Cardinal Health Management Discusses Q2 2014 Results - Earnings Call Transcript

Jan.30.14 | About: Cardinal Health (CAH)

Cardinal Health (NYSE:CAH)

Q2 2014 Earnings Call

January 30, 2014 8:30 am ET

Executives

Sally Curley - Senior Vice President of Investor Relations

George S. Barrett - Chairman, Chief Executive Officer and Chairman of Executive Committee

Jeffrey W. Henderson - Chief Financial Officer

Analysts

Zachary William Sopcak - Morgan Stanley, Research Division

Ross Muken - ISI Group Inc., Research Division

Robert P. Jones - Goldman Sachs Group Inc., Research Division

Glen J. Santangelo - Crédit Suisse AG, Research Division

Charles Rhyee - Cowen and Company, LLC, Research Division

Thomas Gallucci - FBR Capital Markets & Co., Research Division

Lisa C. Gill - JP Morgan Chase & Co, Research Division

George Hill - Deutsche Bank AG, Research Division

John Kreger - William Blair & Company L.L.C., Research Division

Gregory T. Bolan - Sterne Agee & Leach Inc., Research Division

Steven Valiquette - UBS Investment Bank, Research Division

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division

David Larsen - Leerink Swann LLC, Research Division

Operator

Good day, and welcome to the Cardinal Health Second Quarter Fiscal 2014 Earnings Conference Call. Today's call is being recorded. At this time, I'd like to turn the conference over to Sally Curley, Senior Vice President, Investor Relations. Please go ahead.

Sally Curley

Thank you, Kerry, and welcome to Cardinal Health's earnings conference call this morning. Today, we will be making forward-looking statements. The matters addressed in the statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected or implied. Please refer to the SEC filings in 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, and information about these measures is included at the end of the slides. I'd also like to take the time this morning to remind you of a few upcoming investment conferences and events. We will be attending one-on-one meetings at the Citigroup Global Healthcare Conference on February 25 and the RBC Global Healthcare Conference on February 26, which are both in New York, and on March 3 at the Cowen Annual Healthcare Conference in Boston. In addition, we will be webcasting our presentations at the Raymond James Institutional Investors Conference on March 4 in Orlando, Florida, and at the Barclays Global Healthcare Conference on March 13 in Miami, Florida. Details for the 2 webcasts and events are or will be posted in the IR section of our website at cardinalhealth.com, so please make sure to visit the site often for updated information. We look forward to seeing you at an upcoming event.

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

George S. Barrett

Thanks, Sally, and good morning to everyone. We had a very strong second quarter operating performance, closing out an excellent first half to our fiscal 2014, so let's get started.

Total revenues for the second quarter were approximately $22 billion. The decline was 12%, as our revenue line no longer included any sales from the Walgreens supply agreement. Net of this, we experienced growth with existing customers and contribution from the business.

We achieved a very solid increase in our non-GAAP operating earnings. In a quarter where we felt the full impact of no longer serving Walgreens, we were able to achieve a 10% increase in non-GAAP operating earnings. Our gross margin rate expanded by 120 basis points to 6% in the quarter from 4.8% last year, and our gross margin dollars increased by 10%. I will note here that we achieved strong margin expansion and operating profit increases in both our Pharmaceutical and Medical segments.

Our second quarter non-GAAP diluted EPS was $0.90, down from $0.93 last year. This decline, however, includes a charge of $0.16 per share related to a tax reserve. We had mentioned this on our first quarter call and said that it could occur as early as second quarter. As you may recall, our first quarter EPS had an $0.18 benefit from the resolution of some historical tax matter. Note that for the first half of our fiscal 2014, non-GAAP EPS stands at $2.00, an increase of 15% versus last year after the puts and takes of those discrete tax adjustments. So based on our year-to-date result and the strength of our operating performance, we are now raising our guidance to a new range of $3.75 to $3.85 for fiscal 2014 non-GAAP EPS.

Before we talk about the segments in more detail, let me take just a few minutes to discuss our joint venture with CVS Caremark, which we announced in December. You may remember that during our last earnings conference call, I talked about some of the changes in our marketplace and noted that we had been evaluating and would continue to evaluate all options to sustain and expand our competitive advantage and to deliver meaningful and lasting values for our customers and our supplier partners and our shareholder. We believe that the CVS Caremark joint venture accomplishes those objectives. We created a purchasing combination of tremendous scale, which we know is critical in generic. It allows us to bring together 2 of the most knowledgeable and experienced generic-sourcing teams in the world. The 50-50 venture is structurally straightforward. We're not changing the service model or our operating platform. The venture is focused solely on global sourcing for the U.S. market. It allows our 2 companies to pursue our independent strategies to serve our own distinct customers as we see fit, and we will accomplish this while maintaining the capital flexibility to continue to invest in other growth and high-return alternatives.

We believe there will be opportunities to work strategically and collaboratively with our generic manufacturer partners to explore new ways to create value. Finally, as we announced in December, our teams are hard at work with the goal of being operational as early as July.

Now, onto the segments. Our Pharmaceutical segment delivered solid profit growth of 9% on a revenue decline of 15%. We were pleased to see this strong volume growth from new and existing customers. Our segment margin expanded by 54 basis points, driven by the strength of both generic and branded programs and by the product and customer mix initiatives that have been an important part of our strategy for the past few years.

I'd like to take a moment to discuss our presence in retail pharmacy. Of course, we were very excited to announce the extension of the CVS service agreement for an additional 3 years through June of 2019. We remain deeply committed to retail pharmacy. Whether that is delivered through a chain drug, a food and drug retailer or one of our thousands of independent pharmacy customers, we believe that pharmacy must and will play a more vital role in the delivery of health care. With this in mind, we will continue to deliver best-in-class products and services to ensure that our pharmacy customers can serve this valuable role in an evolving health care system.

Our Specialty Solutions team continues to deliver robust growth, validating our perspective that working at the intersection of the provider, biopharmaceutical manufacturer and payer will be important for the future. Over these past 3 years, it has been important for us to build scale in specialty distribution in order to enable greater touch points with clinicians. Now that we've achieved critical mass and through building out more services, operational and clinical, to serve these providers, we are beginning to realize some of the benefits. At the same time, our Specialty Solutions team has been gaining momentum with our biopharmaceutical partner. We are increasingly able to offer the innovative clinical capabilities these manufacturers require to serve patients who often have distinct needs and, at the same time, navigate a complex reimbursement environment. And we've created the teams and made the moves to build a best-in-class, patient-centric hub, serving the needs of patients and reinforcing the work of our manufacturer partners.

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

Our Medical segment performance was strong. Revenue was up 13% to $2.8 billion, and segment profit increased 40%. The largest contributor to that growth came from our AssuraMed acquisition, the centerpiece of our strategy to serve patients in the home. Although acute-care utilization remains somewhat soft, we experienced growth in our existing customer base and increased penetration in our targeted strategic accounts [ph]. Our ability to provide new service offerings is extremely important, as our customers take on new configurations and experience different economic and regulatory forces. Building our preferred products portfolio remains a top priority and a high priority for our customer. Our ability to grow here addresses an important pain point for our customers, hospitals and ambulatory, and we are committed to providing a comprehensive solution set, and this goes beyond the products and includes services and analytics. Customer response has been strong, and we will continue to add to our growing portfolio of clinical alternatives to mature medical devices.

Our medical consumables line continues to gain solid traction. Our product launch rate in the first 6 months of fiscal 2014 was considerably higher than we've ever had. We're moving quickly to add high-quality, high-value options for the customer. Looking forward, we believe we can increase our medical consumable penetration in nontraditional medical channels, such as home health and long-term care.

As we look to home health, AssuraMed reported a very solid quarter, again, outperforming our ideal [ph] model. We remain very committed to following the patient to the home. The demographics are inescapable and the cost-effectiveness of keeping patients well cared for in the home is hard to dispute. To help support our strategy of serving patients in the home, during this past quarter, we made 2 tuck-in acquisitions in the urology, incontinence and ostomy care area, and we'll continue to look for opportunities to draw on the strength of this platform.

Turning to China. We had another quarter of very strong growth on both the revenue and profit line. The sales run rate for this business is now approximately $2.5 billion, and we feel very optimistic about its growth.

China is a unique market going through a very rapid evolution. We continue to play out our strategy here of enlarging our geographic footprint, creating new business partnership and bringing our expertise to new opportunities such as direct-to-patient. We finished the quarter with 28 direct-to-patient or DTP specialty pharmacies, as we move toward our goal of at least 50 across the country, an example of an innovative health care solution to delivering high-cost specialty drug to the patient's hand. We also completed the acquisition of a specialty retail pharmacy company during the quarter that, combined with our existing retail pharmacies, gives us national coverage and e-commerce capabilities. We will continue to expand this chronic care work with a focus on very disease-centric patient support models.

Let me conclude by saying that this is a period of extraordinary change for health care and for Cardinal Health. It's uncommon to experience a moment like this, a moment which requires those of us who have the privilege and the responsibility of being in health care, to demonstrate our ability to innovate and to evolve in a way which can move us toward a system which is higher quality and more cost-effective. I thank our people for demonstrating the readiness to step up to that challenge and for their fine performance.

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

Jeffrey W. Henderson

Thanks, George, and hello, everyone. This morning, I'll be reviewing the drivers of second quarter performance and will provide additional detail on the full year, including our decision to raise our fiscal '14 guidance range. You can refer to the slide presentation posted on our website as a guide to this discussion.

Let's start with consolidated results for the quarter. We reported a 10% increase in non-GAAP operating earnings in our fiscal '14 second quarter versus the prior-year period, driven by margin expansion across both of our reporting segments. Our non-GAAP earnings per share of $0.90 outperformed our expectations, but were slightly down compared to the prior-year period. This decline was driven by an anticipated discrete tax charge of $56 million based on proposed assessments of additional tax. This unusual $0.16 per share unfavorable impact was triggered in Q2 and mostly offset the favorable tax settlement gain of $0.18 per share in Q1 of this year. Including this unfavorable impact, Q2 non-GAAP earnings per share grew a robust 14%, a great quarter of growth. Again, to be clear, both the Q1 positive $0.18 tax benefit and this Q2 $0.16 tax charge essentially offset each other and both have been contemplated in our guidance since the beginning of the year. We mentioned this in our Q1 call.

I'll now go through the rest of the income statement in a little bit more detail, starting with revenue. Consolidated sales were down 12% to $22.2 billion, which was better than we expected. The decline was due to the expiration of the Walgreens contract, which was partially offset by sales growth from new and existing customers. Gross margin dollars increased 10% to 6% of revenue, with the rate up a strong 120 basis points versus prior year. This continues our 3.5-year trend of margin expansion.

SG&A expenses rose 10% in Q2, primarily driven by acquisitions, including AssuraMed, as well as increase in incremental incentive compensation accruals related to the company's over-performance. Our core SG&A was essentially flat year-over-year, evidence of our enterprise-wide commitment to controlling costs and improving the efficiency of our operations while continuing to invest in our key strategic priority.

Our consolidated non-GAAP operating margin rate increased 52 basis points to 2.6%. We have now posted operating margins greater than 2% in 4 of the last 5 quarters, and we are making progress towards our longer-term aspiration of consolidated non-GAAP operating margin greater than 3%. You'll notice that our net interest and other expense came in $4 million higher in Q2 than in the prior year's quarter. This was mostly due to the new $1.3 billion of debt we issued in February of last year associated with the AssuraMed acquisition. Non-GAAP tax rate for the quarter was 43.3% versus the prior year's 36.8%. This unusually higher rate was primarily driven by the discrete $56 million tax charge I mentioned earlier. Please note that this amount only affects our tax line and has no impact on operating earnings or the segment results. As I had mentioned previously, we anticipate both a positive tax impact in the first quarter and the Q2 unfavorable impact when we originally provided our FY '14 tax guidance range. I'll speak about update in that range in a moment.

Our diluted weighted average shares outstanding were 346.2 million for the second quarter, which is about 3 million shares higher than last year. Fiscal year-to-date, we repurchased $50 million worth of shares, all in Q1. And at the end of December, we had $1.35 billion remaining on our board-authorized repurchase program. We'll update you on share count assumptions for the full year later in my prepared remarks.

Now, let's discuss the consolidated cash flows in the balance sheet. We generated approximately $40 million in operating cash flow in the quarter. Year-to-date, operating cash flow of almost $1 billion is about where we expect to be given the unwinding of the Walgreens contract. Of note, the net working capital component from that unwind is essentially complete. And as a reminder, there typically is a large degree of operating cash flow variability in sequential quarters.

Moving on, at the end of Q2, we had $2.7 billion in cash in our balance sheet, which includes $446 million held internationally. Our working capital days decreased versus prior year, primarily due to the expiration of the Walgreens contract.

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

Pharma segment revenue came in better than we expected. However, it did post a decrease of almost 15% versus the prior year period to $19.4 billion. This is the first period where we reported a full quarter of revenue loss in Walgreens, which amounts to just over $5 billion. This was partially offset by sales growth from new and existing customers.

Pharma segment profit increased by 9% to $482 million, driven by strong performance from both of our generic programs and branded agreement, including the impact of price inflation. This was partially offset by the expiration of the Walgreens contract. Unlike our first quarter, this quarter reflects the full operating earnings impact of this expiration.

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

With respect to generics, sales and profits from our generics programs exhibited very good year-over-year growth in the quarter. This is a result of the emphasis we have placed on building the strength of our programs over the last several years, the overall robustness of the market and the effect of price inflation. I'll also note that as anticipated, we did see less contribution from new generic launches in this year's quarter versus the prior-year period.

For the second quarter in a row, the generic deflation rate was essentially flat year-on-year. I do want to note that our generic performance this year has included what we believe to be abnormally high inflation on a relatively small basket of products. Because generic pharmaceutical pricing is still difficult to predict, we remain relatively conservative in our forecasting for this segment.

In addition, we saw strong performance under our branded pharma contract, with brand inflation in the low-double digit, which was slightly better than we expected. We also saw a few branded price increases that occurred late in our second quarter, which we had modeled to occur during our Q3. Pharma segment profit margin rate increased by 54 basis points compared to the prior year's Q2.

And moving onto Medical segment performance. Medical revenue growth was up 13% versus last year. Home health, reflecting our AssuraMed acquisition, was the primary driver of revenue growth in the quarter. As a reminder, we will lap this acquisition in our third quarter. And given that it's becoming increasingly integrated into our operation, we will not call it out separately starting in Q4.

We also saw volume growth from our existing customer base, as we continue to focus on strategic hospital network accounts, which tend to utilize more of our products and services to drive efficiency in their supply chain. Our strategic accounts grew 7% for the period.

Medical segment profit grew a robust 40% in Q2, primarily driven by the performance of our home health platform, AssuraMed. As George said, the AssuraMed integration has done very well, and we are on-track to achieve our original estimate of at least $0.18 of non-GAAP EPS accretion for the full year. Other factors positively impacting segment profit included contribution from planned efficiency initiatives and preferred product. Partially offsetting the Medical segment profit growth was a year-over-year increase in incentive compensation, much of which is based on total company performance and allocated to the segment.

Now a quick note on Cardinal Health China, a business which spans both of our reporting segments. Our business in China, again, posted strong double-digit revenue growth for the quarter, up 37%, and we saw solid margin expansion.

Let me pause for a moment to comment on the overall pharma market in China, which has been experiencing some turbulence recently. Based on external estimates, it appears that the market was growing at a rate in the mid- to high-teens in the first half of calendar 2013. Due largely to the impact of some government regulatory actions to improve the integrity of the system, the growth rate dropped to high-single digits in the second half of calendar '13. However, we are starting to see some signs of recovery and forecasts point to a return to mid-teens growth in calendar '14.

Turning to Slide #6, you'll see our consolidated GAAP results for the quarter, which include items that reduced our GAAP results by $0.11 per share compared to non-GAAP. Included is $0.10 of amortization and acquisition-related costs. Also included in this figure are $0.02 for restructuring and employee severance and $0.02 of impairment on loss on disposals of assets. In Q2 of last year, GAAP results were $0.05 lower than non-GAAP results, primarily related to amortization and other acquisition-related costs.

Now, I'll talk briefly about guidance for the current fiscal year. Given the strong operating performance in the first half of the year and our outlook for the next 6 months, we are raising our non-GAAP EPS range to $3.75 to $3.85. We are also updating a few of our underlying corporate assumptions. First, we are increasing our anticipated diluted weighted average shares outstanding to a range of 345 million to 347 million for the year. A few reasons for this. We are forecasting a fair amount of option dilution in the second half of the fiscal year. Also, we are limited in how often we can go to market to buy back shares during the first half of the year. We still plan of repurchasing shares worth at least a couple hundred million dollars in the second half, with exact timing and amount to be determined based on the market and other factors. Given all this, we have incorporated a range of possible share count outcomes in our EPS guidance.

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

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

Lastly, we are revising the full-year expected tax rate range to 35% to 36%. The large discrete items we anticipated for the year have now been booked in the first half. We do expect a higher tax rate in the second half of fiscal '14 compared to the first half.

As we look to the second half, I wanted to point out a few other differences versus the first half of fiscal 2014. First, we had about a full quarter of earnings from Walgreens in Q1.

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

Third, recall that when we announced the CVS JV, we knew there would be some related costs during the second half of fiscal 2014. Finally, Q3 is typically our strongest quarter for brand inflation, and we expect that to happen again this year. However, we did see inflation on a few products in Q2 that we had modeled in Q3. That may skew our usual seasonal earnings pattern in Pharma somewhat. But most importantly, we continue to expect to build on the momentum of our strong business, and particularly our areas of strategic emphasis.

In closing, I would like to thank the Cardinal Health team for a very strong first half. Their tenacity and execution against our strategic priorities continues to pay dividend. I'm looking forward to the second half of fiscal 2014.

With that, let's begin Q&A. Operator, our first question?

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Ricky Goldwasser with Morgan Stanley.

Zachary William Sopcak - Morgan Stanley, Research Division

This is Zack in for Ricky. I wanted to start by asking about generic inflation and your assumptions for the second half. There was news last week that Ranbaxy had an import ban on one of their plants, and just curious on your thoughts on how that might impact generic inflation and if that's considered in your more modest guidance for the second half?

George S. Barrett

Yes, sure. Why don't I take it? I'll touch on, first, the general environment, and then -- and maybe a little bit more specific around Ranbaxy. So let's start with this. We've indicated and you've heard, and Jeff reiterated, that it's been a bit of an unusual stretch in pricing. We've seen price increases on a number of products, and the number is above what we have historically seen. But I'd remind you here that we carry thousands of generic products, and so when we look at this period, fewer than 5% of these products are experiencing meaningful price increases. So just again, recognize that it's a relatively small subset of the generic portfolio. It is difficult, and Jeff said this, to predict, as you look forward. I think just taking the appropriate assumption here that the recent months have been somewhat unusual and that this dynamic moderates going forward. As it relates to the Ranbaxy problems, again, this is a by-product of some work that we've seen with FDA. The FDA certainly increased its capacity to do inspections outside of the U.S. Clearly, for some companies, that has posed a challenge or a spill-in [ph] for the certain facilities. We, as you would imagine, are very careful to make sure that we stay on top of all the global supply dynamics and, in many cases, utilize multiple sources as a result. I would not say that the specific story around Ranbaxy will have any impact on our business as we look to the rest of the year and going forward. So it's -- they're a player in our mix, but one of many, and won't have any impact on us going into the rest of the year.

Zachary William Sopcak - Morgan Stanley, Research Division

Great. And then just on CVS, just curious, as you've talked with current customers, what their early reaction has been now that it's been 6 weeks or so past the announcement. And if there's been any indication of more interest in purchasing generics from Cardinal due to this deal?

George S. Barrett

Sure. So why don't -- again, it's George, I'll take this again. We've actually had great support from our customers. It's been a noisy stretch, as you know, in the last year. And I think given some of that noise in the market, in many ways, it's been reassuring to our customers that we'll always be in the best position to keep them competitive. And so I would say, generally, we've had great support. I would also add that I think making sure that our joint venture was really a 50-50 relationship really told our customers or other customers that no external party would be dictating or influencing our strategy to serve them. So I would say, thus far, we've had really good support from our customers.

Operator

Our next question comes from Ross Muken with ISI.

Ross Muken - ISI Group Inc., Research Division

So I guess, the underlying results in Pharma continue to be better. It's hard to tease out all the components. It seems like, obviously, we talked about inflation. If you had to look at some of the other pieces that have most surprising to you, at least in the last maybe 3 or 6 months of development, obviously, China maybe is not one of them. But what parts would you say, in terms of how the team has executed, have been kind of the biggest standouts for you in terms of some of the said [ph] outperformance?

George S. Barrett

Why don't I start and then maybe I'll turn it to Jeff. So here's -- you know that we have a pretty broad portfolio. We tend to because of size of certain of our business lines talk only about 1 or 2. It's very common that, that's what happens. But reality is we have a lot of business lines. And actually, what's been happening is many of them are going well. It's one of the nice things about having a portfolio, you have some [ph] of these puts and takes. We've been getting some pretty good performance across-the-board. And so I think that, that's really largely what's at work. So as we said, on our Medical business, while utilization has been sort of stopped, our focus on key strategic accounts and on key business lines, on mix has been really helpful to us. Our team's doing great job there. On our Pharmaceutical segment, we're getting growth in specialty. Obviously, we talked about generics and our work there. And so I think it's really sort of a balance issue, but maybe I'll let Jeff jump in and provide a little more color.

Jeffrey W. Henderson

Yes, I agree [ph]. As I said in my remarks, we really had good performance across-the-board in the Pharma segment. I mean, you briefly mentioned China, Ross. And, yes, we had a very good quarter in China. Now, we expected that. We expect very big things from our China operation, and albeit it's still a relatively small contributor to the overall profit of the corporation, we do expect strong growth there, and we very much got it [ph], in spite of the fact that the market was a little turbulent in the quarter. As George said, specialty posted good revenue and profit growth in the quarter. And we're really seeing our specialty team, they've really hit critical mass in terms of distribution size. They'll take advantage of that positioning to offer other services to manufacturers and providers and payers and that's beginning to drive the profit line for them. Interestingly, we saw better-than-expected results in Nuclear as well, and our team there is doing a really good job of responding to a very tough environment. And we've seen some -- a product, in particular, do quite well for that business. So we are seeing some good trends in Nuclear as well. Yes, it was a very encouraging quarter in many respects, that we really were hitting on all cylinders in most of the business within Pharma. Likewise, on the Med side, I highlighted a few things which were really important to us. One is the continued growth and impact of our home health platform and the fact that we tried to identify some external asset that we can bolt on to that, that are very accretive to us. So that was the great sign, in addition to the growth of the underlying business there. And the overall growth of that market, which is growing, looks like somewhere in the 6% to 8% range. And then finally, the 7% growth in strategic accounts is also very important. And these are accounts, by the way, that we've identified within our portfolio as being very large networks of hospitals and ambulatory sites that tend to buy a lot of our product and services because of the complex operations, and we can provide a host of services and products to them that can help them manage those networks. And seeing 7% growth in that portfolio was also very encouraging. So lots of good news to report for the quarter.

Ross Muken - ISI Group Inc., Research Division

And maybe, you guys were able to kind of attack the whole generic sourcing question in a pretty capital-efficient manner, it leaves the balance sheet and your capital deployment capability in a pretty good place. I mean, as you see the tuck-in or midsized M&A environment today, how would you sort of characterize it versus where we were, I don't know, 3 or 6 months ago, just in terms of activity and the breadth of targets right now that are still out there for you to analyze?

Jeffrey W. Henderson

I think it's a fairly attractive environment right now for the types of assets we're looking for. Particularly now that we've got a year, for example, of AssuraMed under our belt in terms of integrating that core platform into our business, our ability now, in turn, to find smaller tuck-ins that make sense to bolt-on to that platform, has increased. And as we've been looking for those assets, we're certainly pleased by what we've seen, including the 2 that we did in Q2. In China, we continue to do small tuck-ins. We completed 2 more in the second quarter, one which really gave us additional geographic expansion into a new region and the other was the one that George referenced that added to our specialty pharmacy network and gave us e-commerce capabilities. So we'll continue to pursue those types of acquisitions. I would say though, those tend to be relatively small acquisitions, but very important to building on our strategy in time. I'd say more broadly, we continue to see small to midsized assets that makes sense for the portfolio. And to the extent the price is right and the economics makes sense, we have the platforms to put them on, and we remain encouraged about those possibilities.

Operator

We'll move now to Robert Jones with Goldman Sachs.

Robert P. Jones - Goldman Sachs Group Inc., Research Division

I just wanted to go back to -- on the profit side on the Pharma business. It clearly feels like we're living in a pretty robust inflation environment on both the branded and generic side. I guess, just bigger picture, that trend would obviously seem counter to what we're seeing the push to be in overall health care today around savings. I guess, if maybe you guys separately, branded and generic, if you could talk a little bit about what do you think is driving this? Is it really more structural? Is it more circumstantial? And then, I guess, more importantly, how sustainable do you think it is in both of those areas?

George S. Barrett

Bob, it's a really good question and a hard one to answer. This is George. I'll start. But let me just offer this as a starting point in Pharma, which is sort of maybe something we forget often. In the big picture, in the United States, our Pharma spend is the smallest part of our challenge, when all said and done. By the way, that doesn't mean any individual who's got a very expensive drug that they're -- they've been prescribed doesn't have challenges, but we're talking about a small percent of our overall spend. And actually, as you know, systemically, the growth of Pharmaceutical spend has actually been slowing. So I do think part -- as you know, part of that is sort of the level of generic penetration. So from a big picture standpoint, as a health system, actually our bigger challenges are really in our medical system than in Pharmaceuticals. Now having said that, we do think that there are periods that can be a little bit more unusual. This has been sort of on the generics side probably more noteworthy. It's really difficult to predict what's going to happen, but I do think it's always worth reminding ourselves that when we look at the Pharmaceutical segment, really, what you have is a huge number of products that are generic and highly generic, meaning penetration is extraordinarily high, and then a number of typically more specialty drugs that have unique characteristics. And I think that is a trend that we'll continue to see. And so I think, in a way, I think our model, we feel very strong about the model. We're extremely efficient. We work very well with our manufacturers. I think our fee-for-service kind of system is working and is working efficiently. And so, as I said, sort of in the big picture, I think you'd have to look at Pharmaceutical system as relatively efficient across-the-board. That doesn't mean that individual products wouldn't get some attention for their pricing, and we'll just have to continue to watch for them. But I think, in general, what we've done in our assumption is moderate our expectations as it relates to inflation just a little bit more to the historical norms and we thought that's the more cautious mode [ph].

Robert P. Jones - Goldman Sachs Group Inc., Research Division

Great. And I guess, just George, following up on the cash position, it doesn't seem like, again, there's a ton baked in on buybacks. It doesn't seem like that will a big source of deployment, at least relative to the current outlook. I mean, is there any more insight you can share with us on your priorities without, obviously, getting too specific? Are there things on the table right now that have kept you more cautious on getting more aggressive on the buyback?

George S. Barrett

Yes, so I don't think for us it's a matter of cautious on buyback. I think we've always seen a capital deployment strategy that's very focused on returning long-term value to shareholders. So we've done that through investing in our core activities, in the dividend, in looking for acquisitions that strengthen our long-term competitive positioning, and buyback is as part of the equation. So that will still be the case. In terms of priorities, I'll let Jeff weigh in a little bit on it as well, as it relates to our priorities, again, we talked about strategic areas that we think are very important, and those are going to continue to be areas that we watch carefully. That doesn't mean there's always going to be the right acquisition opportunity there. But we've talked about generic, we've talked about specialty, we've talked about our home health and ambulatory platform, we've talked about medical consumables, we've talked about Preferred product, we've talked about China. So these are all areas for us that we believe are on the right side of where health care is going. We'll continue to invest in those. Jeff, I don't know if you want to add anything to it?

Jeffrey W. Henderson

Yes, just 2 other things, Bob. We remain very committed to a dividend. As you know, we view the dividend payout we have as being an important part of the story, in conjunction with our earnings story, and we're committed to maintaining and growing that dividend over time. And as I indicated at the Investor Day, our target is to remain in the 30% to 35% payout range for our dividend. With regards to repo, the fact that we've done relatively small amounts [indiscernible], as I mentioned $50 million in Q1, really, has nothing to do with a reticence to buy back more shares. It more had to do with timing in the first half of the year. Our inability, for a good chunk of the year, really, to enter the market because of some pending announcements, which have since been announced, by the way.

Operator

The next question comes from Glen Santangelo with Crédit Suisse.

Glen J. Santangelo - Crédit Suisse AG, Research Division

George, I just want to ask you about the CVS JV. I mean, I think you said in your prepared remarks that you're expecting that to sort of begin in earnest maybe on July 1. Could you kind of talk about it? If not much is changing with respect to how you buy generics today, like what has to happen over the next 6 months to prepare for that? Do you have to unwind certain generic manufacturing purchasing contracts? And if you could just elaborate on that a little bit more. And then maybe, Jeff, as we think about the fiscal '15 model, I know you don't want to comment on that today, but is it reasonable for us to start modeling the payment to CVS in fiscal '15 and maybe incorporating some cost of goods sold benefit within our fiscal '15 estimates?

George S. Barrett

So, Glen, I'll take the beginning of your question, then I'll let Jeff jump in with the second part. So actually, it's a really good question because it's a reminder of how many moving parts there are in a product -- in our product line that are thousands of product families with many, many suppliers, different length agreements and different buying models. So it -- I can't go through all the individual details, but I think the answer, Glen, is there are a million of them. And actually, it's sort of the irony, as we talk about, this is a very straightforward design, which I think it is, taking out all the operational complexity, at least logistical complexity, but just simply aligning buying strategies, policies, procedures, existing contracts and commitments, is not a small piece of work. And so we have to do that in a very efficient way. It's already underway, and we feel good about that progress. But it is a lot of moving parts, and I'm really glad that we've got 2 talented teams that know what they're doing.

Jeffrey W. Henderson

Glenn, it's Jeff. On the question about payment, at the risk of confusing a lot of people, let me try to explain how that's going to roll out because it's not -- the actual accounting for the payment is not as straightforward as the actual cash flow. So as you know, we are committed to a payment of $25 million a quarter to CVS starting with the beginning of the joint venture and continuing for a period of 10 years, and that's a fixed $25 million payment each quarter. However, the actual accounting for that payment is more of an amortization over time and reflects accrued interest, et cetera. So the actual amount you'll see, particularly in the early quarters, will be slightly higher than the $25 million payment and, really, that's because of the way the payment gets discounted and accrued interest grows out over time. The second point I'll say is that depending on when all the final documentation gets completed with CVS, if that happens this year, we'll actually start amortizing that payment as early as this year, and we expect that to begin as early as the beginning of Q4. Again, hopefully, I haven't confused everyone too much on that. With regards to your second question regarding benefit, we did say at our Investor Day that we expect the JV to be accretive to us in our fiscal '15. We continue to stand by that, which means that the benefits we would expect from the JV would more than offset the accounting of the payments next year. And as I said, the accounting of those payments next year will be slightly more than $25 million a quarter. So that gives you a rough idea, sort of our minimum expectations for the benefits next year. We also do expect that they will phase in over time. If the JV starts on July 1, we definitely wouldn't expect all the benefits to start on July 1. It'll take a good part of a year for us to really ramp up to what I would describe as the more full run rate.

George S. Barrett

Let me just add again, with all the millions of moving parts we just described, we are really excited about this. I think we really know that the U.S. is the largest generic market in the world. It's a single market, it's got secured and known financing systems, incredibly important to manufacturers. And so I'm really excited about being able to put these 2 teams together to do work in this environment. And we think it's going to create great opportunities for us and for our customers and for our manufacturers, so we're excited about it.

Glen J. Santangelo - Crédit Suisse AG, Research Division

George, maybe if I can just ask one follow-up question on AssuraMed. In your prepared remarks, you seem to suggest that the deal is sort of outperforming your original deal model. I was wondering if you could elaborate like where's the source of upside coming from? And then, Jeff, as sort of we think about the outperformance in the quarter, I think we're all trying to sort of figure out where the incremental benefit's coming from, like how would you stack the potential outperformance of AssuraMed on the current quarter and the decision to raise the guidance for fiscal '14?

George S. Barrett

So, Glen, I'll start. Here's what I would say about -- if you remember, when we acquired AssuraMed, we told you that, essentially, it has 2 components. One is basically a B2B business and one is more of a B2C part of the business. The part that we're seeing more dramatic uptake is in the B2C side. And so we expected that, systemically, this would be an area of growth. We think that their demographics are clear, that more patients will be treated in the home. And then as you also know, hospitals will be penalized for readmissions. And so I do think that we expect sort of systemic growth here. We also believe that we have a certain kind of scale, a tremendous sort of billing capabilities, a very high-touch model and that we're an attractive referral here. So what's happening is we're getting perfect [ph] referrals from physicians, from payers that's driving that business, and I think our high-touch model really worked. So I think that's the part of the business that I would say has been driving it and probably outperforming.

Jeffrey W. Henderson

So Glen, just continuing on that, just going through the various elements of the business. On the Medical side, I would say, as we said, the AssuraMed has outperformed our original view of expectations and it continues to grow very well. But I wouldn't necessarily say it was the biggest surprise in the quarter. We expected it to do well, and it delivered on that. Elsewhere on the Med side, I think the growth of our strategic accounts has been a very positive surprise for us. We've invested a lot in those accounts in terms of products and services, and we expected good things. But I think we've seen some growth that is even above what we would've expected, so that was great to see. On the Pharma side, I would say there were 4 or 5 areas that performed better than we expected in Q2. Generic inflation was better as we alluded to. The core performance of the generics portfolio was better than we expected. Brand inflation was a little bit better than we expected. And both specialty and Nuclear outperformed our expectations in Q2. So I hope you can understand why we're pretty excited about the quarter. We saw a lot of very good results across-the-board. It's probably driven by the environment, granted, but a lot also driven by just the strong performance of our organization.

Operator

We'll now move to Charles Rhyee with Cowen and Company.

Charles Rhyee - Cowen and Company, LLC, Research Division

Maybe just staying with the Medical for a second here, obviously we've talked a lot about AssuraMed, can you talk about how we're doing with Preferred products, and was that a big contributor in the growth in the strategic accounts? And then really, where do we think we're going here in terms of the pipeline of products in terms of sort of what type of technology are we going after at this point?

George S. Barrett

So again, I'll start, Charles. Yes, I would say the preferred product portfolio is going really well. I mentioned that our first 6 months was an extremely high run rate relative to anything we've done historically. Again, with, again, that typically sort of had their waves of product, and we had to sort of map that through the year. We expected good performance, and thankfully, our teams are really executing on that. I think this is really, as I said earlier, it's a pain point for customers -- for our customers. They have enormously high spend in sort of the complexity of their supply -- number of -- of products that they carry, and, essentially, helping them build a formula that's more efficient is really an opportunity for them. So this is sort of that classic win-win situation where we believe that we can move share from manufacturers, whether that's our own product or someone else's. We, because we move share, we capture some of the margin and we can create value for our customers downstream, and that's sort of the key to it. It's going well. I'm not sure it's the sole explanation for why our strategic accounts are doing well. I think that's sort of a combination of things. I think we've identified complex systems who have complex needs. They're no longer, for example, simply a hospital and maybe a clinic. They're now multiple hospitals with multiple clinics and cancer centers and surgery centers and maybe affiliated doctors' offices, and I think they're increasingly looking for companies that have the tools to sort of be a solution provider and help them deal with very changing environment. I think that's been at the heart of it. I think our team has identified those kinds of customers with those distinct needs. And I think that's allowed us to do a better job of serving them. And we're going to work really hard to continue to provide new services and offerings that allow them to compete in a rapidly changing environment. Jeff, anything to add there?

Jeffrey W. Henderson

Yes, I would say Preferred products were a driver of dollar growth in the quarter. And I think what was also very exciting was the continued increase we're seeing of Preferred products in our overall portfolio as a percent of gross margin. As you may recall at our Investor Day, Don Casey indicated that our target was to get the Preferred products to at least mid-40s%, 45% as a percent of gross profit for the segment by fiscal '17. And for reference, he gave a historical number, which was in the mid-30%s. Actually, in our Q2, I would describe that percentage mid- to upper-30%s. So we've already seen a tick up, and we expect to continue that trend over the next couple of years as we achieve our target. So yes, there are a lot of things that are driving the overall net margin expansion in Med. Obviously, the growth of the home health platform, the growth of strategic accounts and Preferred products were all important drivers of that very impressive margin rate increase in the quarter.

Charles Rhyee - Cowen and Company, LLC, Research Division

In terms of the Preferred products, I mean, in terms of the type of products you're doing, I know you're talking about like -- you've talked in the past, in the trauma kit. I don't know, you've kind of touched on it in the past here and there. Any potential to sort of move up the technology ladder, or is that something to think about in the future?

George S. Barrett

Yes. So this really relates, I think, in many ways to the sort of what we think of as the physician preference items. We've started -- if there's a spectrum: at one end being products that are extremely highly clinically differentiated; then the other end, products that tend to be really not clinically differentiated. We've sort of focused on the lower end, and I think that makes sense as we're sort of building presence and building credibility in the market with this program. So trauma was a very smart place for us to start. There's a huge amount of interest from our customers, and we're working there up the Ortho line. Wound management is another area that we've been working on. So we are carefully analyzing every line with this question of where -- how much clinical differentiation exists in a given product line and where does it not exist. And I think that's allowed us to start to build sort of a strategy of moving along that spectrum. And we're still at the sort of early end of that. But I'm very excited about it. I think our customers will see a big opportunity if we can continue to execute.

Operator

We'll move now to Tom Gallucci with FBR Capital Markets.

Thomas Gallucci - FBR Capital Markets & Co., Research Division

I guess, just one set of housekeeping item and then another sort of follow up on some other questions that you've already answered. Just, you mentioned the pull-forward of a little brand and price inflation from what you expected in the March quarter. Can you frame at all what we're talking about there, roughly speaking, Jeff?

Jeffrey W. Henderson

It was probably worth a couple of pennies of earnings shift, Tom.

Thomas Gallucci - FBR Capital Markets & Co., Research Division

Okay. Okay, that's helpful. And then I guess, you mentioned a few different times the better growth of your strategic customers on the med-surg side. And I think, George, a question or 2 ago, you started to get into a little bit of what you're doing there, can you just get a little bit more granular? I'm curious about the types of services that you're starting to offer there incrementally to some of these types of accounts? Is it a matter of -- is there buying physicians and you can also service physicians? Or just the mix of things that you're doing would be helpful.

George S. Barrett

Yes. Sure, Tom. I mean, this is, again, it's a bit of a long story, so I'll try to summarize it. So obviously, we can provide the traditional medical/surgical supplies that we've always been able to do. We also can support them both in their acute-care centers and in their ambulatory centers within a line of products that includes surgical kits. We can do freight management. We can do RFID tagging. We do consulting on operational excellence. We do what we call ValueLink, which is essentially where we actually stage all the materials in our warehouses, so it's a purely, truly just-in-time system. So I think we can tell them, we can serve both your acute-care centers, we can serve your oncology clinic, we can serve your physicians' offices. So it's a combination of lines of business and touch points across what is an increasingly complex system, the entire continuum. And in many cases, we can follow that patient to the home. And so that's the overall picture. And I think the more the system integrates, the more complexity is introduced into it, the more that plays to our ability to say, "I think we can provide some solutions to deal with this complexity."

Thomas Gallucci - FBR Capital Markets & Co., Research Division

Right. And you're clearly gaining business with existing customers. Are you winning new customers of this nature as well, given the breadth of product that you can offer?

George S. Barrett

I would say -- I don't know that there has been a monumental change in market share. I think we're doing a really good job with our key customers. I think we've done some segmentation to know who's likely to be a winner and most likely to be able to draw on the tools that we bring. There's always some movement up and down of customers back and forth. But I don't think there's been huge share swings as much as it's been our ability to drive value for existing customers as they change their configuration. I think we have seen a share of wallet changes though within the hospitals where we may have been servicing the hospital itself, and we were able to win their large ambulatory network as a result of that experience. And those are the customers that are actually winning in the market right now, these large complex IDNs that have both strong acute settings, but also ambulatory settings that are tending to be the hospitals that are winning share in the market and being very successful. And then obviously, those are important customers to win with.

Operator

We'll move now to Lisa Gill with JPMorgan.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

Just a couple of follow-up questions. First, on the drug distribution side of your business, I think, Jeff, you called out in the quarter that you had impact from new customers, as well as expanding relationships. Can you talk about maybe the size of the impact, if any, of new customers in the quarter?

Jeffrey W. Henderson

I would say, they're a relatively modest size. There were no huge changes of customers in the quarter. I would describe them as small to mid-size. But we continue to make good progress, with picking up some new customers and, as I said, our existing customers showed good growth in the quarter. So in both respects, it was very positive.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

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

Jeffrey W. Henderson

I would say both. I mean, it depends on the customer. Fortunately, we have some very strong customers in the market, CVS, for example, which continues to post very good results and obviously, we benefit from that as well. But in addition, we continue to sell customers the opportunities to buy more products from us, including generics, and we continue to have good success in doing that. And will continue to be a big theme of ours as we go out to increase our share of wallet with customers, if not win some new -- small to mid-size customers.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

You've also commented a lot, say, about the hospital network accounts and the ability to build out Preferred products and now there is [ph]. Is there any way to quantify what the white space opportunity is with these accounts, number one? And number two, where are you taking that business from, is that from other smaller distributors, are they self-distributing in the hospital today?

George S. Barrett

So let me start. We probably can't give complete line of sight on the opportunity. I would say that it's really sort of early days. So today, we're just really scratching the surface on the acute-care side, which has been primarily where our Preferred products have been going. What's really interesting is our customers, those 10 customers are beginning to realize that there's real value driver. Because I think, in a sense, Lisa, it's not going to be enough for people to squeeze 1 more basis point out of a procurement. What really is going to matter is changing behavior and consolidating the number of products that you use, being more efficient about that, is a change of behavior that can really be valuable to a system. The other thing I would note is that we basically have had no Preferred product position in the ambulatory care to-date or in the home, very little. And so, I think we see opportunities to expand in the acute-care centers, but also in these other channels where basically we haven't really even touched the opportunity. So we're pretty excited about this, because it really is kind of a sort of change of behavior that has material value to our customers versus just squeezing out 1 more basis point from the supply system. The second part, I think, Jeff. I'll let Jeff.

Jeffrey W. Henderson

A few comments to add there, Lisa. First of all, again, because our focus has been on some of these larger, more complex accounts, those also tend to be the accounts that have been continuing to consolidate, bought, buy [ph] others. And obviously, we benefit as they buy others, whether it'd be smaller hospitals or surgery centers or physician offices and as they continue to get bigger and more complex, both our size and our ability to service them there uniquely grows as well. But from a one point, to I'd state, in some cases, we're doing work that was previously done by the hospital itself. And really, that is a significant goal of ours to help the hospital focus on treating patients and allow us to manage their supply chain in a more comprehensive manner. And when we can do that, that's very much a win-win usually for the hospital and us, and then, I think in a couple of cases where we've picked up some additional ambulatory business that sort of -- was part of a larger hospital, they probably were some smaller players that were servicing those accounts that didn't necessarily have the ability to compete with us on the whole network. So it's -- all 3 of those have been part of the driving force.

George S. Barrett

I'd probably just want to add again, just as a reminder, it is a tough system out there. So the other thing that we tried to do is really focused on efficiency. And you've heard us talk about that over the last year. And so it's both creating the opportunities for those customers and also recognizing that, in this kind of system, we've got to be incredibly efficient and we work really hard at that.

Operator

And we'll move now to George Hill with Deutsche Bank.

George Hill - Deutsche Bank AG, Research Division

I guess, George or Jeff, as we look at the inflationary environment in the branded drug space recognizing that the old spec buying days of 2004 and 2005 are behind us. How should we think about kind of the company's leverage to -- and kind of profit contribution from -- that you're able to capture from this kind of pretty high branded drug inflationary environment? And maybe could you -- can you give us an update on whether we want to think about it on a quarterly or an annual basis, how much of operating earnings in the drug segment is coming from your ability to capture a spread on branded drug price increases?

Jeffrey W. Henderson

Yes. It's less than 20% of our branded gross margin now. And I would say, overall for the segment, it's well under 10% of the gross margin of the segment. So it's not near the significant swing factor that it would have been 5 or 10 years ago. And honestly, generally we're pretty good at predicting what the impact will be for the full year. I think the difficulty we always have, especially, these days, is guessing which quarter it's going to be in. So it does have the ability to swing a quarter fairly materially, and as I said, the swing from Q3 to Q2 probably, was about a $0.02 swing. But over the course of the year, it's a factor, but becoming increasingly less of a factor, and as I said, less than 10% of our gross margin in the segment.

George S. Barrett

And I would also add that particularly these very expensive drugs -- biopharmaceutical companies are very careful about how they do this and manage it pretty carefully. So it's not a giant swing factor for us.

George Hill - Deutsche Bank AG, Research Division

Okay. And then maybe just a quick follow up on the med-surg. Can you talk about the margin expansion -- kind of the core business x the AssuraMed business? So we talked earlier that AssuraMed's outperforming kind of the acquisition model. How is the business x AssuraMed performing from a gross margin perspective?

Jeffrey W. Henderson

Yes, I don't want to break down too much here, because AssuraMed is pretty much a part of our overall Medical segment. But obviously, it was a significant driver for the quarter. I would say, excluding AssuraMed, our revenue growth overall in the Medical segment was in the lower-single digits. And we felt some slight margin expansion on that.

George S. Barrett

And that's primarily mix.

Operator

We'll move now to John Kreger with William Blair.

John Kreger - William Blair & Company L.L.C., Research Division

George, can you give us any observations on health care consumption? Did you see any interesting shifts, either from a third [ph] perspective or the early impact of the ACA?

George S. Barrett

For that, I wish I could answer that one, John. I'm going to try, though. It is been -- and you probably heard this from other companies, really difficult to tease out a discernible trend on overall utilization and consumption. You probably heard some people talk about sort of late year spiking and whether not that might have to do with some benefit design issues around the system. I've heard people speculate that there were some apprehension about whether or not -- the changes in policy of the Affordable Care Act might influence their future access to -- their position. And so we tried to sort of look at all that. But to be really honest, we just can't tease it out. There are so many moving parts, so I don't think I could say there's a discernible trend. What we can say is, we see a procedure utilization. So there are certain things that we can see. We see in-hospital, ambulatory and what I would say is that, that trend -- the softness that we're seeing in acute-care procedures is probably one that we would highlight. But I don't know that I could say, we could identify a particular trend right now, just because there's so much noise in the system and so many moving parts. And I think it's just going to take a while for this to shake out. We've not seen -- I would say any uplift, and I'm sure you've heard, as you follow the insurers, any particular uplift from new patients in the system yet, not at this stage. Just one additional comment on utilization. We always tend to focus on the hospital and physicians' office settings, but, I think it's important to keep in mind that we have another very important channel and that's the home, and we still see that market growing at a rate of 6% to 8%, which is obviously very encouraging and very important going forward.

John Kreger - William Blair & Company L.L.C., Research Division

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

George S. Barrett

Let me touch that. I think there is -- I'll do this carefully. I think there is an interesting evaluation that any company now has to do as it relates to their own scale relative to what's happening systemically. I do think that may raise some interesting opportunities, but I do think that the gap between some of the larger players and the larger purchasers of generics, and smallers -- it might be widening. And so, if I am a smaller player now, I'd probably have to think carefully about what's the most efficient way for me to source my generic products. And I do think that given some of the changes in the market, there's probably a lot of, I would say, probably, a lot of evaluation going on in many offices to try to figure out the most efficient way, given some of the dynamics in the market. So we're hoping that, that represents an opportunity for us, but it's too early to say.

Operator

We'll move to Greg Bolan with Sterne Agee.

Gregory T. Bolan - Sterne Agee & Leach Inc., Research Division

So just going back to Charles' earlier question. George, you had mentioned that if you think about the spectrum: to the left, not really clinically relevant; to the right, very clinically relevant PPIs. And you talked about the fact that Preferred products are contributing about 35 -- I think you said mid- to upper-30% of medical gross profit. So is it safe to say that the driver of that increase has really been to the left, so the lower end PP -- at the lower end consumables? And I guess, as you think about, as you move up the technology scale towards the higher end PPIs, is that what takes you from, say, 35% of gross profit to, say, 45% of gross profit by fiscal '17?

George S. Barrett

Greg, it's a good question. And I think -- I am going to try answer this along 2 dimensions. Well, the first part is, yes, because you asked about whether or not it's primarily on the lower end, the left if we were diagramming it. I think the answer to that is, yes. It's clearly on the more commoditized end today. So think about growth, our growth plans work along 2 dimensions. You might even say 3. Let's say dimension one: Increase penetration with existing accounts, who tend to be acute-care hospital focused from as long as [indiscernible] most procedures are. So that's one dimension. Second dimension would be our new channels. So as those opportunities might arise in surgery centers or ambulatory settings, that's a second dimension. And the third, which is actually really exciting, is moving along that spectrum, would be moving upward and to the right towards products that, actually, when you really examine the data, you discover that are probably not clinically all that referenced. So it's really both going forward, with [indiscernible] physician referenced items. And probably if we look at a time horizon, it sort of the new product adding new dimensions is probably a little bit further out as we go, and that's from the time respect [ph].

Gregory T. Bolan - Sterne Agee & Leach Inc., Research Division

That's helpful. And then -- just real quickly. How would you characterize the commoditization of PPIs? I mean, I'm assuming that's a good guide for you in profitability. Any kind of update on what you're seeing out in the marketplace, George. Just as it relates to PPIs that were once seen as, well, PPIs, but now becoming more, I guess, commoditized? I mean stents kind of come to mind, but any comments there?

George S. Barrett

Yes, certainly not about stents, but about the general direction. Here's what I would say. I think this is not a new discovery. I mean, I think if you look inside a complex health system, they would probably understand that historically, the departments sort of ruled and so what happened was every department has their own preferences, physicians have their own preferences and the system was able to accommodate that. But I think, it's been understood for quite some time that, that probably could be done more efficiently. Here's a noteworthy change. The noteworthy change, is that given some very different environmental forces, the more senior folks in the hospital are more aligned with the fact that something needs to be done about this, and I want to actually say that physicians are on board as well. So I think there's more of an awareness inside that health system with a changing demographic and a changing regulatory environment and changing reimbursement environment, that they need to focus on this area of inefficiency and we're helping them do that. So if that makes sense to you. So it's not just our promoting it, it's hospitals and health systems recognizing that they should take action on it, and I think that's probably a noteworthy change over these last year or 2.

Operator

We'll move to Steven Valiquette with UBS.

Steven Valiquette - UBS Investment Bank, Research Division

So the 54 bps margin expansion in Pharma Distribution was obviously quite strong. I guess, would you say, most of that would you say was tied to the core operational improvement? Or is it possible that the rolloff of the lower-margin Y [ph] contract contributed a major portion of that? How would you characterize each of those without getting too specific? Just trying to get a feel for that.

Jeffrey W. Henderson

It's Jeff. I would say there are 3 significant drivers. The largest one, by far, was the performance of generics, both our core performance and the impact of price inflation. Second, was the rolloff of the WAG, which as you would expect, was lower-margin business than our average business in pharma. And then, I think, third was slightly higher brand inflation than we saw last year in Q2. Those were all 3, I'd say, material drivers, in that order.

Steven Valiquette - UBS Investment Bank, Research Division

Okay. One other quick one. Just I think if I heard you right, you mentioned that because the just reported quarter was so strong, that the historical pattern of the Pharma Distribution results being stronger than March quarter versus the December quarter may not necessarily repeat themselves this time around. But just to clarify, does your comment pertain to the segment operating profit dollars, or the operating margins or both, when doing that sequential comparison?

Jeffrey W. Henderson

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

Operator

We'll move now to Bob Willoughby with Bank of America.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Just a quick one. Will the CVS joint venture have any discernible working capital effect? And also, on the inventory build in the quarter, a bit surprised, I guess, with the Walgreens business gone, were you not taking title to the Walgreens inventory, is that the situation?

Jeffrey W. Henderson

With respect to Walgreens inventory. No, we were taking title to the Walgreens inventory, which is why we recognized the sales on our income statement historically. But I would say, on average, we carried fewer days of inventory for Walgreens than I'd say the pharma segment on average. In part because a good chunk of the Walgreens business was bulk, and we would tend to hold bulk inventory for a relatively short period of time. But had to skew the overall WAG inventory down and make it lower than the overall average. So, that's why you saw an increase because of the mix shift. Bob, I forgot the first part of your question.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

The CVS JV, does it have any balance sheet impact?

Jeffrey W. Henderson

No, it does not. There is -- under the current structure, there is no inventory that flows through the JV. So really the only asset the JV has are the physical building it's in and the people that reside in there. The actual product flows flow through the respective companies.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Okay. And just on China, I think you mentioned $2.5 billion revenue run rate. It's at a margin better than the base business was my understanding. What is the asset base look like for that business now?

Jeffrey W. Henderson

We haven't disclosed this publicly. But I will say that assets in general for businesses in China, particularly in our space, tend to be higher and really referring to working capital. And that's primarily because receivable days with hospitals, just by market convention, tend to be longer in China. They're closer on average to 80 days, and obviously they're much shorter in the U.S. So it is a more working capital-intensive business than our U.S. business. That's also by the way, why, we're looking at other areas to grow into that are much more capital efficient in China. So for example, our direct-to-patient business is a very asset-light business for the most part. So we continue to look for ways to improve our mix and improve our return on capital.

Operator

And we'll take Eric Coldwell with Robert W. Baird.

Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division

Most of my topics have been covered at this point, but just a couple of quick ones. Specialty growth, I know you said it's strong, but I didn't catch the rate. And if you can talk about what classes of trade and maybe what therapeutic classes you're seeing the best trends in? And then just one quick follow-up.

Jeffrey W. Henderson

Yes, the revenue growth for Specialty Solutions was 38% in the second quarter, which obviously continues the good revenue growth trend we've seen over the past couple of years. I would say the bulk of our business is still in the oncology space. We continue to build out into other areas, like rheumatoid arthritis and a few other emerging areas. But the bulk of the growth to-date has been in the oncology space.

Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division

And Jeff, what specific trades to classify [ph] on oncology. Is it community, is it outpatient hospital, where are you seeing the biggest demand?

Jeffrey W. Henderson

Most of that growth is driven by sales through community oncologists. I will say, though, that we have seen a shift, and it's been a fairly well publicized shift over the past year or so of more infusions happening in hospital settings as the community oncologists have generally shrunk over the past year or so. That all said, the community space is still a very important and robust one and really, a very important part of our business and our growth story going forward.

Operator

And our final question comes from David Larsen with Leerink.

David Larsen - Leerink Swann LLC, Research Division

I think, if I heard you correctly, yes, the Walgreens revenue impact was about $5 billion. So I'm just looking on a year-over-year basis, if I back $5 billion out of fiscal 2Q '13, you still beat by, like $1.7 billion in terms of top line growth. And I think you mentioned that the new customers were somewhat modest in size. Can you just talk about the revenue upside, where that came from just generally, please?

Jeffrey W. Henderson

Well, I mean, modest in size is a relative term, right? Just given the nature of pharma, it doesn't take a whole lot of customers to have a pretty significant dollar increase in revenue. And we saw good growth from our existing customers. It was really a combination of both of those. But your point that the revenue upside in pharma was a positive surprise to what a lot of people were expecting, I would agree with you. And, quite frankly, it was better than our plans as well. And I think that's a testament to our sales teams who have done a great job over the past year going out and letting customers know what we have to offer, offering creative solutions, and [indiscernible] pick up share of wallet. So, yes, I think the underlying trend that you pointed out was a very positive one.

David Larsen - Leerink Swann LLC, Research Division

Okay. And then just one more quick one. In terms of your specialty capabilities, has there been any impact from sequestration at all or not really? And then, in terms of your relationship with CVS, could that longer term possibly be a way to sort of expand your specialty business?

George S. Barrett

Yes, I'll take it. I think -- again, restate the first part on the special question?

David Larsen - Leerink Swann LLC, Research Division

Impact from sequestration or not, I imagine not.

George S. Barrett

Yes. It certainly had an impact on customers across the system. I think it had a very, very modest impact on our business. As Jeff mentioned, we've been building scale. We've not been terribly exposed to some of the dynamics that were associated with the sequestration. So certainly as we look around the system, sequestration has been difficult thing for many, many physician groups. But it really did not have much impact on us, just given our model. Again, the second part, I'm sorry, David?

David Larsen - Leerink Swann LLC, Research Division

And long-term, your joint venture with CVS, I imagine there might be ways to sort of grow that relationship?

George S. Barrett

Yes. So here's the way you ought to think about this: I think our joint venture itself is really dedicated to the global procurement of generic products for the U.S. market specifically. Obviously, our relationship with CVS Caremark is deep, and having this joint venture certainly, only strengthens it. So we'll continue to look for opportunities to see how we can collaborate in areas that create value, and if specialty is one of those areas, certainly, we will explore it. But don't think of it as a part of the joint venture. I would think, just to make life simple, think of the joint venture as specifically dedicated to this generic procurement strategy, but certainly we'll explore and continue to explore other ways to create value for one another.

Operator

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

George S. Barrett

So, look, it's been a longer call, but great questions, and we appreciate that. All the good questions. We appreciate your continued interest in Cardinal Health, and I wish all of you the best for the New Year. And we'll see you all soon.

Operator

Once again, ladies and gentlemen, that does conclude today's conference. Thank you for your participation.

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