卡地納健康 (CAH) 2014 Q2 法說會逐字稿

Good day, and welcome to the Cardinal Health second-quarter FY14 earnings conference call.

Today's call is being recorded.

At this time, I'd like to turn the conference over to Sally Curley, Senior Vice President Investor Relations.

Please go ahead.

Thank you, Terry, and welcome to Cardinal Health's earnings conference call this morning.

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 the SEC filings and the forward-looking statement 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, and information about these measures is included at the end of the slides.

I'd also like to take the time this morning to remind you of a few upcoming investment conferences and events.

We will be attending one-on-one meetings at the Citigroup Global Healthcare Conference on February 25, and the RBC Global Healthcare Conference on February 26, which are both in New York.

And on March 3 at the Cowen Annual Healthcare Conference in Boston.

In addition, we will be webcasting our presentations at the Raymond James Institutional Investors Conference on March 4 in Orlando, Florida, and at the Barclay's Global Healthcare Conference on March 13 in Miami, Florida.

Details for the two webcast events are, or will be, posted in 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.

We had a very strong second-quarter operating performance, closing out an excellent first half to our FY14.

So let's get started.

Total revenues for the second quarter were approximately $22 billion.

The decline was 12%, as our revenue line no longer included any sales from the Walgreens supply agreement.

Net of this, we experienced growth with existing customers, and contribution from new business.

We achieved a very solid increase in our non-GAAP operating earnings.

In a quarter where we felt the full impact of no longer serving Walgreens, we were able to achieve a 10% increase in non-GAAP operating earnings.

Our gross margin rate expanded by 120 basis points to 6% in the quarter, from 4.8% last year.

And our gross margin dollars increased by 10%.

I will note here that we achieved strong margin expansion and operating profit increases in both our pharmaceutical and medical segments.

Our second-quarter non-GAAP diluted EPS was $0.90, down from $0.93 last year.

This decline, however, includes a charge of $0.16 per share related to a tax reserve.

We had mentioned this on our first-quarter call, and said that it could occur as early as second quarter.

As you may recall, our first-quarter EPS had an $0.18 benefit from the resolution of some historical tax matters.

Note that for the first half of our FY14, non-GAAP EPS stands at $2, an increase of 15% versus last year, after the puts and takes of those discrete tax adjustments.

So, based on our year-to-date results, and the strength of our operating performance, we are now raising our guidance to a new range of $3.75 to $3.85 for FY14 non-GAAP EPS.

Before we talk about the segments in more detail, let me take just a few minutes to discuss our joint venture with CVS Caremark, which we announced in December.

You may remember that during our last earnings conference call, I talked about some of the changes in our marketplace.

And noted that we had been evaluating, and would continue to evaluate, all options to sustain and expand our competitive advantage, and to deliver meaningful and lasting value to our customers, our supplier partners, and our shareholders.

We believe that the CVS Caremark joint venture accomplishes those objectives.

We created a purchasing combination of tremendous scale, which we know is critical in generic.

It allows us to bring together two of the most knowledgeable and experienced generic sourcing teams in the world.

The 50/50 venture is structurally straightforward.

We are not changing the service model or our operating platform.

The venture is focused solely on global sourcing for the US market.

It allows our two companies to pursue our independent strategies to serve our own distinct customers as we see fit.

And we will accomplish this while maintaining the capital flexibility to continue to invest in other growth and high-return alternatives.

We believe there will be opportunities to work strategically and collaboratively with our generic manufacturer partners to explore new ways to create value.

Finally, as we announced in December, our teams are hard at work with the goal of being operational as early as July.

Now, onto the segments.

Our pharmaceutical segment delivered solid profit growth of 9% on a revenue decline of 15%.

We were pleased to see the strong buying growth from new and existing customers.

Our segment margin expanded by 54 basis points, driven by the strength of both generic and branded programs, and by the product and customer mix initiatives that have been an important part of our strategy for the past few years.

I'd like to take a moment to discuss our presence in retail pharmacy.

Of course, we were very excited to announce the extension of the CVS service agreement for an additional three years, through June of 2019.

We remain deeply committed to retail pharmacy.

Whether that is delivered through a chain drug, a food-and-drug retailer, or one of our thousands of independent pharmacy customers, we believe that pharmacy must and will play a more vital role in the delivery of healthcare.

With this in mind, we will continue to deliver best-in-class products and services to ensure that our pharmacy customers can serve this valuable role in an evolving healthcare system.

Our specialty solutions team continues to deliver robust growth, validating our perspective that working at the intersection of the provider, biopharmaceutical manufacturer, and payer, will be important for the future.

Over these past three years, it has been important for us to build scale in specialty distribution, in order to enable greater touchpoints with clinicians.

Now that we've achieved critical mass, and through building out more services, operational and clinical, to serve these providers, we are beginning to realize some of the benefits.

At the same time, our specialty solutions team has been gaining momentum with our biopharmaceutical partners.

We are increasingly able to offer the innovative clinical capabilities these manufacturers require to serve patients who often have distinct needs, and at the same time, navigate a complex reimbursement environment.

And we have created the teams and made the moves to build a best-in-class patient-centric hub serving the needs of patients, and reinforcing the work of our manufacturer partners.

Finally, on specialty, we're seeing an increasing interest among payers who want to see better alignment in the system to improve cost-effectiveness.

Our medical segment performance was strong.

Revenue was up 13% to $2.8 billion, and segment profit increased 40%.

The largest contributor to that growth came from our AssuraMed acquisition, the centerpiece of our strategy to serve patients in the home.

Although acute-care utilization remains somewhat soft, we experienced growth in our existing customer base and increased penetration in our targeted strategic accounts.

Our ability to provide new service offerings is extremely important, as our customers take on new configurations, and experience different economic and regulatory forces.

Building our preferred products portfolio remains a top priority, and a high priority for our customers.

Our ability to grow here addresses an important pain point for our customers, hospitals and ambulatory, and we are committed to providing a comprehensive solution set.

And this goes beyond the products, and includes services and analytics.

Customer response has been strong, and we will continue to add to our growing portfolio of clinical alternatives to mature medical devices.

Our medical consumables line continues to gain solid traction.

Our product launch rate in the first six months of FY14 was considerably higher than we've ever had.

We are moving quickly to add high-quality, high-value options for the customer.

Looking forward, we believe we can increase our medical consumable penetration in non-traditional medical channels such as home health and long-term care.

As we look to home health, AssuraMed reported a very solid quarter, again, outperforming our deal model.

We remain very committed to following the patient to the home.

The demographics are inescapable, and the cost-effectiveness of keeping patients well cared for in the home is hard to dispute.

To help support our strategy of serving patients in the home, during this past quarter we made two tuck-in acquisitions in the urology, incontinence and ostomy care areas, and we'll continue to look for opportunities to draw on the strength of this platform.

Turning to China, we had another quarter of very strong growth on both the revenue and profit [lines].

The sales run rate for this business is now approximately $2.5 billion, and we feel very optimistic about its growth.

China is a unique market, going through a very rapid evolution.

We continue to play out our strategy here of enlarging our geographic footprint, creating new business partnerships, and bringing our expertise to new opportunities such as direct-to-patient.

We finished the quarter with 28 direct-to-patient, or DTP, specialty pharmacies, as we move toward our goal of at least 50 across the country; an example of an innovative healthcare solution to delivering high-cost specialty drugs to the patient's hands.

We also concluded the acquisition of a speciality retail pharmacy company during the quarter.

That, combined with our existing retail pharmacies, gives us national coverage and eCommerce capability.

We will continue to expand this chronic care work with a focus on very disease-centric patient-support models.

Let me conclude by saying that this is a period of extraordinary change for healthcare and for Cardinal Health.

It is uncommon to experience a moment like this; a moment which requires those of us who have the privilege and the responsibility of being in healthcare to demonstrate our ability to innovate and to evolve in a way which can move us toward a system which is higher quality and more cost-effective.

I thank our people for demonstrating the readiness to step up to that challenge, and for their fine performance.

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

Thanks, George, and hello, everyone.

This morning I'll be reviewing the drivers of second-quarter performance, and will provide additional detail on the full-year, including our decision to raise our FY14 guidance range.

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 10% increase in non-GAAP operating earnings in our FY14 second quarter versus the prior-year period, driven by margin expansion across both of our reporting segments.

Our non-GAAP earnings per share of $0.90 outperformed our expectation, but were slightly down compared to the prior-year period.

This decline was driven by an anticipated discrete tax charge of $56 million based on proposed assessments of additional tax.

This unusual $0.16-per-share unfavorable impact was triggered in Q2, and mostly offset the favorable tax settlement gain of $0.18 per share in Q1 of this year.

Including this unfavorable impact, Q2 non-GAAP earnings per share grew a robust 14%; a great quarter of growth.

Again, to be clear, both the Q1 positive $0.18 tax benefit and this Q2 $0.16 tax charge essentially offset each other, and both have been contemplated in our guidance since the beginning of the year.

We mentioned this in our Q1 call.

I'll now go through the rest of the income statement in a little bit more detail, starting with revenue.

Consolidated sales were down 12% to $22.2 billion, which was better than we expected.

The decline was due to the expiration of the Walgreens contract, which was partially offset by sales growth from new and existing customers.

Gross margin dollars increased 10%, to 6% of revenue, with the rate up a strong 120 basis points versus prior year.

This continues our 3.5-year trend of margin expansion.

SG&A expenses rose 10% in Q2, primarily driven by acquisitions, including AssuraMed, as well as increasing incremental incentive compensation accruals related to the Company's overperformance.

Our core SG&A was essentially flat year over year, evidence of our enterprise-wide commitment to controlling costs and improving the efficiency of our operations, while continuing to invest in our key strategic priorities.

Our consolidated non-GAAP operating margin rate increased 52 basis points to 2.6%.

We have now posted operating margins greater than 2% in four of the last five quarters.

And we are making progress towards our longer-term aspiration of consolidated non-GAAP operating margin greater than 3%.

You will notice that our net interest and other expense came in $4 million higher in Q2 than in the prior year's quarter.

This is mostly due to the new $1.3 billion of debt we issued in February of last year, associated with the AssuraMed acquisition.

The non-GAAP tax rate for the quarter was 43.3% versus the prior year's 36.8%.

This unusually high rate was primarily driven by the discrete $56-million tax charge I mentioned earlier.

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

As I had mentioned previously, we anticipated both the positive tax impact in the first quarter and the Q2 unfavorable impact when we originally provided our FY14 tax guidance range.

I'll speak about updating that range in a moment.

Our diluted weighted average shares outstanding were 346.2 million for the second quarter, which is about 3 million shares higher than last year.

Fiscal year to date, we have repurchased $50 million worth of shares, all in Q1.

And at the end of December, we had $1.35 billion remaining on our Board-authorized repurchase program.

I'll update you on share count assumptions for the full year later in my prepared remarks.

Now to discuss consolidated cash flows and the balance sheet.

We generated approximately $40 million in operating cash flow in the quarter.

Year-to-date operating cash flow of almost $1 billion is about where we expected to be, given the unwinding of the Walgreens contract.

Of note, the net working capital component from that unwind is essentially complete.

And as a reminder, there typically is a large degree of operating cash flow variability in sequential quarters.

Moving on, at the end of Q2 we had $2.7 billion in cash on our balance sheet, which included $446 million held internationally.

Our working capital days decreased versus prior year, primarily due to the expiration of the Walgreens contract.

Now let's move to segment performance; I'll discuss pharma first.

Pharma segment revenue came in better than we expected, although it did post a decrease of almost 15% versus the prior-year period to $19.4 billion.

This is the first period where we reported a full quarter of revenue loss in Walgreens, which amounts to just over $5 billion.

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

Pharma segment profit increased by 9% to $482 million, driven by strong performance in both our generic programs and branded agreements, including the impact of price inflation.

This was partially offset by the expiration of the Walgreens contract.

Unlike our first quarter, this quarter reflects the full operating earnings impact of this expiration.

I will also note that each of our pharma segment businesses had strong profit growth compared to the prior-year period.

With respect to generics, sales and profits from our generics programs exhibited very good year-over-year growth in the quarter, as a result of the emphasis we have placed on building the strength of our programs over the last several years, the overall robustness of the market, and the effect of price inflation.

I'll also note that, as anticipated, we did see less contribution from new generic launches in this year's quarter versus the prior-year period.

For the second quarter in a row, the generic inflation rate was essentially flat year on year.

I do want to note that our generic performance this year has included what we believe to be abnormally high inflation on a relatively small basket of products.

Because generic pharmaceutical pricing is so difficult to predict, we remain relatively conservative in our forecasting for this item.

In addition, we saw strong performance under our branded pharma contracts, with brand inflation in the low double digits, which was slightly better than we expected.

We also saw a few branded price increases that occurred late in our second quarter, which we had modeled to occur during our Q3.

Pharma segment profit margin rate increased by 54 basis points compared to the prior year's Q2.

Now moving on to medical segment performance.

Medical revenue growth was up 13% versus last year.

Home health, reflecting our AssuraMed acquisition, was the primary driver of revenue growth in the quarter.

As a reminder, we will lap this acquisition in our third quarter, and given that it is becoming increasingly integrated into our operation, we will not call it out separately starting in Q4.

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

Those strategic accounts grew 7% for the period.

Medical segment profit grew a robust 40% in Q2, primarily driven by the performance of our home health platform, AssuraMed.

As George said, the AssuraMed integration has gone very well.

We are on track to achieve our original estimate of at least $0.18 of non-GAAP EPS accretion for the full year.

Other factors positively impacting segment profit include a contribution from planned efficiency initiatives and preferred product.

Partially offsetting the medical segment profit growth was a year-over-year increase in incentive compensation, much of which is based on total Company performance, and allocated to the segment.

Now a quick note 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 37%, and we saw solid margin expansion.

Let me pause for a moment to comment on the overall pharma market in China, which has been experiencing some turbulence recently.

Based on external estimates, it appears that the market was growing at a rate in the mid- to high-teens in the first half of calendar 2013.

Due largely to the impact from government regulatory actions to improve the integrity of the system, the growth rate dropped to high single digits in the second half of calendar 2013.

However, we are starting to see some signs of recovery, and forecasts point to a return to mid-teens growth in calendar 2014.

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

Included is $0.10 of amortization and acquisition-related costs.

Also included in this figure are $0.02 of restructuring and employee severance, and $0.02 of impairment on loss and disposal of assets.

In Q2 of last year, GAAP results were $0.05 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.

Given the strong operating performance in the first half of the year, and our outlook for the next six months, we're raising our non-GAAP EPS range to $3.75 to $3.85.

We are also updating a few of our underlying corporate assumptions.

First, we are increasing our anticipated diluted weighted average shares outstanding to a range of 345 million to 347 million for the year.

A few reasons for this: We are forecasting a fair amount of option dilution in the second half of the fiscal year.

Also, we are limited in how often we can go to market to buy back shares during the first half of the year.

We still plan on repurchasing shares worth at least a couple hundred million dollars in the second half.

But exact timing and amount will be determined based on the market and other factors.

Given all this, we have incorporated a range of possible share count outcomes in our EPS guidance.

Second, we are reducing our interest and other assumption, but widening the range to $105 million to $130 million, due to a possible gain on investment which may impact the second half of the fiscal year.

Third, we had a slight increase in the expected amortization of intangible-related assets to approximately $184 million, or about $0.34 per share, which captures a few small tuck-ins we completed in the quarter.

Lastly, we are revising the full-year expected tax rate range to 35% to 36%.

The large discrete items we anticipated for the year have now been booked in the first half.

We do expect a higher tax rate in the second half of FY14 compared to the first half.

As we look to the second half, I wanted to point out a few other differences versus the first half of FY14.

First, we had about a full quarter of earnings from Walgreens in Q1.

Second, we believe that the amount and rate of generic inflation in the first half of the year was unusually high, and have assumed a more moderate impact in the second half.

Third, recall that when we announced the CVS JV, we noted there would be some related costs during the second half of FY14.

Finally, Q3 is typically our strongest quarter for brand inflation, and we expect that to happen again this year.

However, we did see inflation on a few products in Q2 that we had modeled in Q3.

That may skew our usual seasonal earnings pattern in pharma somewhat.

But most importantly, we continue to expect to build on the momentum of our strong business, and particularly our areas of strategic emphasis.

In closing, I would like to thank the Cardinal Health team for a very strong first half.

Their tenacity and execution against our strategic priorities continues to pay dividends.

I'm looking forward to the second half of FY14.

With that, let's begin Q&A.

Operator, our first question?

(Operator Instructions)

Ricky Goldwasser, Morgan Stanley.

This is (inaudible) for Ricky.

Congratulations on the quarter.

I wanted to start by asking about generic inflation, in your assumptions for the second half.

There was news last week that Ranbaxy had an important ban on one of their plants.

And just curious on your thoughts on how that might impact generic inflation and if that's considered in your more modest guidance for the second half?

Yes, sure.

Why don't I take it?

Good morning.

I'll touch on first the general environment and then maybe a little bit more specifically on Ranbaxy.

So let's start with this.

We indicated and you've heard and Jeff reiterated that it's been a bit of an unusual stretch in pricing.

We've seen price increases on a number of products and the number is above what we've historically seen.

But I'd remind you here that we carry thousands of generic products.

And so when we look at this period fewer than 5% of these products are experiencing meaningful price increases.

So just again, recognize that it's a relatively small subset of the generic portfolio.

It is difficult, and Jeff said this, to predict as you look forward.

We think -- just taking the appropriate assumption here that the recent months have been somewhat unusual and that this dynamic moderates going forward.

As it relates to the Ranbaxy problems, again this is a byproduct of some work that we've seen with FDA.

FDA certainly increased its capacity to do inspections outside of the US.

Clearly for some companies that has posed a challenge, at least certainly for some facilities.

We, as you would imagine, are very careful to make sure we stay on top of all of the global supply dynamics and in many cases utilize multiple sources as a result.

I would not say that the specific story around Ranbaxy will have any impact on our business as we look to the rest of the year and going forward.

So, it's -- they are a player in our mix, but one of many and won't have any impact on us going into the rest of year.

Great.

Thank you.

And then just on CVS, just curious as you've talked with current customers what their early reaction has been, now that its been six weeks or so past the announcement?

And if there is any indication or more interest in purchasing generics from Cardinal due to this deal?

Sure.

Again, it's George, I'll take this again.

We've actually had great support from our customers.

It's been a noisy stretch, as you know, in the last year and I think given some of that noise in the market, in many ways it's been reassuring to our customers that we will always be in the best position to keep them competitive.

And so I would say generally we've had great support.

I would also add that I think making sure that our joint venture was really a 50/50 relationship, really told our customers -- or other customers that no external party would be dictating or influencing our strategy to serve them.

So I would say thus far we've had really good support from our customers.

Ross Muken, ISI Group.

Good morning, guys.

So I guess the underlying results in pharma continue to be better.

It's hard to tease out all the components.

It seems like honestly, we talked about inflation -- if you had to look at some of the other pieces that have been most surprising to you, at least in the last maybe three or six months of development, obviously China may be not one of them.

But what parts would you say in terms of how the team has executed have been the biggest standouts for you in terms of some of this net out performance?

Why don't I start and then maybe I'll turn it to Jeff.

So, here's -- you know that we have a pretty broad portfolio.

We tend to -- because of the size of certain of our business lines talk only about one or two, it's very common that's what happens.

But the reality is we have a lot of business lines.

And actually what has been happening is many of them are going well.

It is one of the nice things about having a portfolio, you have these puts and takes.

We've been getting some pretty good performance across the board.

And so I think that is really largely what is at work.

So, as we said on a medical business, while utilization has been soft, our focus on key strategic accounts and on key business lines, on mix has been really helpful to us.

Our team is doing a great job there.

On our pharmaceutical segment, we are getting growth in specialty.

Obviously, we talked about generics and our work there.

And so I think it's really sort of a balance issue, but maybe I'll let Jeff jump in and provide a little more color.

Yes, as I said my remarks, we really had good performance across the board, in the pharma segment.

You previously mentioned China, Ross, and we had a very good quarter in China.

We expected that.

We expect very big things from our China operation, albeit it's a relatively small contributer to the overall profit of the Corporation, we do expect strong growth there and we very much got it.

In spite of the fact that the market was a little turbulent in the quarter.

As George said, specialty posted good revenue and profit growth in the quarter and we are really seeing our specialty team -- they've really hit critical mass in terms of distribution size.

They are able to take advantage of that positioning to offer other services to manufacturers and providers and payers and just is beginning to drive the profit line for them.

Interestingly, we saw better than expected results in nuclear, as well, and our team there is doing a really good job of responding to a very tough environment and we've seen a bit of -- one product in particular, do quite well with that business.

So we are seeing some good trends in nuclear as well.

So yes, it was a very encouraging quarter in many respects, that we were really hitting on all cylinders and most of business within pharma.

Likewise on the med side, I highlight two things which are really important to us, one is the continued growth and impact of our home health platform, and the fact that we have started to identify some external assets that we can bolt onto that, that are very accretive to us.

So that was a great sign in addition to the growth of the underlying business there.

And the overall growth of that market which is growing, it looks like somewhere in the 6% to 8% range.

And then finally the 7% growth in strategic accounts, is also very important and these are accounts, by the way, that we've identified within our portfolio as being very large networks of hospitals and ambulatory sites that tend to buy a lot of our products and services, because of the complex operations and we can provide a host of services and products for them that can help them manage those networks.

And seeing 7% growth in that portfolio was also very encouraging.

So lots of good news to report this quarter.

And maybe you guys were able to attack the whole generic sourcing question in a pretty capital efficient manner and leave the balance sheet and your capital deployment capability in a pretty good place.

As you see the tuck-in in or mid sized M&A environment today, how would you characterize it versus where we were three or six months ago just in terms of activity and the breadth of targets right now that are out there for you to analyze?

I think it's a fairly attractive environment right now for the types of assets we are looking for.

Particularly now that we've got a year, for example, of AssuraMed under our belt in terms of integrating that core platform into our Business.

Our ability now in turn to find smaller tuck-ins that make sense to bolt onto that platform has increased and as we have been look at those assets, we have been pleasantly pleased by what we've seen, including the two that we did in Q2.

In China, we continue to do small tuck-ins.

We completed two more in the second quarter, one which really gave us additional geographic expansion into a new region and the other was the one that George referenced, that added to our specialty pharmacy network and gave us e-commerce capabilities.

So, we will continue to pursue those types of acquisitions.

And I always (inaudible) those tend to be relatively small acquisitions, but very important to building on our strategy in China.

I would say more broadly, we continue to see small to midsize assets that make sense for the portfolio and to the extent that the prices right and the economics make sense, we have the platforms to put them on.

And we remain encouraged that those possibilities.

Robert Jones, Goldman Sachs.

Thanks so much.

Just wanted to go back on the profit side on the pharma business, clearly feels like we are living in a pretty robust inflation environment, on both the branded and generic side.

I guess, just bigger picture, that trend would obviously seem counter to what we are seeing the push to be in overall healthcare today around savings.

I guess if maybe you guys -- separately, branded and generic -- if you could talk a little bit about what do you think is driving this?

Is it really more structural, is it more circumstantial?

And then I guess more importantly how sustainable do you think it is both of those areas?

Bob, it's a really good question, a hard one to answer.

This is George, I will start.

But let me just offer this is a starting point in pharma, which is sort of maybe something we forget often.

In the big picture, in the United States, our pharma spend is the smallest part of our challenge, when all is said and done.

By the way, that doesn't mean any individual who has a very expensive drug that they have been prescribed doesn't have challenges, but we are talking a small percent of our overall spend.

And actually, if you note systemically, the growth of pharmaceutical spend has actually been slowing.

So I do think part -- as you know, part of that is the level of generic penetration, so from a big picture standpoint as a health system, actually our bigger challenges are really in our medical system than in pharmaceuticals.

Having said that, we do think that there are periods that can be a little bit more unusual.

This has been, certainly on the generic side, probably more noteworthy.

It is really difficult to predict what is going to happen, but I do think it is always worth reminding ourselves that when we look at the pharmaceutical segment, really what you have is a huge number of products that are generic, and highly generic, meaning penetration is extraordinarily high, and then a number of typically more specialty drugs that have unique characteristics.

And I think that is a trend that we will continue to see.

And so, I think our model -- we feel very strong about the model.

We are extremely efficient.

We work very well with our manufacturers.

I think our (inaudible) service system is working efficiently.

And so, in the big picture I think you would have to look at the pharmaceutical system as relatively efficient across the board.

That doesn't mean that individual products wouldn't get some attention for their pricing and we will just have to continue to watch for it but I think in general what we have done in our assumption is moderate our expectations as it relates to inflation just a little bit more historical norms and we thought that the more cautious approach.

Great.

And I guess just George following up on the cash position, it doesn't seem like, again there is a ton baked in on buybacks doesn't seem like that will be a big source of deployment, at least according to the current outlook.

Is there any more insight you can share on your priorities without, obviously, getting too specific?

Are there things of the table right now that have kept you more cautious on getting more aggressive on the buyback?

Yes, so I don't think for us it is a matter of cautious on buyback, I think we have always seen a capital deployment strategy that is very focused on returning long-term value to shareholders.

So, we've done that through advancement in our core activities, in the dividend, in looking for acquisitions that strengthen our long-term competitive positioning, and buybacks are part of that equation.

So that will still be the case.

In terms of priorities, and I'll let Jeff weigh in a little bit on it as well, as far priorities we've talked about strategic areas that we think are very important.

And those are going to continue to be areas that we watch carefully, that doesn't mean is always going to be the right acquisition opportunity there, but we've talked about generics and we've talked about specialty, we've talked about our home health and ambulatory platform, we've talked about medical consumables, we've talked about preferred products, we've talked about China.

So these are all areas for us that we believe are on the right side of where healthcare is going.

We will continue to invest in those.

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

Just two other things, Bob.

We remain very committed to a dividend.

As you know we view the dividend payout we have as being an important part of the story, in conjunction with the earning story.

And we are committed to maintaining and growing the dividend over time.

And as I indicated on the investment there our target is to remain in that 30% to 35% payout range for our dividend.

As regards to repo, the fact that we've done relatively small amounts so far this year, as I mentioned $50 million in Q1, really has nothing to do with a reticence to buy back shares.

It had to do with timing in the first half the year and our inability for a good chunk of the year, really to enter the market because of some of the pending announcements which have since been announced, by the way.

Next question?

Glen Santangelo, Credit Suisse.

Yes.

Thanks and good morning.

George, just want to ask you about the CVS JV.

I think you said in your prepared remarks that you are expecting that to begin in earnest maybe on July 1st.

Could you kind of talk about it?

If not much is changing with respect to how you buy generics today, what has to happen over the next six months to prepare for that?

Do you have to unwind certain generic manufacturing purchasing contracts?

If you could just elaborate on that a little bit more.

And then maybe Jeff, as we think about the FY15 model, I know you don't want to comment on that today, but it is reasonable for us to start modeling the payment to CVS in FY15 and maybe incorporating some cost of goods sold benefit within our FY15 estimates?

So Glenn, I will take the beginning of your question, and then I will let Jeff jump in with the second part.

So actually it's a really good question because it is a reminder of how many moving parts there are in our product line -- there are thousands of product families with many, many suppliers, different length agreements, and different buying models.

So I can't go through all the individual details, but I think the answer Glenn, is there are a million of them.

And actually the irony as we talked about this as a very straightforward design, which I think it is, it is taking out all the operation complexity, at least logistical complexity, but just simply aligning buying strategies, policies, procedures, existing contracts and commitments is not a small piece of work.

And so, we have to do that in a very efficient way.

It is already underway.

And we feel good about the progress.

But it is a lot of moving parts and I'm really glad that we've got two talented teams know what they are doing.

Glenn, it's Jeff.

On the question of payment, at the risk of confusing a lot of people, let me try to explain how that is going to roll out because it's not necessarily -- the actual accounting for the payment is not as straightforward as the actual cash flow.

So as you know, we are committed to a payment of $25 million each quarter to see the us starting with the beginning of the joint venture and continuing for a period of 10 years and that is a fixed $25 million payment each quarter.

However, the actual accounting for that payment is more of amortization over time and reflects accrued interest et cetera, so the actual amount you'll see, particularly in the early quarters, will be slightly higher than $25 million payment, and really that is because of the way the payment gets discounted and accrued interest flows out over time.

The second point, I will say is, that depending on when all the final documentation get completed with CVS, if that happens this year, will actually start amortizing that payment as early as this year and we expect that to begin as early as the beginning of Q4.

Again, hopefully I haven't confused everyone too much on that.

With regards to your second question regarding benefits, we did say at our investor day that we expect the JV to be accretive to us in our FY15.

We continue to stand by that, which means that the benefits we would expect from the JV would more than offset the accounting of the payments next year.

And as I said, the accounting of those payments next year will be slightly more than $25 million a quarter.

So that gives you a rough idea of our minimum expectations for the benefits next year.

We also do expect that they will phase-in over time, as the JV starts on July 1, we definitely would not expect all the benefits to start on July 1. It will take a good part of the year for us to ramp up to what I would describe as the more full run rate.

Let me just add, again, with all the millions of moving parts that we described, what we are really excited about this.

I think we really know that the US is the largest generic market in the world, it is a single market, its got secure and known financing systems, incredibly important manufacturers, and so I'm really excited about being able to put these two teams together to do work in this environment and we think it is going to create great opportunities for us and for our customers and for our manufacturers.

So we are excited about it.

George, maybe if I can just ask one follow-up question on AssuraMed?

In your prepared remarks you seem to suggest that the deal is outperforming your original deal model.

I was wondering if you could elaborate where is the source of upside coming from?

And then Jeff, as we think about the out performance in the quarter I think we are all trying to figure out where the incremental benefit is coming from.

How would you stack the potential out performance of AssuraMed on the current quarter and the decision to raise the guidance for FY14?

Thanks very much.

So, Glenn, I will start.

Here is what I would say -- if you remember when we acquired AssuraMed we told you that essentially it has two components.

One is basically a B2B business and one is more of DTC part of the business.

The part that we are seeing a more dramatic uptake is the DTC side.

We expected that systemically this would be an area of growth.

We think that the demographics are clear, that more patients will be treated in the home.

As you also know hospitals will be penalized for readmissions, so I do think that we expect sort of systemic growth year we also believe that we have a certain kind of scale, a tremendous billing capability, a very high touch model, and that we are an attractive referral here.

So what is happening is we are getting terrific referrals from physicians, from payers, that is driving that business and I think our high touch model really works.

So I think that is a part of the business that I would say has been driving it and probably out performing.

Glenn, just continuing on that, just going to the various elements of the business.

On the medical side, I would say, as we said, AssuraMed has out performed our original deal expectations and continues to grow very well, but I wouldn't necessarily say it was the biggest surprise the quarter.

We expected it to do well and it delivered on that.

On sort of the med side, I think the growth of our strategic accounts has been a very positive surprise for us.

We invested a lot in those accounts in terms of products and services, and we expected good things, but I think we have seen some growth that is even above what we would've expected.

So that was great to see.

On the pharma side, I would say there were four or five areas that perform better than we expected in Q2.

Generic inflation was better, as we alluded to.

The core performance of the generic portfolio was better than we expected.

Brand inflation was a little bit better than we expected.

And both specialty and nuclear outperformed our expectations in Q2.

So, hope you can understand why we are pretty excited about the quarter we saw the lot of very good results across the board.

Some driven by the environment, granted, but also some driven by the strong performance of our Organization.

Charles Rhyee, Cowen and Company.

Yes.

Thanks, guys.

Good morning.

Maybe just staying with the medical for a second here.

Obviously we have talked a lot about AssuraMed.

Can you talk about how we're doing with preferred products and was that a big contributor in the growth in the strategic accounts?

And then really where do we think we are going here, in terms of the pipeline of products -- in terms of what type of technology are we going after at this point?

So again, I will start.

Charles, good morning.

Yes.

I would say the preferred products portfolio is going really well.

I mentioned that our first six months was an extremely high run rate, relative to anything we've done historically.

Again typically they've had their waves of products and we had to sort of map that through the year.

We expected good performance and thankfully our teams our teams are really executing on that.

I think this is really, as I said earlier, it's a pain point for our customers.

They have an enormously high spend in the complexity of their number of products they carry.

And essentially helping them build a formula that is more efficient is really an opportunity for them.

So this is the classic win-win situation, where we believe that we can move share from manufacturers, whether that is our own product or someone else's.

We It is going well.

I'm not sure it's the sole explanation for why our strategic accounts are doing well.

I think that is a combination of things.

I think we've identified complex systems who have complex needs.

They're no longer, for example, simply a hospital and maybe a clinic, they are now multiple hospitals with multiple clinics and cancer centers and surgery centers and maybe affiliated doctors offices.

And I think they are increasingly looking for companies that have the tools to be a solution provider and help them deal with a very changing environment.

I think that's been a part of that I think our team has identified those kinds of customers with those distinct needs and I think that's allowed us to do a better job to better job at serving them.

And we're going to have to work really hard to continue to provide new services and offerings that allow them to compete in a rapidly changing environment.

Jeff?

Anything you can add there?

I would say preferred products were a driver of dollar growth in the quarter.

And I think what was also very exciting was the continued increase we are seeing of preferred products in our overall portfolio as it expands gross margin.

As you may recall in our investor day, Don Casey indicated that our target was to get preferred products to at least mid 40% or 45% as a percent of gross profit for the segment by FY17.

And the reference he gave a historical number which was in the mid 30s%.

Actually in our Q2, I would describe that percent as mid to upper 30s%.

We've already seen a pickup and we expect to continue that trend over the next couple of years as we achieve our target.

Yes, there are a lot of things that are driving the overall margin expansion in med.

Obviously the growth of the home health platform, the growth of strategic accounts and preferred products were all important drivers of that very impressive margin increase.

In terms of preferred products -- in terms of the type of products you are dealing -- I know your talking about -- you've talked about in the past of the trauma kit.

I don't know -- you've touched on in the past, here and there -- any potential to move up the technology ladder or is that something to think about in the future?

Thanks.

Yes, so this really relates, I think, in many ways to what we think of as a physician preference item.

We started -- if there is a spectrum, at one end being products that are extremely highly clinically differentiated, and the other end, products that tend to be really not clinically differentiated.

We focused on the lower end and I think that makes sense because we are building presence and building credibility in the market with this program.

So trauma was a very smart place for us to start.

There is a huge amount of interest from our customers and we are working there up the ortho line.

Wound management is another area that we have been working on.

So we are carefully analyzing every line with this question of where -- how much clinical differentiation exists in a given product line and where does not exist?

And I think that is allowed us to start to build a strategy of moving along that spectrum.

And we are still at the early end of it, but very excited about it.

I think our customers will see a big opportunity if we can continue to execute.

Tom Gallucci, FBR Capital Markets.

Thanks.

Good morning, everybody.

Appreciate the details.

One housekeeping item and then another follow-up on some other questions that you've already answered.

You mentioned the pull forward of low branded price inflation from what you expected in the March quarter.

Can you frame at all what we are talking about there, roughly speaking, Jeff?

It was probably worth a couple pennies of earning shift.

Okay, that is helpful.

And then I guess you mentioned a few different times the better growth of your strategic customers on the med/surg side, and George, a question or two -- you started to get into a little bit what you are doing there.

Can you get a little more granular?

I'm curious about the types of services that you are starting to offer there, incrementally, to some of these types of accounts.

It is a matter of is there buying physicians and you could also service physicians or just a mix of things that you are doing would be helpful?

Sure, Tom.

This is, again, a bit of a long story so I'll try to summarize it.

So obviously we can provide the traditional medical surgical supplies that we have always been able to do.

We also can support them both in their key care centers and in their ambulatory centers with a line of products that includes surgical kits.

We can do freight management.

We can do RFID tagging.

We do consulting on operational excellence.

We can do what we call ValueLink, which is essentially where we stage all the materials in our warehouses so it is a purely, truly just-in-time system.

So I think we can tell them we can serve both your acute care centers.

We can serve your oncology clinic.

We can serve your physicians offices.

So, it is a combination of lines of business and touch points across what is an increasingly complex system -- the entire continuum.

And in many cases we can follow that patient to the home.

And so, that is the overall picture.

And I think the more the system integrates, the more complexity is introduced into it, the more that plays to our ability to say I think we can provide some solutions to deal with this complexity.

Right and you are clearly gaining business of existing customers.

Are you winning new customers of this nature, as well, given the breadth of product that you can offer?

I would say -- I don't know that there has been a monumental change in market share.

I think we are doing a really good job with our key customers.

I think we've done some segmentation to know who is likely to be a winner and most likely to be able to draw on the tools that we bring.

There is always some movement up and down of customers back and forth, but I don't think there has been huge share swings as much is it has been our ability to drive value for existing customers as they change their configuration.

I think we have seen a share of wallet changes within the hospitals, where we may be servicing within the hospital itself and we were able to win their large ambulatory network as a result of that experience.

And those are the customers that are actually winning in the market right now, these large complex IDNs that have both strong acute settings, but also ambulatory settings that are tending to be the hospitals that are winning share in the market and being very successful and obviously those are important customers to win.

Lisa Gill, JPMorgan Chase & Co.

Just a couple of follow-up questions.

First, on the drug distributions out of your business, I think Jeff, you called out in the quarter that you had impact from new customers as well as expanding relationships.

Can you talk about the size of the impact, if any, of new customers in the quarter?

I would say they are relatively modest sized, there were no huge changes of customers in the quarter.

I would describe it small to midsize, but we continue to make good progress with picking up some new customers and as I said, our existing customers showed good growth in the quarter.

So in both respects it was very positive.

And the growth of your existing customers, is that now that you are distributing more generics, distributing more product, or is it just the growth of the existing customers that you have?

I would say both, it depends on the customer.

Fortunately we have some very strong customers in the market, CVS for example, which continues to post very good results and obviously we benefit from that as well.

But in addition, we continue to sell customers the opportunities to buy more products from us, including generics, and we continue to have good success in doing that.

And that will continue to be a big theme of ours is as we go to increase our share of wallet with customers, if not win some new small to midsize customers.

You both have commented a lot today about the hospital network accounts and the ability to build out preferred products and (inaudible), but is there anyway to quantify what the white space opportunity is with these accounts, number one?

And number two, where you taking their business from?

Is that from other smaller distributors?

Are they self distributing in the hospital today?

So let me start, we probably can't give complete line of sight on the opportunity.

I would say that it is really early days.

So today we are really scratching the surface on the acute care side, which has been primarily where our preferred products have been going.

What is really interesting is our customers, those same customers are beginning to realize that there is real value driver.

Because I think in a sense, Lisa, it is not going to be enough for people to squeeze one more basis point out of a procurement.

What really is going to matter is changing behavior and consolidating the number of products that you use, being more efficient about that, is a change behavior that can really be valuable to a system.

The other thing I would note, that we've that we basically had no real preferred product provision in the ambulatory care to-date or in the home -- very little.

So I think we see opportunities to expand in acute care centers, but also in these other channels, where basically we haven't really even touched the opportunity.

So we are pretty excited about this because it really is a change of behavior that has material value to our customers, versus just squeezing out one more basis point from the supply system.

The second part I think, Jeff?

Just a few other comments to add there, Lisa.

First of all, again because our focus has been on some of these larger more complex accounts, those also tend to be the accounts that have been continuing to consolidate by others, and obviously we benefit by others, whether it be smaller hospitals or surgery centers or physicians offices.

And as they continue to get bigger and more complex, both our size in our ability to service them there uniquely grows as well.

But part of my point too, I would say in some cases we are doing work that was really done by the hospital itself.

And really that is a significant goal of ours, to help the hospital focus on treating patients and allow us to manage their supply chain in a more comprehensive manner.

And when we can do that, that is very much a win/win usually for the hospital for a us.

And I think in a couple of cases where we picked up some additional ambulatory business that was part of the larger hospital, that is probably were some smaller players that were servicing those accounts that didn't necessarily have the ability to compete with us on the whole network.

So all three of those has been part of the driving force.

I probably just want to add, again, just as a reminder, it's a tough system out there.

So the testing we've had to do is really focus on our own efficiency.

And you've heard talk about that over the last year.

And so it is both creating the opportunities for those customers and also recognizing that in this kind of system we've got to be incredibly efficient and we work really hard at that.

Next question, operator?

George Hill, Deutsche Bank.

Hi.

Good morning, guys.

Thanks for taking my question.

I guess, George or Jeff, as we look at the inflationary environment in the branded drug space, recognizing that the old spec buying days of 2004 and 2005 are behind us.

How should we think about the Company's leverage to, and profit contribution from, that you are able to capture from this pretty high branded drug inflationary environment?

And maybe could you give us an update on, whether we want to think about it on a quarterly or annual basis, how much of operating earnings of the drug segment is coming from your ability to capture a spread on branded drug price increases?

Yes, thanks for the question, George, and hello, this is Jeff.

It is less than 20% of our branded gross margin now and I would say overall for the segment it's well under 10% of the gross margin for the segment.

So it is not near the significant swing factor that it would have been 5 or 10 years ago, and honestly generally we are pretty good at predicting what the impact will be for the full year.

I think the difficulty we always have, especially these days, is guessing which quarter it is going to be in.

So it does have the ability to swing at quarter fairly materially, and I have said that the swing from Q3 to Q2 was probably about a $0.02 (inaudible) but over the course of the year, it's a factor but becoming increasingly less of a factor and as I said less than 10% of our gross margin in the segment.

I would also add that particularly those very expensive drugs -- and biopharmaceutical companies are very careful about how they do this and manage it pretty carefully, so it sounded giant swing factor for us.

Okay and then maybe just a quick follow-up on the med-surg, can you talk about the margin expansion of the core business -- x the AssuraMed business?

We talked about AssuraMed is outperforming the acquisition model.

How is the business x AssuraMed performing from a growth in margin perspective?

I don't want to breakdown too much here because AssuraMed is part of our overall medical segment but obviously it was a significant driver for the quarter.

I would say excluding AssuraMed our revenue growth over all the medical segment was in the lower single digits and we saw some slight margin expansion on that.

And that is primarily mix.

Terry, another question?

John Kreger, William Blair & Company.

Hi.

Thanks very much.

George, can you give us any observations on healthcare consumption?

Did you see any interesting shifts either from the perspective or the early impact of the ACA?

Boy, I wish I could answer that one, John, good morning.

But I'm going to try though.

It has been, you've probably heard this from other companies, really difficult to tease out a discernible trend on overall utilization and consumption.

You probably heard some people talk about late year spiking and whether or not that might've had to do with some benefit design issues around the system.

I've heard people speculate that there was some apprehension about whether or not changes in policy, the Affordable Care Act might influence their future access to their physician.

And so, we tried to look at all of that, but to be really honest we just can't tease it out.

There are so many moving parts.

So I don't -- I don't think I could say there is a discernible trend.

What we can say is we see procedure utilizations -- so there are certain things we can see.

We see in hospital ambulatory, and what I would say that softness that we're seeing in acute care procedures is probably one that we would highlight, but I don't know that I could say we could identify a particular trend right now, just because there's so much noise in the system and so many moving parts and I think it is just going to take a while for this to shakeout.

We've not seen I would say any uplift, and I'm sure you've heard if you follow any of the insurers, any output of output of any patients of the system yet.

Not at this stage.

Great thanks.

This one additional comment on utilization.

We always tend to focus on the hospital and physicians office settings, but I think it is important to keep in mind that have another very important channel and that is the home and we still see that market growing at a rate of 6% to 8%, which is obviously very encouraging and very important going forward.

Excellent thanks.

And just a quick follow-up, your reference to some newer customers within pharma, are you having or seeing any discussions about some of the self-warehousing change shifting any generic purchasing back into the distribution channel?

Let me touch that.

I think there is -- I'll be careful, I think there is an interesting evaluation that any company now has to do as it relates to their own scale, relative to what is happening systemically and I do think that may raise some interesting opportunities.

I do think that the gap between some of the larger players and the larger purchasers of generics and smaller -- might be widening and so, if I'm a smaller player, now I probably have to think carefully now about what is the most efficient way for me to source my generic products.

And I do think that given some of the changes in the market there's probably a lot of, I would say, probably a lot of evaluation going on in many offices to figure out the most efficient way given some of the dynamics in the market.

So we are hoping that, that represents an opportunity for us, but it is too early to say.

Greg Bolan, Sterne, Agee & Leach.

Thanks for taking the question.

Going back to Charles' earlier question, George, you had mentioned that if you think about the spectrum to the left, not really clinically relevant to the right, very clinically relevant PPIs and you talked about just the fact that preferred products are contributing about -- I think you said mid- to upper 30% of medical gross profit.

So is it safe to say the driver of that increase has really been to the left of the lower end -- at the lower end consumables, and I guess as you think about as you move up the technology scale toward the higher-end PPIs, is that what takes you from say 35% of gross profit to say 45% of gross profit by FY17?

Greg, it is a good question.

I think I'm going to try and answer this along two dimensions.

The first part is yes, you asked about whether or not it is primarily on the lower end -- left if we're diagramming it.

I think the answer to that is yes.

It is clearly on the more commoditized end today.

So think about growth, our growth plans work along two dimensions.

You might have even say three.

Let's say dimension one, increased penetration with existing accounts who tend to be acute care hospital focused that is where most of the procedures are, so that is one dimension.

Second dimension would be new channels, so as those opportunities might arise in surgery centers or ambulatory settings, that is a second dimension.

And the third, which is actually really exciting, is moving along that spectrum would be moving up into the right towards product that actually when you really examine the data, you discover that are probably not clinically all that (inaudible).

So it is really both going forward with the projection of physician preference items.

And probably if we look at a time horizon, the new products adding new dimensions is probably a little bit further out as we go.

(inaudible)

That's helpful and then just real quickly, how would you characterize the commoditization of PPIs?

I'm assuming that is a good guy for you and profitability.

Any update on what you are seeing on the marketplace, George, just as it relates to PPIs that were once seen as PPIs, but are now becoming more commoditized?

I mean stints come to mind, but any comments there?

Yes, certainly not about stints but about the general direction.

Here's what I would say.

I think this is not a new discovery.

I think if you look inside a complex health system, they would probably understand that historically the departments rule.

And so what happened is every department had their own preferences.

Physicians had their own preferences.

And the system was able to accommodate that.

But I think it has been understood for quite some time that, that could be done probably more efficiently.

Here's the noteworthy change.

The noteworthy change, is that given the very different environmental forces, the more senior folks in the hospital are more aligned with the fact that something needs to be done about this.

And I'm going to actually say that physicians are on board as well.

So I think there is more of an awareness inside that health system with a changing demographic and a changing regulatory environment and changing reimbursement environment that they need to focus on this area of inefficiency and we are helping them do that.

So if that make sense to you.

So it is not just our promoting it, it is hospitals and health systems recognizing that they should take action on it and I think that is probably a noteworthy change over these last year or two.

Steven Valiquette, UBS.

Hi, thanks.

Good morning, George and Jeff.

The 54 bps margin expansion in pharma distribution was obviously quite strong.

I guess, would you say most of that -- would you say is tied to the core operational improvement or is it possible that the roll off of the lower margin WAG contract contributed a major portion of that?

How would you characterize each of those without getting too specific?

Just trying to get a feel for that.

Thanks.

Thanks, Steve, for your question.

This is Jeff.

I would say there are three significant drivers.

The largest one by far was the performance of generics -- both our core performance and the impact of price inflation.

Second, was the roll off of the WAG which was a lower margin business than our average business in pharma.

And then I think third, with a higher brand inflation than we saw last year in Q2.

Those were all three I would say material drivers -- in that order.

Okay.

One other quick one.

I think if I heard you right, you mentioned because the just reported quarter was so strong that the historical pattern of the pharma distribution results being stronger in the March quarter versus the December quarter may not necessarily repeat themselves this time around, but just to clarify, does your comment to the segment operating profit dollars or the operating margins or both, when doing that sequential comparison?

I was referring to dollars but I was talking specifically about the impact of brand inflation, which typically is the biggest driver of our seasonal Q2/Q3 I would say that would be less of a skewing factor this year than perhaps other years.

Does that make sense?

Sorry, Steve I think the operator moved on.

Bob Willoughby, Bank of America.

Just a quick one.

Will this CVS joint venture have any discerning working capital effect?

And also on the inventory build in the quarter -- a bit surprised, I guess with the Walgreens business gone -- were you not taking title of Walgreens inventories, is that the situation?

Thanks Bob for the question.

With respect to Walgreens inventory know we were taking title to Walgreens inventory which is why we recognize the sales on our income statement historically but I would say on average we carried fewer days of inventory for Walgreens than, I would say the pharma segment on average in part because a good chunk of the Walgreens business was bulk and we would tend to hold bulk inventory for a relatively short period time.

The that tended to skew the overall WAG inventory down and make it lower than the overall average.

That's why you saw an increase, because the mix shift.

Bob I forgot your first part of the question?

This CVS JV doesn't have any balance sheet impact?

No, it does not, under the current structure, there is no inventory that flows through the JV.

So really the only assets the JV has are the physical building it's in and the people that reside in there.

The actual products flows through the respective companies.

Okay and just on China -- I think you mentioned $2.5 billion revenue run rate it's at a margin better than the base business was my understanding, what does the asset base look like that business now?

We haven't disclosed publicly, but I will say that assets in general for businesses in China particularly in our space tend to be higher.

Really referring to working capital and that is primarily because receivable days with hospitals, just by market convention tend to be longer in China.

They are closer in average to 80 days and obviously they are much shorter the US.

And so it is a more working capital intensive business than our US business.

But that is also, by the way, why we are looking at other areas to grow into that are much more capital efficient in China.

So for example our (inaudible) business is a very asset-like business for the most part.

So we continue to look for ways to improve our mix and improve our return on capital.

Eric Coldwell, Robert W. Baird & Company.

Most of my topics have been covered at this point, but just a couple of quick ones.

Specialty growth -- I know you said it was strong, but I didn't catch the rate.

And if you could talk about what classes of trade and what therapeutic classes you're seeing the best trends in?

And then one quick follow-up.

Yes, the revenue growth for specialty solutions was 38% in the second quarter, which obviously continues the good revenue growth trend we have seen over the past couple of years.

I would say the bulk of our business is still in the oncology space.

We continue to build out into other areas like rheumatoid arthritis and a few other emerging areas, but the bulk of the growth to-date has been in the oncology space.

And Jeff, with what specific traits on oncology the community, is it outpatient hospital, where are you seeing the biggest demand?

Most of that growth is driven by sales to community oncologists.

I will say though, that we have seen a shift and it's been a fairly well publicized shift over the past year or so of more infusions happening in hospital settings as community oncologists have generally shrunk over the past year or so.

That all said, the community-base is still a very important robust one and very important part of our business and our growth story going forward.

David Larsen, Leerink Partners.

Congratulations on a great quarter.

I think if I heard you correctly the Walgreens revenue impact was about $5 billion.

So I'm just looking at a year over year basis and went back $5 billion after FY13, you still beat by like $1.7 billion in terms of top line growth.

And I think you mentioned that the new customers were somewhat modest in size.

Can you talk about the revenue upside?

Where that came from generally, please?

Well modest in size is obviously a relative term.

Just given the nature of pharma it doesn't take a whole lot of customers to have a pretty significant dollar increase in revenue and we saw good growth from our existing customers.

It was a really a combination of both of those.

But your point that the revenue upside in pharma was a positive surprise to what a lot of people were expecting, I would agree with you.

And quite frankly it was better than our plans as well.

And I think that is a testament to our sales teams who have done a great job over the past year going out and letting customers know what we have to offer, offering creative solutions and attempting (inaudible) to pick up a share of wallet.

So yes I think the underlying trend that you pointed out was a very positive one for us.

Okay and just one more quick one.

In terms of your specialty capabilities has there been any impact from sequestration at all or not really?

And then in terms of your relationship with CVS, could that longer-term possibly be a way to expand your specialty business?

Thanks.

So yes not taken I think again restate the first part of the specialty question?

Impact from sequestration or not -- I imagine not.

It certainly had an impact on customers, across the system.

I think it had a very, very modest impact on our business.

As Jeff mentioned, we have been building scale.

We have not been terribly exposed to some of the dynamics that were associated with the sequestration.

So, certainly as we look around the system, sequestration has been a difficult thing for many physician groups, but it really did not have much impact on us, just given our model.

Again the second part, I'm sorry, Dave?

Long-term your joint venture with CVS -- I imagine there might be ways to grow their relationship.

So here's the way you ought to think about this.

I think our joint venture itself is really dedicated to the global procurement of generic products, for the US market, specifically.

Obviously, our relationship with CVS Caremark is deep and having this joint venture only strengthens it and so we will continue to look for opportunities to see how we can collaborate in areas that create value.

And if specialty is one of those areas, certainly we will explore it, but don't think of it as a part of the joint venture.

Just to make life simple, think of the joint venture as specifically dedicated to this generic procurement strategy, but certainly we will explore and continue to explore other ways to create value for one another.

Thank you.

All right.

At this time I like to turn the call over to George Barrett for any additional closing remarks.

Well look, its been a longer called but great questions and we appreciate that.

All the good questions.

We appreciate your continued interest in Cardinal Health and I wish all of you the best for the New Year.

And we will see you all soon.

Once again ladies and gentlemen that does conclude today's conference.

Thank you for your participation.