卡地納健康 (CAH) 2014 Q4 法說會逐字稿

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

Today's conference is being recorded.

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

Please go ahead.

Thank you, Tina.

And welcome to Cardinal Health's fourth-quarter FY14 earnings and FY15 guidance call.

Today we will be making forward-looking statements.

The matters addressed in these 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 statements slide at the beginning of the presentation found on the investor page of our website for a description of those risks and uncertainties.

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

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

Our press release and details about upcoming events can be found on the IR section of our website at Cardinalhealth.com.

So, please make sure to visit the site often for updated information.

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

George.

Thanks, Sally.

And thank you to everyone for joining us this morning.

FY14 was an enormously important year for Cardinal Health.

Our organization exceeded our financial goals for the year along multiple dimension; revenue, gross margin dollars, non-GAAP operating earnings, and operating margin rate and cash flow.

Of particular note, we were able to absorb a revenue headwind of nearly $17 billion due to the FY14 first-quarter expiration of the Walgreens contract and still grow our non-GAAP earnings over the prior year.

At the same time, we have been able to enhance our market position, deploy capital efficiently and continue to grow the talent so critical to our future.

Equally important, we begin our FY15 stronger and better positioned than ever to address the needs of a healthcare system looking for solutions to two very basic questions.

How do we deliver better care more cost effectively?

And who are those industry players who listen and act to bring innovative solutions to the table?

Answering these questions is at the heart of what we do and our team has approached this, recognizing that we need to compete and win every day in today's marketplace, while at the same time making important moves to adapt to a changing healthcare environment.

You can make a strong argument that this has been a transition year for the industry, as well.

It's been an extraordinary 12 months in healthcare, particularly here in the US.

Last fall we saw the first roll-out of the exchanges under the Affordable Care Act.

And throughout the year, our system continued to explore different models for providing coverage for patients, delivering care and managing costs.

We saw consumers playing a more active role in their own healthcare, much of this fueled by the impact of changing benefit design.

And we saw some medical breakthroughs that expanded our system's capacity to manage and even cure disease, but also test our ability for readiness to pay for that innovation.

At the same time, we saw clear signs of an industry actively repositioning and consolidating upstream, among pharmaceutical and med tech manufacturers, as well as among providers and health systems, and a continued blurring of the lines that delineated what used to be the distinct segments of the healthcare market.

This has certainly been a year of transition.

With that as context, let me talk about our performance in FY14.

My remarks will focus broadly on our annual FY14 and our 2015 outlook.

As I mentioned in my opening remarks, FY14 required some major transitions for Cardinal Health after the expiration of the Walgreens contract.

And given this headwind, I'm particularly pleased with our results.

Our revenue for the year, excluding Walgreens, grew by 8%, fueled primarily by strong growth from existing customers.

Our reported revenues, including the impact from Walgreens for the year, declined by 10% to $91 billion.

Non-GAAP operating earnings rose 4% to $2.1 billion, while non-GAAP diluted earnings per share were $3.84, up 3%.

And our gross margin rate expanded by 80 basis points to 5.7% for the year.

Our team continued to drive capital efficiency this year, generating $2.5 billion in cash from operations.

We returned over $1.1 billion to shareholders in FY14, through both our strong dividend and share buybacks.

And I'm very pleased that we were able to provide our investors with a total shareholder return of 46.7% for the year.

Now let me turn to the segments.

Our Pharmaceutical segment more than met the challenge associated with the Walgreens contract expiration, actually delivering a profit increase, while absorbing that $17 billion revenue headwind.

It's worth noting that the rate of revenue growth, excluding Walgreens, would have been a robust 8% for our Pharmaceutical segment.

Our overall Pharmaceutical segment profit margin expanded almost 30 basis points for the year.

I'd like to take a few minutes to cover a few strategic priority areas for our Pharma segment.

There's little doubt that generic drugs will continue to be a significant lever in holding down prescription drug costs.

Current data suggests that generics now represent over 85% of all prescriptions in the United States.

We have significantly increased our scale in generics through our various internal and external moves, most notably our joint venture with CVS Caremark, now named Red Oak Sourcing.

A few quick comments about Red Oak.

We're extremely excited about our progress to date and getting to a go-live with Red Oak, which was formalized last month.

CVS Caremark has been a terrific partner throughout the process.

As we have worked through the details in our preparation for the launch, our enthusiasm has only increased.

We have assembled a talented team, with both Cardinal Health and CVS Caremark well represented.

Our teams have put in the hard work to manage through all of the intricate details so that we could go to the manufacturers with one face and as one decision maker.

We feel confident that our participation in Red Oak will ensure that Cardinal Health is in the best position to serve our diverse mix of customers in this competitive landscape.

I understand that many of you will want to know more details about the impact, the value and mechanics of the joint venture, but I'll ask you to recognize that Red Oak has only just this past month been engaging in discussions with manufacturers.

It is important to respect the process and for us to let these negotiations proceed between Red Oak and the manufacturers And so, other than the comments Jeff will be making, we'll not provide specifics on the mechanics or the exact value derived from the joint venture.

Of course FY15 guidance includes the assumptions associated with the net benefits from Red Oak.

You know that diversifying our customer base has been a priority.

We've continued to grow our position with independent pharmacies and other pharmacy channels over the year.

Our portfolio of solutions for these customers has never been more comprehensive, and the response of the retailers has never been more enthusiastic.

I just returned from RBC, our annual Retail Business Conference held in Washington, DC, last week.

The gathering of thousands of owners and pharmacists was our largest ever, reinforcing their importance to the healthcare system and to Cardinal Health.

The conference gave these retailers exposure to over 60 continuing education courses, and provided access to the latest tools, technologies, solutions, and innovative programs.

Special emphasis was placed on patient solutions that help with medication adherence and medication therapy management.

Our focus remains to help these critical members of the healthcare system improve patient care, the breadth of their products and services and the efficiency and profitability of their businesses.

At the same time, our ability to serve hospitals and health systems with pharmaceutical products continues to strengthen, including some of the important work we are doing with our clinical pharmacy teams to help with discharge management.

Specialty medicine and the services surrounding these innovations continues to play an increasingly large role in our healthcare landscape and, of course, for Cardinal Health.

During FY15, we were able to deliver a 30% revenue growth in the Specialty Solutions group.

We have expanded our presence in specialty biopharmaceuticals, particularly in building out our tools to interface with patients who need to be served in an integrated and high touch model.

This enables us to serve the providers of care to these unique patient populations, and also to capture value as a partner to biopharmaceutical companies who seek to get closer to the patient.

To support this program, we established a best-in-class patient-centric hub with the acquisition of Sonexus Health in the third quarter of FY14.

This platform and experienced team is an important step to position Cardinal Health to assist in these efforts, and to deliver value-added services.

Moving to the Medical segment.

FY14 revenues grew 9%, margin rate expanded by 35 basis points, and segment profit grew at almost 20%.

The delivery of medical care has been undergoing fairly rapid change, and the work of our Medical segment has been focused on aligning to address the evolution in the system.

Just these past few weeks, we've formalized some adaptation to these changes, launching a team-based approach to addressing the needs of large, integrated delivery networks.

These are not sales teams but rather business and systems experts who are charged with delivering the full range and breadth of the Cardinal Health portfolio to address the complex needs of these diverse customers.

As I mentioned earlier, we've seen consolidation among hospital systems, continued affiliation between doctors and those systems, and some shifting sand as relates to where care is delivered.

On this last point, while the sickest patients will continue to be served in acute care settings, it's clear that many patients with lower acuity will be served in different settings, whether that's a community hospital, surgery center, a clinic, a physician's office or even the home.

This has been at the heart of our strategy to serve patients across the continuum of care.

In this context, the acquisition of AssuraMed a year ago has been an important extension of our strategy.

It has significantly increased our touch points and created opportunities in a market that is growing an estimated 5% to 7% per year.

Most important for Cardinal Health, it's increasing our direct linkages with chronic patients.

Through AssuraMed, we have some form of interaction with the patient, 44,000 times a day.

With this increasing patient interaction, we recently made the decision to rebrand our AssuraMed platform as Cardinal Health at Home.

As we told you at the time of the acquisition, we intended to increase the AssuraMed portfolio.

We have, in fact, broadened the product line, as well as increased the number of Cardinal Health-branded products to this important channel of the home.

All told, we are extremely pleased with the progress here and the fact that AssuraMed exceeded our full-year accretion target of $0.18 per share.

Our medical consumables business has represented an opportunity to use our scale to bring significant savings to the healthcare system, while at the same time expanding our margins.

Our consumables business grew faster than the market this year, driven by share gains from new private label product launches, new channel penetration, and from growth among our strategic accounts.

We saw full-year sales growth of 6% and launched over 500 new SKUs during FY14.

During this past year, we've discussed with you the challenges many of our hospital, IDN and surgery center customers face in managing physician preference items.

These categories tend to consume resources and, from our perspective, represent an inefficiency.

We've recognized an opportunity to bring standardization, and with that real-time value to this system.

We've positioned ourselves to address some critical pain points, building platforms in orthopedic, wound management, and, with our third-quarter acquisition of AccessClosure, interventional cardiovascular.

A few comments on China.

China has continued to be an outstanding growth story for us.

In 2014, we grew revenues by 30%, reaching $2.6 billion.

We continue to build strong relationships with the biopharma and medical device companies at a time when Company reputation is particularly important.

We've expanded our geographic footprint and our lines of business, which now include 30 direct-to-patient pharmacies, focused on specialized pharmaceutical products.

Before I turn to 2015, one more note.

It's been our practice to be transparent with you with regards to areas where we need to be better.

This was a year of enormous accomplishments, but we had a few areas that did not satisfy our high expectations.

Fortunately, these are relatively small parts of our portfolio, and in each case we are taking action to accelerate improvement.

But I do want to call them out.

Canada was a particularly tough market for medical supplies this year and our business declined there year over year.

We believe that we've made the necessary moves to address the pressures of that market, and we look forward to recovery in that business.

Our work supplying medical products to small physician offices has not had the growth that we'd like to see.

While we've had solid performance in most post-acute settings, including surgery centers and large practices, we are committed to making greater progress within these smaller practices, and are taking steps accordingly.

As we leave 2014 and turn to our FY15, we begin the year with increased scale in generics, a more robust specialty business, a reconfigured customer and product portfolio, and some important solution offerings for the medical system, with the flexibility that comes with financial strength, a deep bench of organizational talent, and a sense of confidence in the future.

Most important, we believe our strategic priorities align with the needs of a system experiencing a rapid change, new performance-based models, a new world of bundled risk, changing network design, accountable care organizations, and a more involved patient acting more like a consumer.

So, with this as backdrop, we are guiding to a FY15 non-GAAP EPS range of $4.10 to $4.30.

This puts us on track to deliver on the long-term aspirations we laid out in our December Investor Day.

It's our year end so I'd like to voice a few thank you's.

To our shareholders, we appreciate your support and your high expectations.

For our business partners, manufacturers, providers and caregivers, those who directly touch patients, we thank you for putting your trust in us and allowing us to help you serve your patients.

To all of my colleagues at Cardinal Health, my gratitude for your talents, your spirit and your readiness to respond to important challenges, and to do so with your eyes always on the patient.

Before I turn the call over to Jeff, I want to make a few quick comments on our announcement about his retirement, which will become effective following the end of our FY15.

Jeff has been a talented and trusted partner to me since my arrival at Cardinal Health.

I've often leaned on his agile mind and his quick wit.

Although there will be no Derek Jeter farewell tour, we have a healthy transition scheduled, and I know all of you will get time with Jeff to thank him in the coming year.

And, of course, we'll update you as we formalize our succession plan.

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

Thanks, George.

Good morning, everyone.

And, by the way, I am counting on the Derek Jeter farewell tour.

But thank you for the comments.

I'm happy to be reporting a solid finish to an important transition year.

This morning I'll begin by highlighting key financial trends and drivers of our fourth-quarter results, and then make a few comments on our full year performance.

I'll also provide additional detail on our FY15 guidance, including some of our key expectations and underlying assumptions.

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.

As we indicated during our third-quarter call, achieving the upper end of our non-GAAP guidance range would really depend on two items: the impact resulting from generic manufacturer price increases, and our tax rate.

During the quarter, we grew our non-GAAP EPS by 5% to $0.83 per share, or $3.84 for the full year, a reflection of the relatively favorable outcome for both of these factors.

I'll get into some more detail in a moment.

Now let's review the rest of the income statement, starting with revenue.

Consolidated revenue came in better than expected, down 10% to $22.9 billion, with the decline due to the expiration of the Walgreens contract.

Gross margin dollars were up slightly for the quarter, resulting in a gross margin rate 58 basis points higher than the prior year's Q4.

This continues a 16-quarter trend of gross margin rate expansion.

SG&A expenses moderately increased by 2.5% in Q4, driven by recent acquisitions and year-over-year compensation-related items.

Our core SG&A costs were slightly favorable to last year, due to our continued focus on operational efficiency.

Our consolidated non-GAAP operating margin rate increased 16 basis points to over 2%.

Net interest and other expense was variable in the fourth quarter versus prior year, due in part to lower interest expense.

The non-GAAP tax rate for the quarter was about 34%, versus the prior year's 37%.

This period lower rate is related to favorable state tax outcomes in the quarter.

Our fourth-quarter non-GAAP diluted average shares outstanding were 343 million, nearly 2 million favorable to last year's period.

During the quarter, we repurchased about $285 million worth of shares, bringing the full year repurchase to $673 million.

We have over $700 million remaining on our Board-authorized repurchase program.

Moving on to consolidated cash flows and the balance sheet.

Our operations generated $716 million in cash flow during the quarter.

This brings the full year to approximately $2.5 billion, including the expected benefit of more than $500 million from the unwind of the Walgreens business.

We continue to make good progress on reducing our overall net working capital days, which are down 1.8 days, largely related to a shift in customer mix.

Overall, we ended Q4 with a strong balance sheet, including a cash balance of $2.9 billion, with $420 million held internationally.

Now let's move to segment performance, starting with Pharma.

Pharma segment revenue decreased 12% to $20.1 billion, driven by the continued impact of the expiration of the Walgreens contract.

The decline was partially offset by organic sales growth, specialty and China.

The contribution of revenue from Walgreens in the prior year was approximately $5 billion for the quarter.

If you adjust for that contract loss, our Pharma sales growth in Q4 was a strong 13%, driven by both pricing and volume effects.

Specialty Solutions had revenue growth of 21%, versus the same period last year.

Our China business also contributed to Pharma revenue growth.

Total China sales were up 24% versus the prior period.

This was driven primarily by a local distribution business from both organic growth and as a result of our strategic geographic expansion.

Pharma segment profit decreased by 5% to $377 million, primarily driven by the continued impact of the Walgreens contract termination, which was partially offset by strong performance in our generic programs.

On the topic of generics, I do want to mention that we saw sequential quarter increase in contribution from generic manufacturer price increases, although it was not to the level we experienced in our second quarter.

Manufacturer price increases continued to impact a relatively small basket of generic items.

The overall generic portfolio experienced net inflation in the low-single digits in the quarter.

Very importantly, our generic program saw strong sales growth of about 9%, most notably driven by strong double-digit growth in our stores program.

We also saw continued brand inflation in the low-double digits, about as we expected.

Pharma segment profit margin rate increased by 14 basis points compared to the prior year's Q4, a reflection of the strength of our generics programs and our continued focus on margin expansion.

Moving on to Medical segment performance in the quarter.

Medical revenues grew 4% in the fourth quarter versus last year, driven by growth of existing customers, including solid growth in our strategic hospital and network accounts and the benefit of acquisitions.

Regarding our strategic hospital accounts, we saw low to mid single-digit growth in this key customer category in both Q4 and the full year.

This represents great work on the part of our Medical team given the continued challenging utilization environment, and we expect more of the same in 2015 and beyond.

Medical segment profit declined 8%, which includes two items worth a combined negative $13 million year on year.

The first of these was a year-over-year increase in incentive compensation, the majority of which is based on total Company performance that's been allocated to the segments.

Secondly, we also had some performance shortfalls in our Medical business in Canada which, as George mentioned, reflected substantial market pressures related to Medical spend.

Excluding these two items, Medical segment profits would have shown solid growth.

Turning to slide number 8, you'll see our consolidated GAAP results for the quarter.

The $0.15 variance to non-GAAP results was primarily driven by amortization and other acquisition-related costs, which reduced our GAAP results by $0.12 per share.

In Q4 of last year, GAAP results were $2.51 lower than non-GAAP results, predominantly due to an impairment charge associated with our nuclear division.

Now, let me add a few additional comments on the full year.

FY14 non-GAAP operating earnings were up 4%.

I'm particularly pleased with our excellent progress on margin expansion, with both a gross margin rate and a non-GAAP operating margin rate increasing versus last year, up 80 basis points and 32 basis points, respectively.

This is solid performance in a transition year and is a testament to our organization's flexibility, adaptability, and commitment to growth.

FY14 non-GAAP EPS was $3.84, up 3% versus last year.

As a reminder, our FY13 non-GAAP earnings per share included a discrete positive $0.18 per share benefit from a tax settlement.

In FY14, our non-GAAP earnings per share included a net $0.02 per share benefit from two large offsetting tax items.

Excluding these items in both years, the Company achieved non-GAAP earnings per share growth of 8%.

For the year, Pharma segment revenues declined 12% but were better than expected as organic customer growth exceeded our original expectations.

Full-year Pharma segment profit increased over the prior year, and the margin rate expanded 27 basis points to 2.18%.

Our Medical segment achieved strong year-over-year growth, with revenues up 9% and segment profit growth of nearly 20%, including the impact of AssuraMed.

In addition, Medical reported segment profit margin rate improvement, up 35 basis points to 4.05%.

Very importantly, during the year we also made excellent progress against all strategic priorities, which George shared in some detail in his remarks.

While also returning $1.1 billion to shareholders through share repurchase and dividends.

When I look at our entire FY14, I'm extraordinarily proud of the growth and overall performance we were able to achieve given the headwind we are facing from the considerable shift in our customer base.

With a strong 2014 behind us, I feel we're well positioned heading into a new fiscal year.

Before discussing our FY15 outlook, I want to mention a change in the way we are providing guidance and reporting results going forward.

As noted in the release, we've redefined our non-GAAP earnings measures to exclude LIFO credit or charges.

This change in our non-GAAP definition comes after conducting research on comparable healthcare companies and deciding to simplify comparisons of results versus other peer companies.

We felt that doing this now, when we do not have a LIFO charge in FY14, and do not expect one in FY15, made the most sense.

As George stated, for FY15, we expect our non-GAAP earnings per share to be in the range of $4.10 to $4.30.

And we expect revenues will increase modestly.

I'll now walk through our other corporate assumptions for the year.

We anticipate diluted weighted average shares outstanding will be approximately 337 million to 338 million, which implies that we intend to repurchase well over $500 million worth of shares during the year.

We expect net interest and other expense of $140 million to $150 million.

As a reminder, the FY14 benefit of over $30 million related to gains on minority investments is not expected to repeat.

For FY15, we expect capital expenditures of about $350 million, with the bulk of that spending on our strategic priorities and IT investment.

This amount is higher than historical averages as we focus on updating our information systems within the Pharmaceutical segment, adding incremental manufacturing and 3PL capacity in certain areas, and continuing to build out our footprint in China.

We also expect amortization of intangible-related assets from prior acquisitions to be approximately $177 million, or about $0.33 per share.

We are projecting an overall non-GAAP tax rate in the range of 36% to 37%.

This tax rate reflects our expectations of further discussions and potential settlements of outstanding audit periods, as well as the benefit of our tax planning efforts.

Let me comment on a few segment-specific assumptions.

In Pharma, we're expecting a modest increase in revenues versus prior year.

As a reminder, the impact of the Walgreens contract expiration will not last until September.

We still have the negative impact of two full months or about $3 billion of revenue, and effectively a full quarter of earnings.

As we noted on our first quarter call, given the nature of the wind down of the Walgreens contract, the expirations did not significantly impact our operating earnings in Q1 of FY14 compared to the prior-year period.

With respect to other key retail customer contracts, all now extend beyond our FY15.

We are planning for the brand inflation rate to be similar to FY14.

Generic programs overall are expected to contribute positively to year-over-year profit.

Included in this expectation are a number of underlying assumptions.

First, we forecast a slight year-over-year decline in the benefit from new generic launches.

Also, we have modeled moderation in generic manufacturer price increases, with less impact in FY15 than we experienced in FY14 Remember, the frequency and magnitude of these generic price increases are uncertain and difficult to predict.

Across the overall generic portfolio, our guidance range assumes slight deflation versus FY14, which is a fairly typical pattern.

Also included in our expectations for performance under generic programs, is benefits resulting from the formation of Red Oak Sourcing, net of our payment to CVS Caremark.

As George mentioned in his remarks, we are pleased with the work we were able to accomplish with our partners at CVS, creating a mutually beneficial, long-term joint venture.

As we work together to get this venture up and running over the six months that will lapse since the announcement of the deal, we've further refined certain aspects of our agreement.

I'd like to cover those briefly.

First, the initial payment to CVS is delayed until our FY15 second quarter, reflecting the operational ramp-up associated with this venture.

To be clear, the total amount of the fixed payment from Cardinal to CVS over the life of the 10-year agreement remains the same.

This is simply a slight timing shift.

The actual quarterly fixed amount will be $25.6 million spread over 39 quarters instead of 40.

The fixed payment of $25.6 million will be expensed evenly on a monthly basis, beginning with the realization of meaningful benefits from the JV.

With the operational ramp-up we have modeled minimal net benefits from the JV in our first quarter of 2015.

We expect during the course of the fiscal year that the value to us will ramp.

The payment expense will be reported in our cost of goods sold.

Second, if certain milestones are achieved, we will make additional predetermined quarterly payments to CVS beginning in our FY16.

This reflects the long-term nature of the deal and is designed to align incentives.

Again, all assumed benefits and expected payments are included in our FY15 guidance and longer-term goals.

We are very pleased that we were able to get this joint venture up and running in early July as we had planned.

And we look forward to our continued partnership with CVS and the opportunity to grow the strategic relationship.

Finally, to conclude our Pharmaceutical segment assumptions, we expect continued growth in our specialty and China divisions, as well as increased investment in information systems within the segment.

Looking to our Medical segment, we are planning for low to mid single-digit revenue growth.

We also anticipate continued segment profit growth and margin expansion, primarily due to contributions from our strategic priorities in the second half of the fiscal year.

Our preferred products strategy will continue to develop as we move through the fiscal year.

As we discussed before, preferred products are expected to be a contributor over the mid term as we expand our portfolio, particularly in the physician preference area.

Additionally, we continue to expect above market growth from Cardinal Health at Home, which is a new branding we have rolled out for our AssuraMed platform.

As our Medical segment performance ramps over FY15, we expect a relatively flat utilization environment in the acute settings and mid single-digit growth in the home setting.

As always, we will keep our operations lean and use our flexible model to capture any upside related to utilization should it appear.

Finally, when we net together our assumptions for a slight headwind from commodities, with a positive impact from foreign exchange, these net to essentially neutral on a year-over-year basis.

Before I leave guidance, I want to add a few comments related to the first quarter of 2015.

Typically we don't give quarterly guidance but I do want to point out a few unique issues, which will likely make Q1 our toughest quarter on both an absolute earnings basis and year-on-year growth.

From a compare standpoint, keep in mind that last year's first quarter had virtually a full quarter of earnings from Walgreens and a beneficial tax settlement of $0.18.

And, again, we have not modeled net benefits from the JV in our FY15 Q1, but expect that during the course of the year the value to us will ramp.

And we will be investing to win in certain areas, including the ramp-up of our physician preference platforms and our IT upgrades in the Pharma business.

With that, let me move on to my final remarks.

On the whole I am very proud of what we were able to accomplish this year.

At the beginning of FY14, we faced sizeable challenges.

And I could not be more proud of the work of our teams that resulted in the positive outcomes we are reporting today.

As we look forward, we have the fundamental positioning and strategic alignment to make excellent progress against our long-term goals of margin expansion, earnings growth, and returns to shareholders.

With that, let's begin Q&A.

Operator, please take our first question.

(Operator Instructions)

At this time we'll take our first question from Ross Muken, ISI Group.

Good morning, guys.

On the generic inflation front, it seems just in general it's something that is incrementally hard to forecast, just because of some of these one-off portfolio events you've talked about.

In terms of getting the buying organization amenable to maybe trying to prebuy where there's opportunities or where you see it in a certain category, how do you foresee your ability to change the way you've been doing business a bit to try to capture more or this?

Basically what I'm asking is, it's hard to forecast but if you could see it in the category it's obviously quite profitable.

I guess it doesn't go into the guidance because it's tough to predict.

But how are you working with everyone to make sure you're able to monetize this?

And then how does that also change the way then you deal with CVS on things like this?

Rob, it's George.

Good morning.

Thanks for the question.

So, it's a little hard to answer this.

Partly as I said during my prepared comments, we're literally just this past month beginning negotiations.

Let's start with some basics.

You're right, it is difficult to model price increases.

We have talked a little bit about this in the past, which is, while it's difficult to model the products, we think about the environment and what are the conditions like.

So as we start thinking about our year, while we can't model each product necessarily perfectly, we start thinking about what are the conditions that lead to this, whether or not that is intense regulatory environment or various market disruptions.

Here's what I would say.

We have an incredibly sophisticated team.

And I would say now teams put together, when we look at Red Oak, to evaluate the market and to build into our modeling all the assumptions around price and price increases.

I think we've done a reasonably good job of doing that.

We do what we can and then we build that into our forecast.

If you look at our FY15 guidance, it includes some assumptions about the way products flow through and how they're priced.

But again, it's really hard for me to say too much about this in that we're just beginning these discussions with manufacturers.

But I will say this.

I couldn't be more excited about the quality and the know-how and the experience of the teams that have been put together to do this kind of work.

George, that was a much better answer than my question was.

Maybe just turning to the medical side of things, you guys have been pushing more on the preferred products side, obviously with AccessClosure that gets you deeper into cardio.

You've done stuff in ortho.

I think wound care makes sense as a market.

What's the response you're getting incrementally as you guys continue to move forward with the strategy?

And where are you seeing the most openness and where are you seeing the most pushback at the hospital level?

I think, in general, we're seeing tremendous responsiveness.

And I would say it's pretty consistently across the board at this point.

Again, hospital systems are really facing different kinds of changes, including reimbursement models that look different.

And so they're looking carefully not just about how they squeeze costs but how do they change behaviors.

This is really a behavior change where they begin to think about forcing more standardization on the commodity types of products that are in their medical products categories.

I think our conversations have been really encouraging.

I've been involved in some of those myself.

Again, we've said all along this is a mid-term driver because this is a change in behavior.

But we're really excited about the response.

And we're excited about the buildout of our program, not just the step in interventional cardiology but a little bit of the growth of the platform that we've got in ortho and the movement into wound care.

So, we're really excited about it.

We're getting a very positive response.

But, again, it's, I would say, a little bit more of a mid-term driver as we think about the way this will ramp.

Our next question from Lisa Gill with JPMorgan.

Thanks very much and good morning.

George, can I just start with this quarter and just maybe if we can talk about the revenue growth, revenue growth coming in substantially better than our expectations.

Do you see anything on the specialty side?

Some of your competitors called out Hep C. Or do you think we're seeing the beginning stages of the Affordable Care Act?

Hi, good morning, Lisa.

It's an interesting question.

Let me try the Hep C first.

I would say that the Hep C products did have some impact on revenue, though I would say it's not that meaningful.

And less effect on margin.

So, I wouldn't say it was a major driver of our business.

What we are seeing, I think, first of all, again, the balance of our portfolio of customers is improving.

We're getting great response.

We've seen some important growth in our strategic accounts, meaning I think we're identifying the right customers who really are positioned to compete in a changing environment.

So, I think, in general, when I look at execution, we manage this pretty rigorously.

We're executing on the things that we're supposed to be doing with our customers.

And I just think in general we've seen good performance on a revenue basis across the business.

Specialty, again, you mentioned specifically.

Just a reminder, the two FC drugs are going really primarily through traditional distribution channels, so they are unique drugs, obviously, in many ways.

They address patient populations with very special needs.

But these are oral solids and they're moving through the traditional drug channel rather than through specialty

Our specialty growth has not been about that.

It's been about organic growth, picking up new accounts, and adding to our service package.

And then my second question would just be med-surg Canada.

Jeff called this out specifically as an area -- or you've called that out as an area that didn't meet your expectations.

Can you just go into a little more detail as to what's going on in that market right now?

Is it a reimbursement issue?

How do we think about med-surg in Canada?

I'm going to let Jeff touch on it.

Lisa, I'll take it.

This is my home country (laughter).

We have seen some pressures in the hospital market in Canada.

It's primarily related to reimbursement pressures on the hospitals due to government funding changes.

So there have been generally low utilization and pressures on pricing over the past six to 12 months.

But as George said, we are taking the necessary steps to address those performance shortfalls, both organizationally from a portfolio standpoint and from a cost standpoint.

And we remain very encouraged that given the strength of our Canadian business that over the medium term we'll see that business get back on the right track.

Our next question from Eric Percher with Barclays.

Thank you.

A question on capital allocation.

Appreciate the detail around repurchase and IT investment.

As you think back over the last year with investments in specialty and med-surg, do you think we're seeing a natural balance?

I know you have more cash that you can put to use than just what you're generating.

Where do you think the opportunities are?

Eric, good morning.

We've identified a number of areas that we've been public about that are high priority areas for us.

And obviously we're doing everything we can in every one of those strategic areas to improve our strategic positioning and to be in a position to win.

Where we can deploy capital against them we will.

You know we've done some obviously major work in generics this year.

Specialty's been a target.

Our consumables and physician preference item area has been an area of priority for us.

Obviously, we look at diversifying our customer base.

The home continues to be an area of real interest for us.

Think about, again, the continuum of care.

And then, of course, China's been our main priority in terms of our international expansion because we've seen so much opportunity.

We'll continue to look globally to see whether or not there are opportunities that really enhance our long-term positioning.

Jeff, do you want to add anything to it?

From an external standpoint, with respect to shareholder returns, obviously we remain very committed to our dividend, as demonstrated by our Board's recent decision to increase the dividend by a further 13% heading into this year.

And as we've said consistently for the past several years, we'll look at share repo opportunistically and from a flexible standpoint to look for opportunities to buy back shares and enhance shareholder return, again as we did in 2014 and as we have modeled for 2015, as well.

As you think about specialty, it feels like you've tried to stay away from the lower-margin areas and build the services piece.

Do you feel like there's more to be built there?

Or do the acquisitions you made this year position you to grow organically?

I think there's more opportunity there.

Again, if you think about what's happening in the pharmaceutical side and the R&D side, and the needs, both of these unique patient populations, the physicians who are serving them, and the biopharmaceutical companies, I think there is real opportunity there, so we'll continue to look organically at how we build out our programs.

We've got some really exciting work that we do on the technology side internally.

But if we see something externally that adds to our positioning we're certainly going to be open to it.

Our next question from Charles Rhyee from Cowen and Company.

Thanks, guys.

George, Jeff, just moving back to Medical for a second, we always talk about Canada.

What about on the alternate side?

You talked about the small physician practice needing some work.

Can you talk about, is this an issue of scale?

Is this an area where you think you need to invest more, maybe build more assets here?

Maybe talk about that area.

Good morning, Charles, thanks.

I think when we talk about the small physician office, obviously we started from a small base, so certainly scale has helped.

But I would also say this -- that our physical operational footprint, if you look at the way we're designed over many years, we're really more attuned to larger-type customers.

So we've had to do some repositioning of our facilities and that touch point with those smaller accounts.

It's just a little bit more like a -- almost like a B to C than a B to B business.

So, I think we've had to just do some thinking about how we position effectively, both to touch them in a simple way and to serve them on our platform.

So we've been looking at various ways to enhance that capability and that's the position there.

Generally, going back to the beginning of your question, our Medical business actually is performing well.

If you look at this in a low utilization environment, and you take out the discrete factors that Jeff just described, our core business is doing well.

Our strategic accounts are growing.

We grow our consumables.

We've significantly expanded our footprint on physician preference, AssuraMed, achieved the numbers that we said they would achieve in terms of accretion.

I'm feeling pretty optimistic about the way we position that business and we'll just wrestle through some of the smaller challenges.

That's great.

If I recall, though, when you acquired AssuraMed last year, what, a year and a half ago, that was one of the things you talked about, them bringing you some expertise in small picking and packing that could help your physician business.

Has that not yet translated or is that still your -- are we then closer to it?

It's actually a great observation.

I should have pointed it out.

I think it has been helpful.

But I would also say this -- we've had some real opportunity directly in the home space.

So, as we've looked at this past year, most of our efforts with the AssuraMed or Cardinal at Home -- I managed somehow to bury the lead, as they say, before in defining our new branding -- our Cardinal Health at Home actually has more significant opportunity directly in that business.

And that's really where we've devoted most of our energy.

We'll take our next question from Robert Jones with Goldman Sachs.

Thanks for the questions.

Just a couple on the assumptions around guidance.

One, I thought my understanding here was that there would be more brand to generic conversions in FY15 versus FY14.

So, just trying to understand the assumption a little bit better about less contribution from new generic launches.

Yes, Bob, this is Jeff.

What I said was that the benefit that accrued to us from new generic launches in 2015 we expected to be slightly less than 2014.

Whether the actual amount of branded dollars that goes Generic or not increases or decreases is a different question.

When we look at each launch on a case-by-case basis, and look at whether it's exclusive or not, and the timing, et cetera, the net result in our forecast is a slight decrease in the contribution from new generic launches.

Obviously, like every year, there's a certain amount of estimates and educated guesswork that goes on.

Inevitably, the year turns out a little bit different than we expected.

Thankfully the last couple years turned out more positive than we expected.

So, we'll continue to assess this as the year goes on.

But based on our best information right now, we think the benefit to us is a slight decrease.

The follow-up, just around the assumptions, again, would be around the assumption around slight generic deflation.

I would think your average price per generic would be higher in 2015 relative to 2014, just again, if I think about all the attractive anticipated launches in 2015.

I'm just trying to better understand if the expectation for slight generic deflation is on your total book or is this more a comment on a like-for-like generic basis year over year?

It's like-for-like generic, Bob.

The way we calculate generic deflation is we look at all the generics we had on our book the prior year, and look at their expected prices as a portfolio for the next year.

So it actually does not include generics that launch over the course of the year, it's a like-to-like analysis.

And we'll take our next question from Glen Santangelo, Credit Suisse.

Good morning.

It's actually Jeff Bailin in for Glen.

Thanks for taking the questions.

I know China's been a nice growth driver for you guys, and the Company has employed some pretty rigorous standards looking at other international markets.

But, as you consider the evolving marketplace, and with your competitors currently in both Europe and Brazil, do either of those markets screen incrementally more interesting than in the past right now?

Good morning, Jeff.

This is George speaking.

I would say this.

We have, for many years, actually looked around the international environment to see where there are opportunities for us to bring our value into the system.

And we continue to look at Europe.

Brazil has always been in our sights.

We've mentioned that.

Obviously China's been a priority for us.

We'll continue to evaluate whether or not we think that there's opportunity and value for our shareholders in deploying capital into those markets.

To this date, we've continued to evaluate and we've made decisions based on what we see as the opportunity to create value, sustainable, competitive advantage and value creation for our shareholders.

So we'll continue to look at many markets.

The fact that a competitor makes a move in one market is not our driver of strategy.

Our driver of strategy will be what do we do to compete effectively and create value for all of our shareholders.

I appreciate that color.

Just a follow-up on the sourcing JV with CVS.

I know it's obviously in the early months of that relationship, but anything you can comment on how your conversations with your other customers have proceeded in terms of any that might not buy generics from today perhaps being incrementally more interested in being involved on their generic sourcing with Cardinal?

Jeff, I'll give you a bit of a generalized answer because I have to.

It's a tricky area.

I would say this.

We have substantially, through the joint venture, Red Oak, enhanced our scale.

And ultimately it's about being in the most competitive position possible.

I think the market is probably going through its own changes, various players in the market, as they look at their own ability to compete and compete effectively in this market.

I think this may create some opportunities for us as companies look and see what their own capability looks like and whether or not they need to rethink their own models.

I don't think it will be unusual to expect that those kinds of conversations are going on in this market.

And I think we're extremely well-positioned should our customer base or some of the customer base rethink the way their models work.

Our next question from Ricky Goldwasser, Morgan Stanley.

Hi.

Good morning.

First question, just some clarification on the progression of FY15 guidance.

I know, Jeff, you said that the joint venture will have an impact on 1Q 2015 in terms of the timing of contribution of benefit versus payment.

But just to clarify, do you expect the joint venture to be dilutive to your first fiscal 2015 quarter or will you be able to offset the $25 million payment by the benefit from better sourcing?

Thanks for the question, Ricky.

First of all, I don't expect that we'll expense the full amount of the $25.6 million payment in Q1, as I indicated in the call.

It's a bit of [selleeb].

But we'll begin expensing that on a monthly basis once substantial benefits or material benefits begin to be realized.

I think the more important part of your question, though, is whether we expect net benefits in Q1.

And I would say yes we do.

But I would say not to any meaningful extent.

But I do expect the benefits to slightly outweigh any expense that we will incur in Q1.

Okay.

That's helpful.

And then, secondly, just back to the topic of generic price inflation, you talked in your prepared remarks about net inflation being in low single digits.

Your competitors, as well, are [check].

As opposed to high single digits in the quarter.

I know you also talked about your generic basket and your portfolio.

So, can you just explain to us why would your basket be different versus your competitors', assuming that you're seeing inflation on retail drugs, which I assume you have got like similar share within the retail market as your two other competitors.

Good question, Ricky.

First of all, I don't know exactly how our competitors calculate the generic inflation or deflation.

As I said to Bob earlier on, though, we calculate it based on a like-for-like analysis, drugs that existed last year versus the price of those drugs this year, looking at the entire portfolio weighted for the volume that we have.

Now, again, it's possible they calculate it slightly different.

It's also possible that our mix of business is different.

We tend to have less mail order, for example, than our competitors may.

We may carry slightly different levels of inventory, et cetera.

So, I can't speak for our competitors, but, as I said, I think low single digit accurately describes what we saw during the quarter.

Ricky, I would just add, it would be hard to actually explain a reason that there's really any difference.

This probably has to do with calculation, however one company calculates versus another.

But the market is the market.

So I'm not sure there's really a difference.

And our next question from David Larsen with Leerink partners.

Can you talk about your ability to ship products to large doc offices on hospital campuses versus the smaller doc offices in the community setting, and progress you're making in shipping to alternate sites of care?

Thanks.

Yes, sure, I'll start.

Again, I think our ability to serve in general across the system, David, is very strong.

It's probably the most challenging for us historically when we deal with very, very small practices, just in that the number of SKUs that they might order, the way they order, and the pick-pack operations weren't quite as designed for those.

But our ability to serve across the channel is really high.

We got recognized again this year by Gartner as the number one supply chain company in healthcare.

This is an area of real strength and fluency for us across the board.

But there's some little gaps where I think we need to do some things differently or better and we'll continue to do that.

Okay.

So, when you approach an IDN you can ship products to all their doc offices across all their sites of care, pretty much.

Yes, when we go to an IDN, we're able to make a very comprehensive offer and that's important for our strategy.

Thanks a lot.

Our next question from John Krieger with William Blair.

Hi, thanks very much.

A follow-up question on Medical.

Can you talk about your preferred product pipeline?

I think you said you launched about 500 in FY14.

What would your expectation be for 2015?

We have not at this point shared publicly where we are in terms of our internal target, but I don't think it would be unrealistic to expect a similar number.

We're aggressively going after this.

So, yes, I would say it wouldn't be surprising if we were in the same kind of range.

Great.

Thanks.

And, Jeff, I believe you mentioned, as you talked about the sourcing venture, that there could be an added milestone starting in 2016.

Can you just talk a bit more about that?

What metrics would trigger that?

Should we assume that that's an annual payment or more of a quarterly true-up?

I don't want to get into a lot of detail there.

But first of all, the fixed payment, the $1 billion in total, basically stays intact versus what we discussed earlier.

But as we went through the formation of the joint venture, looked at the long-term nature of the deal, looked at the desire to create common incentives going forward, we did agree that, again, achieving certain milestones -- and I won't go into specifically what those are -- but should we achieve certain milestones there would be additional payments that would be made on any quarterly basis after achieving those milestones.

That's probably all the detail I want to get into at this point, John.

And our next question from Greg Bolan with Sterne Agee.

Thanks for taking the questions.

Just on the Medical segment operating margin, I understand Canada was one source of the weakness, the other maybe a little bit weaker performance on the ambulatory side.

But just as we think about FY15, and we think about the margins that you guys put up this quarter, it sounds like you guys possibly have done some restructuring in Canada, made some pretty decent changes.

What, as we think about the trajectory of Medical segment operating income should we be thinking about throughout FY15?

Is it just maybe this is a low point and just off of that point maybe an ascending trajectory?

Or is it going to be somewhat spotty?

How should we be thinking about Medical?

Yes, Greg, a good question.

Thank you.

First of all, just to clarify the two biggest negative drivers in Q4 were Canada, as you referenced, and incentive compensation, that the amount that was pushed down to the segment based on overall corporate performance was higher than last year.

George also indicated some disappointment with our performance in the small physicians' office.

But from a quantitative standpoint that was not one of the bigger drivers in the quarter.

Getting to the root of your question, though, going forward we do expect over time to continue to drive margin expansion within the Medical segment, and obviously segment profit growth, as well.

However, that won't necessarily be consistent every quarter.

And in terms of the profile next year, I expect most of the beneficial improvement will be back-loaded towards the second two quarters of the year.

First half of the year will be largely about continuing to invest in our strategic priorities, particularly our physician preference items, to ensure that we're reaching critical mass in those areas.

I expect to begin seeing the fruits of those labors as we get into the second half of the year and beyond.

That's great, thanks.

And then, I'm sorry if I missed this, but just the CapEx guidance for FY15 obviously going higher.

Can you just remind me what's driving that, please?

Yes.

A number of things.

First of all, we're going to continue to invest to improve and expand our information systems within the Pharmaceutical segment.

That's number one.

Number two, we're increasing capacity, both for some of our preferred product manufacturing and for our 3PL capacity and capabilities.

And, fourthly, we're going to continue to invest to expand our geographic presence in China.

Those are some of the major items.

I would generally characterize it, though, as investments in IT and investments in our key strategic priorities, including the ones I just mentioned.

Our next question from George Hill, Deutsche Bank.

Good morning, Jeff and George.

Thanks for taking the question.

And I'll say, Jeff, I look forward to grabbing a blue or a Canadian at some point during the farewell tour (laughter).

Just maybe I missed this point already, but I actually thought your FY15 was going to be a better generics launch year than your FY14, given some of the drugs that have been pushed out and what the calendar looks like for your FY15.

Is there any more color you can give us on why FY15 isn't an improvement from the launch calendar perspective, or maybe what you're seeing that we're not seeing?

First of all, I would not describe it as a major dropoff.

It's a slight decline in terms of the expected impact.

Obviously it depends on what assumptions you make for some of the larger launches.

For example, the Nexium launch, still a big question mark, right, regarding when and how it's going to get launched.

So, depending on what you assume for that, that can have a fairly material impact on the overall assumptions for the year.

So, it really comes down to our assumptions about each of the individual major launches.

And obviously we could be wrong.

We tend to model these things relatively conservatively.

Okay.

And then maybe just a follow-up -- on the incremental payments that would get made as part of Red Oak, I would imagine that that would assume that you guys are going to deliver earnings performance above and beyond the original agreement if you guys are required to make incremental payments to CVS.

And then I might even ask with that, why renegotiate the deal that way?

I thought part of the deal was that you guys were making the $100 million payment such that you could enjoy some more of the upside.

What led to CVS having the ability to call back some of the upside?

George, I think in general, as we got through the process, and more information, more data and the teams got together, we felt it was appropriate to make a number of adaptations.

Again, this is a long-term deal and we want to make sure that it reflects the right value creation for both parties.

So, we did make some modifications that under certain circumstances and if certain milestones are achieved we'd make some additional payments.

We feel very positive about this and the final terms of our agreement and the strength of the relationship and economics that will flow from it.

I guess I'd leave it at that.

Our next question from Steven Valiquette, UBS.

Thanks, good morning.

Just a few extra quick ones here on the Medical segment.

First, for the AccessClosure deal, which closed in mid May, did that provide a positive EBIT contribution or an EBIT loss in the quarter just from the deal mechanics?

And will that deal still hopefully be slightly accretive in FY15?

Hi, Steve.

It's Jeff.

It was effectively neutral to our Q4, given that we're still just ramping it up and continuing to invest to expand our capabilities there.

And, yes, our assessment of it being slightly accretive in FY15 has not changed.

If anything, we're even more enthusiastic about the potential that portfolio can bring to us in the future.

Yes, this Mynx product line is really one we're very excited about.

And, so, as Jeff said, we're feeling pretty enthusiastic about the way this is unfolding.

Okay.

One other quick one, just on Red Oak, even though the party's just getting started there.

Can you remind us again of the just feasibility of other partners potentially joining into that JV?

We've seen with some of the others ones in the industry that other parties have come on later which have enhanced those.

I'm just curious, again, let's say, feasibility of that happening for Red Oak.

Thanks.

Steve, we obviously, we have always the opportunity to expand our customer base.

Bringing people into the venture itself is a different story.

Today, our joint venture is strictly between CVS Caremark and Cardinal Health, and we're thrilled about that relationship.

But we always have the opportunity to, again, take advantage of the scale that we've achieved and serve customers of every kind around the system.

We'll take our next question from Garen Sarafian, Citibank.

Good morning, guys, thanks for taking the questions.

First, I want to follow up on the JV questions.

It sounds like things were fluid in terms of as you looked at the deal, and you guys made some adjustments.

But I'm just wondering, does it continue to be a fluid situation where terms and payments might change one way or the other as you go through this year?

Or is this the final leg as you guys were finalizing the deal?

Thanks for the question, Garen, and good morning.

I think we've, at this point, finalized all the agreements that form the venture.

Obviously, it's a fluid market so we're always as a Company, as we sell products, we respond to market conditions.

But all of the terms that are part of the joint venture agreement are now done and complete.

Red Oak is formed.

It's got leadership and talent and it's negotiating directly with manufacturers today.

Got it.

Great.

And then just a follow-up on this fiscal year.

Just on the distribution of EPS, I know you try to stay away from giving quarterly guidance but there seems to be first quarter some comments that it will be the most challenging through this year.

With Red Oak coming on to the back half of the year, it looks like the slope may be a little bit steeper towards the back end.

But when I look at your historical numbers, the back half really hasn't exceeded about 53%, 54% of your annual earnings.

So, do you expect this year to be higher than that?

Or if you can just give us any quarterly progression that would be really helpful.

Thanks.

Thanks.

I'm not going to get into too much detail because I don't want to get down the slippery slope of providing detailed quarterly guidance.

I will repeat what I said, though, that we do expect Q1 to be the lightest.

And just to clarify what you said, we expect meaningful benefits, net benefits, from the CVS JV to begin to materialize at the end of Q1, not towards the second half of the year as you mentioned.

But, yes, Q1 should be the lightest.

Beyond that, I would say the rest of the quarters, fair amount of consistency.

We do have historical seasonality, which tends to make our Q3 larger than the other quarters.

Over the last couple years, though, that seasonality has continued to reduce as generics have taken up a bigger portion of the portfolio, as less and less of our branded income comes from contingent payments, and as branded price increases have tended to be spread more evenly throughout the year.

That all said, I would expect our Q3 still would be the strongest quarter of the year, although probably less extreme than we might have seen two or three years ago.

We'll take our final question from Robert Willoughby from Bank of America-Merrill Lynch.

George, you had mentioned the possibility of expanding your relationship with CVS with Walgreens gone and the joint venture up and running.

Any updates here in terms of any meaningful relationship expansions?

Good morning, Bob.

Here's what I'd say.

Again, I'll probably have to reiterate what I said earlier.

I think our relationship has probably never been stronger.

We continue to explore ways to create value for one another, and I fully expect that to continue.

So I can't provide any more specifics than that, other than to say that working our way through the incredibly intricate details of getting to this go-live has only strengthened, I think, our relationship, and we feel good about that.

That's probably as much as I can say.

Thank you.

Operator, I think that was our last question.

Yes, this does conclude the question-and-answer session.

Mr. Barrett, at this time I'd like to turn the conference back over to you for additional or closing remarks.

Thanks very much.

Listen, thank you to all for joining us today and giving us a chance to cover what was a really important and I think successful 2014.

We look forward to our FY15 and seeing all of you soon.

Thanks for dialing in.

This does conclude today's conference.

Thank you for your participation.