FINAL TRANSCRIPT
CCBN StreetEvents Conference Call Transcript
CAH - Q4 2003 Cardinal Health, Inc. Earnings Conference Call
Event Date/Time: Jul. 31. 2003 / 11:00AM ET
Event Duration: 1 hr 6 min
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CAH - Q4 2003 Cardinal Health, Inc. Earnings Conference Call
CORPORATE PARTICIPANTS
PRESENTATION
Stephen Fischbach
Cardinal Health, Inc - Vice President Investor Relations
Richard Miller
Cardinal Health Inc - CFO, EVP, Principal Accounting Officer
Operator
Robert Walter
Cardinal Health, Inc. - Chairman, CEO
Please stand by. The Cardinal teleconference will begin shortly.
Good morning. My name is Matthew and I will be the conference
facilitator today. At this time I would like to welcome everyone to
the Cardinal Health fiscal 2003 year end earnings results
conference call. All lines have been place on mute to prevent
background noise. After the speaker's remarks there will be a
question and answer period. If you would like to ask a question,
press star and the number one on your key pad. If you would like
to withdraw, press the pound key. Thank you. I would like to turn
over to Mr. Stephen Fischbach, Vice President Investor Relations.
Sir, you may begin.
CONFERENCE CALL PARTICIPANTS
Raymond Falci
Bear Stearns
Larry Marsh
Lehman Brothers
Tom Gallucci
Merrill Lynch
Chris McFadden
Goldman Sachs
Stephen Fischbach - Cardinal Health, Inc - Vice President
Investor Relations
Michael Fitzgibbons
Morgan Stanley
Thank you. Good morning and welcome. Today we will discuss
Cardinal Health's fiscal 2004 fourth quarter and full fiscal year
results, I'm sorry, 2003. A portion of our remarks will be focused
on the business segment attachment of our earnings release. If you
have not received a copy, you may access it over the internet at our
investor page at www.cardinal.com.
Sean Harrington
Banc of America Securities
Steve Halper
Speaking on our call today will be Bob Walter, Chairman and
Chief Executive Officer and Dick Miller, Executive Vice President
and Chief Financial Officer. After the formal remarks, we will
open the phone lines for your conversations and we always ask that
you limit yourself to one question at a time. Before we begin,
please remember that today's call may include forward-looking
statements which are subject to risk and uncertainties which could
cause actually results to differ materially from those projected on
slide. The most significant of those uncertainties are described in
Cardinal form 10-K and form 10-Q reports and exhibits to those
reports.
Cardinal undertakes no obligation to update or revise and forwardlooking statements. In addition, statements made on the call may
include adjusted financial measures governed by Regulation G. For
a reconciliation of these measures please visit the investor relations
page at www.cardinal.com. At this time I will turn over to Dick
Miller for discussion of the Financials, and then Bob will provide
his comments on the quarter and outlook for fiscal 2004. Dick?
Richard Miller - Cardinal Health Inc - CFO, EVP, Principal
Accounting Officer
Thanks, Steve. Good morning. As expected, Cardinal Health's 4th
quarter financial results capped off the year that delivered on the
financial commitment that we made to our shareholders at the
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CAH - Q4 2003 Cardinal Health, Inc. Earnings Conference Call
beginning of the year. Strong revenue growth across all of our
business segments drove continued expansion and operating
earnings.
Our focus on productivity and leveraging the capital requirements
of our businesses yielded record levels of cash flow and returns on
committed capital and equity. The powerful diversity of our
portfolio, Complimentary Healthcare Businesses, clearly
demonstrated their composite value 4th quarter's financial results.
All in all, it was a great quarter to top off a great fiscal year.
You've received the detailed financial information distributed with
the press release, so let me start with some overall comments on
our consolidated performance and I'll add a few highlights from
each of the business segments. Let's first look at our consolidated
financial model for the 4th quarter. 15 percent revenue growth
drove return on sales to 4.62 percent, and that's a new growth
quarter record, with solid contributions delivered from all of our
segments.
Our disciplined operational and financial execution, combined with
capital productivity to generate record returns on committed capital
in each of our four segments with consolidated returns on
committed capital reaching an all-time record of 38.4 percent
during the quarter. As we have been discussing throughout the
year, the combination of strong earnings and capital efficiency
continue to generate significant operating cash flow during the 4th
quarter, bringing us to $1.4 billion for the full fiscal year. As part
of our ongoing program to redeploy low return capital, we sold
another $156 million of - leases this quarter, bringing our total
leases sales for the year to $356 million. The net impact of our
lease sale program on fiscal 2004 cash flow was to increase
operating cash flow by about $300 million. Therefore, for the fiscal
year, we generated approximately $1.1 billion of operating cash
flow exclusive of the - lease sales.
And that exceeds our guidance of $900 million to $1 billion dollars
for the year. Importantly, that $1.1 billion represents 78 percent of
our net earnings for the year. This is a strong testament to the
quality of our earnings. Our focus on capital productivity
continued to drive dramatic reductions in interest costs, providing
earnings leverage during the quarter. Strong cash flow led to lower
average net borrowing, which coupled with lower interest rates to
yielding 11 percent reduction in overall cost versus the prior year.
This capital productivity can be further illustrated by the 4th
quarter record, low net debt to total capital of just 11 percent,
which is particularly impressive in light of our share repurchase
activity throughout the fiscal year. This gives us significant
capacity and flexibility as we consider future investments and
initiatives. Despite being at record low net debt levels, we continue
to deliver strong returns on equity, and in the 4th quarter at a
healthy 21.5 percent and the fiscal year at 21.1 percent, which is a
60 basis point improvement from the prior fiscal year. We ended
fiscal 2003 with a record $1.7 billion in cash on our balance sheet.
This cash position was created from the combination of our strong
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cash flow for the year and the fact that we elected to
opportunistically issue $500 million of medium term debt in the
4th quarter. Obviously, we didn't need the $500 million
immediately, but felt it was prudent to take advantage of very
favorable market conditions.
While this debt carries an already low four percent coupon, our
decision to swap back to even lower short-term rates will allow us
to retain this opportunistic capital with an insignificant carrying
cost until it is deployed. Now, let me comment on just a few
matters of importance in our various operating segments,
beginning with the Pharmaceutical Distribution and Provider
Services segment. Strong revenue growth of 14 percent was driven
by 42 percent growth from alternate site customers and 11 percent
growth from chain customers during the 4th quarter. Incremental
revenue from previously announced new customer wins had a
positive impact during the quarter and served to offset the expected
dampening effect of a slow down in our wholesaler-to-wholesaler
trading revenues, which had a one percent negative impact on our
overall revenue growth rate. A - charge of $ 5.7 million was
recorded during the 4th quarter, versus a $2.3 million credit
recorded in the prior year period.
The current year's charge primarily resulted from some unusual
price activity experienced in generic inventories this fiscal year.
Excluding the impact, operating earnings to the Pharmaceutical
Distribution and Provider Services segment could have grown 14
percent during the 4th quarter, and 15 percent for the full fiscal
year. As you may recall, the financial results for the 4th quarter in
the prior fiscal year included charges totaling about $28 million
which was primarily for inventory - related to the Binly
Distribution facilities integration. These charges reduced gross
margin and operating earnings ratios by 29 basis points in the prior
year and did not recur in the current year. A very strong vendor
margin environment effectively offset the impact of that Binly
inventory write-off in the prior year.
In an effort to better manage products in the supply chain, some
vendors have discontinued certain of the programs that were
proving to be particularly lucrative last year at this time. This
obviously creates a short-term margin issue that is apparent in the
current quarter results and which will continue into the first half of
fiscal 2004 until we anniversary the point where these programs
were phased out. I will move on to Medical Products and Services,
which had an outstanding results with strong top line growth of
seven percent, which was leveraged to operating earnings growth
at ten percent during the 4th quarter. Importantly, new products
succeeded our goal of delivering over $100 million in revenue
throughout the fiscal year, and were a strong contributor to the
incremental growth in the 4th quarter. In addition growth and
distribution remains strong, which bodes well for the future, as it
provides opportunities for additional sales of our higher margin,
self manufactured products.
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CAH - Q4 2003 Cardinal Health, Inc. Earnings Conference Call
Finally, this segment's expense ratio trend in operating earnings
growth rate were negatively impacted in the 4th quarter by a
mismatch in the recording of incentive compensation accruals.
Current year performance relative to internally established targets
was significantly better this year than it was in the 4th quarter last
year, leading to a larger accrual of incentive compensation this
year versus last. If this mismatch were factored out, operating
earnings for this segment would have grown at a substantially
faster rate. As I turn to Pharmaceutical Technologies and Services,
it bears repeating the financial results include the year over year
impact of the acquisition Sincore International acquired on January
1, 2003. Excluding the Sincore acquisition, the segment delivered
an outstanding financial performance during the quarter, with
revenues growing in the high teens and operating earnings growth
in excess of 20 percent. It is important to remember that the
inclusion of Sincore has an apparent deleveraging impact on the
segment as the Nuclear Pharmacy business models' gross margins
are slightly lower and the expense ratios are slightly higher than
the rest of the segment components. The Sincore integration is
proceeding very well and the Nuclear Pharmacy business is
delivering outstanding results with earnings growth exceeding 20
percent. The growth in the other components of the segment is
well-balanced among our various proprietary products and services
with Oral Technologies leading the way. Particularly strong
revenue gains were delivered during the 4th quarter from our
manufacturing services for -- and [lillies], [diprecticitis] and
[mileis amnesteen]. Last but not least, let me discuss the
Automation Information Services segment.
This segment continued its tradition of ending the fiscal year with
strong momentum, delivering a all-time record performance with
19 percent revenue growth and 21 percent operating earnings
growth for the quarter. Importantly, robust demand across the
entire product offering increased the backlog of committed
contracts awaiting installation to an all-time high $233 million. So
in the quarter when we set our all-time record for product
installation, we also achieved the largest increase in our backlog
ever, adding $31 million to the backlog during the quarter. This
performance is a clear indicator of the strong market demand for
our proprietary products while also providing excellent visibility
into future expectations. Let me conclude my comments by
providing some further detail on our special items for the 4th
quarter. We incurred $25 million of merger-related charges
primarily relating to the continued integration activities of recently
acquired businesses.
In addition, we recorded approximately $24 million of other
special charges during the quarter which related primarily to the
execution of restructuring and rationalization plans in two of our
segments. In the Pharmaceutical Technologies and Services
segment, we rationalize capacity in our packaging services and
Health and Nutritional Product categories in order to improve
future productivity. In the Medical Products and Services segment,
we realigned a number of our self manufacturing product lines,
including our custom Sterile Operation, in order to better utilize
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the capacity to meet the growing demand in this segment. Thank
you for your attention and I now would like to turn the call over to
Bob for his comments.
Robert Walter - Cardinal Health, Inc. - Chairman, CEO
Good morning. Our solid 4th quarter performance capped another
strong year for our company. The financial results for the year
were outstanding and we did deliver on the commitments. Once
again, a management team at Cardinal Health demonstrated they
can effectively execute for its customers and shareholders in
dynamic times.
On August 12 in New York City, we will be hosting a luncheon to
go into the details of our strategy and performance of our last fiscal
year and the drivers for fiscal 2004. I think it's important to spend
time today on 2003 and how we see fiscal 2004 shaping up. In our
analyst meeting last August, we forecasted 14 to 17 percent
revenue growth and a 20 to 22 percent earnings per share growth
for Cardinal Health, and our performance was right on target. We
achieved those results while continuing to invest in the future of
the business. We increased our investment spending by over 20
percent in fiscal 2003 as we continue to build our breath of
manufacturing services in Pharmaceutical Technologies and invest
in new products in Automation and Medical Surgical businesses.
Now, for some of the highlights from the 4th quarter in fiscal 2003,
from my perspective, strong revenue growth across the company,
and each segment delivers at or above our expectations. Strong
gross margins in each of our manufacturing businesses, in Medical
Surgical, Pharmaceutical Technologies, and Automation. These
strong gross margins were due to favorable pricing for value
delivered and to improve manufacturing efficiencies and higher
capacity utilization. Expense productivity was just great
everywhere, bar none, reflecting none only management discipline
but also continued investment in technology that are driving lower
distribution in manufacturing cost. Additional highlights are a very
strong cash flow and substantially higher return on capital
throughout the corporation. With our high return on capital and
strong cash flow, we ended the year with the lowest net debt to
capital ratio with have $1.7 billion in real cash on the balance sheet
at year-end. The final highlight is a continued demonstration of our
ability to invest our available capital.
We invested about $1.5 billion during the year in R&D, investment
spending, capital expenditures and acquisitions. And these
investments ensure our strategic position and our growth in the
future. We added capabilities and businesses that were right in line
with our strategy of focusing on health care, of investing in scale
of broadening the offering to customers, and continue to move the
mix of our operating earning towards higher margins for products
and services. The largest investment for the year was the $900
million acquisition of Sincore International which made us the
leader in the fast-growing Nuclear Pharmacy business. This
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CAH - Q4 2003 Cardinal Health, Inc. Earnings Conference Call
investment met all the strategic objectives and is meeting the
performance goals established at the time of the acquisition. While
Sincore was were neither creative or dilutive to our earnings per
share in fiscal 2003, you can bet on it contributing to earnings
growth in the future in a meaningful contributor to the strategic
relationships we enjoy with our customers. Strategically and
operationally, we made a lot of progress in fiscal 2003 that will set
us up for growth in 2004 and beyond. Let me describe some of that
progress in each segment.
In our Pharmaceutical Distribution business we substantially
improved our productivity with the dramatic reduction in expense
ratio. The final Binly facilities were consolidated in the Cardinal
Centers and the last major expansion or retrofitting of our
distribution operations was completed. Revenue growth was strong
with some important new relationships being established that
provides us more from a supplier that moves us more from a
supplier of products to a solutions provider. The business earned
over $1.2 billion with a dramatic improvement in return on capital
in extremely strong cash flow. Now, the Medical Products area.
Medical Products management team made a number of important
gains in fiscal '03. First, was to build sales momentum. They
accomplished that through improved penetration in distribution
and a current self- manufactured products. And by the very
successful launch of new self- manufactured products that are both
proprietary and higher margin. These new products come from our
past investments in R&D. For example, the new esteemed
surgeon's glove helped drive growth in the surgeon's glove
business by over 20 percent.
We are quite optimistic about the - lines, two exciting new
offerings in the - business. More about medical products. Their
growth margins were strong because of the success and selfmanufacturing product sales, because of significant gains in
manufacturing efficiencies, and because of increased out sourcing
of products manufacturing to more cost-efficient geographies.
Obviously, the outsourcing has helped our tax rates. Medical
products focused on expense reduction through facility
rationalization and use of technology. And finally, the team
managed assets more aggressively achieving a substantial increase
in return on capital and strong cash flow. So recapping for '03 for
Medical Products, they played the entire business equation well.
From revenue through margin expense and finally, assets. They are
even better prepared for '04. Pharmaceutical Technologies and
Services is a great business and the investments that we've made in
this area are paying off. Last year at this time, I forecast that this
would be our fastest growing business in FY '03. It was, but that
included an acquisition. Without Sincore, its operating earnings
growth rate was in the high teens for the year, but accelerated to
over 20 percent in Q4 and should be even faster growth in FY '04.
PTS revenues in the future looks strong coming from a number of
different sources. First, the strong core growth in current products
using our technologies like ZYPREXA - -- we are also
experiencing new demand for our manufacturing and packaging
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capacity for other products already in the market, particularly in
the sterile area.
Additionally, there a number of large products in the pipeline
awaiting FDA approval that we expect to launch in FY '04 and
beyond. In addition to the manufacturing demand, the opening of
our Technologies and Service Center in New Jersey is adding to
our pipeline of future business. Customer interest in the
Technology Center has accelerated throughout the second half of
this past year and is leading to a market increase in deal flow. We
are also adding capacity in PTS to handle this increased demand.
In the UK, we are in the process of adding capacity to our facility.
In the 4th quarter we expanded our sterile capacity in Albuquerque
and are quickly filling that expanded capacity with several
products that are already approved. Our Raleigh, North Carolina
facility will be validated in FY '04, bringing additional capacity
online. We added to our capability and capacity in Puerto Rico.
We would not be adding all of this capacity if the demand for
offerings was not there. So in PTS, demand is there, and along
with it, strong margins. We have invested well in capacity and
capability, and we are becoming more effective at integrating our
offering. Finally, Automations business had another big year with
our expanded product line, continued investment in new product
innovations, the customers need for cost and labor savings, in the
focus on patient safety, the demand for PIXUS offering has never
been stronger. And so far, I am just referring to PIXUS' traditional
product line. In FY '03, we took PIXUS to the patient at bed side
with Patient Station. It is logical, innovative, and at the right time
for the market.
So the market potential for PIXUS just grew dramatically. What's
really interesting is that Patient Station is creating a new market,
something that PIXUS has repeatedly done over the last 15 years.
PIXUS grew revenues 19 percent, expanded its already healthy
operating margin, raised its return on capital, and added sizably to
its backlog. Profits were up 27 percent for the year. Our lease
renewal rate stayed at 98 percent, a strong indication of customer
satisfaction and demand for additional product solutions. The
customer is seeing the benefit of expanding PIXUS system-wide
with its Med Station and Supply Station offerings. And Patient
Station is off to a strong start. For example, a recent order from a
large health system includes well over 1,000 Patient Station units,
one for each one of its beds. We have continued to funnel R&D
investments into PIXUS, a business that’s proven it can innovate.
So the quarter in year, yet again demonstrates how the breadth and
diversity of our portfolio of businesses provides unique value and
diversity to our customers and consequently, to our shareholders. I
would like to say we are a mutual fund of healthcare products and
services with a growing proprietary nature. The solutions that we
offer manufacturers and providers can't be matched in the market
place. And both sets of customers are increasingly relying on the
scale and breadth of services that Cardinal Health offers. The
pharmaceutical manufacturers, the quality and scale of our
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CAH - Q4 2003 Cardinal Health, Inc. Earnings Conference Call
manufacturing is critically important, providing quality processes
that are equal to or greater than our customer's standards in making
the best use of capacity in the industry, our manufacturing
customers get high quality at a lower cost than they could get in
their own operations. Healthcare providers came to rely on the
breadth of the solutions that we provide. Notice I said solutions,
not just products. Solutions are formed around customer needs.
Let me conclude today's call by talking about the future of
Cardinal. Our future will be built on the same fundamentals that
have driven our growth for the past 20 years as a public company.
Those fundamentals are; first, focus on the fast-growing healthcare
industry, second, building scale to achieve leadership positions of
number one, number two, and everything that we do. Third, focus
on improving the proprietary nature of what we do and finally,
continue to build the breadth of our offering for customers. That
basic business model is how we've operated in the past and how
we will build our business in fiscal 2004 and beyond. While the
strategic direction and financial models for Cardinal will be similar
in 2004, as in the past, the guidance we are giving you in 2004 for
EPS is less than the past for two reasons only. First, we have
concluded that it's prudent to be more cautious about vendor
margins in this environment, particularly in the first half of '04, and
particularly when compared to a strong vendor margin
environment in '02 and '03. And second, we are choosing to give
ourselves more flexibility on the timing of the deployment of our
excess capital so we can continue to be strategic -.
And consequently, we are not planning on any benefit for this
deployment, either of stock buy back or acquisition. Not
withstanding the fact that we have a lot of opportunities on the
horizon. We recognize that we are not operating at the optimal
capital structure with such low debt. It is my job to move us
strategically towards a more optimal capital structure. Now, let me
be specific on what these words on guidance mean for '04 and
beyond. First, we are giving you our long-term growth rate when
we say mid-teens or better. We see mid-teens, those two words, as
our base minimum annual commitment much as our 20 percent
meant in the 20 percent or better guidance that we gave previously.
And the "or better" words means that we have a lot of range above
that minimum base which we expect to reach for. Much as we have
in the past, when we said 20 percent or better, and delivered over
25 percent for ten years, and 21 percent over the last three years.
Given you our minimum commitment at mid-teens allows us the
flexibility to choose the timing of our capital deployment and the
freedom to be prudent in investing for the long term. It is our style
to be long-term oriented and strategic. We recognize that we could
deliver 2-3 percent more earnings per share growth in '04 with a
reasonable stock buyback program using a portion of the cash on
the balance sheet at year- end.
Now, with regard to the guidance I've just given you for '04, let me
remind you of three things. First, after providing for caution in
vendor margins in RX distribution, and after providing for
appropriate other contingencies normally inherent in our budgeting
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process, our operating earnings growth rate for all of Cardinal will
be at the same pace in '04 as in '03. But the composition of those
operating earnings will be even richer. Secondly, our optimism for
all other operations is unchanged for '04 and beyond. And third,
the impact of the caution relative to vendor margins in '04 affects
overall Cardinal growth rate by two to three percent in '04.
Pharmaceutical Distribution will be 35-40 percent of total Cardinal
operating earnings in '04. In the unfavorable comparability in '04
versus '03 goes away in fiscal '05. Also, we expect to redeploy a lot
of capital in '04, and to do it strategically, so, obviously our
optimism for '05 is for higher growth than '04. Last comment on
guidance relative to timing. First, after completing the normal
budgeting process in late June, and after review of June actual
results in mid-July and assessing the vendor margin trends and
potential at that time, we conclude to be more cautious about
vendor margins, particularly in the first half.
This has nothing to do with the excellent positive conversations
that are ongoing with our manufactured partners and nothing to do
with sales or expense ratios in Pharmaceutical Distribution, or a
change in our outlook for any other segment of Cardinal. And
secondly, reaffirming our belief not to include in our guidance the
assumption of deployment of capital intended for the long-term in
order to benefit the short-term. Let's look at the formula for '04.
First, we are confident that revenues in each of our segments will
continue to be strong. And I've already given you some of the
reasons for that. Revenue growth for the corporation should be in
the mid-teens. So there is a lot of confidence in sales. In gross
margins in Medial Surgical Products, Pharmaceutical Technology
and Automation, the information will be strong. Growth margins in
the Pharmaceutical Distribution business will be lower. Every
segment will continue to achieve substantial improvements in
expense ratios, and consequently, operating earnings are expected
to grow at the same pace as in fiscal '03 with each segment
generating a robust flow. That is all really good news because that
formula is dependent on known trends and existing operations, that
is all internal growth. Now let me discuss Pharmaceutical
Distribution in a bit more detail.
Again, we expect strong revenue and continue to expect
improvement, but as we pulled our budget together for the fiscal
year and reviewed recent activity, we came to the conclusion
vendor margins will be down when compared to a relatively strong
'02 in first half of '03. Some manufacturers are seeking a
distribution relationship that pulls inventory out of the channel
when compared to fiscal '02 and fiscal '03. Their goal is to match
production in sales more closely to script demand at the patient
level. Keep in mind, I said some, but not all. I want to
accommodate their needs as we view them as our upstream
customers. And convinced, after extensive conversations with
many of our manufacturing partners, that they are not seeking to
pull margins from the distribution partners. Our relationships are
strong and favorable. They understand the need to maintain the
margin, they pay us for distribution. This shipments closer to
patient demand model will streamline the channel, eliminate cost
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CAH - Q4 2003 Cardinal Health, Inc. Earnings Conference Call
to manufacturers at distributor lever, and free up capital for
Cardinal. Now, I want you to recognize that this shift is
evolutionary, not revolutionary. But it's important. It's not
threatening the position enjoyed by distributors in the marketplace.
Neither the manufacturer nor provider can replace the quality or
efficiency of distributors logistical, administrative, or information
services provided. So our position is secure. In the role of a
distributor, requiring a trader's mentality will still be present, but to
a slightly less degree. In the past, Cardinal Health has passed on
our improved efficiencies and a portion of our growing vendor
margin to the provider customer. The balance of the growing
vendor margin was kept by us, driving up a return on sales. In the
future, with somewhat lower vendor margin, more of the future
efficiencies will need to be retained by us, and - margins should
level out instead of decreasing. Return on capital will rise and cash
flow will be strong.
So, fiscal '04 will be strong in spite of relatively weaker buy
margins in Pharmaceutical Distribution. The second half will be
stronger than the first and even more optimism for '05 as we move
to more normal comparisons. As we move to more normal
comparisons in vendor margins in our Pharmaceutical Distribution.
And as our other businesses continue to remain robust. Here's what
I like. I like the prospects of each of our businesses. I like the
overall diversity of our earnings base. I like to increase richness of
our earnings base as the higher margin proprietary offerings
become an even larger component of our overall earnings, and
finally, I like the size of our resources and our competitive
position.
One last comment before going to questions. And that is about
deployment of our -capital. We have a lot of opportunities. A
strong management team that can manage more, and a
demonstrated history of deploying capital profitably and wisely.
Our capital will get used and it will be accretive to shareholder
value. Operator, I would like to open the call now to any questions.
Operator?
Operator
If you would like to ask a question, please press star, then the
number one on your telephone keypad. Again, that's star, then the
number one if you have a question. And we will pause for just a
moment to compile the Q and A roster. Your first question is from
Raymond Falci with Bear Stearns.
QUESTION AND ANSWER
Raymond Falci - Bear Stearns
Good morning and thanks. I would like to follow-up on some of
your concluding remarks on the overall vendor margin and overall
margin outlook for your - distribution business. I guess my
question is, number one, what gives you confidence that this is
more of just an issue of a anniversarying a good environment and
that we don't have a structural, I guess, deterioration of your
margin structure, and then number two, to the extent that you said
longer term and you hope to be able to retain the synergies that you
gain, which would suggest a stabilizing on your sell side margins. I
was wondering if you had any recent discussions to support that
view?
Richard Miller - Cardinal Health Inc - CFO, EVP, Principal
Accounting Officer
Good morning, Ray. Well, why I know this is not any major
structural problem is I recognize -- first of all, I talked to the
leadership and not just trade relations people. I've talked to the
leadership of major pharma. and if they were doing it with mostly
branded products, we're certainly not dealing with generic margins.
I've talked to the leadership at the top of - and reaffirmed their
feelings about their dependency on us for the services we provide.
We know about the dependency of our customer on the services
we provide, at the efficiency level we provide. Now, over the 20
years in business margins, the major mix changes over time.
And how you place your customer changes over time. This is
evolutionary, not revolutionary. I have been in the business for a
long period of time and have a good perspective on this. With
regard to retaining efficiencies, we -- there is a lot of visibility on
the part of our customers to how we make money. That visibility
they will see our margins expanding on the side. They are in the
market and aware themselves they can't buy direct, but they know
about the profitability is.
If we have more buying margin available, that is just part of the
equation. The market is certainly competitive. Our competitors
have - margin available. That tends to get passed on to customers
through reduced seller margins. We are confident in our
relationship downstream with the providers and we are confident
we will be in a position to continue the kinds of returns that we
have. That's how I would answer your question.
Raymond Falci - Bear Stearns
Okay, I guess, I mean, I was really focusing more on timing. Is it a
function of when your next set of contracts come up for renewals
that you believe the discussions may go to a slightly different
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CAH - Q4 2003 Cardinal Health, Inc. Earnings Conference Call
direction or are there other mechanisms that - I understand it's
evolutionary, but that could maybe change that timing?
Robert Walter - Cardinal Health, Inc. - Chairman, CEO
I don't understand your question. I guess we are always dealing
with customers. We are really dealing with, I think, a very strong
margin environment in '02 and '03. Our view is that the '04
comparability to '02 and '03, it won't be as strong for us. It doesn't
mean we have to go back and change our pricing to customers,
obviously, we are also getting more efficient.
And what I said is, I don't see us passing on the same amount of
efficiencies to our customers over the next couple of years because
it's a balance. You get buy margin and you have margin from
manufacturers and you have to price your services to the customer
base on that. So there is an ebb and flow of that and we obviously,
another factor in it is efficiency you have in your cost structure.
We have a real leadership position in cost structure in this industry
and that's a nice position to be in. There is not any revolutionary
thing that has to happen with customers here. We are talking about
comparability of our buying margin going forward with what I
think was pretty robust periods in the last two years. Can we go to
another question?
Operator
The next question is from Larry Marsh with Lehman Brothers.
seeing two or three months ago? And then along with that, I know
last quarter you talked about one particular manufacturer - and felt
like they weren't into their new relationship, not giving you any
appropriate compensation. I wonder if there's any updates in that
relationship that you can speak about?
Robert Walter - Cardinal Health, Inc. - Chairman, CEO
Yeah, Larry, as I said in my talk, and I tried to stamp at home, my
optimism is not any different than 90 days ago when I talked in
February. Other than one thing, we freed up -- there is less
inventory, and I first said this in January. I thought there was going
to be less inventory available on the pharmaceutical side. And if
there is less available in the market, I said that's what we
experienced in our December quarter. That does affect your vendor
margin.
In April, I was wrong, there was less available, and what I'm
saying is that there was less inventory buying availability to
generate more vendor margin, but that also generated more cash
for us to take and reinvest. You have a timing gap and we don't
feel in a rush to reinvest that. Nothing wrong with the overall
model and how we priced the customers and our returns on capital,
and we will be up in the Pharmaceutical Distribution business. It's
really about, I think, vendor margin and mismatch. Profitability
and vendor margins in the next six to nine months versus a strong
'03. With regard to Bristol-Myers, I choose not to talk about any
one manufacturer, but to say that I'm happy with the conversations
we are having with Bristol-Myers and believe they would say they
are happy with the conversations we are having.
Larry Marsh - Lehman Brothers
Just to clarify. I guess you're going to be giving more of the
detailed views on August 12? Is that right, by segment like you
usually do?
Robert Walter - Cardinal Health, Inc. - Chairman, CEO
Surely. here will be a lot of details about all of the segments and to
help you get to even more closely on why I was optimistic about
new products, for example, PIXUS, or PTS, or whatever. We will
be in a lot more detail on that.
Larry Marsh - Lehman Brothers
In February and April, you talked about the business model for
Cardinal more predictable than margins, some reduction, greater
cash flow, and so I think you have been talking about through this
evolution for a while. I guess my question is this a further
revolution of what you have been saying?
Or is there something, when you went through the budgeting
process that was a real change in what you thought you had been
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And that this is led to the statement I made on the call in April led
to more active conversations at the high level with other
manufacturers and I am very pleased with those conversations and
met with the CEO's of some of the major pharma. manufacturers to
talk about and make sure they know about distribution and make
sure they understand how moving to what I call a closer -- a model
that has sales in production and closer to demand of the patient.
When they move that model, we need to change how we get paid
by them. They can't be clumsy about moving there because I have
been reassured we are not trying to take margin from you. I said
fine, then. One of my conversations is that I guess we were kind of
clumsy about how we went about that. We need to straighten that
out. We already did with that one. We are managing the model. I
remember in '92 when the Clinton Administration came in and we
had a high dependency on 8-9 percent inflation and then the
inflation in pharmaceuticals went to two.
There was a - I wouldn't call it a panic, but a lot of concern about
what happens to the model? It evolves into something slightly
different as we manage the inflows of our margins and how we
priced downstream. I guess that's the way I would answer your
question.
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FINAL TRANSCRIPT
CAH - Q4 2003 Cardinal Health, Inc. Earnings Conference Call
Larry Marsh - Lehman Brothers
Thanks.
Robert Walter - Cardinal Health, Inc. - Chairman, CEO
Next question.
Operator
The next question is from Tom Gallucci with Merrill lynch.
Tom Gallucci - Merrill Lynch
Good morning, everyone. Just as a follow-up to that first, you are
managing the model, and I'm wondering, I guess, given the change
in the last few months in expectations, is it taking you longer or is
there more management of the model required than you thought?
My other question separately is on the deployment of cash flow. It
seems like there's a lot more cash there than we thought. It's a
strong debt to total capital position, what are your thoughts on
share repurchases, potentially on dividends, and how are you
thinking about the acquisition landscape today?
Robert Walter - Cardinal Health, Inc. - Chairman, CEO
The good news to managing the business for the first question
about this managing the ebb and flow. There is good news to talk
about it in basis points. Let's put this in perspective, in my
conversation I said that that the less optimism on buying margin,
vendor margin for the next six months affected the overall growth
rate of Cardinal's operating earnings by 2-3 percent. Now, if you
calculate that, what you figure out, that's something like $50
million or $60 million.
If you take that back and figure out what is the basis points, now
Cardinal has a superior return on sales. What does that mean in
terms of -- it means 20-30 total basis points in our Pharmaceutical
Distribution business. Not a disaster, but a lot of money and we
look for every penny. This is not a major thing for the corporation
because I want to remind everybody that we love Cardinal
distributions, great long-term business. Great customer relations,
good top line growth, great secure position, but it's also only
between 35 and 40 percent of Cardinal's earnings.
At some point, we want everyone to understand there are a lot of
other gross margins things going on inside of Cardinal distribution
that are favorable around generics and things like that. There
favorable gross margin things in our other businesses. That
contributes 60 for next year and 60 plus percent of operating
earnings. That's perspective I did on you, I said we're managing the
model. We are not managing the model in wild flings, but every
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basis point is a lot of money and I need to put it in the right
perspective. Yes, we have more cash flow and cash on the balance
sheet than we expected. We expected cash flow to be as strong, but
we made the commitment and thought it would be over a billion
dollars and it was. We freed up capital in the distribution business
that is good news. If you believe we can use that capital. I would
remind everybody in the 10-year period of the '90s, Cardinal
reinvested in external capital through acquisition and joint venture
and whatever. We reinvested at a rate of $1.3 billion. That was at a
time when we had to manage that.
We had to find opportunities, we had to manage that. That was at a
$1.3 billion per year and that means it was at a time when the
company was on average less than half our size, I don't think it's a
daunting task to reinvest this. We are not talking about new
platforms, we are talking about building and enhancing what we
do. Our cash flow -we will evaluate dividends and shown we are
able to do stock buybacks. It's a fairly easy thing to do. If you view
the stock buyback we did last year, we went out and gathered up
shares knowing we would have to issue shares in a -- stock options
or for a $1 billion acquisition.
I think you might view us as right now not - I mean, we can do
stock buyback, and maybe we will, but I think there's an
inclination that we want to horde more - to put into other growth
opportunities. If there is some beyond what we think is reasonable,
we'll do a stock buyback. That depends on where our stock price is
etcetera. That's where we are. We feel we are in a great position. I
said I thought our optimal capital ratio was - not at that often with
capital ratio.
I recognize that I have a responsibility to get us closer to that. And
11 percent net debt to total capital is not where we should be.
Frankly, we should be closer to 30 percent or higher. That gives
you some idea of what my objectives are over the next several
years. Next question?
Operator
The next question is from Chris Mcfadden with Goldman Sachs.
Chris McFadden - Goldman Sachs
Thanks for the detail on the call this morning. First, clarification.
In your prepared comments, you talked about the Pharmaceutical
Distribution and Provider Services segment being at 35 to 40
percent of operating profit.
To make sure we are talking apples to apples, does that compare to
50 percent of operating profit that that segment represented in
fiscal '03, and then second question would be as we think about
that same division, you had great success in '03 at the operating
leverage line in part due to the synergies this year. This year you
had about $50 million in less operating expenses than you did in F
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FINAL TRANSCRIPT
CAH - Q4 2003 Cardinal Health, Inc. Earnings Conference Call
'02. How would you expect it to How would you expect the
operating expense comparison to play out for F '04? Thanks.
Robert Walter - Cardinal Health, Inc. - Chairman, CEO
Okay, Chris, thanks for reclarifying that. I know I have given so
many numbers, but let's just be specific. In that segment which is
Pharmaceutical Distribution and Provider Services, you have a -what people know as the general line traditional, we used to call it
core drug distribution business and we have other provider
services. That might be our medicine shop and service of
consulting services to hospitals and there is lots of other businesses
in there.
Our specialty distribution business. When I refer to the 35 to 40
percent, the funding for the distribution is about 80 percent of the - about 80 percent of that segment. So what I said was
Pharmaceutical Distribution will be just that. 35-40 percent. That
segment next year will be more like 45 percent. The total segment.
That's helpful to get clarification.
The reason I picked out just the comparison of Pharmaceutical
Distribution, is, at the time they did the first acquisition which
broadened the offering to the customer, that was medicine shop in
'95, first time we did that, somebody asked me, do you ever see the
day when Pharmaceutical Distribution, that traditional business we
had was less than 50 percent? I said yes. So today I'm telling you
it's between 35 and 40 percent. Second question, operating ratios in
that business, you have had a lot of success at it and we are good at
operations. We have no operating problem going on in the
company.
We can deliver the product at the right price and get increased
productivity and customers are happy with that. In distribution, our
operating expenses are coming down pretty dramatically and there
still opportunities to drive them down further. We're talking about
in the next year, more in the 20 basis point reduction and then
maybe a 40 basis point reduction which we probably averaged over
the last five years.
Chris McFadden - Goldman Sachs
Thank you.
Robert Walter - Cardinal Health, Inc. - Chairman, CEO
Okay. Next question?
Operator
The next question is from Michael Fitzgibbons -- from Morgan
Stanley.
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Michael Fitzgibbons - Morgan Stanley
I was thinking about the timing of -- you talked about the margin
having an impact in '04 and improvement in '05. It seems like is
your -- is this year of the first half of '03 having a significant
benefit with a tough call for the next six months?
Is that something you discovered more recently and part of what
changed in the last six months since the analyst meeting in New
York or why is your view of that difficult comp changed? One
other question was on the sell margin. If you presumably have
been starting to talk to customers that you will renew contracts
with and talked to them about the possibility of looking at
customer more in the future to get your margin, if the vendor
margin is down, in recent conversations, what has been the
response? Have you had any contracts for getting traction there and
starting to maybe have increases in pricing versus the historical
decline?
Robert Walter - Cardinal Health, Inc. - Chairman, CEO
Okay. Two questions. One is about what's changed from either
conversations or feelings in February or anything along the line in
the last six months.
I would say the only thing that's changed, I don't want to keep
emphasizing, but our view about availability of investment in
inventory available in the market in the branded area. When
compared to what our expectations were. There two effects on that.
We are expecting then that there would be less margin relative to
strong buying margin opportunities. We are expecting that there
will be more cash available for reinvestment. There will be by and
large, you signal that that's the only change, with regard to living, I
would say with regard to the other areas, we frankly have increased
confidence in the area, but don't feel compelled to reflect increased
areas that increased guidance about the areas right now.
But they are in great shape and the budget process came out well
and a high degree of confidence and spent lots of time with their
management. That's kind of where we are. With regard to dealing
with customers, I don't want to get into that as a competitive, but
we have a great relationship with customer and it's a negotiating
process and if you have more money in your pocket, it will be a
margin and you negotiate to what you think is an acceptable return.
That's the way the process works. It's works in every business that
way. So we won't pass on efficiencies to customers, but what I said
is in the past, Cardinal's operated on the basis that we are very
aware of what the margins are. As we got more buying margins
and vendor margin and as we got more efficiency, if you look at
the history of what we've done, you would say we passed all of the
efficiency on to the customer and the second thing, you pass some
of the buying margin on to the customer. If there is somewhat less
buying margin available, we can't pass it on to the customer and
we have some of the efficiency which we create in the future.
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CAH - Q4 2003 Cardinal Health, Inc. Earnings Conference Call
That's the model. That's what I believe will happen. I believe it's a
competitive environment and we will have to ask the others what
they expect to do.
We are trying to communicate to you this is the way that the
business works. Our returns will be terrific and they are. We feel
really secure about the relationships in what we do. Incidentally, in
our passing efficiencies on to the downstream customer, the
provider, the benefit of doing that is they are now able to acquire
product through us at substantially lower cost than if they tried to
do address or pricing in the right way relative to other
opportunities they might have to acquire product. This is the right
thing to do because it ties those customers in to acquire product
through the wholesale distribution channel.
Sean Harrington - Banc of America Securities
In terms of redeploying the capital --.
Robert Walter - Cardinal Health, Inc. - Chairman, CEO
Is there another question? I'm not trying to -- if we have time we
can come back to that. Any other questions at this point?
Operator
You have a question from Steve Halper.
That has been done in an extremely well. Good job by us and
major competitors. We have the provider that needs us and needs
our service and we do things they can't possibly do themselves.
Emergency delivery and five day a week deliveries on electronic
connectivity to us and 100 percent service level. The model is in
good shape. Next question?
Operator
Relative to your competitors, do you believe that you are more
conservative in line or more aggressive in achieving the margin?
Your perception.
Robert Walter - Cardinal Health, Inc. - Chairman, CEO
The next question is Robert Willabee with Banc of America.
Sean Harrington - Banc of America Securities
Morning, Sean Harrington in for Robert Willabee. In terms of the
guidance change, in terms of the factors, what's having the greatest
impact in your mind? The vendor change, elimination of
reinvestment of capital going forward? What's the primary driver
there?
Robert Walter - Cardinal Health, Inc. - Chairman, CEO
To repeat what I said in the presentation, that the only change,
only two changes to our guidance, that is that this is for '04. I
already said that very optimistic about our growth rates in '05
being faster than '04. We are saying it's two changes. One, more
conservative about the prospects for vendor margins and
distribution and we have freeing up of capital investing in
inventory and Pharmaceutical Distribution and the mismatch of
timing in reinvesting that capital recognizing that any capital is
sitting on the books today and we earned one half or two percent or
something like that.
That's really the only changes. The rest of our business are robust
and strategy is working. The customer relations are terrific and
deal four and PTS is magnificent and we try to stamp home and
say this is a good story the fact that we are dealing with an issue
here and we have all these other things that we are focusing on.
They are doing very well.
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My perception is we have two smart competitors. We have a
slightly lower cost of capital and probably more capital. We have a
long history of -- my expertise, I said that for us and all
competitors, there is a trader's mentality, there is always
opportunities to acquire product in a price advantage way.
There is many reasons that manufacturers want to place product in
the marketplace. They are smart. They have good buying
operations and they have plenty of capital. I would say historically
we have probably been more deeper in inventory than they have
been. Recently, the difference is not all that great, but I guess
fortunately they don't give their internal financial statements and
I'm guessing, but we are knowledgeable about it. This was not that
complicated. We have committed a lot and view it as part of how
you run a good distribution business.
If you run a good distribution business, you have plenty of
inventory to make sure your service level on a critical products,
which is pharmaceuticals, is extremely high. Secondly, we have to
look to the margin to make sure you acquire product at the best
available price at the time. Wal-Mart does that in their business
and everybody does to make sure. So I believe that our competitors
are aggressive in doing that. Probably historically, relatively, you
may have been more aggressive in doing that. That's good for us.
Nothing wrong with that. I view them as knowledgeable buyers. I
think at this point we will wrap up.
I appreciate you taking the call. We are feeling confident about the
future and look forward to getting into the details on all of our
businesses and not just Pharmaceutical Distribution, on August
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FINAL TRANSCRIPT
CAH - Q4 2003 Cardinal Health, Inc. Earnings Conference Call
12th in New York City, where we will host an analyst meeting and
get into more of the details. Thanks for participating this morning.
Operator
This concludes Cardinal Health's conference call. Thank you for
your participation and you may now disconnect.
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