卡地納健康 (CAH) 2014 Q3 法說會逐字稿

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

Today's call is being recorded.

And at this time, I would like to turn the conference over to Sally Curley.

Please go ahead.

Thank you, Kayla, and welcome to today's third-quarter FY14 earnings call.

Today we will be making forward-looking statements.

The 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 presentation which can be found on the Investor page 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'd also like to remind you of a few upcoming investment conferences and events.

We will be attending one-on-one meetings in the Mizuho Securities USA Second Annual Healthcare Corporate Access Day on May [6].

In addition, we'll be webcasting our presentations at the Deutsche Bank Securities Annual Healthcare Conference on May 8 in Boston.

The Bank of America Merrill Lynch Healthcare Conference on May 15 in Las Vegas.

And the William Blair Growth Stock Conference on June 11 in Chicago.

Details for the upcoming webcast and events are or will be posted on the IR section of our website at www.cardinalhealth.com so please make sure to visit the site often for updated information.

We look for 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 solid third-quarter operating performance.

Our businesses are competing well and the moves we are making continue to position Cardinal Health on the right side of healthcare trends.

Based on our work through nine months and what we're seeing in our markets, we are reaffirming the guidance we provide this January of non-GAAP diluted earnings per share of $3.75 to $3.85.

Total revenues for the third quarter were $21.4 billion, a decline of 13% versus last year's third quarter.

This decline was expected as last year's revenue number included sales under our now expired Walgreens supply agreement.

Our gross margin rate expanded by nearly 80 basis points to 6% for the quarter.

Our third-quarter non-GAAP diluted EPS was $1.01 down from $1.20 last year for reasons that Jeff and I will cover later in our remarks.

When we initially provided guidance last August, we anticipated an unusual year given the expiration of the Walgreens contract.

Now after completing three quarters, I want to acknowledge our entire team for executing against our strategic goals and for the 6% non-GAAP operating earnings growth that they've delivered year to date.

Now onto the segments, starting with Pharmaceutical.

As expected, revenues for our Pharmaceutical segment declined 15% which was partially offset by sales growth from new and existing customers.

Strong performance from our Generic programs help to partially offset the impact with the Walgreens contract expiration resulting in a 9% segment profit decline for the quarter.

I'm extremely proud the way our Pharmaceutical distribution team is competing in a unique transition year.

For the period, revenue increases outperformed the market in all classes of trade obviously with the exception of Gen pharmacy.

Our 50/50 generic drug joint venture with CVS Caremark is making progress and our teams are deeply engaged and working through all the details so that we'll be able to -- that we will meet our target go live date, which we have said would be as early as July 1. The new venture will operate under the name Red Oak Sourcing, LLC, will be comprised of key talent for both Cardinal Health and CVS Caremark and will be located in Foxborough, Massachusetts.

At the same time we continue to build strength with our other customer groups.

For example, we just recently renewed our pharmaceutical distribution agreement with Kmart, one of our larger generic customers.

For independent pharmacists, we continue to broaden our set of offerings.

As a recent example, we have a new suite of offerings designed to help the pharmacy owners navigate the new reimbursement requirements for the CMS star ratings.

Our program focuses on providing insights on how best to achieve the quality ratings which are now so important to inclusion and network.

We continue to believe that Pharmacy will play an expanding role in our healthcare system and we are committed to the industry to help enable this growing role.

Our Specialty Solutions group continues to deliver excellent growth.

We are sustaining our strong upward trend in our core specially distribution and our platform to support our biopharmaceutical partners.

During this recent quarter, we announced the acquisition of Sonexus Health.

Sonexus Health offers biopharma manufacturers comprehensive commercialization solutions in the US including access and patient support, distribution and pharmacy services.

All aimed toward ensuring patients receive and successfully complete the therapies they need.

Sonexus Health complements and grows our current specialty teams offerings and creates a truly best in class patient centric hub.

Based on all available data, more new specialty medicines were brought to market in 2013 than ever before.

And we know this is a healthcare area in which we will play an increasingly important role.

I'll end with just a quick note on our Nuclear business.

We did see some revenue and profit increase in the quarter compared to a year ago.

This is certainly good news and we appreciate the teams hard work.

Our Medical segment whose performance was solid.

Revenue was up 7% to $2.7 billion, and segment profit increased 11%.

There was however a discernable softness in utilization during the quarter, some of which would seem to be weather-related but which is externally difficult for us to precisely quantify.

We did see increased penetration in our targeted strategic accounts, but our progress during the quarter was slowed somewhat by utilization softness and by volume shortfalls in our surgical kitting business.

Having said this, we are continuing to build out our preferred products portfolio.

And recently took a significant step with the announcement of the acquisition of AccessClosure, our leading manufacturer distributor of extra vascular closure devices in the United States.

AccessClosure gives us an outstanding [lead] product, the Mynx product family.

But equally important, it gives us a scalable platform, a strong customer base, a low cost service model and a seasoned management team.

As you know, last year we launched our orthopedic trauma solutions to an enthusiastic response.

And the acquisition of AccessClosure broadens our offering in another physician preference category.

With both cardiovascular and orthopedic trauma product lines, we can now address some of the most significant customer pain points.

Our Medical consumables business continues to grow faster than the market driven by share gains from new product launches as well as from new channel penetration.

We're also driving growth in our consumables in the home health channel through AssuraMed and recently launched our first products under the Cardinal Health label.

AssuraMed continues to contribute meaningful profit growth and margin accretion to the Medical segment.

Edgepark, the direct-to-consumer business reported especially strong revenue and margin expansion as patient count continues to grow.

It's just common sense that our healthcare system will have to take a more active approach to managing the growing population of people who need care in the home and we have moved decisively in the space.

We see a system in need of innovative ways to reduce cost while at that same time improving quality, safety and the patient experience, these are not mutually exclusive goals.

With this in mind, we built a strong capability in contemporary Lean Six Sigma methods and recently launched an educational program for healthcare providers, in partnership with the Ohio State University's Fisher College Center for Operational Excellence.

This program, the Academy for Excellence in Healthcare, is targeted at acute care and surgical centers, focuses on clinical and operational performance management and uses experts from Cardinal Health and OSU faculty.

Our initial sessions addressed issues raised by participants from leading health systems.

And some of those topics included the patient care model, improving the pre-procedure experience, inventory management of high-cost specially pharmaceuticals and improving post anesthesia care unit throughput.

Turning to China.

With another quarter of very strong growth on both the revenue and gross margin line.

And as we've told you before, the business is on track to deliver about $2.5 billion in sales this fiscal year.

We remain very optimistic about its growth potential.

We will continue to play meaningful role in China's healthcare evolution by playing out our strategy of enlarging our geographic footprint, creating new business partnerships and bringing our expertise to new opportunities such as direct-to-patient.

As an example, similar to what we do in United States, we're supporting China's hospital [core] initiative by working closely with hospital pharmacies and introducing hospital pharmacy management and services.

We now have 10 hospital pharmacy pilot projects with some of the largest hospitals in China.

Before turn the call over to Jeff, I want to welcome David Anderson to the Cardinal Health Board of Directors.

Dave has an extraordinary track record and recently retired from his position as Senior Vice President and CFO of Honeywell.

We look forward to Dave's contributions drawing on his two decades of experience as CFO of high-performing public companies.

And with that, I'll hand the call off to Jeff.

Thanks, George, and hello, everyone.

Let me begin by echoing George's comments regarding our year-to-date results.

Delivering 6% non-GAAP operating earnings growth given the Walgreens headwind we faced coming to the year is a testament to the organizations' performance focus and the strength of our business portfolio.

Now onto the third-quarter results.

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

Let's start with consolidated results for the quarter.

We reported a 3% decrease in non-GAAP operating earnings in our FY14 third quarter versus the prior-year period driven by the expiration of the Walgreens contract.

Our non-GAAP earnings per share of $1.01 met our expectations but were down year-on-year.

In addition to the contract expiration, this decline was also driven by an unfavorable tax rate comparison versus the prior-year period which had included a positive tax element worth $0.18 per share.

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

As expected, consolidate sales were down 13% to $21.4 billion.

Gross margin dollars increased slightly versus prior year and we continued our strong track record of margin expansion with a rate increasing almost 80 basis points.

SG&A expenses rose 3% in Q3 primarily driven by acquisitions including AssuraMed.

Our core SG&A was essentially flat year-over-year, evidence of our enterprise wide commitment to controlling costs and to adjusting our expense base in response to changes in our customer mix.

We remain focused on improving the efficiency of our operations while continuing to invest in our key strategic priorities.

Our consolidate non-GAAP operating margin rate increased 26 basis points to 2.6%.

Moving below the operating line, interest and other expense came in $28 million better than Q3 in the prior year's quarter.

This is mostly due to a $0.06 per share gain related to the sale of our minority equity interest in two investments.

Recall that last quarter we mentioned a possible gain which is reflected in the revised guidance range we provided at the time.

The non-GAAP tax rate for the quarter was 37.7%, in line with our expectations.

As I mentioned earlier, this was a tough compare versus the prior years' unusually low 25.1%.

Again a result of an $0.18 benefit realized in that period.

Our diluted weighted average shares outstanding were $346.8 million for the third quarter, about $2 million higher than last year.

During the quarter, we repurchased $340 million worth of shares which brings our fiscal year-to-date purchases to about $390 million.

At the end of March, we had just over $1 billion remaining on our Board authorized repurchase program.

We remain committed to our capital deployment strategy, and so far this fiscal year have returned $700 million to shareholders in the form of share repo and dividends.

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

We generated $820 million in operating cash flow in the quarter.

Year to date OCF of $1.8 billion is slightly favorable to our expectations and reflects a net positive benefit of unwinding the Walgreens contract.

As we previously noted, there is typically a large degree of operating cash flow variability from quarter-to-quarter and we expect our Q4 operating cash flow to be quite light.

We ended the quarter with $3 billion in cash on our balance sheet, which includes approximately $480 million held internationally.

As a reminder, our acquisition of AccessClosure is expected to close in the coming weeks and that will result in a net outflow of $320 million to complete the deal.

Our working capital days decreased versus prior year primarily due to the Walgreens contract expiration which reduced our date sales outstanding.

Now let's move to segment performance.

I'll discuss Pharma first.

Pharma segment revenue posted a decrease of 15% versus the prior year period to $18.8 billion.

The prior period included approximately $5 billion of sales related to the Walgreens contract.

The current period includes strong sales growth from new and existing customers.

I'll note two other items, first as George mentioned, our revenue growth is strong in each of the Pharma distribution channels, excluding chain of course.

Second, our other Pharma segment businesses has strong revenue growth compared to the prior-year period including China, Specialty and somewhat surprisingly Nuclear.

Pharma segment profit decreased by 9% to $452 million driven by the Walgreens contract expiration.

The decline was partially offset by strong performance from our Generics programs.

With respect to Generics, sales and profits from total Generics programs exhibited very good year-on-year growth in quarter.

This is the 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 effect of specific manufacturer price increases.

Later, I'll provide a little more detail.

First our Generics source sales continue to be strong, up 19% for the quarter.

Second, we saw slightly more contribution from new Generic launches in the third quarter versus the prior-year period.

The net effect of Generic manufacturer price changes on our portfolio sales resulted in slight inflation in the third quarter.

Finally, in Q3 we continue to see some generic manufacture price increases on a relatively small basket of products.

Compared to Q2, we realize the sequential decline and related margin benefit.

Looking ahead, there's a fair degree of uncertainty with respect to Q4.

And as we've noted in the past, we have been relatively conservative in our modeling of this contribution because it is so difficult to predict.

I'll also note that we saw brand inflation in the low double-digits, which was slightly better than we expected.

On our Q2 call, we mentioned this quarter is typically our strongest quarter for brand inflation benefit.

But that we had also experienced what we thought was about a $0.02 swing from this quarter that we realized in Q2.

Finally, I'll note that the Pharma segment profit margin rate increased by 15 basis points compared to the prior year's Q3 due to our mix of higher margin business this year.

Now moving on to Medical segment performance.

For the third quarter, Medical revenue grew 7% and segment profit was up a solid 11% with the profit rate expanding by 15 basis points.

Top and bottom line performance is primarily the result of our movement to home health and the integration of AssuraMed, which has gone well.

For AssuraMed, we continue to be on track to achieve our original estimate of at least $0.18 of non-GAAP EPS accretion for the full year.

As a reminder, we lapped the timing of this acquisition in Q3.

In addition to our home healthcare platform, our strategic IDN accounts also continue to grow.

The result of our focus on these very large networks of hospitals and ambulatory sites that tend to buy a lot of our products and services because of their complex operations.

It was particularly rewarding to see this growth is the slow utilization environment.

The segment's performance was partially moderated by the effect of overall procedural volumes softness and reductions in pre-source kitting volumes.

Now a quick note on Cardinal Health China, which spans both of our reporting segments.

Our business in China again posted strong double-digit revenue growth for the quarter up 33%.

We noted last quarter that the overall pharma market in China had been experiencing some turbulence due largely to the impact of some government regulatory actions to improve the integrity of the system.

It appears the impact of these actions on growth is diminishing.

However, growth is still not back to what we had been seeing prior to these actions.

Turning to slide number 6, you will see our consolidated GAAP results for the quarter.

The variance in non-GAAP results was primarily driven by amortization and other acquisition related costs which reduced our GAAP results by $0.10 per share.

In Q3 of last year, GAAP results were $0.20 lower than non-GAAP results.

Switching gears let me provide a few comments regarding our expectations for the balance of this fiscal year.

We are maintaining our non-GAAP EPS range of $3.75 to $3.85.

In past years, we would typically be narrowing our range going into the fourth quarter.

However this year we have a couple of fairly large swing factors that still have a fair amount of potential variability to them.

Specifically, achieving the upper half of our guidance range will mostly be dependant on two factors in particular.

First, a return to levels of benefit from generic manufacturing price increases in we saw in Q2 of this year.

And second, realization of a Q4 tax rate which result in us achieving a low end of provided full-year tax rate range.

In closing, we are pleased with our results so far this fiscal year.

Our presence across the continuum of care provides balance for our performance and we believe this is a strong strategic advantage for our customers.

Our talented team continues to drive results and remains focused on serving our customers well and executing against our strategic priorities.

With that let's begin Q&A.

Operator, please take our first question.

(Operator Instructions)

Ricky Goldwasser, Morgan Stanley.

Couple of quick questions here.

Let me actually start with the medical segment.

So obviously with the medical segment, with the acquisition in the quarter, what's the feedback that you're getting from the IDNs and how they're thinking about you increasing your scope in medical devices?

And are there more open (inaudible) of devices?

Ricky, good morning, it's George, I'll take that.

Yes I think we're getting a great response from IDNs and health system partners on our program.

I think everybody's looking for new ways to do business, recognizing the world is changing.

They're very much aware that in particular there's a whole category of what they think of as physician preference items which cause an inefficiency in this system.

So I think we're touching a part of their overall cost structure that is really meaningful.

And that's -- as you know we started in the orthopedic space, particularly along the trauma line which is probably the most commoditized of the kinds of products; we're getting really good response.

We've actually been expanding our program that we launched with a relatively small line of products.

That product line is expanding and hopefully over the next 6 to12 months, we'll be able to describe it pretty significant expansion of that.

Our entry into cardiovascular with the acquisition of AccessClosure is a really important step for us.

And primarily today that work is being done in the cath lab, but it really opens up doors for us.

And again, I think our customers recognize this is a place to really alter behavior to increase standardization, which they know is going to be central to being able to manage costs and getting the right outcomes.

And is the relationship directly with the IDNs?

Or are you also going through the GPOs?

It's really both; it's really both.

So naturally we have to have those direct touch points to the IDNs and to specific hospitals, but we continue to work closely with GPOs as well.

Okay, and my last question -- and maybe you mentioned in the prepared remark and I missed it -- but obviously a lot of uncertainty around the expectations for Nexium and Diavan and it seems that different companies are taking different approaches.

So is (inaudible) a contribution from Nexium in 4Q guidance?

Or did you take it out?

Hey, Ricky, this is Jeff.

Good question, actually.

In our internal forecasts, we're not really counting on any benefit from either Nexium or Diavan this year.

In fact the benefit from those potential launches for us is probably more of a first half of FY15.

Okay, thank you

Charles Rhyee, Cowen and Company.

I might have missed it a little bit earlier, but when I look at the revenues in the March quarter, I generally think of it being -- correct me if I'm wrong -- I generally thought of the March quarter as your strongest revenue quarter in distribution, generally on par with others [semi] quarter but we see a fairly steep drop off here.

Can you touch on what other factors might have been affecting that?

Yes, thanks, Charles, this is Jeff.

I'll try to take that.

Actually I would describe the revenue in Q3 as quite strong.

If you actually strip out the Walgreens impact for our pharmaceutical business, which I think is what you're referring to, we actually grew over 9% for the rest of the business.

And that really reflects strength across the board.

As both George and I alluded to, we had above market growth in all of our channels in pharma distribution, with the exception of chain, and that was obviously driven by the Walgreens loss.

But on top of that, if you look at the rest of businesses within pharma, we had great growth in specialty, 33% growth in China, good growth in nuclear which, as I said, was somewhat of a surprise, but a very positive one, obviously.

So we actually feel very good about the underlying growth that we saw in Q3.

Now is it possible -- that all said, is it possible that there was some dampening of scrip volumes in Q3 because of the weather?

We've been hearing from some of our customers that, that in fact was the case.

And so if there was any dampening in Q3, that might have been a factor that was driving it.

But as I said, our underlying growth was strong, in excess of 9% excluding the Walgreens impact.

So would you -- is it fair to say you didn't see really any weather -- when you book revenues, is it when you ship to your customers?

So unless you got stopped by the weather to deliver, does that affect how you book your revenues?

Yes, obviously we book them when we ship.

We still didn't get the second order impact from any weather-related issues.

Like I said, a few of our pharma customers did mention that scrip volume may have been impacted by the weather to some degree.

Again, it's always tough for us to calculate that very specifically because of the second order effect.

But based on what we're hearing, there probably was some moderation from that.

I'd say, on the medical side, it's probably a little bit easier to calculate, although still difficult.

We definitely saw some weather impact on our lab business and it also appears to have impacted physicians' office and hospital business as well.

So I would say, overall for our Company there was a slowdown in utilization related to the weather -- although, again, trying to quantify that specifically given the nature of our business is somewhat difficult

Okay, thanks.

And one quick follow up on medical.

You talked about softness in the Presource kitting.

Is the Presource kitting -- is that where you're -- is that the trauma kit where you have a lot of the preferred products going into?

No, Presource kitting refers to the surgical kits that we prepare for surgical procedures in the hospital and outpatient and surgery center facilities.

They're usually custom kits that are prepared for specific operations.

That is separate from our emerg trauma portfolio.

Now it could be that some of those trauma products could be in a procedure tray, but when I was referring to the Presource kitting I was really referring to the broader customer procedure trays that we provide.

Okay, great, thank you.

(Operator Instructions)

Eric Percher, Barclays.

So we heard earlier from another peer some conservative commentary looking out over the next 12 months.

We'll get guidance from your other peer in a week.

Are you at a point in your planning process where you can comment on your expectations over the next 12 to 18?

Eric, it's Jeff.

I'm probably going to frustrate you a little bit with my response, but the simple answer is, no.

We generally provide our guidance in our Q4 call, which will be in August this year, in main part because we are still going through our planning processes.

Until we complete those, really not in a position to provide quantitative guidance for our FY15.

That all said, let me provide a couple of qualitative comments on drivers and our approach heading into next year, and I'll go through these in no particular order.

First, we continue to expect the accretion from the CVS generic sourcing JV; net of the accounting for the quarter, the payment to CVS to be accretive.

We said that at our December Investor Day, and based on everything we know to date, we continue to very much expect that to be the case.

The other thing I'll mention about the CVS JV -- as George said, we're still on track to be up and running as early as July 1. But it'll take time for the contracts to flow through and the benefits to ramp up.

So clearly we're not going to see a lot of benefit day one.

We'll progressively ramp up over the next course of our FY15.

Second point I'd make is, we're going to continue to maintain our conservative posture with respect to health care utilization.

And as we said before, we're not going to try to forecast when ACA volume upticks might kick in.

That's proven to be a very difficult proposition that we decided some time ago that, for the purpose of our internal forecast and planning we will be relatively conservative and really not try to model when ACA-related volume might kick in.

And we expect to continue that as we forecast for our FY15 as well.

On the subject of being conservative, we're also going to continue to be somewhat conservative when trying to forecast the benefit from generic pricing relative to what we experienced so far in FY14.

As I said in my remarks, and as we said multiple times, generic price increases from manufacturers are a very difficult thing to predict, given the fact that it affects a very small part of the overall portfolio, less than 5% of our product.

So again, we're going to continue to be somewhat conservative in terms of forecasting any benefit we might get from generic price increases.

We do expect growth next year in virtually all of our key strategic priority areas, including specialty, China, preferred products, and hospital services.

As you know we continued to focus on those for the past year, invest in those and I fully expect our FY15 plan will reflect some the fruits of those investments.

The commentary that I may have expected, but perhaps a little bit more conservative -- the outlier here being that you do expect the JV falling through in line with where you were.

So that's very much on par.

Do you think you'll be in a point to give us guidance in terms of the benefit you're receiving from that when we get full-year guidance?

I'm not sure we're going to give a specific number related to it, quite frankly.

But it will be reflected in whatever guidance we give in August -- our best estimate of the net accretion that we'll get from that JV.

And you stated it correctly, we continue to believe that it'll be net accretion when you add everything up, and then we continue to feel very good about the potential benefit from that JV -- again reflecting that there's going to be a ramp-up period.

Thank you

Glen Santangelo, Credit Suisse.

George and Jeff, I wanted to follow up on the previous question about third-quarter results relative to where you were just a quarter ago.

You gave a lot of color regarding the year-over-year growth rates, but if I look sequentially from fiscal 2Q to 3Q, your revenues were down pretty sharply in both segments and your profit was down almost double that rate in both segments; and actually even more on the medical side.

And so I hear you called out [some specific] drive, whether weather, maybe slower volumes or lighter generic profitability.

I'm wondering if there was anything else that might help explain or reconcile the sequential decline we saw from fiscal 2Q?

Yes, I'm going to speak mainly about profit, Glen.

So on the pharma side, I mentioned that the sequential benefit that we realized from manufacturer price increases on generics was materially less in Q3 than it was in Q2 -- which, by the way, was pretty consistent with the way we had modeled it as well.

So that was a driver of that sequential reduction that you referred to.

I'd also mention the fact that, although we saw good brand inflation in Q3, there was a partial pull-ahead into Q2 of probably about $0.02, and again that's something we had referenced during our Q2 call.

On the medical side of things, I would say Q3 was one of the weaker quarters we've seen in terms of overall utilization.

And how much of that was due to weather, how much of that was due to a lighter flu season -- keep in mind that Q2 was fairly strong from a flu perspective; Q3 was noticeably lighter.

But overall, we did see some relatively weak utilization.

I'd also say, from a year-on-year growth perspective in Q3, we lapped the AssuraMed acquisition in the quarter, so that resulted in some dampening of growth year on year.

I might add a little color, Glen.

From the pharma standpoint, our pharmaceutical segment, actually our revenue numbers -- again, stripping away the expression of (inaudible) -- were really good, actually.

So we competed very effectively and we like our positioning there.

And on medical, as Jeff said, I would be really hard to point to any meaningful competitive or operating performance difference between the last quarter and this quarter; essentially the main change being the environment; and as Jeff said, the lapping of AssuraMed.

So from a competitive positioning standpoint and where we are, actually feel pretty good about it.

Okay so maybe if I -- Jeff, clarify what you said with respect to fiscal 4Q.

It sounds like you're expecting another significant step down in the profitability of the pharmaceutical segment, just basically to be in line with the midpoint of your guidance.

But yet the biggest swing factors will be some uptick in terms of generic pricing and maybe the Q4 tax rate.

So is it fair to say, embedded within your expectations for next quarter, you have continued very conservative assumptions with respect to generic pricing?

Absolutely, Glen.

Our current forecast implies another fairly significant sequential decline in benefit from manufacturer price increases on generics.

Now, as I said, though, we could be wrong on that; and that is the biggest swing factor in where we'll end up within the range.

So I would second what you just said.

Also mention that we modeled it pretty accurately heading into Q3, but we're going to continue be somewhat conservative on that point.

Okay, thanks for the comments,

Ross Muken, ISI Group.

It seems like your execution in the China business continues to be a net positive for the overall Company.

As you think about the growth trajectory there and what you've learned now, being a broader international business, and your key partner on the JV continues to search for assets in Brazil.

How are you thinking about some of the rest of world opportunities?

And obviously your peers have gone into Europe.

But how are you thinking about some the emerging markets, the opportunities, as you've seen what else has developed in some of these regions?

So, Ross, why don't I start and then we'll let Jeff join me and probably some specific comments about China you might want to make.

We continue to look everywhere where we think there may be opportunity for us to explore competitive advantage.

Remember that we do this really by business line.

So obviously the thing that gets the most attention, of course -- and we've seen major move in the pharmaceutical distribution business in Europe, for example from our competitors -- but for us, we'll look very carefully at every market and we'll look at it with a pretty disciplined eye, and we'll look at it by our business lines.

So again, we have a fair amount of experience in our senior team; we do sell a number of our products in the markets around the world -- that's likely to expand.

We're looking at individual markets really across the globe.

But again, we'll do it with a very disciplined eye, with a goal of making sure that we can enhance our strategic positioning, that we've got a reason to compete -- meaning, reason to win.

And that assures our shareholders and other stakeholders as well.

So we're pretty active looking across the world.

But again, you have to remind -- I think remind yourself that we have multiple lines of business and we'll consider them, both in the broad context and by line of business.

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

The other thing I'd add is, every [new] that's going into China, I think anytime you make a move into an international country, you have to do it with a sense of purpose and you can't dabble, honestly.

Any international country requires a pretty significant management focus; and so any decision we make to enter additional countries has to be made with recognition of that -- that it's going to take a fair amount of management time and attention, as it should.

So if we are going to enter a country, it's going to be because, as George said, we can win and that we're prepared to invest the necessary management time to being successful.

And we can add value and deliver a good return for our shareholders.

So none of those decisions will get made lightly, but we'll continue to look.

And if we can find markets that can turn out to be as successful as China has been so far -- that's great.

And we'll apply our learnings from entering China into any significant future opportunities we find.

Great, guys, thank you.

Robert Jones, Goldman Sachs.

Not to be dense on this, and to follow up on the 3Q cadence -- I know you guys referenced why revenue was a little bit down sequentially, and profit dollars, obviously, subsequently down as well.

But if I look back at 3Q in both segments is also your highest profit margin quarter.

And I understand some of the timing issues you mentioned that would impact that.

But for both segments, clearly the operating profit margins probably lower than what we have grown accustomed to in this particular quarter.

Anything else worth calling out, as far as mix or anything else with any segment that might have driven that?

Yes, thanks for the question, Bob.

First of all, I think it is important to remind everyone that this is -- the Q3 was the second quarter we haven't had Walgreens.

And that's going to continue through in terms of lapping that loss; it's going to continue through the first quarter of next year.

I think we had such a strong quarter in Q2 that perhaps people lost sight of that.

But we're still facing the drag on revenue and operating earnings year on year from that loss.

I'd also say about Q3 -- actually we're pretty pleased with where we ended up.

We basically ended up exactly where we are forecasting to be; we over achieved versus plan.

And yes, there some lightness in utilization, particularly in medical, that was a bit of a disappointment.

But, as George said earlier, from a competitive standpoint, from strategic party standpoint, we continue to be firing on almost all cylinders, which is important.

And I think it bodes well for the future.

So I -- quite frankly from our perspective, Q3 came in as or slightly better than we expected and we feel pretty good heading forward.

Okay, great.

And then Jeff, you mentioned some of the things to keep an eye on for next year, ahead of official guidance, obviously.

One specific question I had around contracts -- can you remind us of your exposure to the DOD?

Anything you'd call out there as far as how you're thinking about repricing that renewal?

And then, along those lines, any other contracts that we should have on the radar as we think about modeling FY15?

Thanks.

So most of this, if not all of it, is public information; so I'll repeat what's in the public domain.

Our total pharma revenues, annual revenues with the DOD, are about $600 million.

We had two specific regions that we service the DOD.

The contracts for both of those regions expire in our Q4 of next year.

Obviously, it's something we'll be very focused on during the next couple of months as the contracts come up for rebid, et cetera.

But quite frankly, in terms of impact on FY15, given the timing and given our overall exposure to the DOD, we expect it to have a fairly minimal impact on our FY15.

In terms of other contracts, Bob, I'm happy to say, actually, that if you look at our large pharma contracts, which is what I think you're referring to, we're really pretty well-positioned through the end of FY15 with all of our large customers.

And as George alluded to, we're happy that we were able to extend the Kmart contract well into the future.

And that's very important for a number of reasons, including the fact that they're a fairly large generic buyer of us.

So from a contract stability standpoint, we're probably better positioned now that we've been in some time.

And obviously you all know that the CVS distribution contract is extended for number of years as well.

So good overall stability.

Great, thanks so much.

Lisa Gill, JPMorgan.

I was wondering if maybe you could give us a little more color around the CVS JV go-live.

For example, what portion of generics do you expect will purchase through the JV come July?

Is this going to be rolled on over time, Jeff?

Lisa, I'll start and then I'll let Jeff jump in.

Again, you should assume that pretty much all of our generics are going to roll through that joint venture.

There could be unique hospital lines that -- injectables that are not.

But you should assume that this is really going to be our generic sourcing model.

And we can't provide too much detail beyond what I said in my comments, Lisa, except I'll say this: As Jeff said, we feel good and competent that we'll cover our financial obligations under the JV structure.

We've made great progress; there are a million moving parts in getting to the finish line and the teams have been really working hard to get to that target date.

The spirit of cooperation is incredibly good.

And I think we're at a point where we're having good conversations with manufacturers; I think they appreciate that we're building a pretty transparent model.

And so from that standpoint we're feeling good about it.

I don't know, Jeff, if we can add much here?

To your -- when the sourcing rolls into the JV, I would say the JV responsible for virtually all generic sourcing from day one.

When I was referring to ramp-up, I wasn't really referring to us gradually giving responsibility to the JV, because that does happen day one.

What I was referring to is really when the JV would be able to realize significant benefits in terms of repricing contracts, et cetera.

That will ramp up over time, as you would expect, because it's not like we'd be able to redo every contract on day one.

And then you mentioned the renewal of Kmart and the fact that it's a large generic customer.

I'm curious, are you seeing any increased interest from other customers in your generic business, now that you have this JV cooperative?

Yes, Lisa, it's a great question.

As you know there's been -- these last 6 to 12 months have been a period of incredible amount of movement around the pharmaceutical industry.

I would say there is certainly increased interest from players who might be at a smaller scale as to how they can best achieve a greater position.

I can't go into great detail, but I think your hypothesis that this is likely is right on.

And we'll continue to just be thoughtful and in touch with everyone who can be a player in this field.

So yes, I thinks it's reasonable to say that there's continued and probably increasing interest.

Okay, great, thank you.

David Larsen, Leerink Partners.

Can you guys touch on what you're doing to work with your independent pharmacy customers to basically help them improve the way they deliver care?

We're hearing a lot about how retail pharmacies are becoming more providers of care.

Any thoughts around how you're helping with them along that path?

Thanks.

Yes, good morning, Dave, I'll touch on it.

The model that we've evolved, really, with the independent pharmacies is essentially to provide an extraordinary amount of service support to them to enable them to do the things that they're most likely to compete on effectively, which is getting out in front and engaging directly with customers.

And so our programs really cover the gamut from generic programs, obviously; reimbursement tools.

I mentioned this help on the CMS star model, just a little detail.

That's really -- the way this works, CMS has implemented a rating system for all plans, for Medicare plans, and so the ratings come with bonus payments related to certain things.

We're working with those customers to do that.

We're helping them build centers for diabetics inside their stores.

We're doing programs for them that help fulfillment on the home care and dealing with patients who are elderly and have unique needs in their pharmacies.

So I would say the basic concept is a huge wraparound service system that allows them to operate in the most effective way they can in their community.

Very specialized, very targeted; it's not a one size fits all.

And I think that's where we've gotten better in recent years, is that we've been able to really target these customers, segment them, and understand that each of them has to compete differently in their own community.

And I think the better we understand how they compete and what we can do to help them, the more effective we'll be.

I think the retail business is showing the signs of that high service and high touch model.

Great.

And I'm also hearing about how hospital IDNs are obviously forming accountable care organization types of programs.

And a lot of these are including pharmacies in their networks.

Is that part of it?

Yes, it is.

Okay, thanks a lot.

Greg Bolan, Sterne Agee.

So on the preferred products in the medsurg segment, Jeff, what percentage of gross profit would you say preferred products comprised of at this quarter?

Yes, Greg, great question, and obviously something we watch very closely.

It was about 36% of gross profit for the quarter

And it's still -- call it 23%-ish of medsurg revenues?

22%, 23% -- in that range.

Got it.

Okay.

And so with this acquisition, obviously you're planning on moving into other areas beyond interventional cardiology.

But as you think about the contribution from preferred products to that segment gross profit line, it would seem to me that over the coming years this is going to be -- this acquisition and obviously layering on additional high-end or high-tech type devices will enable you to basically transform the segment margin higher.

And I was wondering, is this something that you view this acquisition and what you're going to do with it, as well as all the other things that you're doing on the core business transformative to this segment gross profit margin?

Yes, Greg, why don't I start and then again, I'll turn it to Jeff.

Yes, this is really at the heart of the strategy.

This is again a place where we know it's a significant need for our customers.

I think it's change of behavior that's going to really alter their game, not necessarily squeeze in one more basis point of some product.

It's really about a change in behavior.

Much of this requires standardization.

And I think we're seeing an increasingly receptive customer to this, and we've started to make some moves to build out that platform.

So in ortho, we had already begun to do that.

You mentioned the high-tech.

Obviously, we've started really on the lower tech, which I think is the more appropriate place to start.

The key for us is evidence-based equivalence; that's what we're focusing on and building that case, starting in trauma.

In cardio, we've really started with this acquisition.

We wanted to make sure that we had a Company with credibility, a product line that had some reach, a management team that we believed in, and actually a relatively efficient low-cost service model, go-to-market model.

And we believe that with AccessClosure we get that.

So this allows us, again, to think about other areas.

For example -- again, thinking more along the lower end of clinical differentiation, more like guidewires or catheters or diagnostic catheters that might be used in this setting.

So, again, the way to think about this is starting really on the lower end and making sure that we can build the support there in our community.

To go back to ortho, I would also remind you that we are, I would say, pretty significantly ramping up our capability and the product line in our trauma area.

Because again we started with a relatively thin line; and what's important is to be able to have a basket of products.

So we do think that this has the potential to really change the game for our customers, and in terms of our own margin rate, should be very positive.

Yes, to build on the margin rate question, Greg -- as we said in our December Investment Day, our goal is to achieve a medical segment profit margin rate of at least 5.75% by FY17.

And there's really three things that are going to drive it.

And one of those things is not getting paid more for core distribution -- that's not our expectation.

But we do believe that the things we can wrap around our supply chain capabilities will be key drivers of that margin expansion.

And specifically, that's preferred products; and, as we said at the time, our goal is to get the gross margin contribution from preferred products to about 45% of the overall medical segment gross margin.

Secondly, continuing to aggressively build our home health platform.

And thirdly, layering on additional services that we can provide to the hospitals that are clearly very high-margin.

So it's really those three initiatives that are going to drive our margin expansion over the next three years.

And again to reinforce, because it's important -- we really are focused on a particular part of the market and these are really at the moment areas where clinical differentiation is not really relevant, not -- and standardization, the benefits of standardization will be really compelling.

So wanted to make sure I highlight that.

Sure, sure, that's great.

I'll stop there, thanks, guys.

George Hill, Deutsche Bank.

George, I wanted to pick on your expertise here.

And I want to ask, from your background, how much variance is there in the contracting between the drug wholesalers and the generic drug manufacturers?

Because with the new purchasing entities that have been formed by some of your peers, it seems like there's a lot of new bells and whistles that are trying to be introduced to how the contracts are structured between the manufacturers and the wholesalers.

So I guess I would ask, are you guys seeing more bells and whistles being introduced?

And George, from your (inaudible), can you talk about how much variance there was in the contracts between the wholesalers (inaudible) customers?

So George, great questions, part of which I can answer, part of which I can't.

So in terms of differential on pricing, that's not something I can speak to at this point.

I think you guys have to use your own judgment as to how you would believe a different size and scale might influence how pricing is delivered from a manufacturer to the channel.

Obviously we -- there's enormous amount of work we've done in this internally, but not something we can really share.

In terms of the bells and whistles question, it's a really interesting one.

I would argue this: that having sat in the manufacturer's seat, you want the system to be pretty simple.

And so, in fact, attaching too many bells and whistles is not necessarily where we want to go.

I think we want to simplify the relationship with the manufacturer.

I think we want to have a great line of sight between them and us.

I think we need to be able to demonstrate to them that we can create value for them; that certainly is market share and our ability to influence market share.

But it's also having a model that they connect to and that works for them.

So I would say we're not trying to attach things to the model.

We're actually trying to simplify in many ways and make sure that when we go to the market as a single joint venture, it's very straightforward, very clear, very transparent, they know who they're working with.

I don't know if that's helpful?

Yes, it is helpful from the [andy] perspective.

But what I'm trying to figure out is how should we think about the procurement savings that you and CVS are going to achieve?

We're dumb sell-siders; we think about this in terms of dead net price reduction versus will there be rebate structures, GPO structures, GPO fee or GPO admin fees, pay to price structures?

So that's the type of complexities that I'm talking about, and we're hearing about lots of interesting structures that are being examined.

I'm trying to figure out how much of this is new and how much of this is normal.

So historically there have been multiple -- very quick context, there been multiple ways that companies deal with the generic manufacturers.

Again, let me be very clear, though.

We want to keep it simple.

So our goal is really going to be to do that, not to add layers of complexity.

What I can't give you, and I think was the beginning part of your question and I simply can't do that, is how much value is there coming from the venture.

And the only thing we can share with you at this point is what we shared when we announced, which is that we've got an obligation under the joint venture agreement we feel positive that we'll cover those obligations and that we expect this to be accretive.

But again, transparency, simplicity is probably going to be more the order of the day in our model rather than adding layers of complexity

Okay and last one, and I'll hop off with, is -- can you update us on generic drug private label strategy?

I'm sorry?

Generic drug private label strategy?

Yes, let me try to do this very generally.

To me, in the US market -- again, let's talk about the US market, and that's primarily today where we're competing in generic drug.

We don't really believe that the label, whether or not we have a private label, is a relevant dynamic for those that are making the purchasing decisions.

So other companies may choose to go down that path and we totally respect that and understand it and maybe it's part of a procurement strategy.

And to that extent, we'd always evaluate those things, so we don't rule them out.

But as a commercial downstream market strategy, we don't believe in the US -- and this has been tried over the last 40 years -- in the US we don't think that's a particularly relevant thing.

But certainly as part of a procurement strategy, if we thought it helped us in that part of the business, we're always open to it and never rule it out.

Good deal.

Appreciate the color.

Thanks, George.

Steven Valiquette, UBS.

I missed a couple or your comments on the generic inflation stuff.

I know last quarter you characterized as still as abnormally high inflation on a relatively small basket of products.

My question is, big picture -- where do we stand on resolution of supply shortage situations?

Big picture, are we seeing those circumstances starting to dissipate a little bit?

Are we seeing an increase in shortages?

Want to get a big picture comment on that.

Yes, sure Steve, I'll start this, and again, Jeff is always free to pile in here.

We've said pretty much through the early part of the year that we thought we were seeing some relatively unusual pricing patterns, if you can even use the word patterns.

Obviously, these tend to be individual markets.

I always remind people that thousands of generic drugs, it's thousands of individual markets.

We did expect to see some moderation during the second half of the year.

And then, that's what we saw in Q2 and we were not far off our expectation on that.

So I think the question about what's happening in the market and the disturbances -- I'm not sure that we've seen a lot of change there.

There continue to be disturbances in the market, significant disturbances in the injectable space, in the hospital space as you know.

And that has made it very complicated for the system.

And I know that there are a number of both policymakers and a lot of the companies trying to figure how best to navigate that environment.

But I would say we continue to see some manufacturer shortages and I'm not sure that has materially changed.

But it moves from product to product, as you probably know.

The only other color I'll add, Steve, is that the number of products that actually had an increase in Q3, sequentially was slightly higher than what we saw in Q2 although still under 5% of our portfolio.

However, as I said earlier, the net benefit to us from price increases in Q3 was materially lower than Q2.

Okay, that's helpful color, thanks.

Garen Sarafian, Citi.

A follow-up question regarding your joint venture and the ramp-up.

I'm wondering -- how does the progression of the ramp occur?

So I'm trying to figure out why wouldn't, especially if the model is to keep it simple, if it would hit its run rate by the end of your fiscal year next year -- so it's in a 12-month period.

Or is there something inherently something that's longer term, such as contracts that you can't get out of that require a three-year period or something?

So if you could elaborate on that a little bit would be helpful.

Thank you.

Thanks, Garen, good question.

What I've said before, which we still believe to be the case, is FY15 will be a ramp-up period.

And that's because it will take time to renegotiate new contracts, we also have some contracts that still have to play out in FY15 -- existing contracts I'm referring to.

That all said, we do expect that we'll hit probably a more normalized run rate in FY16.

I don't think we're looking at a multi-year ramp-up period.

But again, to repeat, probably 2015 will be a ramp up period, 2016 will be more of a normalized run rate.

Got it, great.

Thank you.

I'd like to turn it back to George Barrett for any additional or closing remarks.

Okay, great, thank you.

Look I'd like to thank all of you for joining us on today's call and for your questions and your interest in Cardinal Health.

And we look forward to seeing you at upcoming meetings.

Thanks all.

This concludes today's conference; thank you for your anticipation.