everyone that we are now burdening our segment results including current and prior year with equity compensation expense, which currently has a positive impact on our segment growth rates. In addition, we have reallocated to our remaining segments a portion of corporate overhead expenses that were formally allocated to PTS.

Within Healthcare Supply Chain Services Pharmaceutical, revenue for the fourth quarter increased 4% to $19.6 billion. Pharma distribution direct store-door revenue was up 7%, and revenue from both customers was up.

Key factors impacting year-over-year Q4 revenue include branded engineered conversions, a lapping of large bulk increases in Q4 of '06, and the sale of our specialty business to OTN in the fourth quarter of last year. The negative revenue impact of this divestiture alone versus Q4 of last year was $225 million.

Segment profit was $303 million, a decrease of 3% over the prior year period. As we've discussed during our last earnings and guidance calls, our fourth quarter Supply Chain Pharma performance was impacted by the difficult compare with FY'06. As a reminder, a few of the items from Q4'06 did not reoccur in 2007: our manufacturer price increase and a DSA agreement that benefited from our retroactive fee adjustments. Together these represented approximately $25 million in FY'06.

As mentioned above, last year we still had our specialty distribution business from part of the quarter. This contributed approximately $10 million to '06 earnings. And finally, we benefited from a $7 million LIFO credit a year ago and had none this quarter. All totaled, these account for approximately $40 million of earnings last Q4 that did not reappear again this year.

Looking forward in Q1 of '08, we are expecting pharma profits to return to solid growth. However, as we've always said, quarter-on-quarter variability exists in this business due primarily to the timing of vendor price increases and generic launches.

With those segments, we continue to focus on effective use of capital as an important leverage to improve economic returns. In this regard, one of our biggest drivers -- days of inventory on hand, was down about two days over Q4 of last year.

Despite progress in capital reduction, Supply Chain Pharma's economic profit margin decreased 1 basis point to 78 basis points in the quarter, compared to 79 in the same period last year due to previously discussed lower Q4 profitability. However for the full year, EP margin is up, improving 11 basis points over the prior year to 0.86%, driven by both earnings growth and reductions in tangible capital.

Turning to slide 9, our Healthcare Supply Chain Services Medical segments revenue for the quarter was $1.9 billion, up 5% over the prior year, supported by strong growth in lab, ambulatory and Canadian operations.

Total segment profit for the quarter was $83 million, down 2% over Q4 '06. Profit in the quarter was impacted by operational investments particularly in our customer service processes. And customer-related write-offs increased by $7 million over Q4 of last year. Economic profit margin in Q4 declined 14 basis points over the prior year, to 1.36% due primarily to a decline in segment profit.

Medical Product Manufacturing delivered an outstanding quarter, marking the return to its first half performance that we expected and communicated previously. Revenue increased 14% to $500 million, and segment profit increased 27% to $58 million.

Revenue and profit growth was driven by strong demand across most businesses, including demand for new products and gloves, respiratory and surgical instruments. The recent acquisition of VIASYS also played a role in driving sales, adding approximately 3 percentage points to top line growth.

Profit margin expansion in the segment was driven by a shift in mix to higher margin products. Improved sourcing and many manufacturing cost reductions was somewhat offset by costs associated with the VIASYS acquisition. Unlike the revenue benefits, VIASYS had a negligible impact on MPM segment profits due to the limited time it was in our books and the impact of purchase accounting adjustments.

Moving on to slide 11. Clinical technologies and services had an excellent quarter as well. Segment revenue was $756 million, up 17% over the prior year Q4, and segment profit was a $144 million, up 50% compared to the prior year. Several factors led to the exceptional quarter delivered by PTS. First, at the beginning of the fiscal year, we added approximately 100 people to our installation teams. They are now fully trained and contributed meaningfully to the exceptional quarter. At the same time, demand for Alaris and Pyxis products is very strong; as we've seen with prior investments in innovation, quality and customer service is paying off.

PTS has delivered double-digit earnings growth in seven of its last eight quarters, and the future looks very strong as well. Pyxis ended the year with 40% year-over-year growth since backlog, and 36% growth in Q4 committed contracts. The May contracts for Alaris were up as well with a 19% year-over-year increase; a clear sign that the business is extending its leading position.

In addition to the strong top-line performance I've just discussed, business delivered substantial segment profit margin expansion reflecting improved gross margins from product sales mix, operational excellence initiatives and focused efforts on cost control. Now let’s turn to the fiscal 2007 full year results.

Again, please note that my comments will reflect the financial results from continuing operations on a non-GAAP basis. And the historical numbers reflected divestiture of our PTS segment.

Consolidated revenues were up 9% to $86.9 billion, and operating earnings were up 12% to $2.2 billion reflecting strong demand and profitability in our Supply Chain Pharma, Clinical Technologies and Medical Product segments. For instance, continuing operations for the year were 1.4 billion, up 13% over prior year. Diluted EPS for the year was $3.42 compared to $2.86 last year, up 20%.

As we said in the June guidance call, the PTS related share buyback had a positive impact of approximately $0.08 per share on earnings, improving growth for the year by approximately 3 percentage points. As you can see, even without the PTS impact Cardinal performed exceptionally well in fiscal '07.

Let me provide for the quarter. On slide 13, I wanted to discuss the specific items that had an impact on current and prior year operating results and earnings per shares. First, let me quickly review the special items. During the year, special items totaled $772 million, $529 million after tax impacting dilutive EPS a $1.31 per share versus $0.14 a share in fiscal 2006. $613 million of this was litigation related costs which we discussed at length during our third quarter earnings conference call. Impairment charges and others were $17 million and reduced EPS by $0.04 per share for FY ‘07 versus $6 million and $0.01 per share in FY ’06.

Now let’s turn to the non-recurring other items. There were no non-recurring other items for Fiscal ’07. For fiscal ’06 these items totaled $26 million for the year and impacted EPS by $0.04 per share. Just to remind you, the $26 million charge in '06 related to a vendor credit adjustment within our HSCS Pharmaceutical segment.

As I indicated at the beginning of FY '07, we were not planning on labeling these types of items as non-recurring anymore. We will simply absorb them in the business regardless where they impact us, positive or negative unnecessary of something truly extraordinary we need to call out. As such we don't expect to be calling this out in future earnings calls.

On slide 14, I want to take a few minutes to discuss our FY '07 segment performance. In short, three of four segments delivered outstanding results in fiscal '07. HSCS Pharmaceutical delivered revenue growth toward the top end of our long-term guidance range at 9%, and segment profit growth of 14% significantly exceeding profit growth targets. This was driven by increased generic margins, strong branded buy-side margins from those DSA fees, and pharmaceutical price appreciation and focus cost control.

HSCS Medical was in line with a bottom end of revenue growth targets that delivered relatively flat profit growth for many of the same reasons that we said previously.

Moving on to Medical Product Manufacturing, by any measure MPM performed exceptionally well in fiscal '07, delivering both revenue and profit growth well above imagined FY '07 targets. The strong demand for new and existing products and the inclusion of recently acquired VIASYS Healthcare, MPM is poised to have another breakout year in 2008.

Despite being hindered by product launch delays and a recall charge in Q1, Clinical Technologies and Services turned in a strong performance for remaining three quarters to deliver revenue growth in line the long-term goals. In addition, profit growth was at the top end of the segment’s previous 15% to 20% growth goals, reflecting continued and strong demand for Alaris and Pyxis products. The impact of new product launches and focused cost control.

A few things shouldn't be lost in segment-by-segment review. First, as expected, PTS and MPM have emerged as significant growth engines for Cardinal. Second is the fact that Cardinal Health [leaving] an outstanding fiscal 2007 with non-GAAP EPS growing 20% versus prior year unless with only three of four segments delivering strong performance.

Slide number 15 is our acquisition scorecard. Here is listed our acquisitions over the past three years or so. When we look at many factors and reduced analysis, our primary measure is the actual economic profit delivery and forecasted versus our expectations at the time of the acquisition. We do this for a three-year period after deals are closed. I am happy to report that since this is during the new acquisition integration process that we developed with our earlier purchase, all acquisitions have received in a passing grade.

Please note that VIASYS has been added to this list since last quarter. I'd like to provide you with some details of the acquisition, as I am sure you have a few questions surrounding the impact of purchase accounting and how the integration is progressing.

In respect to the accounting for Q1, we expect little or no profit impact from VIASYS. This is due to the purchase accounting associated with acquisition. Key elements impacting Q1 profits include inventory and deferred revenue adjustments. Also for the full year and going forward we are expecting amortization of intangibles to be approximately $35 million annually.

In respect to the integration itself, we now have a number of teams working full time and making integration as success including the corporate integration playbook we developed during the Alaris integration.

Specific plans for the integration of devices corporate office function and share services are already well into implementation. At the same time, plans for country-by-county go-to market strategies and manufacturing facility optimizations are being put in place. The VIASYS U.S. sales team is joining our national sales this week to commence the process of integration into our sales operations. Bottom line, we are well on our way to delivering the first year synergies and more. We'll be sure to give you our progress in this important area with you quarterly going forward.

Moving on to our FY'08 financial targets and goals. On slide 16, I’d like briefly to remind everyone of our 2008 performance targets. We originally provided outlook on June 27, which is exactly the same as I've provided in this slide. In FY08, we continue to expect diluted non-GAAP EPS from continuing operations to between 95 to 415 per share, which represents an EPS growth range of 15% to 20% for the fiscal year.

Turning briefly to the segments. As briefly discussed, we are expecting good performance from HSCS Pharma segment with profits at the top end of our long-term growth goals. In particular, we expect Q1 to be a return to solid profit growth, but I expect the overall profitability growth in this segment will be weighted to the second half.

As you all well aware, during the midst of turning around the performance of our HSCS Medical segment, overall we expect flat profit for the year, with performance improvements and profit growth expected in the latter half of fiscal '08. I will discuss in more detail later, but as a reminder for fiscal '08, we have refined the overhead allocation methodology within HSCS. This change negatively impacted our Supply Chain Medical segment growth by approximately 7 percentage points.

Moving to CTS, as we've discussed during our June guidance call, we've increased our three-year performance goals for segment profitability from 15% to 20%, to 20% to 25%. And we expect FY'08 performance to be in line with these targets. There is clear momentum in the business with benchmark performances being delivered across the segment.

For MPM, you may recall that we substantially increased our three-year performance goals during our guidance calls as well. Revenue goals are raised from 6% to 8%, to 8% to 12%, and our segment profit goals increased from 10% to 12%, to 25% to 30%. Again, this not only reflects the impact of VIASYS acquisition, but also reflects the strong demand within our existing Medical Products Manufacturing segment, and our expectations for improved profit margins.

As I stated earlier, VIASYS will have little-to-no profit impact on Q1 '08 due to purchased accounting, but it will have a positive impact in the second half due, and part told, for the large plan synergies we're expecting.

Overall, we view FY'08 to be a strong year for Cardinal, and continuing our momentum for outstanding future performance. We believed we have a platform for strong sustainable growth; we're the best in class healthcare distribution company. It is differentiated by the size and growth potential of our Clinical and Medical Products businesses.

In that regard, we expect our CMP sector to be more than 30% of operating earnings next year, and a well on its way to 35% to 40% of operating earnings by 2010. And we're not finished; we're developing plans to building on this performance trajectory.

Turning to slide 17, I'd like to wrap up our love for FY'08, now that being you on some of our underlying assumptions around performance. As of mid July, we completed our $4.1 billion share repurchase -- I think purchased $1.6 billion in the fourth quarter, and completing the remainder in the first two weeks of Q1.

Also, our board just authorized an additional $2 billion in share repurchase that we expect to execute on over the next two years. Those repurchases combined with our expectation for the impact of option testing and exercises, result in our forecast for average shares outstanding during FY'08 to be in the range of $375 million.

Other performance drivers to fiscal 2008 include SCC and related litigation settlements which were incurred in FY'07, but have a negative impact on this year's interest expense for at least $0.05 per share. In total, we expect interest to be in the range of $220 million to $235 million.

We have an expected non-GAAP effective tax rate in the range of 31.75% to 32%. And finally, once again refinement for our methodology for allocating corporate costs in FY'08 that we discussed during our June guidance call, reflected in the FY ‘08 numbers. As a reminder, last year Cardinal started fully burdening its segments with cooperate costs to get a truer picture of performance, but at the same time we moved to our new reporting segments structure. But this is a big step forward, we improved what we needed to better reflect the changes to our structure and to reflect actual resource consumption based on our year’s worth of experience performing for FY ’08, and improved our allocations between Cardinal’s two distribution segments HSCS Parma and Medical.

As previously discussed, this will cost on year-and-year comparability challenges within HSCS and we will openly discuss throughout the year so that every one of us is aware when assessing Cardinal’s performance. For FY’08 the refinements to corporate allocations should positively impact HSCS Pharma’s profit growth by approximately 1.8 percentage points, and will impact HSCS' medical profit growth by approximately 7.3 percentage points. With that I complete the formal remarks, and I should thank everyone for their time this morning and open up the call for your questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question will come from the line of Lisa Gill representing J. P. Morgan. Please proceed.

Lisa Gill - J. P. Morgan

Hi. Good morning, Jeff, could you just talk about the cast flow in the quarter and maybe just give us a little color around the accrued liabilities and them coming down by so much? And then secondly, Kerry could you just talk to us a little bit about your acquisition strategy going forward, should we be looking for other tuck-in acquisitions like VIASYS? Should we be looking for you to make larger acquisitions as you potentially grow out your international presence? If you could just give us some path would be great.

Jeff Henderson

Good morning, Lisa and thanks for the questions. This is Jeff. Really the answer to both of your questions is effectively the same -- that our operating cash flow in Q4 was distorted by the substantial litigation related payments that were largely booked in Q3, but went into escrow in Q4 and as a reminder, for our litigation class action settlement we reserved $600 million at the end of Q3, and that flowed up the door in Q4. So that was the primary driver taking over the relatively normal operating cash flow period and driving it to the tune of $200 million negative plus.

The answer to your accrued liabilities question is also the same as we established the reserve at the end of Q3 for that SEC settlement, and once we made the payment, obviously that accrued liability reduced in the range of $600 million.

Lisa Gill - J. P. Morgan

Okay. Great and then, this is a follow up to that, can you just tell us where you are with the class actions lawsuit at this point? Is there any update?

Jeff Henderson

We really can't comment on that. As we have indicated previously we’ve reached an agreement with the plaintiffs in this regard, but it’s still subject to final approval by the court.

Lisa Gill - J. P. Morgan

Okay.

Jeff Henderson

Kerry?

Kerry Clark

Lisa. Hi, good morning. Just talking about the general level of acquisitions and tuck-ins, first of all, we would never have suggested that VIASYS was a tuck-in acquisition. It’s an important acquisition for us, and we are focused very, very much on making sure that we deliver our goals. Yesterday we announced a $2 billion share buyback program, over the next two years, and I think that gives you a lot of visibility on how we are thinking about our priorities. First of all, we do think right now our share is a very good investment value, and so we are going to be using a fair amount of our cash to repurchase shares as it becomes available through out the course of the year, however, we do reserve each year a portion of money for tuck-in acquisitions. We also have a budget for that this year, and we do have few small things in the pipeline as sort of fit into our larger plans, but I think that going forward over the foreseeable future our strategy is to take maybe the 20% to 25% of our operating cash flow for tuck-in acquisitions, but the rest that we are going to be focus on making VIASYS work and using the opportunities that present themselves in the coming months to buy back our shares.

Lisa Gill - J. P. Morgan

Right. Thanks for the detail.

Bob Reflogal

Next question.

Operator

Your next question will come from the line of Tom Gallucci representing Merrill Lynch. Please proceed.

Tom Gallucci - Merrill Lynch

Thank you. First, just a quick one on -- I want to confirm the $0.05 impact from charitable contributions is not excluded from the EPS number that you talked about Jeff?

Jeff Henderson

That's correct Tom.

Tom Gallucci - Merrill Lynch

Okay. And then, I guess, looking more closely at the segments, CTS clearly had a very good quarter but as I'm looking at the numbers it would seem that you are not considering the fourth quarter a run rate for next year, as I think about the target that you set for that segment next year fiscal '08. So, is there something unique to happen in the quarter that isn't going to continue or am I looking at it incorrectly?

Jeff Henderson

Thanks Tom for the question. Yeah regarding CTS first of all, I would agree with you that they had a very strong Q4, and I do want to point out that there were no significant one timers in Q4 that drove up the earnings. However, I would say that I think we saw perhaps the impact of the installation team is allowing us to deliver on some pent-up demand, some pent-up committed contracts and perhaps give more installed and recognize more revenue than we would normally see in a more average quarter. So, I would say Q4 was a bit of an exception in that regard, again a large product just to the success for installation teams but I think our guidance for FY '08 still stands based on what we see right now.

Tom Gallucci - Merrill Lynch

Okay, that's good. Thank you very much.

Jeff Henderson

Welcome.

Operator

Your next question will come from the line of Ross Muken, representing Deutsche Bank. Please proceed.

Ross Muken - Deutsche Bank

Hi, good morning gentlemen. As we listened to the call today, there was obviously a clear focus on your hospital facing businesses and you talked about how you're now leveraging the three platforms really as one within the hospital to really be able to drive some additional gains -- they are need to businesses and leverage the scale. Can you talk a bit about what's changed over the last 12 months? And then, also with the addition of VIASYS, I understand from a product perspective what it brings the portfolio but strategically can you also comment about how that really strengthens a few areas, specifically like international and your R&D efforts those hospital facing businesses?

Kerry Clark

Hi Ross, good morning it's Kerry. I'll just talk a little bit about that and maybe Jeff will add some thoughts as well. I think first of all what's really happened over the last 12 months was effective of October of this fiscal year, we completed the integration of our multiple hospital selling organizations into the single integrated selling organization, and that was rolled out effectively October 1st and so we've had a few months without under or about and we've learned how to make it better and over the coming months we will be rolling out some additional improvements and that's how we do that. What it is really allowing us to do is with our full range of products, it allows us to be a very large -- about the largest suppliers that hospitals are interfacing with, it is allowing us access to top level executives, because of the portfolio of our products, and we're able to create longer, more complete deals with our hospital customers and we've closed a couple of those fairly recently that we think really is the advantage of going to market as one customer.

And I think it also gives a lift in some ways to our capital equipments businesses, because again we become part of a more complete offering to our customer. So, what we're seeing is the scale of our business allows us to work directly with senior executives in hospitals to create broader and more comprehensive longer and secure deals with our hospital customers.

VIASYS is another advantage here. In fact, this type of sound organization will be an advantage for VIASYS, because again it will able to come in under the complete Cardinal umbrella with our customers. So, in the U.S. it's going to be a big factor for us.

Internationally, VIASYS is perhaps even more important because externally, outside the U.S., I would say relatively speaking Alaris is a bigger part of our business than our MedSurg component. So, VIASYS is a big part of it, I think to give you some perspective today, VIASYS is at 40% of the sales outside of the U.S., but Alaris for example has 30%. So, we have actually an opportunity globally that VIASYS' international footprint would be an aid to our existing growing international business.

Jeff Henderson

We just build on current accounts with a couple of specific examples that come to mind there, and I think provide even more tangible evidence of progress we are seeing with the hospital customers. So, first of all, our Integrated Medical Solutions which really have just gotten off the ground over the past year or so are exceeding all of our sales targets, and really that demonstrates the power or bringing all of our offerings together through one sales force with our key customers. That can be an example or given an international one in Canada which I know very well because it reports to me operationally, but we traditionally had a very strong hospital MedSurg distribution operation in Canada.

But clearly it’s been over the past nine months that we've brought our three businesses together in Canada and that's allowed us really to go to the hospitals where we already had a strong relationship with the C-suite due to our Source Medical distribution business, and leverage that strength to begin winning contracts for CTS products, which quite honestly in the past were dramatically under representing Canada.

So, already we're seeing a significant benefit of bringing those groups together, leveraging our presence in the hospital and then seeing real tangible results coming out of it. Next question please.

Operator

Your next question will come from the line of Larry Marsh, representing Lehman Brothers. Please proceed.

Larry Marsh - Lehman Brothers

Thanks, and good morning to Jeff and Kerry. Thanks for the clarity. First question really -- and a question to clarification, first on drug, to just secure you are communicating -- you see your business growing top line at market adjusted for mix. Should we assume that your mix helps you in that top line as you've already guided or not? And along with that, as you think about that business over the next year or so, how much visibility do you have around top line of margins, given with coming into an election year? The publication of AMP, and this big drop off of anemia product sales, does that give you sort of that variability, or do you feel like your business gives you a great visibility in spite of all that?

Kerry Clark

Well, I think first of all, in terms of top line growth since our business mix is more weighted to some of the larger retail drug chains, and these companies growing at a slightly faster rate, it tends to give us a bit of advantage on top line revenue versus overall market trends. So, we see it as a slight upper versus general market growth dynamics.

Looking down the road over the next 12 months, we try to get a real sense of what we think topline revenue growth is going to be in the market, and both our internal look and tapping as many as external people as we can. And we'll really see probably over the next 12 months market growth in Rx of around 6%.

So that’s sort of what we have been baking into our numbers, and so our customer mix we should be a little bit faster growth than that but not much. So, but we will get a little bit up on that. So, in terms of operating margins going forward, we have a lot of initiatives under way, and our view is we should be able to keep our operating margins really stable to slightly up on the year, and that's the basis of how we are going forward. Maybe Mark will add a little bit more perspective.

Mark Parrish

Yes. Thanks Kerry. Maybe just to comment specifically, Larry, on your point about elections and AMP and anemia drugs and what impacts those might have on the business going forward, the elections are something that we certainly look at very carefully. We've -- actually last election cycle spent a great deal of time studying what happens with the branded manufactures, and there is really no clear pattern that’s emerged over the last four or five elections cycles. In fact last election cycle we didn’t see much change in behavior at all from the branded manufacturers. And right now we are projecting that branded manufactures will behave consistent with the way they have behaved over the last few years.

AMP is a different situation; I think it’s very fluid, certainly the rule is out and we have a good visibility of what that rule looks like, but there are also pieces of legislation that are moving both within the house and the Senate that seem to have an impact on it. So, I think it's too early to call any type of impact on the business. We, frankly, are not directly impacted by AMP, in a way it would be played out in the market place. And there are factors such as the dispensing rates that the stores may receive from the states, that have to be considered as well and a number of unknowns. We obviously watch it carefully. We will continue to watch it carefully. We’ll continue to be involved in the legislative process and the regulatory process in the common period here. But at this time we don’t project any negative impact.

Finally, the Anemia drugs are certainly an issue in the market place. They are not a huge issue for us at this particular time, and we haven't had the exposure to that situation that some of our competitors have.

Larry Marsh - Lehman Brothers

Okay. And just, thank you, a clarification here for Jeff. Jeff, moving back into June you kind of guided the interest expense to about $220 million this year, and I think you are saying now $220 to $235 interest in other. I just want to make sure, would you be including in other or are you just kind of giving it at the same range or growing that a little bit?

Jeff Henderson

Well, Larry it is giving us the same range of broadening it out, nothing unusual has been added since lastly we spoke.

Larry Marsh - Lehman Brothers

Okay. Alright, great. Thank you.

Bob Reflogal

Thanks, Larry. Next question?

Operator

Your next question will come from the line of Ricky Goldwasser representing UBS. Please proceed.

Ricky Goldwasser - UBS

Hi, good morning.

Jeff Henderson

Good morning.

Kerry Clark

Good morning.

Ricky Goldwasser - UBS

First a question on the drug distribution business, when you look at the June quarter, can you quantify for us what percent of the profit decline was from lack of investment buying or inflation opportunities versus some lower prices in generic? And then, if you look ahead into fiscal year '08, you are talking about a very strong first quarter with pharma profits expected to return to strong earnings growth. Does this reflect better inflation on the impairment side that you’ve already seen in the quarter? And if so, is this ahead of kind of a few initiatives with patients, or are you just getting back with your loss in the June quarter?

Jeff Henderson

Okay, Ricky, this is Jeff, thanks for the question and good morning. And let me start with that and if Mark wants to add anything by all means he can jump in. Regarding your question on the impact on Q4, we had a significant price increase from our major vendor in Q4 of '06, which didn't replicate itself in Q4 of this year. That was worth about $15 million worth of earnings for the year on that specific issue. Now, when you look forward into FY '08, we make certain projections regarding when the price increases are going to happen for the year, I would say several of them had at least partially happened in Q1 thus far, so we have seen generally to be on track for Q1. One of those quite awfully was the one that didn't happen in Q4 that got delayed into Q1. So, do we have perfect visibility? No, it's always a certain amount of uncertainty regarding exactly when and which quarter they are going to happen but we have to make our best estimates for that, and generally over the course of the year they even out, just results in some quarterly work though volatility over the course of the year.

Ricky Goldwasser - UBS

Now, is the $15 million that you are talking about in Q4 '06, is this kind of the number that we should think about for 1Q '08?

Jeff Henderson

Yeah, I don't want to get that specific Ricky, that was one specific vendor. I'd say in Q1 there have been a couple of increases, but price increases happen in different ways, sometimes it's the whole portfolio, sometimes it's the portion of the portfolio, so I wouldn't wanted to get too specific and plus the quarter is not over yet so it still remains to be seen what actually will materialize.

Bob Reflogal

Thanks Ricky, next question.

Operator

The next question will come from the line of Randall Stanicky representing Goldman Sachs, please proceed.

Randall Stanicky - Goldman Sachs

Great. Thanks for the question and I apologies if I missed it, did you talk about the One Cardinal Health program and some of the cost savings and reinvestments of those cost savings, more of that today?

Jeff Henderson

No, we haven't talked about it but it's a great question, as I indicated actually back in the November call, I can reiterate what I said there because we're still very much on track towards our ultimate goal of realizing $500 million of run rate sitting versus FY '04 by FY '08. Now, I will mention, if I’m aware of that, about 35% or so of those savings were attributed to PTS and obviously now with the sale of PTS those savings, we're sold over the businesses well. Now, the good news is, I believe we've got the benefit of those savings when we sold the business and I think that's one of the reasons we were able to get the attractive price we did, but if you back out that amount and look at so the remaining portion for remaining businesses we're still very much on track to achieve effectively 53% of that $500 million. In FY '07, we realized about 75% of that total, so you could say there is still an incremental 25% to go in FY '08.

Regarding your question about reinvesting it, I've indicated in the past that we'll plan to invest -- reinvest about 20% to 30% of the savings, I would say 25% is a good number that we've been putting back in the business, and we'll continue to put back in the business primarily for things like new products, R&D and new services that we're developing, and obliviously the benefit from more in Cardinal Health, not only -- partially flow to the bottom line, but it provided us the opportunity to make very solid investment for a longer term health of the company as well.

Kerry Clark

Thanks Randall.

Randall Stanicky - Goldman Sachs

Thanks.

Bob Reflogal

Next question?

Operator

Your next question will come from the line of David Veal, representing Morgan Stanley. Please proceed.

David Veal - Morgan Stanley

Great. Thanks, and good morning. Just with respect to the drug distribution business, we look at the bulk business, until about two quarters ago that business was growing at 20% plus, and this quarter came in around 4% which is the weakest you've seen in a number of years. Could you discuss what is maybe driving that trend, and how you're thinking about the growth rates of the two different buckets in fiscal '08?

Mark Parrish

Yeah, thanks for the question. This is Mark. The specific activity in bulk business -- and I think we've share this really consistently over the course of the years, that we had a large win from one of our major customers in bulk area last year, and this was the quarter that finally lapped that win. And we expect the bulk business to approach a more normal growth during the course of year, again adjusted for the costumer mix that’s buying the bulk products from us. But we're not surprised by the result, we expected this, and there was a slight, maybe a little bit less bulk business, I would say in Q4 than we expected only because of a timing issue with one of the our bulk customers as we did pick up some additional bulk business from one of the -- small amount that will help our growth rate, but that did materialize in Q1. So we’re very bullish about the bulk sector, it's a good business for us. It's not a high margin business at the gross margin line, but it’s a good operating margin and very good use of capital for us.

David Veal - Morgan Stanley

So you more or less expect those two -- the two segments to grow roughly in line with each other?

Mark Parrish

No, roughly in line with market as we've indicated, yes.

David Veal - Morgan Stanley

Thank you.

Bob Reflogal

Thanks David. Next question?

Operator

Your next question come line of Charles Boorady, representing Citigroup. Please proceed.

Charles Boorady - Citigroup

Thanks, good morning. My first question is just sort of housekeeping on the interest expense and other line of $19 million. About how much of that was from investment income versus interest expense versus other, if you can break it down into those three?

Jeff Henderson

Yes, we generally don’t break out that sort of detail. I do want to comment on the Q4 number though, because you look at that number, and then you compare it to the total FY '08 forecast that we are looking at, and it's hard to correlate it to. But I just want to remind people of a couple of very unique things that happened during Q4. First of all, at the very beginning of the quarter, we received about $3.1 billion of cash related to the PTS divestiture. And over the course of that quarter, we had that cash basically earning interest income on it, as we were doing our share repurchase over the course of the three months. But certainly we had the benefit of that cash for a good chunk of that period.

The other thing -- significant thing that happened towards the end of the quarter is that we had two large cash outlays, the $1.5 billion or so provides us, and the $600 million related -- is going into escrow related to the class action settlement. So, that cash came on the door at the end of the quarter, and obviously impacts both our debt position and our cash position heading in to FY '08. So, I would say for those reasons Q4 was a bit of an anomaly, and FY '08 really reflects, I would say more constant levels of cash and debt that we are expecting to maintain the company.

Charles Boorady - Citigroup

Thanks, that was helpful. And my second question is just on the pharma segment. You mentioned 6% market growth expectations and that your revenue growth expectations assume reasonably that you'll gain some market share as well. And I'm just wondering if you could breakout the pricing versus volume component of that 6% or your 7 to 10 expectations and how have expirations impacted that in terms of potentially lowering the unit price component, and maybe having an impact on the volume side as well?

Kerry Clark

Yeah. Thanks Charles, just kind of a correction to the comment as to our growth rate. We do not expect to be picking up market share as a result of that growth rate. What we say is we think the market is going to grow about 6%, and we believe it will be based upon our mix of customers, the customers that we have today, we might be - we expect rather to be slightly above that.

So, the issue is not a question of taking share in the market place. It’s a question of the relative growth rates of our customers in the segments that they operate within. Relative to pricing versus volume, I prefer not to talk directly to that, but what I can tell you relative to patent expiration and so forth is that we are watching very closely the schedule of patent expiration; that is a fairly public piece of information that most of you also take a look at.

And then what you can see during the course of the year is that for the balance of this calendar year the scheduled patent expirations are fairly modest compared to what will come out in the first six months of calendar year '08. So, I think from a patent expiration standpoint you can assume that in our expectations that we are looking to the second half of the year and I think Jeff referred to that earlier. The second half of the year is to be a more active year for patent expirations.

Bob Reflogal

Thanks, Charles. Operator, we have time for one more question.

Operator

Thank you. Your final question will come from the line of Steve Halper representing Thomas Weisel Partners. Please proceed.

Steve Halper - Thomas Weisel Partners

Hi, good morning. You talked about 40% pick up in backlog at Pyxis, could you put that into perspective and what it’s been doing the last several quarters?

Jeff Henderson

Thanks Steve for the question. I don’t like giving specific numbers, but I would say we've -- Q4 was an exceptionally large pickup, and to a large part to the end of the -- so hospital buying period typically we see large capital expenses in Q4. That all said, I would say backlogs to our most of FY’07 was strong and building momentum as we went out through the year and heading into FY ‘08.

Steve Halper - Thomas Weisel Partners

Great. Thank you.

Jeff Henderson

I also want to make one final comment that relates to Cardinal Health because, you know, I was asked the question earlier about the cost savings. The other thing I want to mention related to Cardinal Health which is very important is the platform that it has given us now as we make acquisitions like VIASYS, to basically plug the new company into an established platform in a company. One other reason we are able to feel confident about the synergies is that we can get from VIASYS like acquisition is that we can take their existing corporate functions and share services and sales force, should that matter. I really would have plugged them into an integrated well-functioning operating structure. We didn’t really have that opportunity in the past. So, in addition to the real time savings it is giving us, it is also providing substantial opportunity for value creation in the future as we look at the VIASYS of the world, and other smaller tuck-in acquisitions that we have done.

Bob Reflogal

That concludes our conference today. Thanks everyone for your participation.

Jeff Henderson

Thank you.

Bob Reflogal

Operator?

Operator

Ladies and gentleman, on behalf Cardinal Health Incorporated, thank you for your participation in today's conference. This concludes your presentation. You may now disconnect. Good day.

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