卡地納健康 (CAH) 2014 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Cardinal Health Fiscal Year 2014 First Quarter Conference Call.

At this time, all participants are in a listen-only mode.

Later, we will conduct a question and answer session and instructions will follow at that time.

(Operator Instructions)

As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Sally Curley, Senior Vice President of Investor Relations.

You may begin.

Thank you, Nicole.

Welcome to Cardinal Health's First Quarter Fiscal 2014 Earnings Conference Call.

Today we will be making forward-looking statements and matters addressed in the statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected or implied.

Please refer to our SEC filings and the forward-looking statements slide at the beginning of the presentation, found on the investor page of our website, for a description of those risks and uncertainties.

In addition, we will reference non-GAAP financial measures.

Information about these measures is included at the end of the slide.

I would also like to remind you of a few upcoming investment conferences and events in which we will be webcasting; notably, the annual meeting of shareholders at 8 AM Eastern on November 6 at our headquarters here in Dublin, Ohio and our invitation-only Investor and Analyst Day on December 10 in New York.

The details of these webcasted events are or will be posted on the IR section of our website at Cardinalhealth.com, so please make sure to visit the site often for updated information.

We look forward to seeing you at an upcoming event.

Now, I'd like to turn the call over to our Chairman and CEO, George Barrett.

George.

Thanks, Sally, and good morning to everyone.

Our fiscal 2014 is off to a very strong start.

Our first quarter performance demonstrated growth and balance and progress on our key strategic priorities.

There's a lot to discuss, so let's get right to it.

Total revenue for the first quarter was $24.5 billion; down 5% year-over-year, as we lapped the loss of the Express Scripts business and absorbed the expiration our Walgreens contract, which occurred at the end of August.

We were able to partially offset this revenue loss with growth in existing customers and the contribution from new business.

Our non-GAAP EPS grew by 36% to $1.10, helped by an $0.18 benefit from the resolution of some historical tax matters.

Looking deeper, the results show we achieved a very healthy 13% growth in non-GAAP operating earnings, fueled by strong margin expansion and operating profit increases in both our Pharmaceutical and Medical segments.

For those of you keeping score, our year-over-year gross margin rate has expanded every quarter for the past three years.

We also had an outstanding cash flow performance, generating $950 million in the quarter.

Importantly, the wind down of the Walgreens work was done very efficiently and effectively.

Our team did an outstanding job.

They were able to dramatically reduce our inventory, while maintaining the uncompromisingly high service levels we expect.

Walgreens worked closely with us to ensure a smooth transition for us and we do appreciate that.

The bottom line -- our balance sheet is rock solid and our growth is very healthy.

We are well-positioned to continue growing and to seize quality opportunities wherever they emerge.

Based on our first quarter results and the strength of our operating earnings performance, we are now guiding to a new range of $3.62 to $3.72 for fiscal year 2014 non-GAAP EPS.

This guidance reflects a full year tax rate assumption that is unchanged from our original expectations, although we do expect to see some quarterly fluctuation in the rate and Jeff will give you some more detail on this.

I'm sure all of you saw this morning our announcement of the authorization of a new multi-year share repurchase program for $1 billion.

This will allow us flexibility as we execute our balanced capital deployment philosophy.

I'd also like to take a few minutes to give you my perspective on recent moves in the marketplace.

The world is rapidly changing and no industry more so than healthcare.

In these past 18 months, we've witnessed and participated ourselves in several noteworthy realignments in our industry.

Clearly, last week's announcement that McKesson is acquiring Celesio is the most recent.

For our part, we try to bring our collective experience and insights to the moves that make us stronger and better positioned.

We will be uncompromising in our commitment to uphold and grow an effective competitive advantage and top tier returns for our shareholders.

Many factors contribute to our sustainable competitive advantage, but I'd like to call your attention to a few.

First, our unrivaled touch points across an increasingly integrating system will be more efficient, effective, and connected across the continuum of care.

Second, we have the size and impact to create benefits for our customers and to create clear share opportunities from manufacture partners.

Third, we deliver with world class execution.

This is a standard against which we will constantly measure ourselves.

Finally, we're an organization with the unwavering discipline, the imagination, and the flexibility to bring solutions to systems badly in need of them.

All of this requires having the capital and the flexible capital deployment strategy to compete in the world going through rapid change.

These things are all strengths of Cardinal Health and we can use periods of industry change to expand them.

As always, we'll thoroughly evaluate all options to expand our competitive advantage and deliver even better returns and we continue to have options for growth available to us.

We are ready to move and will do so decisively when the lights are green, but we will follow a simple principle with discipline.

Any decision we make must deliver meaningful and lasting value to our customers, our supplier partners, and to our shareholders.

Not all opportunities that present themselves are created equally.

It's our responsibility to know the difference and act accordingly and you should expect nothing less of us.

Now, on to the segments -- our Pharmaceutical segment delivered robust profit growth of 8% on an expected revenue decline.

Our segment margin expanded by 29 basis points.

Our growth in both new and existing Pharmaceutical distribution customers reflects the value that we've been bringing to them through both our branded and generic programs.

Our Pharma margin was further expanded by our continued progress on our sourcing programs and our product and customer mix initiatives.

Our Pharma team continues to perform well in the retail independent space and we see continued market share growth.

As you know, this has been an area of focus over the past few years and we remain deeply committed to retail pharmacy.

We are continuing to see steep revenue growth in Specialty Solutions and we're picking up new accounts at an excellent pace, especially in the oncology services and distribution area.

In addition, we've been adding to our clinical talent base in Specialty and we're seeing the benefits.

Our thesis in Specialty Solutions is that we can create significant value in connecting providers, payers, and biopharmaceutical companies in collaborative ways that results in better patient care at lower cost that will be central to specialty pharmaceutical care and that's why it's at the core of our specialty model.

The environment around nuclear imaging remains challenging but our nuclear business continues to adapt effectively to market conditions.

The Medical segment performance was strong.

Revenue was up 13% to $2.7 billion, and segment profit increased 43%.

The key driver was AssuraMed, which accelerated that growth, and we also saw volume growth in our existing customer base and penetration within our targeted strategic accounts.

Investments into strategic platforms and a strong focus on our efficiency initiatives also contributed to a sharp segment profit increase compared to a year ago.

Building our preferred product portfolio remains a top priority.

It's an example of what makes Cardinal Health tick.

We listen to our customers and then act.

Their needs and expectations drive our decisions.

Our preferred product portfolio addresses our customers' need for lower cost alternatives to mature medical devices.

In fact, we introduced more new preferred products in this fiscal first quarter than we did all of last year.

Our priority is to be ready and able to meet changing needs, so we've adapted our go-to-market model to ensure we're 100% aligned with market trends.

As a result, we're getting more products to more patients, more cost effectively throughout the continuum of care.

In line with this, the trend toward home healthcare is unlikely to diminish, with today's strong focus on cost containment and greater healthcare consumerism.

Our March 2013 acquisition of AssuraMed, the leading distributor of medical products to the home, gives us a tremendous platform through which to move into this market.

AssuraMed is performing well with profit contribution exceeding the acquisition model.

The expected synergies and efficiency gains are being realized.

We are only just beginning to leverage this platform across the Cardinal Health organization.

Our Medical segment continues to innovate.

This past Tuesday, we jointly announced with FedEx our new strategic alliance by combining our healthcare expertise, third party logistics capabilities, and specialized facilities.

With FedEx's global transportation, logistics, and technology capabilities, we will offer tailor-made third party logistics and supply chain solutions for the healthcare industry.

Turning to China, first quarter revenues were up nearly 30% year-over-year.

Our strategy here remains to enlarge our geographic footprint, to create new business partnerships, and to bring our expertise to new opportunities, such as direct to patient and consumer health.

A lot has been happening in China and Jeff will touch on that in a moment, but one thing is totally clear.

Healthcare in the China will continue to grow.

We're very well-positioned to play an essential role in this rapidly expanding healthcare marketplace.

As you know, we've made several acquisitions in China over the past two years, largely focused on building out our geographic footprint.

Most recently, we closed on an acquisition that will broaden our capabilities and will give us a platform to begin building out an e-commerce business for nonprescription products.

This platform will be used as both a B to C platform and in conjunction with our rapidly expanding direct to patient pharmacy network.

As I finish up today, let me make a few quick comments on the Affordable Care Act.

As is well documented at this point, the roll-out out of the exchanges has experienced its challenges.

As you remember, we've been clear from the start that we were not building into our guidance any upside based on short-term expectations for new volume in the system.

This is a major piece of legislation.

We recognize that these are early days and that the opening pitch has just been thrown.

We're going to stay on top of this and we'll be ready for whatever comes next.

I'll conclude by welcoming Patricia Hemingway Hall, President and CEO of Healthcare Services Corporation, to our Board of Directors.

Pat has built a distinguished career on both the provider and payer side of the industry and we look forward to the wealth of knowledge she'll bring to our Board.

I also want to thank Jean Spaulding, who will be stepping down from our Board next week.

Her insights and guidance over the past 11 years have been invaluable.

Her legacy will be lasting and we wish her well.

Again, we're off to a great start to fiscal 2014.

With that, I'll turn the call over to Jeff.

Thanks, George.

Happy Halloween, everyone.

In case you're wondering, I am dressed as a Canadian today.

This morning, I'll be reviewing the drivers of first quarter performance and provide additional detail on the full year, as well as our somewhat atypical decision to raise the fiscal 2014 guidance range after only our first quarter.

You can refer to the slide presentation posted on our website as a guide to this discussion.

Let's start with consolidated results for the quarter.

We reported a 36% increase in non-GAAP earnings per share in our first quarter versus the prior year's period.

This was driven by two major items.

First, and most importantly, we began fiscal '14 with great execution across our businesses, posting a 13% increase in non-GAAP operating earnings.

Second, our results include an unusual tax benefit of $0.18 per share.

Even when excluding the $0.18, non-GAAP earnings per share grew a robust 14%, a great quarter of growth.

Let me go through the rest of the income statement in a little bit more detail, starting with revenues.

Consolidated sales were down 5% to $24.5 billion, which was better than our expectations.

The decline was due to the expiration of the Express Scripts contract, which we have now fully lapped and the Walgreens business, which just ended August 31.

Gross margin dollars increased 9% to 5.15% of revenue, with the rate up 68 basis points versus prior year.

SG&A expenses rose 6% in Q1, primarily driven by the recent AssuraMed acquisition and partially offset by planned efficiency initiatives.

Our commitment to controlling costs and improving the efficiency of our operations resulted in a decrease in our core SG&A spend versus the same period last year.

Our consolidated non-GAAP operating margin rate increased 36 basis points to 2.17%.

We've now posted operating margins greater than 2% in three of the last four quarters.

You'll notice that our net interest and other expense came in higher in Q1 than in the prior year's quarter.

This is primarily due to the $1.3 billion of debt we issued in February associated with the AssuraMed acquisition.

The non-GAAP tax rate for the quarter was 24.7% versus the prior year's 37.8%.

The uncharacteristically low rate was primarily due to beneficial tax elements totaling $63 million in the quarter.

Please note this amount only affects our tax line and has no impact on operating earnings or segment results.

Without those discrete items, our tax rate for the quarter would have been about 37%, much more in line with our normal rate.

I'll discuss tax assumptions for the full year later in my prepared remarks.

Our diluted weighted average shares outstanding were 343.7 million for the first quarter, which is about 700,000 favorable to last year.

During the quarter, we repurchased $50 million of shares and at the end of the period, we had $350 million remaining on our Board authorized repurchase program.

Today, as George mentioned, we announced that our Board authorized a new repurchase program for $1 billion.

This plan is in addition to the $350 million remaining under our previous plan.

Now, let's discuss the consolidated cash flows and the balance sheet.

We generated $950 million in operating cash flow in the quarter, which greatly exceeded our expectations.

There were two major factors that contributed to this strong cash flow generation.

First, our strong underlying operating earnings performance and second, the wind down of the Walgreens contract, which contributed over half of the first quarter's cash flow, as we reduced inventory levels significantly and faster than we originally anticipated.

Given this accelerated wind down, we would not expect to see a similar level of cash flow contribution in the second quarter.

On the Walgreens unwind, I echo George's comments and thank our team, who insured that we exited the Walgreens contract smoothly, balancing extremely high service levels with a rapid reduction in inventory.

Moving on, at the end of Q1, we had $2.8 billion of cash on our balance sheet, which included $475 million held internationally.

While our working capital days decreased versus prior year, I would like to note that our working capital metrics are distorted this quarter, due to the expiration of the Walgreens contract in mid-period.

We don't believe these metrics provide meaningful measures compared to the prior year's period and therefore, will not be providing these metrics for the quarter.

Now, let's move to segment performance.

I'll discuss Pharma first.

Pharma segment revenue came in better than expected, although it did post a decrease of 7% to $21.8 billion, driven by the expiration of the Express Scripts and Walgreens contracts.

This decrease was partially offset by volume growth from new and existing customers.

As a reminder, we lapped the Express Scripts contract expiration this quarter.

Given the August 31 Walgreens contract expiration, revenue from Walgreens was $1.7 billion less than the prior year's quarter.

Pharma segment profit increased by 8% to $433 million, due to contributions from across our businesses, with strong performance from both our generics and brand product portfolios.

Given the nature of the wind down of the Walgreens contract, the expiration did not significantly impact our operating earnings compared to the prior-year period.

We do expect the contract expiration to have an adverse impact on our period-over-period comparison of results of operations during the remainder of this fiscal year and the first quarter of fiscal '15.

This is incorporated in our fiscal 2014 guidance assumptions, which I'll discuss in a moment.

With respect to generics, we did, as expected, see less contribution from new generic launches in this year's quarter versus Q1 of fiscal 2013.

Nevertheless, sales and profits from all generics programs exhibited very good year-over-year growth in the quarter, reflecting the emphasis we have placed over the last several years in building the strength of our programs and the overall robustness of the market.

Sequentially, from Q4, generic deflation moderated slightly from the lower single digits to essentially flat.

We also saw strong performance under our branded Pharma contracts with brand inflation in the low double-digits, about or perhaps slightly better than we expected.

Pharma segment profit margin rate increased by 29 basis points compared to the prior year's Q1, a reflection of the strength of our generics programs and our focus on margin expansion, including customer and product mix.

In addition, within customer categories, our [generic] expansion and Pharma distribution was strong across almost all of our customer classes of trade.

Moving on to medical segment performance, Medical revenue growth was up 13% versus last year, an increase of $319 million.

The AssuraMed acquisition was a primary driver of revenue growth in the quarter.

We also saw volume growth from our existing customer base, a result of our continued focus on strategic hospital network accounts, which tend to utilize more of our products and services to drive efficiency in their supply chain.

Medical segment profit grew 43% in Q1, primarily driven by AssuraMed.

As George said, the integration is on track and we continue to be excited about the growth we've seen in the home health market and the potential of the AssuraMed platform.

I will note that we remain very confident in our original estimate of achieving at least $0.18 of non-GAAP EPS accretion for the full year.

Other factors positively impacting segment profit included contribution from planned efficiency initiatives and growth in our preferred products portfolio.

Now I have a few words on Cardinal Health China, a business which spans both of our reporting segments.

Our business in China again posted strong double-digit revenue growth for the quarter, up 29%.

While we're on the subject of China, let me take a few more moments to comment on the environment as we see it.

First, although we continue to see news around the slowing of industrial growth in China, the healthcare market in China is growing and will continue to grow at rates well in excess of GDP growth rates.

Demographic changes, lifestyle trends, the expansion of health insurance programs, and the government's pledged support development are all factors that make healthcare in China an attractive place to be.

Second, the recent compliance investigations by the government authorities are affecting the promotional activities of certain Pharma companies and we expect this to moderate growth in the near term.

However, we continue to remain bullish on medium to longer-term growth and in particular, our ability to build on our unique brand of supply chain excellence, integrity, and service offerings.

Turning to slide number 6, you'll see our consolidated GAAP results for the quarter, which include items that reduce our GAAP results by $0.11 per share compared to non-GAAP.

(inaudible) $0.09 to acquisition-related costs, which reflects $0.08 of amortization of acquisition-related intangible assets.

Also included in this figure is $0.02 of restructuring and employee severance.

In Q1 of last year, GAAP results were $0.02 lower than non-GAAP results, primarily related to amortization and other acquisition-related costs.

Now I'll talk briefly about guidance for the current fiscal year.

As you know, we provided an initial guidance range on our August call of $3.45 to $3.60.

Given the strong operating performance in Q1, we are now raising our range to $3.62 to $3.72.

I will add that it's unusual for us to update guidance this early in our fiscal year, given the amount of time that's still ahead of us.

However, this year, we have made an exception due to our first quarter results and the strength of our operating earnings performance.

Most of the underlying corporate assumptions remain unchanged from our previous comments; however, I do want to mention a few points.

First, we are not changing the full year expected tax rate range of approximately 34.5% to 36% that we provided in August, because it's (inaudible) [impossible] that the favorable impact of the first quarter tax settlement could largely be offset by unfavorable discrete items in future quarters of fiscal 2014.

Put another way, quarterly tax rates will fluctuate throughout the year, but we expect our full year rate to end up somewhere within the original range we provided.

To be clear, our changing guidance is unrelated to taxes.

Second, we are essentially holding our anticipated diluted weighted average shares outstanding less than or equal to 343 million for the year.

Although, I don't like to telegraph exactly what we may do regarding share repurchases, I will say that, at a minimum, we'll offset dilution.

Our existing authorization, combined with the new Board approval, gives us ample flexibility as the year progresses.

Third, we reduced our interest and other assumptions by $5 million and now assume a range of $140 million to $150 million.

Finally, in regard to cash flow, as I noted earlier, we were able to realize the majority of the working capital benefits from the Walgreens transition in Q1.

This positive cash flow will be partially offset by the continued after tax lost earnings and a LIFO-related cash tax impact later this year.

Timing of all these of moving parts has resulted in seeing most of the positive cash flow early in the year, while we expect the offsets to occur through the remainder of the year.

We continue to project that all these moving parts will net to more than $500 million of cash flow for the year.

In closing, I would like to thank the Cardinal Health team for a very strong start to fiscal '14.

It is exciting to achieve these levels of growth and margin expansion and it only happens with the hard work and dedication of our employees.

I'm optimistic about the rest of the year, as we continue to build on our strategic priorities.

I'm looking forward to seeing many of you at our Investor and Analyst Day on December 10.

With that, let's begin Q&A.

Operator, please take our first question.

(Operator Instructions) Ross Muken, ISI Group.

In the Pharma business, maybe just to start with the quarter, can you talk a bit about what you've experienced in the independent channel?

Obviously, you've sort of been in transition there for a number of years post the Kinray buy.

It seems like you've had a lot of momentum.

The customer base, you've really done increasingly better with, it was a big conference recently.

What has been your experience there and how would you think your growth rates compare to market?

Yes, as you know, we've devoted a lot of energy, a lot of resources in recent years to our retail customer base and diversifying that base, as you know, and I think the commitment is paying off.

We've attracted talent to focus in this area.

Our offerings are broader, more creative, allow them to compete.

That's not just on the pharmaceutical side.

That's on the front end.

That's in other tools, for example, in helping them set up a diabetes center in the store.

I think we're building capabilities.

I think that set of customers feels that from us and I think they recognize that we're focusing.

I would say that we have probably expanded our market share a bit, but I probably would not attribute it to a single thing.

I think it's really a comprehensive effort that has been going on for now a good four plus years and Mike Kaufman and his team have done a great job of strengthening our position in that side of the market.

Great.

You touched upon, at the beginning, there's obviously a lot of change going on in the industry.

A lot of it, in terms of the investor focus, continues to been on the procurement of generics, obviously something you have a unique perspective on, given your background.

As you think about the way you're contracting in market today and the changes you've made to your generic strategy over time, what are the key things you're thinking about as your peers continue to do things that are a little bit atypical from the historical perspective?

What are the things you're looking for?

What are the things you're trying to focus on to make sure you're competitive in that market?

How do the conversations go with the manufacturers, as obviously it's a little bit of a slippery slope for them in terms of ceding too much price versus what the tradeoff is for volume.

That's a really good question and it probably deserves a very long answer.

I'll try to give it a summarized perspective.

Obviously, a lot is happening.

We all know that.

Much of that, by the way, is still relatively early stage, so it's so hard to discern exactly the implications of all that.

Here's what I'd say about what's happening for us.

Our sourcing programs have just simply gotten better every year.

We have a deeper team.

We've got greater capabilities, including, really, global know-how.

We work with our manufacture partners really closely.

If I had to describe one of the changes that's most notable for me is the level of strategic dialogue and discourse that we have with those manufacturers.

I think we do a really effective job coordinating our upstream and downstream.

I think we do a much better job on connecting the sourcing to our go-to-market model.

I think there's a lot happening.

Our team deserves a lot of credit.

They execute really well.

We've gotten bigger and I think that has helped.

There's a bit of a cycle that occurs.

It's not about one dimension.

Obviously, scale matters, strategic relationships matter, awareness of the strength of any given Company, any given product area matters, and understanding how to deal with a market that has occasional disruptions matters.

I think we've just done a good job of improving every aspect of the way we think about sourcing, both tactically and strategically.

Thanks, George.

Lisa Gill.

I just really had a couple of questions on the [med/surg] side of your business.

Clearly, talking about preferred items, continuing to see increases there.

What are your expectations over the next year or so?

Secondly, any expectations at all as we move into the Affordable Care Act and increasing utilization on that side of your business and your relationships with the hospitals?

Let me start with preferred products.

I think in a broader sense, we're seeing increasing attention in the provider space among hospitals and the integrated systems on what they call physician preference items.

I think they recognize that this is an area where efficiency needs to carry the day and that has not historically been the case.

This is an area that we're very focused on.

We've done really well in growing this space.

I would expect that to continue to grow for us.

A lot of our preferred products fall into this category.

As you know, we've done some things to take a step forward in the system.

For example, again, our partnership with Emerge, which is really in the order orthopaedic trauma area, while it's early, we're seeing real enthusiasm and a lot of demand from our customers on this.

We'll continue to roll out that program and I would expect that we'll add additional categories going into the future.

I expect preferred products to be a driver for us.

On the broader question of our customers, it's really a unique time, as you know.

There's a huge amount of change, a lot of experimentation in the market in terms of trying new models.

For us, I think our ability to touch all parts of this system matters here because I think we can gain insights from being able to connect to all the players in the system and start thinking about their solutions from a broader perspective.

It's no longer just simply, how do you drop a basis point out of your medical surgical distribution, it's how do you create solutions that allow them to change the game a little bit?

Because I think more of them are thinking about more significant changes than just focusing on an individual price, it's not going to get there alone.

I think we've done a good job with our sales organization of realigning around those strategic partners and we're trying to be very creative, very open minded.

We don't do one size fits all and I hope they will see us a Company they can go to when you're facing some vexing problems and we have some solutions that we can bring.

George, when we think about that in the context of margin, and maybe this is a question for Jeff, if I remember historically, your private label allegiance product has a much better margin.

As we think about these preferred products, is this a nice margin-enhancing opportunity over the next couple of years?

It's Jeff.

Absolutely.

Virtually everything we're doing in the medical space these days is geared towards margin expansion, whether it be our entry into home health or our focus on providing additional services to our hospital customers or expanding in the surgery centers and physicians' office space and definitely, preferred products are very much in the forefront of that as well.

We've said previously, that right now, with the inclusion of AssuraMed in the overall portfolio, our preferred products make up about 20% of the revenue of the Medical segment.

From a gross profit standpoint, that's closer to the mid-30%s, so just from that you get a pretty good idea of how much higher margin our preferred products are.

Clearly, there's opportunities to continue to expand that portfolio very aggressively and it will enable us to drive up the Medical segment profit margin over time.

Greg Bolan, Sterne Agee.

As you think about your portfolio over the next several years, how would you characterize the concentration of limited source generics relative to total brand generic conversions?

I know it's a difficult one to predict, but just any directional comments would be very much helpful.

Hi, Greg, it's George.

I wish I could give you a great answer on that.

I think that we will have and continue to have certain products that have, on the generic side, characteristics that probably bring fewer number of competitors.

That could be a statutory exclusivity.

It could be a court case, as one we just saw on a complex drug.

I do think that we see some of the more complex drugs posing greater challenges for the manufacturers and so there are those that will have the capabilities to do those things and those who are probably working a little bit lower in the spectrum of complexity.

I would say we'll continue to have a mix of products in our 4,000 generics.

You're probably always going to have 3,500-plus that feel more typically commoditized and then a smaller set, whether that's 100 or 200, that have unique characteristics.

I don't see why catalysts for some change there.

I think the characteristics that we're seeing, have been seeing for a while, are ones that we see at least into the near term.

That's great.

Thanks, George.

As you think about your medical surgical portfolio, we've talked about in the past moving up as it relates to just the ASP, the sophistication of technology or medical equipment that you're offering on a preferred basis.

But any updates that possibly you could give us as it relates to partnerships you're thinking about, maybe with an ex-US manufacturer wanting to come into North America or potentially acquiring IP or the development capabilities?

Any commentary there would be very helpful.

Yes, probably only general commentary, although really good questions.

We are very much focused on building out our preferred product program and we recognize that there are categories that probably have a lot of very mature products and those are places where you naturally see some opportunity.

You could imagine that we are exploring many.

We'll probably provide a little more color on this in December when we get together.

But you should assume that we think about this quite broadly, rather than a single product line.

We recognize that there are opportunities and opportunities to work collaboratively with some well-known companies.

We're open minded about how to do this.

But you should assume that we have a wide screen here, not an incredibly narrow one.

Robert Jones, Goldman Sachs.

On the guidance raise, I just wanted to confirm, Jeff, that's all operational?

Said another way, the assumption is that the tax rate goes up considerably for the balance of the year.

Is that right?

That's absolutely correct, Bob.

We have not changed our full year tax rate assumption one bit.

There will be some volatility in the quarters, like we saw in Q1, we had a significant positive benefit.

We are expecting to see some significant negative benefits potentially later on in the year.

It'll average out over the course of the year.

But our assumptions in that regard have not changed one bit.

The raise in guidance was 100% related to operating performance.

Got it.

Just one on generic pricing, it looks like you guys noted flat generic pricing in the quarter.

We've seen similar anecdotes across the industry.

What's your view, George, on what's driving this?

Maybe if you could just help us understand how you're thinking about generic pricing going forward, what's reflected in the current guidance, that would be helpful.

Again, you've heard me say this before, so I apologize if it sounds like a broken record.

Modeling this going forward is, as you know, really difficult.

But Jeff did mention that we characterized moderating deflation and in some specific generics, inflation.

Again, we're talking in general on those about a smaller subset of products rather than the broader portfolio, but nonetheless, it can have an impact.

I think in terms of market conditions, it's driven by a number of things.

Certainly, there's consolidation in the industry.

There have been some real supply challenges, as you know, heightened inspectional intensity, a number of things that have given some, let's say, disturbances to the market or have caused some companies to focus more specifically on a group of products and essentially not others.

I think those characteristics which we see today are the ones that probably we've been seeing for the last at least six months.

It's probably a number of things contributing to this environment, but that's basically what I would say.

Ricky Goldwasser, Morgan Stanley.

I you have a quick question on the Pharmaceutical Distribution segment.

Backing out Express and Walgreens, you get to 14% organic growth rate for the segment.

Can you give us some color when we think about the pharmaceutical margin improvement in the quarter?

If you can help us quantify or understand what percent of it was really driven by the transition of the lower margin business versus organic?

It's Jeff.

First of all, let's be clear -- the Express Scripts contract did have a negative profit impact year-on-year for the quarter.

The Walgreens contract actually did not have a material profit impact and that was really due to the nature of the unwind and how various things happened as we were going through the transition.

To answer your question about margin rates, I would say there are three major contributors to the 29 basis points or so that we saw for the quarter.

The biggest was the overall performance of our generics portfolio and then the other two were the disappearance of the Express Scripts numbers in this year's quarter and the wind down of the Walgreens contract.

Those were the three very significant drivers for the quarter, but the biggest was our generics programs.

When you think about the organic growth, should we assume that those rates will continue for the remainder of the year?

I'm not going to give you specific guidance on the margin, Ricky, but I would expect that our margin rates year-on-year will continue to show improvement for the course of the year; due to the customer mix, again, obviously we don't have Walgreens anymore going forward, but also, just because of the continued performance of the overall business.

Tom Gallucci, FBR.

In the med/surg business, can you frame the growth that you saw ex-AssuraMed and are you seeing any inflection points in utilization in the marketplace that you can perceive?

Why don't I start on utilization and then we'll talk generally about how we're doing.

I would still describe the overall utilization environment as relatively soft.

I probably would not be able to say there's been a deterioration since our last call, nor would I say there's a discernable uplift.

But I would say, still, relatively soft.

An exception, however, would be in the home health space.

I do think that just the forces of the market are going to increase demand in the home and we see that and we're continuing to align around those changes.

But we are seeing some really good performance generally and Don Casey and his team have done a great job of thinking about the changes in the market and seeing some progress in a number of areas of the business outside of AssuraMed.

Part of it has to do with, again, delivery of services at the right time in the right place to the right set of customers.

Jeff, I don't know if you want to add to this?

I think the most significant change we saw in this quarter was really the growth in our strategic accounts.

These are generally larger IDN accounts that have considerable networks, including both hospitals, surgery centers, and physicians offices.

They've been a focus of considerable attention from us over the past while; in particular, because we're about the only player that can fully service the needs of those entire strategic account networks and we really saw that pay off in Q1.

Those accounts were up 8% on the top line, which is really, I think, a validation of our efforts.

I think what's also important about it is that growth is being driven by, very often, them choosing to increase their preferred product portfolio, to increase the services that they're buying from us, et cetera, because they're really seeing opportunities by increasing their portfolio purchases from us to increase the efficiency of their supply chain network.

I would say that was probably the most significant change that we saw in Q1.

Thanks.

On the follow-up, George, I appreciate your comments about the landscape and the evolving world that we're in.

You talked a little bit about your perspective vis-a-vis the manufacturer.

Can you tell us anything about the conversations or the questions you're being asked from customers in light of what your competitors are doing out there?

From customers or from our manufacturer partners?

No, no.

You talked a little about manufacturers before, so I was thinking brought retailers, et cetera, and what they're thinking or saying to you.

Yes, as it relates to our broad base of customers, I would still say that a lot of the things that all of us are talking about here on this call are not generally their day-to-day worry.

Their day-to-day worry is competing in a unique time with some formidable competitors with challenging reimbursement rates and all the dynamics around how they compete in their communities.

I would say that's primarily the conversations that we have with them, about how do we help them compete and do their work, rather than a lot of conversation about what's happening upstream.

I would say it's not typically -- obviously, they're aware of it, but it's still early for them to even discern how that may or may not impact them.

I think right now, they're focused on day-to-day competition, how do they do it and how do we help them.

Okay, great.

Thank you.

Steven Valiquette, UBS.

Just a couple things from the press release -- you mentioned that both generic and branded programs showed strong performance, which would characterize it further that maybe one of those was a bigger contributor than the other.

There's been a lot of talk around the generic inflation tailwinds.

I'm wondering if that was maybe a bigger part versus branded?

For the quarter, generics programs were a bigger contributor than branded programs, but I would ascribe both of their contributions as meaningful for the quarter.

But we're pleased with the entire product portfolio.

By the way, we're also pleased with the progress in nuclear and specialty as well, which really, together, as a group, made up the Pharma results.

Okay.

Has anybody asked about the revenue upside in the quarter?

It was pretty meaningful versus consensus.

I'm just trying to get a sense for whether that was maybe just some overtime from Walgreens on the roll-off of that or just other factors, maybe just strength within the existing customer base or just as generic erosion is not quite as severe now that we're anniversarying the big wave from 2012, is that part of it as well?

It's a good question, Steve.

First of all, it wasn't because of Walgreens.

Actually, the Walgreens revenue transition happened exactly as expected and as I mentioned, it actually was worth about $1.7 billion of decrease year-on-year for the quarter.

I would say the other factors you mentioned, though, were all drivers.

First of all, we did pick up some incremental business with existing customers, as well as some new business.

We saw good volume growth organically with our existing customers.

We did see a little bit stronger brand inflation than we had budgeted for.

As I said, generic deflation was probably a little bit more moderate than we expected as well.

On top of that, specialty had a nice pick-up in Q1 as well from a revenue standpoint.

I'd say all of those were contributors to an above expectation performance.

Okay.

That's great.

Thanks.

Ricky Goldwasser, Morgan Stanley.

Just a clarification regarding the EPS range for the remainder of the year.

I know, Jeff, you said that guidance excludes tax benefit.

Can you just clarify that applies to [$2.70 to $2.80] for remainder of the year?

Just to be clear, the guidance does include the $0.18 tax benefit in Q1, but it also includes an expectation that will largely be offset later in the year by negative tax adjustments.

Net-net, all the tax is in there, but when you net them all against each other they end up back at where we expected the tax range to be for the year, which is 34.5% to 36%.

My comment was that the change in the guidance range going from $3.45 to $3.60 to $3.62 to $3.72 was, in no way, linked to any changes in our you assumptions about taxes.

Really, the tax situation this year is really just a matter of timing in the quarter.

Our basic expectation for taxes has not changed at all.

Can you just help me, because I'm a little bit slow on that, what does that imply for the remainder of the year?

I get to two ranges, either $2.70 to $2.80 or $2.52 to $2.62.

The range you should be assuming, including tax, is $3.62 to $3.72.

What that implies, though, is that in a future quarter, we will likely have a significant negative tax impact, which will offset the positive that we saw in Q1 and so they'll largely net against each other.

But the $3.62 to $3.72 is the right range.

Okay.

Got it.

That's helpful.

Thank you.

Glen Santangelo, Credit Suisse.

George, I just wanted to follow up on some of the commentary you made with respect to generic pricing.

It kind of sounds like you've been talking about more moderating deflation rates now for a couple few quarters.

I'm kind of curious to see if you're willing to call that a trend at this point?

Then this quarter, it seems like a couple of you have called out certain supply disruptions and I'm kind of curious as to what's been driving the margin more, is it the supply disruptions or is it the moderating rate of deflation?

That's a hard one to answer.

Let me try, Glen.

I think the pattern that we've seen, we have seen now for quite some time.

Deflation, on the bulk of products largely as expected.

On a few products that we modeled, the deflation was lower and then on a few products, we actually saw some inflation.

Those are the big moving pieces.

There are thousands of pieces in that equation, but I think that is the pattern that we've seen and I'm not sure it's changed dramatically.

Again, so the question is when you say trend, like what I model it going forward in the future, I'd say right now, there's nothing in the market that we're seeing that's going to change that.

The basic competition is as it is.

We will very carefully watch every court case to see whether or not that -- we had one recently -- affects a number of competitors in any given product.

It has been a pattern that we've seen for some time.

As we talk about disruption, I really put that in the context more of whether or not there's some sets of products where competition seems more limited.

I think what can happen when you have some supply disruptions in a market that maybe had six or seven players now has three or four, two or three, and that may have a tendency to stabilize prices in that set of products.

I think we have seen some of that over the last couple years.

We've seen some well-publicized cases of some companies going through some facility issues, FDA, as you know, has done more foreign inspection in recent years.

I think that is part of our current environment and I expect that to continue and so that's partly what we're seeing.

How to tell you exactly how much is attributable to a disruption versus just sort of competitive behavior would be really hard to discern.

I just think it's part of the general environment that we're seeing.

Maybe if I could just ask one follow-up, I know you don't want to comment on calendar '14 and '15, but as you look at the patent expiration schedule over the next 24 months, we on the street all have a tendency to want to look at the dollar value of brand-building generic.

Do one of those two years look bigger to you or bigger opportunity for you versus the other or do they both look good or neither as good as what we saw the past couple years?

How would you characterize it?

It's really early.

I'm sorry, I can't give you a full answer on this one.

We just started our '14.

It's hard to characterize '15.

I think if we go back to the beginning of our year when we talked about the pattern, we probably saw '15 not altogether different than '14, but that was early in our fiscal year.

It would be hard for me off the top of my head to sort of give you a quick answer and probably would be a little bit hesitant to do so at this stage, anyway.

It's very early.

I would remind you of this and I think maybe our current performance highlights that, Jeff mentioned that our contribution from new products was actually less in this period and yet, we had a very strong generic performance.

I would remind you that while generic launches influence our performance, there are a lot of other things that actually contribute to how we generate growth and profits on our generic program.

We've been able to do that, even in the face of what I guess you would call a headwind, on new launch values.

That's just sort of a reminder.

Okay.

Thank you.

John Kreger, William Blair.

George, you mentioned specialty as a contributor.

Was most of that coming from oncology or are you seeing nice growth in the other therapeutic classes as well?

Yes, John, I think we're seeing growth everywhere, but oncology was probably the biggest driver in this particular period.

Great.

A follow-up on medical, if you're willing, can you give us a sense of how your operating income across Medical breaks down into some of your key client categories?

I'm thinking home care, now that you have AssuraMed versus institutional versus perhaps ambulatory.

I'm not going to give you specifics, John.

We don't break it down that way publicly.

I would still say our hospital and hospital-related business is the largest chunk of both revenue and earnings, followed by home health now with the addition of AssuraMed, followed by pure ambulatory, physician's offices, et cetera, that are unrelated to large IDNs, that's sort of the rough order.

Obviously, the biggest change there has been the big step-up in home health over the last couple months with the inclusion of AssuraMed.

I think we'd probably add, though, that the rates don't necessarily follow that pattern.

The rates would probably be higher in the more ambulatory settings where the cost to serve and the requirements of how you do that, the (inaudible) operations, everything else is quite different.

I'd say the rates are probably -- I'm not sure they're completely inverted, but more on the home ambulatory as you move back toward the big IDNs.

Very helpful.

Thank you.

John Ransom, Raymond James.

Jeff, could you help us understand the next three quarter effect of not having Walgreens in your numbers from an EPS standpoint?

Probably not is the honest answer.

I'm always a little bit loathe to give directly attributable to a customer and I'm sure Walgreens wouldn't appreciate that either, but I will say probably a repeat of what I said earlier.

Q1, there was very little, if any, earnings impact, just given the nature of the wind down, despite the fact that revenue was down $1.7 billion.

That will not be the case for the next three quarters of this year or the first quarter of next year until we lap it.

There will be a meaningful, both revenue and earnings, impact.

All that impact has been reflected in our guidance from day one and it continues to be reflected in our guidance.

George, I know you touched on this, but just to kind of reset, obviously, your two competitors have done large deals overseas, trying to move toward global sourcing.

You obviously ran a big generic supplier.

Is there a card for you to play potentially or do you just not see a need for it?

Is there an opportunity cost in not pursuing what your competitors have been doing?

I'm going to give you, of course, an answer you're going to hate, because it's going to be quite general, but I think we'll have to go with that.

Right now, we're competing very effectively.

I like where we are.

You can imagine that we're not sitting still.

We have a pretty broad-based knowledge base of what's happening in markets around the world.

There's very little that we don't explore.

As I mentioned, I think we're well-positioned, but we're going to stay very open-minded about new ways to create value.

But that has to be real value for our customers and our suppliers and honestly, for our shareholders.

What I would say is, I think there are chess pieces always available and we'll keep our hands on those chess pieces.

But we'll deploy capital with an open mind, but I'd say sort of a disciplined hand, always conscious of making sure that we're in the most competitive position.

I know that's a very broad answer, but that's the best I can do for now.

Okay.

That's fine.

Just shifting into a little more of a micro topic, if you looked, say, five years out in the US and think about cost containment pressures intensifying, how far off the value curve do you think, let's say, off-brand devices could get to?

Could we start talking about the equivalent of generic knees and hips and things like that or do you think there's a limit to what can be done there?

I'm not going to give you a specific answer but I think it is reasonable to assume that we, in my view, that we need both innovative medical devices, which continue to be developed and I think actually some of the pressure is to develop more of them.

But I think, on mature products, that we do need, given the cost containment pressures, some way of bringing greater competition to those products.

We're on that issue.

We understand that.

I think your question is right on the mark.

It's not, certainly, a complete analog to what we see in generics where you have sort of a mechanism that we call, maybe, writing that creates a go-to-market model.

But I do think there are ways to do this but it requires, I think, unique sets of skills.

Those are clinical skills that we're building that requires a go-to-market strategy and you need to be doing it based on data and not just on a wish.

We're doing all those things to put ourselves in a position to help support a system that probably needs some ways to reduce costs on some of these older, more mature products.

Eric Coldwell, Robert W. Baird.

George, I see Teva's looking for a you new CEO.

You're not getting antsy on us, are you?

I had a very public comment yesterday explaining I was not a candidate.

As you know, I've got great admiration for all that they do and I had great experience there.

I'm having a great time leading Cardinal Health and very committed to seeing our continued progress.

That really wasn't a trick, but the quarter was a treat.

Good job.

Three questions on specialty -- I'll make it one question, wrap it into three subparts.

First off, I missed the growth rate.

Second of all, can you give us a sense on where the oncology growth share is coming from and what's the nature of that business -- community, hospital, other?

Third part, as distribution growth is accelerating more than services growth around specialty, does that lead to margin compression in the group or are you getting scale efficiencies that can allow overall specialty profitability to improve?

Thanks.

Start with it, Jeff.

It's Jeff.

We didn't give a number for specialty, but I'll give it to you now.

Our Specialty Solutions group grew revenue 41% in Q1.

George, you want to take it?

Yes, I would say primarily it's coming in the community setting for now.

Here's what I'd say -- I think we're getting additional scale in distribution, which gives us additional positioning and just credibility in the offices.

I do think that the services that wrap around this work is always critical.

I think many of us can do distribution and I think we certainly established ourselves as a very credible and now a scale-based player in distribution side.

I think it's very important to be able to deliver the kind of services that can help them in a very different world and that sort of thing, like our (inaudible) tools and other tools that help sort of connect these three players with the patient.

Obviously, the three players being the BioPharma Company, the provider, and the payer.

I think the wrap-around services are very important for us.

Generically, on the margin profile, faster growth in distribution, does that weigh on the profile or are you getting scale efficiencies there?

I think we expected our growth on the distribution side to be heavier.

It's the nature of it.

Obviously, distribution margins relative to certain kinds of service margins are lower, but it's not negatively affecting our projection on how we expected this growth to occur.

This is, as we though, we're pleased to see the growth on the revenue side because it just means we're getting more presence.

That's great.

Thanks, again.

Listen, I think we're going to wrap up the call.

First, those of you who know Sally is a rabid Red Sox fan, so we've been just trying to keep her on the ground today.

She's a little excited.

I'd just conclude by saying, it's been an excellent start, I think, to fiscal '14 and we really look forward to seeing all of you.

Thank you for joining us on the call today.

We look forward to seeing you in December.

Thanks.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude today's program.

You may all disconnect.

Have a great day, everyone.