卡地納健康 (CAH) 2015 Q1 法說會逐字稿

Good day, and welcome to the Cardinal Health first-quarter FY15 earnings conference.

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, ma'am.

Thank you, Lisa, and welcome to Cardinal Health's first-quarter FY15 earnings call.

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

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

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

Information about the 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 webcasting our presentation at the Credit Suisse First Boston conference on November 11 in Phoenix.

And in addition we will be hosting one-on-one meetings at the Bank of America One-On-One conference in Chicago on December 11.

Today's press release and details for webcast events will be posted on the IR section of the website at CardinalHealth.com.

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

We hope to see many of 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, everyone.

Our FY15 is off to a really good start.

Our Organization performed well across the board, and I'm proud of the work our people have done in positioning the Organization to anticipate and address the evolving needs of a fast-changing market.

During Q1, we saw growth in both pharmaceutical and medical segment profits, our gross margin rate expanded by over 40 basis points to 5.6%, and we returned nearly $500 million in cash to our shareholders in the form of dividends and share repurchases.

Total revenues for the quarter were $24.1 billion, a decline of 2% versus last year's first quarter.

This is the last quarter in which we will be comparing to a prior year's period which included sales to Walgreens.

The decline from the Walgreens contract expiration was largely offset by sales growth from both new and existing customers.

Our first-quarter non-GAAP diluted EPS was $1, down from last year's $1.10, which included an $0.18 benefit related to tax settlements.

Back in August, as we began our FY15, we provided a non-GAAP EPS guidance range of $4.10 to $4.30.

We are reaffirming that guidance today.

I will note, however, that while we still expect the contribution to profit to be more back-half weighted, the strong start to the year is certainly an encouraging sign.

I'll provide a very quick overview of our first quarter, which Jeff will cover in greater detail during his remarks.

I'd like to devote the rest of my time this morning to covering our progress on our strategic priorities.

Our pharmaceutical segment reported revenues of $21.2 billion, down 3%.

Revenue growth from both new and existing customers partially offset the Walgreens effect, as I noted earlier.

Our pharma segment margins continue to expand.

Pharmaceutical distribution had an excellent beginning to the year.

We continue to outgrow all markets, with the exception of chain drug, where, of course, Walgreens affected the numbers.

And I'm happy to say this is the last quarter where we will feel the Walgreens quarterly headwind.

Our pharma teams continue to demonstrate a deep understanding of market dynamics and those tools which can help our customers compete in this extraordinary market.

Investments in analytics, reporting, and dashboarding are giving customers needed visibility into their performance against critical metrics.

Improving performance is essential to network access, and a top priority for pharmacies.

Specialty solutions continues its strong performance, again showing double-digit sales growth in the first quarter.

And our nuclear pharmacy business has made excellent progress after the dramatic market changes of the past few years.

The introduction of Xofigo, a product used to treat metastatic cancers in bone, has been an important introduction for the radiopharmaceutical market, and should increasingly contribute to our nuclear performance.

Our medical segment had a good start to the year.

First-quarter revenues were $2.9 billion, up 5%, and segment profit increased by more than 6%.

This is good news in the context of an environment in which system-wide utilization has remained somewhat subdued.

Cardinal Health at home, the former AssuraMed business, continues to perform well.

We are particularly excited that our direct-to-patient business reported strong double-digit growth.

We continue to see great opportunity here enabled by an expanding product line and an increase in Cardinal Health-branded products for the home.

Overall, our medical segment continues to demonstrate great balance, which is very valuable at a time of enormous and often rapid change.

Just as important, our medical segment continues to innovate and explore new ways to bring value to a system hungry for solutions to new challenges.

I will touch on these as I discuss our strategic priorities.

Finally, in relation to the quarter, I would note that China had an outstanding first quarter, with revenues up by more than 30%, as well as expanding operating margins.

We continue to broaden our footprint, build the direct-to-patient pharmacy business, and offer both distribution and a widening range of services aligned with our biopharma and medical device partners.

As I mentioned earlier in the call, I'd like to devote most of my time today to covering the progress we're making on our strategic priorities.

Over the past few years, we've been intensifying our efforts in these priority areas.

Each of these priorities aligns with the powerful changes occurring around healthcare.

Success in these areas continues to contribute to value for our customers, growth of our Business, and expansion of our margins.

These priorities include: generic pharmaceuticals, solutions in the specialty pharmaceutical arena, growth in our product and service offerings to hospitals and health systems, increasing presence in the ambulatory and post-acute settings, and growth in the Chinese market.

So, let me touch on each of these, one by one.

First, generics: With close to 85% of all prescriptions being filled with a generic pharmaceutical, it has never been more important to be a market leader.

From our perspective, this requires several ingredients.

First, a solid base of customers who recognize the benefit of our model.

Second, significant scale.

And third, the experience and know-how to source products from a complex and global supply network.

On the first, we now serve over 20,000 retail pharmacies, and nearly half of them use Cardinal Health as their primary source for generic drugs.

As it relates to scale and experience, I'm extremely optimistic about the strategic and financial value of Red Oak, our generic sourcing joint venture with CVS health.

As you know, Red Oak Sourcing has been up and operational since early July, and I could not be more excited about the progress to date.

Red Oak will be the largest purchaser of generic drugs for the US market, the world's largest generic market.

The leadership team of Red Oak has worked incredibly hard to design a model which is straightforward, simple, transparent for manufacturers, with a signal point of decision-making and clear working terms.

We've had an encouraging response from manufacturers who appreciate the simplicity of the program and recognize the opportunity to work closely with us.

The group leverages the extensive knowledge of the Cardinal Health and CVS health organizations about the global generics supply system.

Having said this, any of you attending a Red Oak meeting would have difficulty identifying who is a pharma Cardinal Health employee and who came from CVS health.

At this stage, we can say that we fully expect to achieve our goals for the year, although as we've mentioned, because of the transition out of each Company's respective programs, the benefits of Red Oak's new agreements will ramp over time.

Turning to specialty: As a healthcare system, we are at an important inflection point in the application of scientific innovation, which has been incubating over the past two decades.

We are seeing the commercialization of pharmaceutical therapies, which leverage the convergence of the expansion of our understanding in human biology and the explosive access to big data.

The result is a flow of drugs which offer both exciting new treatments for many of the challenging diseases of our time, as well as the promise for cures.

It is in this context that our progress in specialty should be viewed.

Although we typically don't break out our specialty financials, I wanted to just give you a sense of our progress.

We began the repositioning of our specialty organization about four years ago, with a business of approximately $1 billion.

Since that time, our run rate for annual revenue has grown to approximately $5 billion.

Our specialty distribution has shown consistent growth over the past few years.

Further, we acquired Sonexus Health, a patient access and support hub in March of 2014.

Feedback and momentum from customers has been very positive, and the asset fits very well into our overall biopharma offering.

In the new world of managing risk and improving the patient experience around quality, cost and outcomes, we are working with several major oncology practices on deploying new tools, like our Pathway product, to help them operate in this new environment.

We continue to advance our position and our support of community oncologists and specialists.

Turning to health systems and hospital solutions: As healthcare goes through rapid changes, we continue to focus on providing scaled solutions for our acute care customers that enable them to deliver great patient care more cost effectively.

First, our position preference item: We believe that there is an opportunity to help our acute care partners by delivering what we refer to as evidence-based equivalents in some medical/surgical categories that represent significant pain points for our customers.

We have made tangible progress in this area, and I'd like to provide more color on this.

We see the trauma space as an area of low clinical differentiation and weak standardization.

And with that in mind, we invested in a business called Emerge Medical last year.

That product line has been increasing.

In the past quarter, we assumed ownership of Emerge Medical to strengthen our position in orthopedics.

This will allow us to launch a full line of trauma products late in this fiscal year and into early FY16, while building credibility with key institutions over the coming months.

The Emerge products were extremely well received at the Orthopedic Trauma Association's annual meeting in Tampa just a few weeks ago.

About six months ago, we completed the acquisition of AccessClosure as a first step into the interventional cardiology area.

AccessClosure has a simplified, standardized, and more forward-looking go-to-market model, all built around the Mynx product line, which gives us great presence and credibility with interventional cardiologists.

Finally, consistent with our program to address physician preference items, we acquired, this past quarter, a company called Innovative Therapies, a negative pressure wound therapy company with a proven technology.

And we are now launching over 250 products in advanced and traditional wound care.

The combination of these acquisitions and the work that we've done these past few years gives us the foundation of a comprehensive program to help our customers deliver care in the most cost-effective way with the highest quality.

Beyond physician preference items, we continue to believe that healthcare has significant efficiency gaps.

With this in mind, we focused on innovations that improve the efficiency of the overall supply chain.

We've made several investments over the past 12 months to create new growth platforms.

We invested in an RFID technology called WaveMark, an inventory management solution to help both suppliers and customers optimize their supply chain, and reduce inventory and labor cost.

An example is an application targeted to tracking and tracing inventory flowing through a large customer's cath lab.

We have launched this and several other initiatives under our umbrella of the Cardinal Health Logistic Solutions.

Our customers have responded well, as evidenced by the progress in this quarter.

As we move to alternate sites of care, like ambulatory and post-acute settings, you've heard us talk consistently about the importance of being able to serve patients across the continuum of care.

We have a system in the US that was built to treat acute illness, but a population increasingly suffering from multiple chronic illnesses.

This requires a rethinking of the way and the place in which we deliver care.

We've made important moves to address these channels.

First, our ambulatory surgery centers have a market-leading position with increasing connectivity to our IDN customers, and have grown solidly in the last few years.

And we continue to take actions to more cost effectively provide products and services to smaller physician practices.

Our acquisition of AssuraMed, now called Cardinal Health at Home with a commitment to address the growing number of Americans who need care in the home.

The acquisition has gone extremely well, and our direct-to-patient business continues to grow at double-digit rates.

Just a few comments about our progress in China: When we entered China in 2010 with the acquisition of Yong Yu, the business was a pharmaceutical-centric national distribution business providing basic import, 3PO, and warehousing functions with a fairly limited geographic presence.

Since then, we have made substantial progress in China, growing the business from approximately $1 billion in revenue in FY11 to $2.6 billion at FY14.

We have developed a strong local presence in 10 regions, expanded DCs from 7 to 13, and completed seven small tuck-in acquisitions.

We opened our first direct-to-patient specialty pharmacy in China in calendar 2013, identifying a niche we could fill using our unique competencies in compliance and secure supply chain.

Today we operate about 30 of these specialty retail pharmacies.

Expanding beyond pharmaceuticals, we now handle a wide range of products for the Chinese market, including clinical trial material, medical devices and consumables, vaccines, diagnostics, biologics and blood products.

We've added capabilities including industry-leading compliance management, cold-chain logistics, and diagnostics and vaccine management, data analytics capabilities, and hospital, pharmacy and retail channel services.

In summary, our Organization is well aligned around all of our enterprise-wide priorities.

And we are truly excited about the opportunities they represent.

I'd like to make a few quick comments about the ebola situation, as a number of you have asked us about whether there have been any implications for our Business.

Let me start by saying that our Organization responded quickly to the challenges confronting Liberia and other West African nations.

Our donations of products and supplies have been substantial, and our people have demonstrated great generosity.

As it relates to concerns here in the US and the implications for our Business, I would say that we would not expect the demand for safety-related products and supplies to have any material impact on our economics.

We do anticipate some shortages of safety products, particularly those recently specified by the CDC, which as you might expect have experienced a sudden increase in demand.

We will continue to work closely with all customers and manufacturers to help navigate the supply issues.

As it relates to products we produce, such as gloves, we are operating at full capacity.

Before I turn the call over to Jeff, since we last spoke we announced the appointment of Mike Kaufmann to succeed Jeff as the Chief Financial Officer of Cardinal Health.

Mike, Jeff, and I have been working closely to map out the transition.

Although Mike has not yet begun his new role, we wanted to give him a chance today to say a quick hello and introduce himself to those of you who have not yet met him.

Mike?

Thanks, George.

I'm really excited to be moving into the CFO role.

What you may not know about me is that while I've spent most of my 24 years here at Cardinal Health in sales, procurement, and general management, I've also been a division Controller and CFO for our medical and pharmaceutical distribution businesses.

I've also spent over five years in public accounting before I joined Cardinal.

So, in many ways, I'm going back to my roots.

George, Jeff, and I are already working together on the transition, and with Jeff here through August, I'm confident it will be smooth.

I look forward to meeting many of you over the coming months at the various conferences and events.

But for now, I'll turn the call over to Jeff for his final earnings call as CFO.

Good morning, everyone.

Thank you, George and Mike.

I share George's sentiment in welcoming Mike, and look forward to passing him the CFO baton officially in a few weeks.

As you can tell from George's remarks, we're off to a strong start, and making very good progress on the key strategic initiatives that will drive our performance this fiscal year and beyond.

In my prepared remarks, I will first focus on outlining the drivers of the first-quarter financial performance.

I'll then provide some insight into our expectations as we move through the remainder of FY15.

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

Although non-GAAP EPS for the quarter was $1, down 9% versus the prior year, the first quarter of FY14 included an $0.18 favorable impact related to the settlement of federal and state tax matters.

Eliminating the tax settlements from the prior year, non-GAAP EPS grew 9%.

Revenues, at $24.1 billion, exceeded our expectations in the first quarter.

Excluding the impact of the Walgreens contract expiration, the FY15 first-quarter revenue grew a robust 13%.

Gross margin dollars were up 6% for the quarter.

And the gross margin rate expanded 42 basis points versus the first quarter of last year.

Global SG&A increased 6% versus the prior year, driven by increased acquisition-related expenses.

Consolidated non-GAAP operating earnings were up 6% to $566 million.

The non-GAAP operating margin rate increased 18 basis points versus the prior year to 2.35%.

Interest and other expense was essentially flat to last year.

Our non-GAAP tax rate in the quarter was 36.5%.

As I previously mentioned, in Q1 of last fiscal year, the tax rate was unusually low due to the favorable impact of certain settlements.

Including those settlements, the FY14 first-quarter non-GAAP effective tax rate would have been 37.3%, slightly higher than our tax rate in this fiscal year's first quarter.

Our first-quarter diluted average shares outstanding were 340 million, 3.6 million shares favorable to the prior year's quarter.

During the quarter, we repurchased $360 million worth of shares, and I'm confident we'll exceed the $500 million in share repurchase we mentioned in August as part of our FY15 assumptions.

As of the end of Q1, we had almost $1.4 billion of repo authorization remaining under our Board approval.

Moving to consolidated cash flows and the balance sheet, operating cash flow in the quarter was relatively light, but largely just a function of timing, as we saw some shift between quarters.

As a reminder, OCF in Q1 of FY14 was unusually high due to the accelerated nature of the wind down of the Walgreens contract.

At the end of this quarter just ended, we had $2.5 billion in cash on our balance sheet, which includes $447 million held internationally.

Working capital days came in at 8.7 days.

A comparison to prior year isn't really meaningful this quarter, as last year's figures were skewed due to the Walgreens contract roll off.

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

Pharmaceutical segment revenue declined 3% to $21.2 billion.

As we mentioned, the quarter comparison includes two months of impact in Q1 of FY14 related to the conclusion of the Walgreens contract.

Excluding that impact, pharma segment revenues grew 15% year over year, driven by growth in our existing customer base and new customers, as well as strong growth in our pharma segment in China.

In addition to China, pharma revenues reflect increases across our generics, specialty, and nuclear businesses.

Pharma segment profit increased 4% to $451 million with a margin rate up 14 basis points compared to the prior year's Q1.

These solid results are due to growth in new and existing customers, as well as strong performance under our generics programs.

With respect to our generics programs, the net impact of the Red Oak JV was slightly accretive in the quarter, although it's still early in our ramp-up of the benefits we are expecting.

And we did see a slight year-over-year increase in contribution from generic price increases in the quarter.

Overall generic percent inflation was higher than last year's Q1, but reasonably consistent with Q4 of last year.

As a reminder, we calculate generic deflation or inflation based on products that have been in the market for at least a year, and based on weighted average selling price.

And finally, I want to note that the quarter includes benefit from resolution of some long-standing customer issues worth about $20 million.

Let's go now to the medical segment performance.

Revenue for the medical segment increased 5% to $2.9 billion, driven by acquisitions and the net positive impact of customer growth.

Within our strategic hospital accounts, we continue to see organic growth, with those customers increasing almost 4%.

This is an indication that we're focusing on the things that are most important to this customer base.

More broadly, we are seeing that overall utilization has stabilized to some extent, and there are pockets of elevated usage within healthcare.

However, it is not yet at a point where we would describe it as an uptick in overall market utilization.

During the quarter, medical segment profit increased over 6% to $113 million.

This increase is a result of profit growth in Cardinal Health-branded products, as well as growth in services, partially offset by a decline in contribution from national brands.

Our Canadian business continues to operate in a tough market environment, but we are implementing the operational and product mix changes necessary to adapt.

Finally, as George mentioned, we have now entered into three categories we were targeting for Cardinal Health brand physician preference items.

While we are pleased with this progress, we are still in the early stages of this medium-term driver, and expect a gradual ramp during the course of the year.

For now, much of the focus is on launching the products and positioning our Organization for future growth in this area.

I'd also like to make a few comments on our China business, which spans both of our reporting segments.

As we approach the four-year anniversary of the initial Yong Yu acquisition, I am extremely pleased with the progress we have made, much of which George highlighted in his remarks.

China revenues saw strong growth again this quarter, posting a year-over-year increase of 34%, driven by new and existing customers.

We continue to significantly outpace the healthcare market growth in China, while pursuing our strategy of geographic expansion to the relevant population centers and expanding our capabilities to meet the needs of this unique market.

Turning to slide 6, you'll see our consolidated GAAP results for the quarter.

The $0.22 variance to non-GAAP results was primarily driven by amortization and other acquisition-related costs and litigation expenses.

Litigation expenses increased due to a $27-million reserve related to the previously disclosed Florida DEA matter.

Looking at the rest of the fiscal year, we are reaffirming our non-GAAP earnings per share guidance we provided in August of $4.10 to $4.30.

Reflected in this range are a few assumptions, which we think are worth updating on the expectations we had outlined when we spoke to you during our August earnings call.

First, we are incrementally more positive on the consolidated revenue growth for the full year, which we had previously described as up modestly.

This is largely driven by pharma brand sales.

Second, we have reduced our forecast for earnings contribution from new generic launches.

A specific note: Built into our original plan assumptions for our pharma segment was a forecast for a generic Nexium launch in November of this year.

However, given recent developments, we no longer expect any benefit in our FY15 from a generic Nexium launch.

Third, given what we have seen in the first quarter, our expectation for full-year generic pricing has changed from slight deflation to slight inflation.

However, our full-year forecast for the earnings impact from generic price increases remains lower than the amount we realized last year.

Finally, given recent oil price movements, we do forecast some benefit in certain of our commodity costs within the medical segment in the second half of the year versus original expectations.

However, that upside is partially offset by negative foreign exchange movements.

Most of the underlying corporate assumptions shown on slide 9 remain unchanged from our previous comments.

However, I do want to mention a couple of items.

We still expect the full-year tax rate to be between 36% and 37%.

As we've said previously, this will likely fluctuate quarterly due to unique items affecting individual periods.

Also, note that we are increasing our assumption for acquisition-related intangible amortization to approximately $184 million, or $0.35 per share.

This change is due to a few smaller acquisitions that close during the quarter.

It has no impact on our non-GAAP earnings.

So, when you add it all up, and recognizing the fact that we're only one quarter into the year, our full-year guidance range has not changed.

One final comment about the evolution of earnings over the course of the year, a pattern which has not really changed substantially from our original expectations.

We continue to expect the year to be quite back-half loaded from an operating earnings growth standpoint, driven by a few factors.

As I've stated previously, the benefits from the Red Oak sourcing entity will ramp over time.

Further, we'll be investing up front to accelerate the growth of Cardinal Health brand physician preference items over the medium term.

Bottom line: There a number of puts and takes for the year.

However, overall I feel good about our Organization's ability to respond to a rapidly changing environment, and how we are positioned coming into the first quarter.

In closing, I would like to say that after almost 40 earnings calls, more than 150 sell-side events, and 1,700 or so investor meetings, I'm certainly ready to sleep a little more.

As I've said to some of you in person, I've always considered investor relations to be one of the most gratifying parts of my role.

I view investors and analysts as my customers, and I've appreciated the back-and-forth and relationships we've enjoyed over the past decade.

And I take pride that your confidence and investments in Cardinal have been rewarded over the years.

And to all of our Cardinal employees, you'll still see me around through next summer.

I look forward to working with Mike as we transition him into the CFO role, and to continue to work closely with George and my China colleagues until my retirement next August.

This is my last earnings call as your CFO, so let me just say what a privilege it has been to serve you in this role for the past 9.5 years.

We've been through a lot together, and you've created a great company of which we can be very proud.

Thank you all.

So, with that, I'll say goodbye for now.

Operator, let's begin our Q&A.

(Operator Instructions)

Ross Muken, ISI Group.

Good morning, guys.

And Jeff again, congrats.

I was curious if you think the Canadian business was weak as a protest to your leaving the company?

(laughter)

I'm sure that had a big piece to play in it, yes, Ross.

Maybe just, there was a lot of assumption changes seems like on the generic side.

We know about some of the push outs and obviously we've all been tracking inflation.

As you look at the performance in the pharma business, I mean ex wag, obviously the growth was pretty spectacular.

As you break down your thoughts more so on the profit side for the quarter, obviously not much you can give on the number side, but just more anecdotally, where do you feel like you really excelled on margin dollars and where are you hoping for a little bit better performance in the year?

Obviously we know Red Oak is going to come in, but I'm curious just more so on the line items?

Ross, good morning.

Let me just start.

I think part of the driver for us is a focus on key priorities.

And that really influences the mix of our product lines and services.

And so as we look across the business those areas where we are growing I think are higher value areas for our customer base, and as a result they tend to be higher margin businesses for us.

So again I think we are doing very well in generics.

That customer base is expanding, our specialty business continues to grow.

On our medical side again utilization was okay.

Obviously we are still seeing it to be somewhat some what subdued, but I think we're doing really well with our strategic accounts, and then again with key products in those accounts that are really important drivers for us and important value drivers for them.

So I think it's largely about a very clear focus on priorities and mix.

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

If you look at -- I'll start with Pharma.

If you look at each of the different businesses within the pharma business, you've got core pharma distribution, nuclear, specialty, and the China piece that's relevant to pharma, they all outperformed our expectations for the quarter.

I'd say really across the board we are pretty pleased with the results.

But I think you touched on the one area that wasn't a disappointment, but I think we're still not seeing the full potential from yet, and that's the Red Oak JV.

As we've always said there's going to be a ramp up over time.

Q1 was largely about setting up the JV, starting the discussions with the manufacturers, and starting to sign up manufacturers, but as we've always expected the actual benefit that will flow through to us will come over time.

I'd say that's the one piece that was largely missing from Q1, but that was as expected.

Yes, that's important.

That is what we anticipated.

So again, not a disappointment that it didn't happen.

I think that's key is that we know that that flows as the year goes.

On the medical side obviously we're pleased to see segment profit growth for the quarter, particularly in a utilization environment that still really hasn't ticked up yet.

I think the one area that, again this is not a disappointment, just something that we knew was going to happen, we are still investing in our position preference item rollouts.

And it's more of an investment story right now than it is a profit story, but that's expected.

We want to make sure that we're properly positioned and we have the right portfolio products and the right sales force and organization supporting it, et cetera.

So we're going to see those benefits more towards the latter part of this fiscal year and heading into next year.

So again, not a disappointment, just something that really wasn't a significant driver for us in the quarter.

That's helpful.

And just quickly it seems like you picked up the tuck in M&A activity strictly on the medical side.

You've got a differentiated strategy there.

What's the pipeline look like, and do you feel like you're filling in a lot of the holes?

You moved into wound care.

You've got some stuff in ortho now.

What else is left?

I think now it's executing as Jeff said, these are major initiatives for us that we've always described as midterm drivers, Ross, so I think the positioning on orthopedics is really good.

By end of this year we're going to start to see some of that flow through the system.

The move into cardiovascular, interventional cardiology I think was really exciting for us.

It's doing well and that bag will begin to fill.

And then as we think about wound care, that's a really interesting area for us.

And as I mentioned we're talking about 250 launches that are in process.

I think now it's more about rolling it out, executing, and we're really excited about these programs.

Great.

Thanks, George.

Thank you.

Lisa Gill, JPMorgan.

Thanks very much.

And Jeff, just let me say that I wish you well in your retirement and I really enjoyed working with you over the years and the last 40-plus earnings calls.

(laughter)

So my first question really George, just a follow-up on what you're talking about around PPI products and clearly tuck in acquisitions.

But do you see any bigger opportunities in the market?

This is clearly a place that Cardinal's differentiated themselves on the med surge side.

I think I heard you earlier talking about continuing to take action to deliver products to physician offices.

Do you feel like you have what you need in order to deliver to physician offices?

Or do you need to make an acquisition to continue to grow that business?

Good morning, Lisa.

There are two parts to that question.

The first one is really around our PPI program.

And again I think for us we like where we are.

We'll continue always to look for opportunities to accelerate those programs.

So we've got a dual responsibility now.

One is to make sure that we're doing the right strategic things to get the bag positioned to sell with good coverage, and the second part is really about execution and making it happen.

I think we've got a great foundation now, but we'll continue to look at opportunities both organically to drive the program new products and whether or not there may or may not be opportunities externally.

The second part is really about the physician's office and here's what I'd say.

I would say again there's two stories to it.

Part of the physician office business as you know is increasingly affiliating with the IDNs.

And we've had obviously enterprise-wide relationships with many of those IDNs and tend to be stronger there.

We've been less strong in those independent practices, and we continue to look at various ways to strengthen that part of our business.

But I think overall as I look -- if I draw a continuum of our business we feel pretty strong in the continuum of care but will continue to look at ways to strengthen any pockets where we're not quite as strong.

I guess really what I'm looking for is as we think about Cardinal, you've got a lot of cash sitting on your balance sheet, your business is running very well.

Should we expect to see you do a larger acquisition this year?

That's really what I'm looking at.

So I'm trying to figure out different places where you could potentially add to your business.

But really the core of my question is should we expect Cardinal to do something bigger in this fiscal year?

I totally understand the question, Lisa, and I think you know it's a hard one to answer.

I think you should expect Cardinal to deploy its capital efficiently and I hope very smartly.

When we see opportunities externally that we think drive our strategies we are not going to be shy about pursuing them.

But we also see obligation to make sure that we're returning cash to shareholders.

If those opportunities aren't appearing in the right way strategically as it relates to acquisitions then we'll look very carefully at how we deploy capital.

Jeff, any --

An example of that is what happened in the first quarter.

We were building up cash, no significant opportunities were executed during Q1, so we saw an opportunity to use that cash to buy back shares.

And that will be our ongoing approach to it.

Okay, great.

Thank you.

George Hill, Deutsche Bank.

Good morning.

And Jeff, I'll continue with the pats on the back.

Nice work and it's been a pleasure working with you.

Thanks, George.

One thing I would like to revisit is Red Oak.

I'm kind of surprised to hear that it's been accretive this early in the JV.

I guess I'd ask a couple of things.

Could you provide -- I don't know if you can provide any more color on the accretion, but I assume it was accretive net of the payment to CVS?

And then the other comment that, George that you made was that manufacturers appreciate how simple and streamlined the program is.

I guess is there any color that you can give us on how Red Oak might be -- or how you guys perceive Red Oak to be differentiated from any of the other procurement programs?

Thanks for the nice words.

We did not expense any of the payment to Cardinal Health in the first quarter.

That payment from a cash standpoint will flow for the first time in Q2 of this year and we'll begin expensing it on a monthly basis starting in October.

So there was no expense related to that payment in Q1.

So the benefit that we saw largely flow to the bottom line, although I would describe those benefits as relatively minimal at this point.

George, I'll touch on the second one.

Again I'm going to be careful because obviously this is -- the work that we're doing here in Red Oak and the relationships with those manufacturers is quite proprietary and sensitive.

I would just say this, there is a lot of change happening in the system.

That can be very disquieting for people.

We recognized early on that a key to our relationship with manufacturers was to be very, very clear about terms and conditions, about where the decisions were going to be made, about -- there are so many mechanical parts in a generic program, moving parts, and we realized that if we could make that very, very simple that that would be appreciated, and has some value to the manufacturers.

So what I would say without going too far into it is that we've had a huge number of meetings already.

We're getting very good and very positive feedback that people know what we are try to do, they understand it, and I would say people have been really cooperative in working with us and they've expressed some support for the way we've approached this and just the simplicity of the program.

Okay, that's helpful.

And then maybe just a quick follow-up there would be because it seems like if you've looked at the other procurement situations that have taken place in the industry, the ramp that seems to come from these JVs or whatever you want to call them actually winds up being pretty quick.

I would just ask is that your assumption as well, is that Red Oak will ramp pretty quickly and we should -- if we think about by the end of FY15 exiting year we should probably see pretty close to the full annualized benefit?

First and then I'll turn it to Jeff, this is George.

I probably would not comment on anybody else's programs and the speed at which they can achieve value.

It's just not my place.

I think for us I'm incredibly proud of the work that's been done in less than a year to get this thing rolling.

You would be astonished at how many moving parts there are.

So great work has been done.

As we've said we do expect to start to see a rich benefit as the year unfolds.

But, Jeff?

George, I think the way you've described it as getting to a more normal run rate by the end of this fiscal year is a fair comment and consistent with what I've said previously.

Now that doesn't mean there won't be incremental benefits that will go forward in FY16 and FY17 and beyond, that definitely will be the case.

But again, characterizing it as reaching a more normal run rate by the end of FY15 I think is fair.

Okay, very helpful.

And Jeff, again, great working with you.

Eric Percher, Barclays.

Strategic priority commentary and I wanted to drill in a little bit on specialty.

Where you talked about moving from $1 billion to $5 billion today, I guess my first question is is the $5 billion really specialty distribution, specialty pharmacy, hub services outside of specialty flowing through the traditional wholesale business?

And then could you talk a bit about where you focused and grown in those different components of the specialty business?

Yes, thanks Eric.

This is George.

It's a little bit of all of the above.

First of all, and again we're talking really about run rates.

It's been encouraging.

I think the good news about the way we've approached this, we've had a pretty methodical approach to our specialty business and most of this is organic, as you know.

I think we've seen each of the little sub segments of our specialty work, whether that's our services to biopharma or distribution as pieces that we need to drive.

Obviously from a revenue standpoint distribution is always going to carry more weight, but I think in general we're pretty encouraged by the progress.

And I think the addition of this patient hub for us while it's very early, I think is really an interesting value driver as it relates to the work that we can do for biopharma companies, and thinking about where they're going, how they're trying to increase those touch points with patients in the system.

I would say generally speaking we're pretty encouraged by what's happened through most of those sub businesses and encouraged by the run rate, much of it organic.

Let me just add to that.

We've always said that achieving success in specialty is going to be dependent on really two factors.

Number one, getting to critical mass in size so that we're relevant to the manufacturers and to the docs and payers.

I think now at a $5 billion run rate we can definitely say we are relevant and then we have a significant share now of the specialty market.

The second piece was as we gained relevance from a size standpoint to start wrapping services, continue to wrap services around that volume, that we can profitize with the manufacturers, et cetera.

And that has also happened as well and was accelerated clearly last January with the purchase of Sonexus, which really helped to round out the toolkit that we have now that we can sell as services to the players in specialty.

I do feel very good about the position that we've achieved over the last couple of years.

So it's felt like some of your positioning was that you didn't need to have a massive footprint but enough to be relevant to manufacturers.

So it sounds like you're feeling that you've reached that and Sonexus and the hub services will be the test case for your ability to have relevance.

And I guess the way I would throw a question on there is how do you think that your assets differentiate from others when manufacturers are deciding which hub to go with?

So it's a great question, Eric.

Here's what I would say.

This is going to be a story of defining services that are very uniquely targeted to a biopharma company and the patient population that they are addressing.

So I would love to tell you that there's a broad answer to that.

It's really a sort of you've seen one you've seen one kind of answer.

We're very targeted.

We actually have an innovation center that all they do is software solutions that address unique needs of some of our customer base, this would be one of those customer bases.

So I don't know if I can do a comparative analysis for you, rather than say our team is very targeted and we certainly have the presence in the market to allow us to do the things that we'd like to do and have those touch points.

So very targeted, very customer centric, practice centric work.

Thank you.

Charles Rhyee, Cowen and Company.

Thanks a lot, and congrats, Jeff.

Good luck with everything going forward.

I actually had a question on nuclear.

This quarter you talked pretty positively about it, I believe you talked positively about it last quarter.

Can you tell us the shape of this business at this point?

If I recall years ago this was something like maybe almost a $2 billion business with something like 20% EBIT margins.

Can you give us a sense of the financial health of this?

And one time you talked about how much you like the -- how does it stand now in relation to all your other priorities that you look for?

Charles, let me just start and then I'll turn it to Jeff to give color on the financial aspects of it.

But here's what I would say, the business has been through I think I described a really significant change over the couple of years.

It's really the market has is gone through the significant change primarily around the utilization.

Our hope is that those changes have essentially worked their way through the system and those are beginning to stabilize.

That's good news for us.

The second element -- so one is that while it's not, you're not seeing a big increase, what we've seen is some stabilizing.

The second element, which is exciting, is the development of new technologies.

And so I used Xofigo just as an example, so we're not just now seeing radiotherapeutics but radiopharmaceuticals and I think there are some opportunities there and we're excited about the potential.

But the market has been through a really major multi-year reset.

Jeff, do you want to give any more color on that?

As a reminder we wrote down the goodwill in this business over a year ago now really because the core business itself was not growing and in fact was shrinking due to some of the issues we've talked about previously.

I think what is given us some renewed optimism about the business really has been some of these new launches, like the Xofigo launch that George referenced.

I'd say we're hopefully optimistic now about the nuclear business and we see some particular product areas where there's potential to grow over time.

But I would not describe the nuclear business as one of our more significant strategic growth drivers going forward.

It's good margin as long as we can continue to grow it.

With these new products it will be a good contributer to the bottom line, and it is margin accretive.

But it probably won't be a business that you'll hear us talk a lot about going forward.

Unless of course some of these areas that George referenced begin to really, really take off, and hopefully they will and we'll let you know when that happens.

Is this related to the biomarkers area?

Is that where we should expect really the growth at this stage -- this sort of business turns around?

Is that the spot that we focus on?

I think that may be an element of what we're describing, but I also think if I were to describe the biggest change again, assuming that the core market is not going to go through massive change, I think to me the biggest development is the potential commercialization, let's say two things.

One is if there's some real breakthroughs on the Alzheimer's side the diagnostic piece becomes much more exciting.

And the second is seeing some products that are actually not diagnostics but are actually therapies.

Those are the things that probably are most present in our minds.

Okay, great.

Thank you.

Robert Jones, Goldman Sachs.

Thanks for the questions and, Jeff, it's been a pleasure.

Wanted to shift over to medical where revenue came in at the high end of your low to mid-single digit range for the year.

Several med tech companies this quarter have been citing improved volumes.

Your largest competitor on the acute side talked about it, one of the best environments they've seen in a while.

Can you maybe just talk about what you're seeing within the marketplace?

I know you commented briefly on it in the prepared remarks, but just curious from a volume standpoint, demand standpoint, how that market has been trending and probably more importantly, how you're contemplating the progression of that market into your FY15 guidance?

Yes, good morning, Bob, thanks.

I'll take this.

We've obviously heard a lot of commentary on different companies, and actually we're hearing quite different things and I think there's a good reason for that.

I would say this, because of our really broad reach we have a relatively good line of sight on the system.

And so what we'd say from a system perspective, utilization is somewhat flat to slight, maybe slightly up, although obviously it's early to subscribe that as a trend overall.

What's noteworthy, and this is why you may be hearing different perspectives, is that it's not one size fits all.

We are seeing some systems and some hospitals showing disproportionate growth in relation to others, and we're seeing some shift in channel.

So some utilization that was, for example, happening in the acute care center is moving to ambulatory centers.

So you have this interesting dynamic which is an overall system number, but some shifting on how and where it's done.

So that partly explains I think why you might hearing things.

We certainly believe over the long haul both true access to healthcare, insurance, and demographics we're going to see a lift.

I would say right now in the short term it's still relatively modest.

I think that's the way I would characterize it.

One other thing worth noting again which is as we listen, for example, to hospital systems make sure we distinguish utilization from now compensation for what was uncompensated care.

So there's a number of moving parts, and I would just encourage everybody to look at all the individual pieces.

That's helpful.

And then I guess just a follow-up on inflation, just to get in how important it is to the business.

I know you guys guided for moderation in generic inflation for FY15, but this quarter it sounds like you said inflation was consistent.

I'm just wondering have you started to see any signs of the actual moderation in the marketplace?

And George, even longer term obviously having sat on the other side of this equation, how prolonged can this inflationary environment go in your view from high level?

Are we talking quarters, are we talking multi year?

Any perspective there would actually be really helpful.

That's a really -- there are two parts to the question and the last part is really hard to answer.

I do think historically we see cycles, that's not unusual.

The question is how long those cycles last, and they depend on a lot of different things.

They depend on how many companies are beginning to resolve technical issues which would allow them back in the markets.

So I think it's a -- Bob, I wish I could give you a good answer on the prognostication on that cycle.

What I can say on the short term is it is pretty much, Jeff you would agree, as we saw for example in the last quarter.

But it was better than what we had originally modeled for Q1, and that's the reason why we've changed our overall assessment for the year, now looking at slight inflation versus a slight deflation that we had talked about back in August.

Great.

And Jeff, enjoy.

Thanks.

Ricky Goldwasser, Morgan Stanley.

Yes, good morning.

And Jeff, I know we'll miss you.

Enjoy your extra sleep time.

And Mike, welcome to the role.

I'm looking forward to working with you more closely beyond just the once a year Dublin Day.

Thank you.

So I have two questions.

The first one is around specialty.

You know its said though in run rate based on our assumptions I think Cardinal now accounts for about 8% of the specialty market.

Can you help us better understand whether this is more concentrated around some specific drug therapies where you have higher share?

And also as we think of new drug launches in the coming years, should we assume that you are now in a position to gain your fair share, i.e.

that 8% across the different drug categories?

Ricky, good morning.

I'll start.

First let me say this.

Again I would say I think we're well-positioned.

We've got significant presence across the business.

I think there are always going to be individual products that have distinct service contracts.

That's probably true for our competitor as well.

I think we're positioned to participate in any part of the specialty area.

One thing that I probably should point out, I didn't get a chance to or I didn't in the last question related to this, is that I do think that we've done a very good job, and this may be a bit of unique positioning for us, of in a world again where there is a lot of issue around risk management, of connecting the payer perspective with about pharma company and the patient.

And I think we've worked pretty carefully at that intersection, and we've had some creative solutions.

But I would say in terms of our overall positioning, we can compete broadly.

I'm not sure there's a single area where we would not play, and certainly hope to take our fair share as the growth in the system continues.

Okay.

And then just two follow-up questions on the numbers.

So Jeff, first of all just to clarify on your guidance regarding inflation.

Do you now expect additional inflation for the remainder of your fiscal year?

Or is the change to your view just based on the calculated inflation that you saw in the September quarter?

It's a little of both, Ricky.

Obviously what's happened already is, it happened so that's baked into the numbers.

I think what happened in Q1 slightly changed our view for the rest of the year.

So it's a little of both.

Okay.

And then you had very nice sequential improvement in distribution operating margins.

Can you just walk us through what contributed to that?

Obviously Red Oak is probably part of it, but you highlighted that Red Oak was relatively modest.

So is there anything else that we should be aware of?

Yes, I think your assessment of Red Oak being relatively modest is an accurate one.

It wasn't a big contributor to sequential margin expansion.

I really would point to the continued strong performance of our generic portfolio overall.

Really independent of Red Oak we continue to grow our sales very, very nicely and really all aspects of our generic program are really hitting on all cylinders which will make the addition of the Red Oak benefit even more exciting to see as we get towards the back half of this year.

I think the continued growth in specialty, nuclear, China all higher-margin areas have improved our mix and that has driven sequential improvement.

And then on the medical side obviously having medical grow this quarter given that it is a higher-margin part of the overall consolidated business, improves our mix as well.

And I think the contribution from preferred products and services, which as you know are our higher-margin elements within medical, also contributes as well.

There's no one thing I'd point to.

It was really the continued growth and success of a lot of the various strategic initiatives that we've been pushing for some time are continuing to drive a shift in product and customer mix that's very favorable to us.

Dave Francis, RBC Capital Markets.

Good morning, Jeff, I'll add my congratulations and hope to see you on another trip down to Vanderbilt sometime soon.

As it relates -- if I go back to George's question earlier on Red Oak and timing of the benefits there, if I could ask a little bit differently.

George, can you walk us a little bit through the process for whether it's simple annual contracts being renegotiated, or what is it in terms of the mechanics of getting the Red Oak piece up and running that allows you to so quickly recognize the benefits of that relationship moving them into the income statement?

So again, I'll try to give you some color without providing answers that would make us uncomfortable given our proprietary relationships with our suppliers.

We started working on this right away, identifying the teams with a clear sense of what we wanted to do.

And so in a way it was just that discipline of putting the teams together, identifying the right talent; we've got tremendously capable people working in this, and then the support of two companies from the back-office perspective.

What we had to do is to really do a full analysis of the market.

Every product line, every supplier, all their capacities, what their pipelines look like.

And so the Red Oak team I think has done all of that, what I would describe as serious analytics work to identify what the opportunities were and how to work with each manufacturer.

And each of those relationships is very distinct.

And so we've worked very hard at making sure that everybody feels like they're in the tent, both big companies and small.

And the Red Oak teams have been having meetings really since early July with all those manufacturers.

So the progress has been really gratifying.

I'm extremely proud of the team, but impressed by what I've seen.

And they are working their tails off.

This is incredibly hard work.

As I sad, I don't think anybody can ever appreciate how many moving parts there are, how many products in sales, how many manufacturers can have multiple products, and so I think just doing this work and doing the analytics to support a simple program was enormous.

So it's hard to give more color than that, but --

I guess my question is more to as you look at both your and CVS's contractual relationships with the manufacturers, it sounds like just structurally speaking things are on a relatively short calendar, such that you are in a position as a combined purchasing entity to restructure those agreements and begin to recognize the benefits more quickly than we might have otherwise thought.

Is that fair to say?

Yes, I think all of us are phasing out, again, we all had obligations and commitments and existing product relationships.

So I think that is all flowing through and I think we can say that as we work through the year we'll look like one sourcing entity and I think the manufacturers will see that, do see us that way and yes, I think we'll see the benefit as it unfolds during the year.

That's helpful.

And as a quick follow-up if I may ask, appreciate the color relative to your expectations on Nexium in the fiscal year.

More broadly speaking as it relates to other generic launches going forward and understanding that Nexium has some specific circumstances surrounding it, are you guys seeing anything differently from either an FDA perspective or a manufacturing perspective that might create a more drawn out process relative to other larger products going through a generic launch process?

Or is Nexium and perhaps some of the others out there that we've seen some delays with, are those just one-off situations?

Is there something more endemic there?

I'm sorry, I think they're largely one-off stories.

I think actually FDA has been talking about increasing their cycle time, speeding up their cycle time.

So I'm not sure we're seeing an endemic situation all.

These tend to be very unique issues that may or may not have legal issues or manufacturing issues, but I think what we would say is these are largely one-off dynamics that we're describing.

David Larsen, Leerink Partners.

Hi.

Excluding Walgreens, the revenue growth I think of 13% year over year looked very good.

Can you maybe just touch on in the pharma division we're hearing about some significant wins you're picking up.

What's going on in the market that's maybe new this year versus last year?

And from the pharma distribution point of view, what are you doing that's different than some of your competitors?

Thanks.

Good morning, Dave.

Again, always a little reluctant do a lot of comparative analysis with our competitors in this call, but here's what I would say.

I think our group has a very clear sense of how we create value.

I think we become increasingly immersed in the needs of our customers, and I think we demonstrate that in a very consistent way.

Again, not a comment on anyone else, I just think our team is doing an extremely good job of I think increasingly being recognized as a company that gets it, understands the dynamics of the system as it's changing, and we seem to be feeling a good momentum in the way that we are interacting with customers and the things that they seek from us.

So it's hard to describe more than that.

Other than that I think our work is really good.

I've watched it very closely, for example when I went to our RBC, our resale business conference, and I watched the interaction that we're having with our customers, the service offerings that we have and their response to that.

Now I would say generally it is quite positive.

So each client is unique and you go the extra mile to basically meet each of those unique needs.

Okay.

And then just one other question.

I think you said you aren't expecting any benefit from Nexium in FY15.

I thought that that was going to originally launch in November of 2014, so to not have any benefit for the next three quarters, that's a fairly conservative approach, right?

I'm not sure I'd consider it conservative.

I guess I would consider it a fairly realistic view from our standpoint of how that's going to play out.

Maybe we'll be wrong, maybe it will go earlier, but again I'm not sure I'd necessarily characterize it as conservative.

Again, I would say just based on the data that we've received to date, the original expectation we had which was a late fall launch, we've taken that out of our assumptions.

And I think probably the more cautious assumption, as Jeff said, is appropriate.

John Kreger, William Blair.

This is actually Robbie Fada in for John today.

Going back to the physician preference items that were discussed at length earlier.

In the past you guys have quantified the percent of revenue and/or earnings that these items comprised.

Are you willing to quantify that today?

Or perhaps what kind of growth rates you've been seeing of late?

Yes, I'll characterize it though not just physician preference items, but all preferred products.

In this latest quarter preferred products made up low 20s in terms of revenue and approaching 39% in terms of percent of gross profit of the medical segment.

Great.

Thanks very much.

And secondly on utilization, we talked a little bit about the medical utilization.

Have you have seen any changes in script consumption this year?

Yes, I think again the data that we're seeing from certainly IMS and others is slightly favorable.

That's probably a little bit of a different story on the drug side in terms of overall utilization as compared to the procedural utilization we're seeing.

Yes.

Steve Valiquette, UBS.

Thanks.

Good morning, George, and Jeff, congrats again on your retirement.

I'm definitely jealous especially on a day like today when there's about 6 or 7 earnings reports we're all dealing with here simultaneously.

(laughter)

I know you already discussed generic inflation a bit at this point obviously, but I guess as we analyze this it does seem now that generic inflation may be moving beyond just product supply shortage situations.

It seems to be happening now in a wider basket of older products.

In fact I think some observers now suggest that maybe generic inflation on a growing number of products on the list price is actually in response to the generic procurement JVs that are being formed in the supply channel as the manufacturers try to offset some of the greater volume discounts.

I guess I'm curious to get your thoughts on those particulars within the overall generic inflation picture?

Thanks.

Okay, good morning, Steve.

It's a fair question.

It's hard to know again, the drivers for generic inflation.

I think again you have to remind yourself that each product is a market, it's own market.

So I think in general what we look at when we look at products is how many players are in a market.

We look at who they are and what their historical patterns are.

And that's I think the best you can do in analyzing it.

Whether or not it's in relation to any consolidation of purchasing, I'm not sure I would necessarily say that's the cause because we've been seeing this kind of inflation now for a relatively extended period.

So there are probably multiple factors in this and so we try to analyze the best we can.

But I would say multiple factors probably.

Does it feel like though it's evolving maybe beyond just product supply shortage situations though?

Is that a safe assumption now that (multiple speakers)?

Yes, it probably is a little bit less event driven today than I might've said one year ago.

Okay.

Great.

Okay, thanks.

Garen Sarafian, Citigroup.

Thanks for taking the questions.

And Jeff, again, congrats on the retirement.

And Mike, we all look forward to working with you.

Wanted to just quickly ask on specialty, to touch back on it.

Thank you for the additional visibility, very much appreciated.

So now that you've reached critical mass, I'm just curious to get your view of what the specialty market growth rate as you define the basket at what rate it's growing, and if you think the next few years that you guys can grow above or at that rate?

Just any sort of visibility would be helpful.

Good morning, Garen.

I don't know if I can actually give you the exact market growth because it's defined so differently.

Clearly what we're seeing as it relates to the new product flow, what's in Phase 3 trials we should expect a continued growth in products that we tend to call specialty products.

And we get started -- we had to start it very early.

In drug development we're looking at every product that's in process.

We work in every one of the niches in specialty, and so what I would say is we expect significant growth in the market.

I can't give an exact number.

We feel pretty confident that we will be able to grow our business consistent with that market.

And again, starting from a smaller base I think the growth rates could be a little bit more accelerated.

But we're feeling very good about our positioning and our ability to compete in any one of these areas as products start to flow through the FDA and into the market.

Do you think there are any more assets that you could consider through M&A that for any reason didn't qualify a few years back?

We've said this before, we continue to look.

All of our strategic priorities are areas where we think we have an opportunity to really add value.

And so we're doing that obviously organically in terms of our own internal work and our internal investment.

But in every one of these areas we'll continue to look for opportunities externally that we think add strategic value and where we can execute.

So we will not take our foot off the gas pedal at looking at those opportunities.

As you know they don't come up every day.

So we'll pursue this dual strategy of driving organic growth, building our capabilities, using our increasing scale, and looking for opportunities externally.

Fair enough, thank you.

Glen Santangelo, Credit Suisse

Thanks and good morning.

George, just wanted to ask about the medical segment.

I think this is an area that has been a focus for you since you became CEO.

And it feels like the Company's been constantly investing in this area.

And I would say I think it is fair to say that the profit margins in this segment are probably not where you'd like them.

And if we go back to Analyst Day you laid out some pretty aggressive assumptions over the next several years in terms of the profit margins in that segment.

So maybe can you opine on where you think we are at this point and what you see as the keys to success to be able to improve the profit margins in that division?

Yes, generally as Jeff mentioned earlier, the profit margins in that segment tend to be higher than the profit margins in our pharma segment.

So A, it is -- the work in our medical business is accretive to our margin rates.

Number two we have been seeing some really encouraging work that's affecting our margins, and it really has to do with the mix of products and services that we provide.

And that is a huge range of products and services.

The areas that we are prioritizing tend to be areas that are actually accretive to our margin rates, and we'll continue to drive those.

So we've talked about the consumables area.

Those are positive to us.

Our growth in the direct-to-patient work that we are doing through Cardinal at Home.

That is beneficial to our margin rate.

Obviously it's the midterm driver that we've talked about in terms of preferred products or physician preference item that is accretive to our margin rates.

So what I would say is these are all for us priorities because they are really needed, they address real pain points in the system, but they are also beneficial to us in terms of our overall mix and profit.

So I'm pretty excited about the work that we're doing and the recent moves that we've made, particularly to build that foundation on the physician preference items is probably a good new story.

I don't know if Jeff wants to add anything?

The goal we gave in Investor Day last December was to achieve at 5.75% operating margin or segment profit margin in medical in FY17.

And I would say we've taken the steps and remain on track to achieve that.

It's not going to be one smooth glide.

There's going to be quarters where we need to invest to accelerate certain areas, and there will always be certain parts of the business that may have a blip, and in this particular quarter Canada was probably our blip from an operating perspective given the market conditions there.

But the general trajectory we are on remains on target for the 5.75% that we set for ourselves.

Okay.

And maybe if I could just follow-up with one question on the pharmaceutical segment.

Jeff, I jumped on the call late but I thought I heard you say within your prepared remarks that that segment benefited from a resolution to some long-standing customer issues of about $20 million.

Was that a one-time event in this quarter?

And could you maybe give a little bit more color and clarity what that was about?

Yes, I would describe it as a -- well, first of all we're always resolving customer issues.

Between us and our customers, disputes, et cetera that need to be resolved over time.

This particular one in Q1 was relatively large at approximately $20 million.

So I described it as one-timeish given the size of it.

And all I'll say about it is for some time now we've had certain issues that ultimately got resolved in the quarter, and a result of that we were able to flow it through to the bottom line.

Operator, I think we have time for one more question, giving we are running up against the timeframe here.

David Toung, Argus Research.

Good morning.

Thanks for getting me in.

My question is about physician preference items.

And I think Jeff or George you talked about investing in it, and you're expecting some better contribution in the back half of year.

Can you just talk a little bit more about these investments and sort of what is it?

Is it on the clinical side, or is it on the marketing side?

I'm also -- if you could just address sort of the customer uptake of these physician preference items?

Or, I'm not sure is it preference items or is it medical devices?

Thank you.

So let me do a little defining.

These physician preference items are medical devices.

It's just that a subset of medical devices, David.

So margin investment is a couple of areas.

Building out the infrastructure and sales force, make sure that we can do what we need to do to get the products in and out of the system.

We have some development clots.

These are not what I'd call research clots in the classic sense, these are more development, making sure that the product line is positioned the way we want.

And so for example, just expanding that Emerge product line requires some cost.

We've got launch activities associated with some of these wound management products.

So I think we're a little bit in that stage, but we're pretty excited about the flow of products.

And I would say the customer response is very positive right now.

And as Jeff said we're looking towards the back half with some greater sense of enthusiasm about the flow.

That's great.

Did you have more to say?

Yes, just one piece I would add since the AccessClosure acquisition has occurred.

I would say this, that the uptake on the product line coming out of AccessClosure has actually been very positive.

Again, it's early on negative pressure wound, ortho is just building, but I would say on that cardio it's already beginning to show some good results.

Great.

And ladies and gentlemen, this does conclude today's question-and-answer session.

I'd like to hand the conference over to George Barrett for any additional or closing remarks.

Thanks to everyone for joining us on what I know is really busy day for all of you, and it's a bit of a long call.

So thanks again for your time and we'll see you all very soon.

Thanks.

Ladies and gentlemen, this does conclude today's conference and we do thank you for your participation.

You may now disconnect.