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Cardinal Health (NYSE:CAH)

Q4 2012 Earnings Call

August 02, 2012 8:00 am ET

Executives

Sally Curley

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

Jeffrey W. Henderson - Chief Financial Officer

Analysts

Glen J. Santangelo - Crédit Suisse AG, Research Division

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

Ricky Goldwasser - Morgan Stanley, Research Division

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

Charles Rhyee - Cowen and Company, LLC, Research Division

George Hill - Citigroup Inc, Research Division

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Ross Muken - ISI Group Inc., Research Division

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

Steven Valiquette - UBS Investment Bank, Research Division

David Larsen - Leerink Swann LLC, Research Division

Lawrence C. Marsh - Barclays Capital, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Cardinal Health, Inc. Fourth Quarter 2012 Earnings Conference Call. [Operator Instructions]

As a reminder, this call may be recorded. I would now like to introduce your host for today's conference, Sally Curley. Ma'am, you may begin.

Sally Curley

Thank you, and welcome to Cardinal Health's fourth quarter fiscal 2012 and our FY '13 guidance conference call.

Today, we will be making forward-looking statements, and matters addressed in these statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected or implied. Please refer to the SEC filings and the forward-looking statements slide at the beginning of the presentation found on the Investor page of our website for a description of those risks and uncertainties. In addition, we will reference non-GAAP financial measures. Information about these measures is included at the end of the slides.

Now I'd like to turn the call over to Mr. George Barrett. George?

George S. Barrett

Thanks, Sally. Good morning, and thanks to all of you for joining us today for our fiscal 2012 fourth quarter and year-end call.

2012 was a year of considerable accomplishments. We achieved virtually all of our financial goals, including revenues, operating profit, earnings per share, margin rate growth and capital efficiency. We made excellent progress in most of our strategic priorities and continued to strengthen our organization through a focus on talent development and supplemented through the addition of some world-class talent. It was also a year which brought us challenges. But through this, we continued to grow and to learn, a necessary ingredient for any organization with bold, long-term aspirations.

The work we've done in fiscal 2012 continued to move us down a path we started on 3 years ago when we spun off CareFusion and set in motion a plan to transform Cardinal Health. Today, we serve a total of over 25,000 retail pharmacies, including chain, food combo and over 7,500 independents, a group that 3 years ago numbered around 4,000.

So we possess a significantly broader network of Positron Emission Tomography facilities, well positioned to grow and benefit from the exciting developments in neuroscience and oncology. Today, our specialty solutions group serves more than 1,700 oncologists through almost 400 oncology practices. We serve in excess of 150 urology practices, 70% of the nation's largest practices, all customers with which we had virtually no presence just a few years ago. We have grown substantially in our ability to serve health care customers in subacute settings and to follow patients through the continuum of care.

Our preferred medical product programs offer significant value for our customers, and this area is growing at a rate significantly in excess of market rates, contributing disproportionately to our margin. We have built an IT platform for our Medical segment, which should allow us to marshal the full capabilities of Cardinal Health portfolio and to create value for our customers, replacing a patchwork of systems, which, in the past, made it difficult to work across business lines. Today, we have a business in China, which is positioned to serve this enormous population and will act as a platform for growth for a number of business lines and as a platform for innovation.

These operational and strategic accomplishments have helped us achieve important financial goals. You may recall that during our December 2010 Investor Day, we laid out some long-term financial objectives. These included achievement of a compound annual non-GAAP EPS growth rate and operational TSR of at least 10% and 11%, respectively. Operational TSR being defined as EPS growth plus dividend yield. We have tracked well ahead of those trajectories in 2011 and 2012 and remain committed to those long-term goals.

Let me offer some observations about the quarter just completed, then I'll provide some color on our expectations for fiscal year 2013. We had a strong fourth quarter. While our revenues were essentially flat, largely an outcome of brand-to-generic conversions, our non-GAAP EPS of $0.73 was up 22% versus last year's fourth quarter.

Our Pharma segment continued its strong performance, with 15% profit growth, as margins continued to expand. Performance under our branded agreement, new customer wins and strong contributions from our base of independent pharmacy customers contributed to profit growth.

Our pharma distribution business held its 21st Annual Retail Business Conference just a few weeks ago. We enjoyed the largest turnout to date, with nearly 7,500 people in attendance representing 4,100 pharmacies. The event provides peer-to-peer networking, buying opportunities, continuing education sessions and programs and technologies to help pharmacists improve patient care, efficiency and profitability.

And lastly, we closed on our acquisition of the regional wholesaler, Dik Drug, giving us the opportunity to serve another 500 independent pharmacies. This acquisition is consistent with our strategy to both build out a retail independent customer base and grow our generics business.

Our Specialty Solutions group posted another quarter of robust revenue growth. The business continues to build important relationships with both providers and payers by offering innovative and value-enhancing programs, as evidenced by increased revenues from both new and existing customers.

Highlights from the quarter included continued traction in the focus areas of oncology and rheumatology. On the provider front specifically, we've been named as the primary health care solutions partner for the Medical Oncology Association of Southern California Purchasing Network. We added several major new GPO accounts and achieved important wins in rheumatology. At the same time, we introduced new technology solutions to enhance payer and physician collaboration to improve the quality and the cost of caring for patients with complex diseases.

Our nuclear performance in the quarter was again characterized by 2 distinct patterns. Demand in the low energy business remained soft, indicative of the industry's macroeconomic and reimbursement trends, while the PET business continued to show growth. As I mentioned last quarter, we've been taking the necessary actions to ensure we're operating as efficiently as possible in our low energy business.

On the other hand, we remain very excited about the future of PET. I would note that PET doses have grown at a compound annual growth rate of 16% since fiscal 2008. We continue to support numerous clinical trials, and we're pleased to note that we have begun producing commercial doses of Amyvid, Eli Lilly's new diagnostic brain imaging agent.

Turning to Medical. Revenue increased 5% to $2.4 billion. Profit increased 2% to $79 million due to strong growth of our preferred products, offset by the expenses related to MBT, our medical business systems transformation. And the year-long commodity headwind moderated, as expected, during the quarter to around $6 million.

Our 2012 stream of Cardinal Health branded product launches, designed to bring quality, value and enhanced clinical benefit to our customers, has been well received and contributed to revenue growth in the fourth quarter. And just a few weeks ago, we announced the launch of our new integrated orthopedic solutions offering that will allow hospitals and surgery centers to access high-quality fair-priced orthopedic products. We believe our unique blend of product and supply chain expertise can bring greater cost effectiveness to our orthopedic customers.

The ambulatory care channel, physicians' offices, surgery centers and other subacute markets, continued to record good growth in the fourth quarter. We will continue to expand our position here as care continues to move into more efficient and specialized settings.

Our Canadian business had a strong fourth quarter, with double-digit revenue growth. The integration of Futuremed, our third quarter 2012 acquisition, continues to go well. We feel confident that Futuremed will complement our existing acute care medical surgical platform and enhance our ability to serve Canadian patients across the health care continuum.

Now I'd like to give you some color on our expectations for fiscal year 2013. Because of the enormous shift in dollars associated with the conversion of over $30 billion of brand-name to generic drugs over the past 9 months and the nonrenewal of the Express Scripts distribution contract, we expect that our 2013 revenue will decline by approximately 7%. However, our margin will continue to expand.

Systemwide, we anticipate continued growth in overall prescriptions as pharmaceutical therapy remains the most cost-effective component of our health system. We do see generic utilization approaching 80%. And while the number and value of generic launches is likely to be lower in fiscal year 2013 than it was in fiscal year 2012 and therefore, the uplift from generics less pronounced, we do see our generic business continuing to grow, driven by overall utilization, improved customer and product mix and program strength.

Specialty pharmaceuticals will continue to be a valuable part of providers' set of treatment options and a growth driver for the industry and for Cardinal Health. We expect to continue our solid top line growth in this area. And while our Specialty Solutions bottom line growth will be slowed somewhat in fiscal 2013 by the business loss we mentioned last quarter, the data supporting our momentum is unambiguous.

We expect our Medical segment profit to grow at a double-digit rate in fiscal year 2013. We have made the major infrastructure investments, and we have the talent and the portfolio to create value for our provider customers and our medical device partners.

We no longer expect to see commodity costs as a headwind for the year. We expect to reap some of the benefits from our Medical Business Transformation to improve margins and lower inventories as we resolve some of the short-term disruptions associated with the installation and the corresponding change management processes.

We've also grown out our Medical segment clinical capabilities critical for the implementation of our preferred product strategies. As we put all the pieces together for fiscal 2013 and with new clarity on the Express Scripts decision, we are providing a fiscal non-GAAP EPS guidance range of $3.35 to $3.50. We enter 2013 with a strong position, with a scale and reach to help shape our market, with deep health care experience and insight and with a commitment to long-term shareholder value creation.

Before I turn the call over to Jeff, it would seem strange to provide a year-end recap without making just a few comments about the Supreme Court's landmark ruling on the Affordable Care Act. We have operated under the assumption that all or part of the Affordable Care Act will be upheld, but also with a strong belief that even had it not been that health care will go through and is already going through some significant changes.

The realities of demographics and our nation's economic situation demand it. More Americans need to come into the system through the front door, so to speak, not being dependent on emergency rooms as primary care. And we know that our system needs to be more highly coordinated and efficient. It needs to be safer, and will need to incentivize the right outcomes rather than activity. And consumers will play a greater role in their own wellness and their own health care consumption.

And this has implications for Cardinal Health. We will continue to focus on productivity to efficiently support the additional patients in the system and deal with the corresponding pressures to reduce health care costs. We'll use our scale, our broad reach across the system and our portfolio of services and products to help bring coordination and efficiency. We will continue to innovate around new ways we can help all of our partners, both upstream and downstream, to provide high-quality care in the most cost-effective way.

As we look forward, these are the things around which we will mobilize.

And finally, I would also like to thank all of our employees for their contributions this year. Your dedication to our customers is what will continue to drive Cardinal Health's success.

With that, I'll turn the call over to Jeff to provide more details on the quarter, the full year and on guidance for fiscal 2013. Jeff?

Jeffrey W. Henderson

Thanks, George. Good morning, everyone. It's great to be reporting a strong fourth quarter and a conclusion to a very successful fiscal year.

Let me begin by highlighting key financial trends and drivers of our fourth quarter and full year performance. Then I'll provide additional detail on our fiscal '13 guidance, including some of our key expectations and underlying assumptions.

Starting on Slide 5. During the quarter, our non-GAAP EPS growth was driven by 13% non-GAAP operating earnings growth, lower share count and a more favorable tax rate versus 2011. Interest and other expense came in $5 million unfavorable compared to last year, largely driven by changes in the value of our deferred compensation plan.

Our non-GAAP tax rate for the quarter was 36%, which is lower than the prior year quarter, but largely consistent with our 2012 third quarter and our expectations. The year-over-year variability was driven by a slightly lower state tax rate and net favorable discrete items versus last year.

The 349 million diluted average shares outstanding during the fourth quarter compares to 355 million in the prior year's quarter. The fiscal '12 share count reflects $100 million of share buybacks in Q4 and brings our share repurchase to a total of $450 million for the year. I should also note that thus far, in fiscal '13, we purchased another $100 million of shares, bringing the authorization remaining under our existing board approval to $200 million.

Before shifting to a discussion of segment results, let me comment on a few items from our consolidated cash flows and the balance sheet. We ended Q4 with approximately $2.3 billion in cash, of which about $380 million is held overseas. This cash balance does not include our investments in health and maturity fixed income securities, which totaled approximately $70 million at quarter end. For fiscal 2012, our operating cash flow figure was approximately $1.2 billion.

Cash flow in the fourth quarter was dampened somewhat by a tax deposit of $100 million we made with the IRS during the period. Our working capital days were higher at quarter end versus the prior year due mostly to inventory increases related to onboarding a new pharmaceutical customer, as well as a temporary increase in receivables related to our Medical Business Transformation implementation.

Now let's move to segment performance, starting with Pharma. I'll be referring to Slides 6 and 7. Revenue in the Pharma segment decreased 0.5% to $24.3 billion for Q4 due to the continued brand-to-generic conversion. This decrease was anticipated and was partially offset by increased revenue from new customers.

We again experienced strong growth in our generic programs, up 23%, and our Specialty Solutions business continues to add new distribution customers, growing revenue this quarter 79%. Pharma segment profit increased by approximately 15% to $354 million in the quarter, driven by the overall strong performance under our generic programs and the benefits of expanded business with new and existing customers, including strong contributions from retail independents. We also benefit from performance under our branded agreements.

Margin rate increased by 20 basis points compared to the prior year's Q4, with the rate increasing in each of our pharma distribution classes of trade. We also benefited from a continued mix shift as our non-bulk customer percentage of sales reached 61% in Q4 versus 57% in Q4 of 2011. Generic deflation in the quarter was not as steep as we anticipated due to material inflation on a few generic products.

As we discussed on previous calls, our nuclear business has continued to be challenged due to the softness in the low energy space or SPECT legacy business. During the past several months, we have taken steps to realign our business model to what we believe is the new normal demand curve, while, at the same time, investing in the growing PET side of the business. Overall, a very strong quarter once again for the Pharma segment.

Now turning to Medical. For the quarter, Medical segment revenue increased by 5.2% to $2.4 billion. Let me highlight a few drivers of this result. On our Q1 call, I discussed the reassignment we made in the way we report results for our international commercial operations. In the fourth quarter, this change contributed 2.3 percentage points to the Medical segment revenue growth rate. As we have now lapped this transition, this would be the last time I quantify its impact on medical revenue growth.

Our Futuremed acquisition, which closed in Q3, contributed 2.1 percentage points to the segment revenue growth rate in the quarter. Our inventory channel, another strategic growth area, posted 8% revenue growth for the quarter. And we are very pleased with the Medical segment return to profitable growth of approximately 2% for the quarter versus prior year. We believe we've turned the corner in Medical and are well positioned for strong growth in fiscal '13.

We continue to see the positive margin benefit of increasing sales of our preferred products. Consistent with the forecast we provided on last quarter's call, we saw approximately $8 million of incremental depreciation expense associated with the Medical Business Transformation.

Commodity prices negatively affected our current period cost of products sold by $6 million versus Q4 of last year, in line with our expectations and significantly lower than the previous 3 quarters of this fiscal year. I'll provide comments regarding our forward-looking commodity assumptions later when I discuss FY '13 guidance. Foreign exchange was an additional negative $3 million impact for the quarter.

On a different note, Cardinal Health China once again posted double-digit revenue growth, and we continue to see outstanding growth from our local direct distribution business, which grew its revenue by more than 50% during the quarter. As of the end of Q4, we've expanded to 11 distribution center sites in China.

In this regard, I wanted to highlight one regional acquisition among several we made in fiscal '12 and one which significantly enhanced our geographic reach. The acquisition of Da Sheng Group, which closed recently, expands our direct channel platform in the Ningbo market, which is the 11th largest city in China, with a population of almost 8 million. This is exactly the type of investment which allows us to build on our core platform, expand our local direct distribution business and will help to accelerate our growth long term.

On Slide 8, you'll see our consolidated GAAP results for the quarter, which includes items that had a negative $0.05 per share net after-tax impact, primarily related to the exclusion of $0.03 of amortization of acquisition-related intangible assets from our non-GAAP results. In the same quarter last year, GAAP results were $0.02 lower than non-GAAP results, again driven by acquisition-related costs.

I do want to call out one item we recorded in Q4 related to our Specialty business. Based on discussions with the founders and previous owners of P4 Healthcare, we negotiated a final earn-out payment, reducing the remaining amount of payable to $3.5 million and recognizing the $19 million reduction from our previous balance of income. This amount is part of the acquisition-related cost line and excluded from our non-GAAP results.

Now I'll make a few comments about 2012 in total, starting with Slide 9. For the full year, non-GAAP EPS, and it was at $3.21, an increase of 15% year-on-year and essentially at the upper end of our most recent guidance range. Operating earnings of $1.9 billion increased 13% versus fiscal '11. In particular, I am very pleased with the strong progress on our goal to expand margins, with both gross margin rate and non-GAAP operating margin rate increasing versus last year, up 17 basis points and 13 basis points, respectively.

I echo George's comments of our achievements this past year, and thank our employees for their contributions. We had a strong financial finish to the year, marked by significant progress against our strategic initiatives. And our results enabled us to return $750 million of cash to shareholders in 2012 through both our differentiated dividend policy and share buybacks. Our performance in 2012 provides a solid foundation from which to navigate 2013.

So turning to Slide 12. Our outlook for non-GAAP earnings from continuing operations in fiscal 2013 is $3.35 to $3.50 per share. This range reflects the expiration of the Express Scripts contract at the end of September. It also includes the potential range of expectations for external factors such as generic launches, branded inflation, generic deflation, commodity prices and the med device tax scheduled to begin in January.

Revenues are projected to be down approximately 7%, again reflecting the Express Scripts contract expiration and the impact of brand-to-generic conversions within pharma. Regarding utilization, we are taking a reasonably conservative view of any potential variation in the coming year, particularly as it relates to the markets our Medical segment serves and with respect to nuclear MPI procedures impacting our SPECT volumes.

Slide 13 outlines some of our key corporate expectations for the year. We anticipate our overall tax rate to be between 36.5% and 37.5%, comparable to the 2012 rate, although tax rates will fluctuate quarterly. But our diluted weighted average shares outstanding are assumed at approximately 347 million shares in fiscal '13. Again, we expect the benefit from share repurchases to be partially offset by share issuances and the impact of share price on the dilution calculation and exercising of options.

We estimate interest and other to net between negative $105 million and $115 million. We will continue to invest appropriate resources in our identified strategic initiatives, continuing the momentum we gained in fiscal '12. We expect capital expenditures in the $210 million to $225 million range, but we continue to focus on IT investments.

As of the end of June 30, 2012, our estimate for future acquisition-related intangible amortization expense is approximately $77 million. This only incorporates deals closed before year-end, and so will change over time.

Given the variability of our operating cash flows, we generally don't provide any type of guidance in this area. However, I will point out that all else being equal, our cash flows will be moderated next year by 2 onetime items, which, together, total over $500 million. The first relates to some large tax payments expected when we ultimately resolve past audits with the IRS, which is our expectation for the coming year. The second relates to the negative working capital impact that results from the nonrenewal of the Express Scripts contract.

Now I'll spend a few minutes going through some of the segment-specific assumptions, starting with Pharma on Slide 14. Clearly, Pharma segment sales will be down for the reasons I cited earlier when I spoke about consolidated revenue trends, with a corresponding impact on our branded margin dollars. Our expectation for brand inflation is that the rate will be similar to FY '12.

We continue to forecast year-over-year growth from our generic programs despite the benefit from [indiscernible] launches being substantially less than fiscal 2012 and the expectation for steeper generic deflation in 2013, driven by certain large products which will come off exclusivity -- which have come off exclusivity in fiscal 2012. We expect to benefit from growth in both our China and Specialty businesses.

Turning to Slide 15, in the Medical segment. We expect mid-single digit revenue growth and double-digit profit growth in fiscal '13, reflecting the benefits from our recent investments and the momentum we've gained. Preferred products will again be an important contributor to our profit growth and continue to grow in significance in our portfolio. The medical device tax associated with the Affordable Care Act has an estimated impact on the second half of the year in the range of $13 million to $23 million.

Our guidance includes the assumption of a neutral to slight benefit related to commodities and foreign exchange on a year-over-year basis. As we've discussed previously, we use the chemical data index and related forward curves as the basis for our commodity price forecast. On a simplistic basics -- basis, our guidance effectively assumes oil prices per barrel in the 90s for oil-related commodities.

Just a final word on FY '13 guidance. While we do not provide detailed guidance for the quarters, I did want to mention that we expect the first quarter of fiscal 2013 to be generally in line with our full year growth rate range. So in closing, let me reiterate that I am very pleased with our overall performance for the quarter and the year. 2012 was a period of strong operational execution and financial results. I am confident that we will continue to execute on our priorities and drive performance throughout fiscal 2013.

With that, let me turn it over to our operator to begin the Q&A session.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Glen Santangelo of Credit Suisse.

Glen J. Santangelo - Crédit Suisse AG, Research Division

I just wanted to ask 2 quick questions, George, regarding generics. Based on some comments you made, you said that you saw generic deflation that was not as steep as you had anticipated. I was wondering if you could maybe quantify that a little bit in terms of what you're seeing. And then secondly, you kind of said that you expected generic uplift to be less pronounced in fiscal '13. I think everyone's kind of aware that, based on the timing of the patent expiration schedule. But as we think about that within the context of your fiscal '13 guidance, could you give us a little bit of a sense for how big that headwind is year-over-year?

George S. Barrett

Glen, thank for the question. I'll take the first, and then maybe Jeff will chime in. So there are a couple of issues that you talked about. One is the general direction of pricing on generics and what we've experienced. Again, largely what has been happening is a lot of movement driven by the exclusivities coming off some of the major drugs. And so that is something that I know you all expect to see and see regularly. Generally speaking, what we've been seeing has been interesting, that a few of those products deflated at a slightly slower rate than we had modeled. As I've mentioned before, we have a very large portfolio of generics, so we've got close to 4,000 products in there. Many of the products that are sort of in their mid-maturity are behaving much as we've typically seen them. Some of the older products, particularly, have been inflating a bit. And then what we've seen is variability on these products that are losing their exclusivity. And so the general direction of that has been slightly favorable to our forecasting. The second one which is, again, I think probably about quantifying it, and there's only so much that we're comfortable providing as it relates to actual numbers in this. I don't know if you want to add anything, Jeff.

Jeffrey W. Henderson

Well, it wasn't actually deflationary. I'd say it was slightly better in Q4 than we -- what we saw in Q3. And again, that was in part driven by some unique inflation we had on a couple of products. So overall, I would describe deflation as flattish in Q4. And regarding the impact of generic launches, I don't want to get into a specific number there. I will say it's a fairly significant dropoff from FY '12 that we're expecting, which has been our assumption all along. And keep in mind that, that requires a fair amount of estimation and probilization [ph] of expected launches. But based on everything we see at this point, I would describe it as a fairly significant dropoff in value.

George S. Barrett

But, be it from the new launches. Yes, Glen.

Operator

Our next question comes from John Kreger of William Blair.

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

Could you give us an update on the broad utilization pattern that you're seeing across your portfolio? Have you changed this in the quarter versus maybe March quarter or as the quarter played out?

George S. Barrett

Yes, John. It's just -- it's a very, very choppy set of data when you -- again, we do probably what you do in terms of looking at external data. And we've got a number of sources. Generally speaking, I would say Q4 looked slightly improved on overall utilization trends versus Q3. But I would still say, if you look at it on sort of a broader basis, it's still pretty soft, and it tends to be very choppy by month. So I would still say we're operating in a reasonably soft utilization market.

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

And should we assume that pattern is roughly unchanged as fiscal '13 plays out in your budget?

Jeffrey W. Henderson

Yes. As I said in my comments, John, we're not expecting a significant variation in the pattern of utilization heading into next year based on what we've seen this year. And just to get a little bit more specific on the trends by area -- and again, we're seeing a lot of the same data you are, so I'm not sure this is necessarily new news. But for office-based physician trends, it did appear, based on external data, that there was some pickup in our Q4, but keep in mind that, that data is quite choppy. But for the 3 months in Q4, we saw growth in each of those quarters. I would say with respect to surgical volume, it kind of depends on whether you're looking at inpatient or outpatient. Outpatient appeared to have a fair amount of increase year-on-year. And the data that we have for Q4, I would say for inpatients, it was down year-on-year for the quarter. And then with respect to prescription volume, I'd say overall, script trends was pretty flat.

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

Excellent. One follow-up question. I realize it's early, but what is your initial thinking as the ACA bill is implemented? What sort of growth benefit would you expect from that?

George S. Barrett

Boy, that's a tough one to answer, John. I think over the long term, we do expect additional patients coming to the system. But also, I think as you all know, some of those patients find their way into the system, as I say, sort of through the back door. And so modeling the actual increase from this is extremely difficult. So I would say, again, over the long term, will see some benefit, very hard to quantify for you right now. On a very short term -- again, that's not something we're modeling in for the very short term.

Operator

Our next question comes from Ricky Goldwasser of Morgan Stanley.

Ricky Goldwasser - Morgan Stanley, Research Division

I have a couple of questions. But George, if you can provide us with some of your perspective on pricing in pharma in the industry. And has it changed with what you've seen historically?

George S. Barrett

Thanks, Ricky. Yes, this is always a difficult one to answer, partly in that we operate in multiple markets. And I've sort of said this before and tried to emphasize that we operate across our markets in very competitive markets, and that's true today. I would have a very difficult time discerning a particular pattern or giving a generalized characterization of pricing. It tends to be very business-line-specific, customer-specific, sometimes even region-specific. So it is -- I'm not sure I could give you, Ricky, a discernible trend break right now other than to say that we generally operate in a competitive environment, and I don't see that differently right now.

Ricky Goldwasser - Morgan Stanley, Research Division

Okay. And then Jeff, just to confirm the guidance for the first quarter, the growth rates you provided for the EPS was $0.76 to $0.78. So how should we think about the headwinds and tailwinds in the September quarter? And then when you think about the rest of the year, should we think about fiscal year '13 as being a year where growth is fairly fluid quarter-to-quarter?

Jeffrey W. Henderson

Thanks, Ricky. This is Jeff. Let me answer your second question first. I don't want to give specific quarterly guidance. But as I said, for the first quarter and I'd probably extend that to the first half of the year, we generally see the growth rate for those quarters to be consistent with the growth rate range that we gave for the full year, so that's probably as far as I'll go in terms of quarterly guidance. In terms of headwinds and tailwinds, I'd say for the most part that headwinds and tailwinds for Q1 are similar to what we see for the full year, with one notable exception being the fact that our Safeway contract extends through September 30, so we'll begin seeing the impact of that last volume only in Q2 and beyond -- I'm sorry, our Express Scripts, not Safeway. Express Scripts contract expires September 30, and so we'll begin seeing the impact of that last volume starting in Q2 and beyond. But more broadly, the headwinds both for Q1 and the full year, I would say -- from a macroeconomic trend standpoint, as I've said, we're being relatively conservative in our assumptions on utilization, particularly with respect to medical procedures and nuclear MPI volumes. And so I'd say, probably best case, that's sort of neutral year-on-year. Also, as we said, less anticipated generic launch benefit year-on-year, and that would be true for Q1 as well. We are expecting steeper generic deflation for the year than we saw this year given the products that have come off exclusivity. We've got the loss of some branded by margin just given the fact that we've had a very large amount of branded products go generic this year. And obviously, that impact will be felt throughout next year just given the less brand volume that we have. We've got the normal pricing erosion that we would typically see in any period. I would say in terms of tailwinds, we are in the process of beginning to realize the benefits from our MBT implementation within medical, and that will ramp up over the course of the year. But we're driving to start achieving those benefits as early as Q1. And I'd say, generally, we're expecting better medical performance, both given the lack of headwinds in commodities and FX, but just generally delivering on the investments that we've made over the past year or 2. We've got a couple of new customers, Department of Defense in Medical and Safeway in pharma, that I would describe as tailwinds. We're going to continue to be very focused on operational efficiencies, both in Q1 and the full year. And I would say we expect some growth in Specialty in China as well as we continue to invest and realize benefits of those investments in Q1 and the full year. There's one other headwind I forgot to mention that is not going to happen in Q1 but will occur in the second half of the year, and that is the medical device tax, that I referred to earlier, of somewhere between $13 million and $23 million for the second half of the year. And again, as I've said before, the reason we have a fairly broad range there is there's still some uncertainty regarding exactly how the medical device tax will be applied to certain of our products, and we're still sorting that out with the regulators. I hope that helps.

Ricky Goldwasser - Morgan Stanley, Research Division

Okay. But at the high end, you kind of assume worst-case scenario for the device tax. Is that fair?

Jeffrey W. Henderson

Yes, that would be the worst case half-year impact.

Operator

Our next question comes from Lisa Gill of JPMorgan.

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

So just a couple of questions on the Medical segment. George or Jeff, you talked about your expectations around mid-single digit growth? Are you taking market share, number one? And number two, can you talk about the different segments where you're taking -- if you are taking market share, where you're taking it from? And on the ambulatory care side, is that more of the IDNs buying physician practices and picking up that business? Or are you actually winning business out of the marketplace and taking market share?

George S. Barrett

Lisa, I'll start, and then Jeff will -- of course, feel free to chime in here. It's really sort of -- again, recognize, we have a broad line, set of lines that are covered in our medical business. And so generally speaking, we've been doing well in our medical surgical business. I wouldn't say dramatic swings in share. Jeff mentioned DOD. We've had some good progress, and I think some good progress with key IDNs who are performing very well in the market, and that's been beneficial to us. I think we've had solid growth in ambulatory. I think particularly, surgery centers has been an area, as you know, as care has been shifting, to some extent, from the acute settings into more ambulatory treatment centers. We have been well positioned to serve those surgery centers, and I think we've picked up some share there. But they've also grown their businesses there. And the physician's office area, we've probably grown a little bit past market. Some of this, again, it has to do with what you described, which is some of the practices moving into the IDN-affiliated networks. And some of it just, again, increased attention on our part, systems that are more finely tuned towards the needs of a smaller practice. And so again, the growth has been sort of broadly distributed, I would say.

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

Okay. And then just secondly, on the commodity aspect. And I guess maybe this is a question for you, Jeff. I'm just surprised that there's not more of a tailwind in 2013 just given how big the headwind was in 2012. Is there anything else that goes into that calculation? I mean, oil in the 90s is kind of fairly comparable with what it was in '12? But aren't we seeing some of the other commodities looking better as we move into '13?

Jeffrey W. Henderson

Yes, we've seen latex and cotton definitely improve. But I would say from an oil-based derivative perspective -- and keep in mind oil-based derivatives make up well more than 50% of our commodity exposure. I would say in that regard, we're seeing fairly similar rates. Throughout FY '11, probably the average price of oil we experienced was in the high 90s to low 100s. We're modeling a rate in the 90s, so there's a little bit of pickup there. But we don't want to get too aggressive with our assumptions just given the volatility that we're seeing in oil prices. Obviously, if oil stays in the -- or if it goes to the low 80s, which is what we saw a couple of weeks ago, that would provide some additional benefit, but we don't want to count on that yet, again, just given the volatility.

Operator

Our next question comes from Charles Rhyee from Cowen.

Charles Rhyee - Cowen and Company, LLC, Research Division

I've got a question. Jeff, if I heard you correctly, you guys bought $100 million of shares back in the fourth quarter and another $100 million now in the first quarter. Can you talk about what you plan for share repurchase versus dividends this year? Because you [indiscernible] have a higher dividend yield than your competitors, sort of [indiscernible]. But that is the real value with share repurchase. I mean, any way to think about that in terms of change in the cap next year on dividends, if that's the thinking?

Jeffrey W. Henderson

Charles, you're breaking up a little bit, but I think I got most of the gist of your question. Just to clarify, the amount we purchased in Q4 was $150 million and the amount that we purchased, thus far, this year was an additional $100 million. Regarding our plans for the year, I never like getting too specific about -- for our plans in this regard, I think, for somewhat obvious reasons. But I will say what our assumption is. Our assumption is basically -- in the 347 million average diluted shares outstanding I referenced in my prepared remarks, that basically assumes that we're done repo for the year, quite honestly. Now that doesn't mean that we may not do more, but for guidance purposes, that is the assumption we've made. So the $250 million we bought over the last 2 months is effectively what's reflected in the guidance. Over time, we will have opportunities to consider repo, again in the entire portfolio of things we may invest in. But also keep in mind that our cash flow will be a little bit lower next year for the reasons that I've stated. So it'll be somewhat of an abnormal year in FY '13 from an operating cash flow standpoint because of the impact of the tax payments and the ESI nonrenewal that I referenced in my remarks. Regarding the dividend, I really can't comment on that. Ultimately, that's up to our board to decide our dividend policy going forward, and that's probably all I can say on that.

Charles Rhyee - Cowen and Company, LLC, Research Division

If I could follow up, then. You guys have roughly $2 billion in cash on the domestic side, that's zero [indiscernible] speaking. But then you're estimating here a higher interest expense for the next year. I couldn't really hear your -- I might have missed it. What are you expecting to drive the interest expense up?

Jeffrey W. Henderson

Well, keep in mind that we issued $500 million of debt a few months ago, which was intended to -- partially to prefund several hundred million dollars of debt that comes due at the end of FY '13. So that's one of the major drivers of the higher interest expense. We're just simply carrying more debt this year than we did in FY '12. We'll also have slightly higher debt overseas as well related to our Chinese operation as well. So those are the 2 primary drivers of the higher interest expense year-on-year.

Operator

Our next question comes from George Hill of Citigroup.

George Hill - Citigroup Inc, Research Division

I'm going to follow up on Ricky's question on pricing, and I'll get a little more specific in the large national accounts. Obviously, ESI got great pricing on their renewal, which you guys chose not to match. How should we think about, as we look forward with the other national accounts that you guys service? Is that level of pricing kind of going to be the prevalent rate that we should think about at which business gets done? Or was there anything special about that contract process?

George S. Barrett

George, thanks for the question. Again, trying to compare some of these large accounts one to the other is quite difficult. They have very unique strategies, very unique business models and very unique needs in terms of servicing. So sort of applying some set of conditions across them would be really difficult. I think it's very difficult to try to give you some kind of forward-looking observation about what's going to happen in particular with renewals. I would just say this. We were extremely efficient at the servicing of these large accounts. We've built our systems around them. We're flexible. We're attuned to the needs of their complexity. We provide a very broad range of service components: connectivity, management of significant amounts of working capital. So I think you have to put that into the equation, and then you have to put into the equation the business mix that each of those accounts manages. And in reference to the Express Scripts business, that was a -- largely a bulk -- bulks business for us, and it played out as it did. But as it relates to our other large customers, they have very distinct needs, and we're very, very happy to be serving them. And we hope to continue to do that and bring the services, the tools and the capital to bear to make sure we do that well.

George Hill - Citigroup Inc, Research Division

Okay, great color. And then maybe, Jeff, just a quick follow-up on the tax rate guidance. The high end of the tax range -- the high end of the tax rate guidance range would be above [indiscernible] this year. Anything specific that would tend to drive the range higher?

Jeffrey W. Henderson

One of the big drivers of our range is our foreign mix, and it's that combination of earnings overseas both related to products that we manufacture and source overseas, as well as products that we sell commercially in places like Canada and China, et cetera. So that's one significant driver. And then as always, there's discrete items that come up over the course of the year as you fine-tune reserves on tax liabilities, et cetera and/or reach resolution with the IRS or other taxing agencies on outstanding audits or appeals. So it's really just meant just to cover those 2 ranges in variability, which are fairly common in any given year. But there's nothing really unusual beyond that, that I would point to. George, in answer to your prior question, just a thing I'd like to mention regarding differences in accounts. As George said, Express Scripts, being an mail-order account, is virtually 100% bulk, whereas most of the rest of our large customers are a combination of both bulk business, as well as direct store delivery business. So again, you have to look at each of those based on the profile of the business that we serve. The other thing I'd say -- and this is often not very visible to all of you, but it's obviously very important as we price accounts, and that depends on the terms and the capital that either gets generated by the business or that we have to deploy into the business. And obviously, those terms can have a pretty significant impact on the pricing that we give, so that's -- obviously there's value to that capital in both directions.

Operator

Our next question comes from Tom Gallucci of Lazard Capital Markets.

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

I think in that last question, we were sort of talking around some of your bigger customers. We usually ask a lot about Walgreens and CVS. Can you just remind us, are they up for renewal next summer? And is there anything in your fiscal '13 guidance that would account for any -- assumptions for any changes there?

George S. Barrett

So the -- our Walgreen contract expires at the end of August of next summer. Our contract with CVS Caremark expires at the end of June, just about a year from now.

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

I'm trying to find out, will there be any assumptions in your fiscal '13 guidance for any changes there? I know you don't want to get into the details, but is that really more viewed as a '14 event, fiscal '14? Or what's the relation to this year's guidance?

Jeffrey W. Henderson

I think I wouldn't want to get into specifics there just due to the confidential nature of those agreements. But in any given year, we make certain assumptions regarding when we're going to renew and the impact, et cetera, so this would be no different in that regard. But again, I wouldn't want to get into specifics.

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Okay, okay, fair enough. And then George, in your prepared remarks, I know you had highlighted the pressure relief, I think, over the last few weeks related to the product offering on the med-surg side. Could you give us a little bit more background on that? I thought it was going to be just one routine resolution [ph].

George S. Barrett

Yes, so just very generally, as you know, we've been investing here and building out on our own capabilities, particularly clinical capabilities to support preferred product offerings. This is a little bit -- in some ways, it is characteristic of the generic industry, but in other ways, it's quite distinct in that these are products that really need to be sold to clinicians who don't necessarily have a rating system such as maybe ratings happens in the drug setting. So you have to have a clinical capability to be able to support your offering of preferred products. We have seen the area of orthopedics as an interesting area, a place where we have some skills. We have been able to track some skills where we could build a partnership with a player who could support the technical needs of delivering and supporting that market. So we're really excited about this. It's early days, but we have a lot of enthusiasm for and we're getting some high level of interest from business partners downstream on the provider side.

Operator

Our next question comes from Robert Willoughby of Bank of America.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Jeff and George, can you remind us why the CapEx numbers falls as much as it does in '13? Was there something unusual in '12? And just as it relates to the deal spending in the coming year, just the normal dinks and dunks or is there some appetite for larger deals?

Jeffrey W. Henderson

Let me comment on the first one. The biggest reason for the falloff in CapEx, Bob, is simply because the Medical Business Transformation program ended. Most of the spend ended actually in Q3 of FY '12, so the dropoff of that program is, by far, the biggest contributor to the lower CapEx next year.

George S. Barrett

So, we -- our thinking about acquisitions is pretty much as it has been, which is, we are trying to continue to make sure that we're positioned in the best way to drive long-term sustainable value to the strategic areas that have been particular of interest to us. We've made some investments in those areas. There's nothing particularly to highlight other than to say to the extent that we can find or do find the opportunity to drive shareholder value through a move, we are ready to do that. But nothing specific to call out at this stage.

Operator

Our next question comes from Ross Muken of ICI (sic) [ISI] Group.

Ross Muken - ISI Group Inc., Research Division

So on the China business, it seems like you've had some pretty good growth momentum there. Obviously, the market remains pretty healthy. You've done some interesting acquisitions. I think you highlighted them on the call. As you look forward, do you think the sort of biggest incremental opportunities is sort of moving into some of the Tier 2 or other Tier 1 space that you don't currently service? Or is it also sort of expanding the breadth of products distributed beyond the medical side, maybe lab, and sort of running a broader product set through the distribution network that you've built?

George S. Barrett

Yes. Why don't you start, Jeff?

Jeffrey W. Henderson

The answer is both. And I think they are sort of mutually dependent, too, quite honestly, in that we need to continue to build out our geographic presence so we can cover more of the country, not only allowing us to cover more hospitals and pharmacies, but also giving a greater coverage that, in turn, our manufacturing partners can utilize to push product through. So that's sort of the basic part of the strategy, is to build our geographic presence. And as I've said before, our goal is to get to close to 25 sort of focus areas. We currently have 11 DC sites, so we're halfway there. We'll continue to focus on that both through organic and inorganic means. However, at the same time and really in parallel, we need to expand our portfolio in terms of products that we push through that channel. And I think we have an opportunity to do that in ways that are perhaps very different from the U.S., as we've said before, because it's a very different market and the needs of our manufacturing partners are very different. And how we get to market may vary a little bit, too, in terms of, for example, providing specialty pharmaceuticals all the way directly to the patient, which we've done through several specialty pharmacies that we've set up now in 2 different cities. So I would say it's both. And like I said, they sort of depend on each other because we need the channel in order to provide enough coverage to, in turn, expand our portfolio of products and drive that through to the market.

Ross Muken - ISI Group Inc., Research Division

And maybe on the specialty business. I know you quoted growth on kind of [indiscernible], so I know it's off of a small base. Do you feel like with the deal you announced -- the win you announced in the quarter and some of the momentum you've seen there in terms leverages, building a bigger platform in the context of 1 or 2 or 3 more key wins. I know there's a lot more to look at, presumably a large win to go. But do you feel like you've sort of gotten where you really compete with the other 2 larger players in that market and gain some of their share?

George S. Barrett

Yes, yes, this is George. You sort of hit it, which is you have to establish a certain amount of scale presence, which brings additional credibility, which allows us to reinvest. It's sort of -- virtually a cycle. And so we are beginning to see that momentum. We had a really great presence out of Chicago at the Cancer Association meeting, the Oncology Association meeting. We're beginning, I think, to establish ourselves as not only capable of doing everything in this space but innovating in this space. And yes, I feel very encouraged about our growth. As you said, we're still smaller in the -- at a different stage. But I like where we are, and we are gaining momentum. And I think others are seeing that and seeing what we're doing, and that helps us as we approach each customer. So I feel encouraged by it.

Operator

Our next question comes from Robert Jones of Goldman Sachs.

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

I just wanted to talk about the Express loss, just wanted to make sure we're thinking about that correctly. Is the EPS impact for next year really as simple as taking a bulk margin against the $7 billion of sales? Or is there some lost P&L leverage that we should expect from losing a customer of that size? Any more quantification around the impact on fiscal '13 would be helpful.

Jeffrey W. Henderson

Bob, given the confidential nature of any of those discussions, I can't get into the specific rate that we had previously for Express Scripts. But I do think taking the last sales volume and applying our bulk rate, which, for the year, by the way, ended up at 38 basis points for the full year, FY '12, I think that's a reasonable proxy. Now inherent in that rate is some allocated fixed cost that we would need to cover. But I would say compared to most of our business, the fixed costs associated with bulk business are relatively light because we generally allocate fixed cost based on activity, and activity associated with mail order is clearly much less than you'd see with the other classes of trade. So bottom line, I think applying the general margin rate is probably a good proxy.

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

And then just on the MedTrend, you guys laid out a lot of the assumptions here. And I know previously on the Medical Transformation, you guys said that the financial benefits would outweigh the cost in '13. I might have missed this earlier in the call, but I was just wondering what the view is today as we look to fiscal '13. And any more quantification around that financial benefit would be helpful.

Jeffrey W. Henderson

So what I've said previously still stands, that we expect depreciation of about $35 million in FY '12, and we expect the benefits to net, be accretive to that number. And as George alluded to, they both come in the areas of margin, which would be both gross margin improvement, as well as SG&A reduction. And then separate from that, we would expect to see some inventory reductions as well, which would help our operating cash flow.

Operator

Our next question comes from Steven Valiquette of UBS.

Steven Valiquette - UBS Investment Bank, Research Division

Just 2 quick ones for me. First, for FY '13, just given the earlier discussion on direct store delivery versus bulk, should we assume that the Safeway contract position is likely more profitable for Cardinal than the Express Scripts subtraction? Or is that not the right assumption? And then the second one, just quickly. If I missed this, I apologize. You guys announced this Dik Drug acquisition. Is that material enough in size to move the needle on EPS accretion for FY '13? Or should we assume it's not that material and so therefore, kind of more neutral to EPS?

George S. Barrett

Steve, as you can imagine, we really can't answer the first question. Sorry about that. But it really -- specific to individual customer contracts is a place where we can't go on these calls. But Jeff, do you want to comment on the second part, on the Dik Drug?

Jeffrey W. Henderson

Yes, I would say it's relatively immaterial for next year. Net-net, it's accretive, but by a very small amount. So I'd say, for modeling purposes, it's relatively insignificant.

Steven Valiquette - UBS Investment Bank, Research Division

Does it get more accretive over time or just assume overall, it's not big enough to really move the needle?

Jeffrey W. Henderson

I would say as a general statement that it's not big enough to move the needle. But I would expect by the second year for it to be $0.01 or $0.02 accretive.

Operator

Our next question comes from David Larsen of Leerink Swann.

David Larsen - Leerink Swann LLC, Research Division

Most of my questions have already been asked and answered. But for 2014, assuming that 35 million more people do actually get health insurance, how are you guys thinking about now how that may impact your business? We -- and roughly a good portion of those end up being in your exchange-based plans or Medicaid plans. Would that potentially result in lower reimbursement for you guys and that -- and possible higher volumes? Can you sort of talk about that at all?

George S. Barrett

Yes, David, I can only give you a sort of generalized statement on this. But again, we would assume that in 2014, there will be additional people coming into the system. As I've said, the overall health care system is going to go through this dynamic, one which is more people coming into the system both through legislative change and demographics and then the other is how are we going to, as a society, pay for all of this? And so we just assume that we're going to have to continuously improve our productivity, focusing on our own productivity, but also productivity for our customers so that we can enable them to compete in that landscape. So I think it's reasonable to assume that, that's a dynamic we'll be experiencing generally as a system, and then just regarding the whole.

Operator

Our next question comes from Larry Marsh of Barclays.

Lawrence C. Marsh - Barclays Capital, Research Division

George and Jeff, two quick ones. First, on nuclear, I know last year you had a tough low energy environment around utilization, but this fall, some exciting potential developments on the clinical trials and tests. You may have already addressed this, but how are you thinking about the outlook for nuclear this year in your guidance?

Jeffrey W. Henderson

I'm going to say generally very much as it has been in the past few months, which is soft demand utilization on the SPECT on the low energy side. We're growing at a nice clip on PET, although it's much smaller. We do believe that, again, that the evolution of the diagnostic agents, particularly, right now, in neuroscience, are important. I think part of the long-term drivers here will be what's happening on the therapeutic side. So the combination of the therapeutic and the diagnostic is sort of critically linked. And so we'll be watching carefully, not just to see what's happening on the diagnostic side, but what's happening on the therapeutic side. Any breakthroughs there would be very, very helpful.

Lawrence C. Marsh - Barclays Capital, Research Division

Great, okay. A lot of areas could be some variability. And the second quick follow-up is on cash flow. I just want to make sure I got this right. I normally think of you guys generating about 75% of EBITDA and cash flow from operations. This fiscal year, fiscal '12, was a bit below with the fourth quarter. Jeff, you had said, expect cash flow to be impacted this year by, I believe, $500 million and then some negative working capital implications with Express. Are you suggesting that's going to be a deflection off of the $1.2 billion you generated this year or just off a normalized trend? And would there be any reason to think about cash flow trends not being -- being different from that sort of typical 75% of EBITDA as you kind of go forward?

Jeffrey W. Henderson

Yes, first of all, I would say this year's cash flow of $1.2 billion was a little bit light because of the $100 million tax deposit we made with the IRS in Q4. So on a more normal run-rate basis, if you can call it that, I would have expected closer to $1.3 billion. I'd say, next year, that's $500 million off of a normalized run rate.

George S. Barrett

Again, Larry, I just want to make sure, I thought you said $500 million, plus the Express and I don't think that's...

Jeffrey W. Henderson

The $500 million is a combination of both the expected tax payments we have to make next year, unique tax payments we have to make next year, as well as the impact of unwinding the Express Scripts business.

Lawrence C. Marsh - Barclays Capital, Research Division

Okay, I got it. And that's off of normalized rates. So it won't be a dramatic difference versus cash flow from this year, it sounds like?

Jeffrey W. Henderson

No, I've got to tell you it's not [indiscernible]. If you assume this year is somewhat normal other than what the $100 million, it'd be $500 million lower.

Lawrence C. Marsh - Barclays Capital, Research Division

Off of that?

Jeffrey W. Henderson

Yes.

Operator

Our final question comes from Eric Coldwell of Robert W. Baird.

George S. Barrett

So I think we will wrap it up. I'd like thank all of you for joining us this morning, and we look forward to the opportunity to speak with many of you in the coming days. So thanks, and have a good day.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.

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