May 2, 2013
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
Steven Valiquette - UBS Investment Bank, Research Division John W. Ransom - Raymond James & Associates, Inc., Research Division Roberto Fatta Stephan Stewart - Goldman Sachs Group Inc., Research Division Eric W.
Coldwell - Robert W. Baird & Co.
Incorporated, Research Division Lisa C. Gill - JP Morgan Chase & Co, Research Division Thomas Gallucci - Lazard Capital Markets LLC, Research Division Ricky Goldwasser - Morgan Stanley, Research Division Glen J.
Santangelo - Crédit Suisse AG, Research Division Ross Muken - ISI Group Inc., Research Division Robert M. Willoughby - BofA Merrill Lynch, Research Division Charles Rhyee - Cowen and Company, LLC, Research Division Chris Abbott - Leerink Swann LLC, Research Division George Hill - Citigroup Inc, Research Division
Operator
Good day, ladies and gentlemen, and welcome to the Cardinal Health Third Quarter Fiscal Year 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.
I would now like to introduce your host for today's conference, Sally Curley, Senior Vice President of Investor Relations. Ma'am, you may begin.
Sally Curley
Thank you, Sam, and welcome to our third quarter fiscal 2013 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 our 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 risks and uncertainties.
In addition, we will reference non-GAAP financial measures. Information about these measures is included at the end of the slides.
I'd also like to remind you of a few upcoming Investment Conferences and Events in which we will be webcasting, notably, the Bank of America Merrill Lynch 2013 Healthcare Conference at 8:40 local time on May 14 in Las Vegas and the Goldman Sachs 34th Annual Global Healthcare Conference, again, at 8:40 a.m. local time on June 11 in Rancho Palos Verdes, California.
The details of these events are or will be posted on 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 some of you at the upcoming events. Now I'd like to turn the call over to Cardinal Health's Chairman and CEO, George Barrett.
George?
George S. Barrett
Thanks, Sally. Good morning to those of you joining the call.
We've had another strong quarter, which Jeff will describe in detail in a few minutes. Typically, I devote most of my time to review the performance of the quarter just ended, but this has been an extraordinary few months, highlighted by 3 significant events, and I'd like to spend my time today putting those events into context.
First, last week, we renewed a very important strategic relationship with CVS Caremark. Second, some weeks ago, we announced that we would not be renewing our agreement to supply Walgreens; and third, we announced during the recent quarter the acquisition of AssuraMed.
I'd like to touch on all of these. Let me start with our recent multiyear agreement to continue to serve CVS Caremark.
CVS has been a longtime partner. We've been privileged to play our part in helping them grow and they have continued to bring value to our business.
The presence of large customers in any portfolio requires close, strategic economic and operational alignment, and in our relationship with CVS, we achieve those things. Moving to Walgreens.
Our announcement that we would not renew our supply agreement followed their announcement of a plan to invest in and, in combination with Alliance Boots, work with AmerisourceBergen on their supply chain needs. I'd like to give you my perspective on this.
The nonrenewal of any business is really something we or you want. Let me be clear.
The loss of a customer the size of Walgreens even at lower margins and with high invested capital is anything but trivial. But over this past year, it had become increasingly difficult for us to align with Walgreens' direction, particularly in light of their Alliance Boots acquisition.
Given this, we had been preparing strategies for the future, which did include Walgreens, and Cardinal Health will be healthier for it in the long run. I don't want to leave this topic just yet.
We've listened to many of your questions in recent weeks about scale and I'd like to provide a few quick comments on this. Cardinal Health is a business of enormous scale.
Pharmaceutical Distribution alone will continue to serve 18,000 retail pharmacies as well as thousands of hospitals and clinic pharmacies in the U.S. And biopharmaceutical companies depend on our experience and our reach to ensure that their products get to patients in the safest and most cost-effective manner possible.
We, in turn, depend on their innovation and commitment to patient care in serving the health care system. It's a partnership that is clearly working and will continue to drive strong value for the foreseeable future.
On the generic side, we are one of the largest generic drug purchasers in the world and will remain so, and we expect that this business will continue to grow, particularly as a result of the changing health care dynamics and policy direction coming from Washington. Over these past years, we have deepened our knowledge of and our ability to source products across the global network.
This has been extremely beneficial to our customers and to our margin rates. We have the scale and the reach to move market share for our manufacturer partners and to assure best-in-class pricing for our customers.
I should point out here that none of this was affected by the Walgreens nonrenewal. As Walgreens has been primarily a direct buyer of generics, they have served largely as a backup on generics contract business.
The third important point to this conversation is the enormous strategic relevance of the move we made during this recent quarter to take a leadership position in the market that serve patients in the home with our acquisition of AssuraMed. There are 2 overwhelming facts that without exaggeration will change health care.
First, demographics don't lie. Our population is aging, living longer, and more care will be delivered in the home.
That's not opinion, it's math. And second, the economic realities, largely driven by that demographic shift, will bring pressures to treat patients in the most cost-effective setting and to keep patients from being readmitted to hospitals.
Safe, high-quality care in the home will be essential to accomplishing this. AssuraMed is an important addition to our Medical segment and to Cardinal Health as a whole.
It is a natural extension of our strategy to follow the patient throughout the continuum of care in an increasingly integrated health care system. It leverages our experience and our scale in sourcing those products used by patients in other health care settings we serve.
It helps us support our health care system's partners, who will increasingly be responsible for the patient after that patient leaves the hospital or clinic, and it will support our retail provider partners, who can use our platform to serve their patients in the home. And this acquisition brings us directly in contact with the patient, whether that patient is chronically ill or one requiring post-acute care.
Think about it. More direct interaction, more health care on the patients' terms, suited for the patients' life.
This is an important new dimension for Cardinal Health, and one which builds on our DNA and supply chain management. We are thrilled to close the transaction and welcome Michael Petras, his leadership team and all of the AssuraMed people into Cardinal Health.
The integration is already under way and going very well. In many ways, these recent events accelerate the journey we began more than 4 years ago.
This journey was focused on driving balance and growth by diversifying our portfolio of customers, products and channels. This required expanding into higher-value, higher-margin settings and higher-value, higher-margin products and services, all on a sustainable foundation that requires rock solid alignment with our customers.
The progress we've made is significant. Over these past 4 years, we've increased our base of independent retail customers from 3,800 to nearly 7,800, and our non-bulk business now represents 70% of total pharmaceutical sales.
Our generic sales have nearly doubled. We've increased our position at our service and product offerings in hospitals, clinics, surgery centers, oncology, urology and rheumatology practices, doctors offices, and now with the AssuraMed acquisition, the home.
For the first time in our history, wherever health care products or services are needed at any stage of the patient experience, we are there for them. We've continued to drive a preferred product portfolio in our medical segment that addresses our customers' needs for more cost-effective medical products.
And finally, we've expanded into China, where our unique value proposition allows us to build a strong brand, enhance strategic alignment with its biopharma and medical device companies and participate in a rapidly growing Chinese health care system. Through these efforts, we have grown our non-GAAP EPS at a compounded double-digit rate, deployed our capital effectively, including a further 10% increase in our dividend announced today.
We've expanded our margin rates and more effectively position Cardinal Health to create value in an increasingly patient-centered health care system. Before I close, let me take a moment to put my comments into some financial context.
As you may remember, when we announced the Walgreens decision on March 19, we felt that it was important to provide some early indications as to how our fiscal year 2014 might look. At that time, we provided a non-GAAP diluted earnings per share target range of $3.42 to $3.50.
We now have another month of work behind us and some additional clarity on some important moving parts. And although our fiscal year 2014 budget is not complete yet, we would now preliminarily target a number for fiscal 2014 towards the upper end of that EPS range.
And we're not sitting still. We will serve the market with a clear sense of purpose, the discipline to execute and the self-awareness to note that there are always areas where we need to get better.
I hope this gives you a bit of a window into what we're thinking and I look forward to your questions. With that, I'll turn it over to Jeff.
Jeffrey W. Henderson
Thanks, George, and good morning, everyone. Before I get into my prepared remarks, I did want to mention a big event we have coming up here.
Many of you know Kevin Moran, our Manager of Investor Relations. Well, next weekend, he's marrying his lovely fiancée, Sarah, and George and I just want to take this moment to congratulate him and wish him and his future bride a long and happy marriage.
Okay, back to business. This morning, I plan to review the drivers of the third quarter performance and our full fiscal 2013 outlook.
You can refer to the slide presentation posted on our website as a guide to this discussion. Let's start with consolidated results.
We reported a 28% increase in non-GAAP earnings per share in our fiscal 2013 third quarter versus the prior year's period. This was driven by 2 major items.
First and most importantly, we achieved a robust 11% non-GAAP operating earnings growth. Second, our results also included $0.18 related to a favorable discrete tax settlement.
Excluding the $0.18, non-GAAP earnings per share grew 8.5%, another very solid quarter of growth. Let me go through the rest of the income statement in a little bit more detail, starting with revenues.
Consistent with our expectations, consolidated revenues were down almost 9% to $24.6 billion due to the previously announced nonrenewal of the Express Scripts contract and the continued pharmaceutical brand-to-generic conversions. Gross margin dollars increased 7% with the rate up 77 basis points versus prior year.
We successfully expanded our year-over-year gross margin rate every quarter for the past 11 quarters, reflecting a concerted effort to drive favorable customer and product mix and a focus on accelerating the growth of certain higher-margin strategic initiatives. SG&A expenses increased by 4% in Q3 with acquisitions comprising 2.6 percentage points of that increase.
We remain very focused on controlling costs while balancing our investments in key strategic priorities. Our consolidated non-GAAP operating margin rate increased 41 basis points to 2.36%.
Interest and other expense increased versus last year's third quarter due to the funding of the AssuraMed acquisition. Let me take a minute explain our unusual tax rate for the quarter.
We had an abnormally low non-GAAP tax rate of 25.1% in Q3 due to the favorable $64 million tax settlement I mentioned earlier. The settlement resulted in a revaluation of our deferred tax liability and related interest on unrepatriated foreign earnings.
Please note that this amount only affects our tax line and has no impact on operating earnings or the segment results. Without that single discrete item, our tax rate for the quarter would have been 36.7%, much more in line with our normal rate.
I'll discuss tax assumptions again when we talk about our total year guidance later in my prepared remarks. Our diluted average shares outstanding were 345 million for the third quarter, approximately 5 million favorable to the prior year's quarter.
Our opportunistic share repurchases during fiscal 2012 and the first quarter of fiscal 2013 continue to positively impact our share count. Now let's discuss consolidated cash flows and the balance sheet.
We generated almost $1 billion in cash from operating activities in the quarter. Year-to-date, operating cash flow of approximately $1.4 billion is slightly ahead of where we were at this point last fiscal year despite absorbing the Express Scripts unwind, which had a negative impact on net working capital.
This reflects a strong underlying performance of our businesses. I will point out here that we do expect our fourth quarter operating cash flow to be negative due in large part to some significant tax payments we expect to be making.
This is consistent with the assumption that we've laid out for you at the beginning of the year. Also note in Q3, we raised $1.3 billion of long-term debt at a very favorable weighted average rate of 3.1%.
The debt was used for the $2.1 billion acquisition of AssuraMed, and brings our total debt balance to about $4.2 billion, including both short- and long-term obligation. At the end of Q3, we had approximately $2.3 billion in cash on our balance sheet, which includes approximately $370 million held internationally.
Our working capital days ended the quarter higher than the prior year, primarily driven by the exploration of the Express Scripts contract and seasonal purchasing patterns. Now let's move to segment performance.
I'll discuss Parma first. In line with our expectation, Pharma segment revenues decreased 10% to $22.1 billion due to the expiration of the Express Scripts contract and continued brand-to-generic conversions.
This decrease was partially offset by revenues of some new customers. Of particular note, sales to non-bulk customers continued to increase, up over 5% for the period.
In Q3, sales to non-bulk customers represent 70% of the segment total versus 60% in last year's Q3. Our generic programs continue to perform well, posting a revenue increase of 11% versus the prior year.
Contingent brand inflation was in the high single-digits, about as we expected. As a reminder, Q3 is typically our highest quarter benefit from contingent brand inflation.
In Specialty Solutions, we had revenue growth of over 60% versus last year's quarter. Pharma segment profit increased by 12% to $498 million, driven by the overall strong growth in our generics programs and performance under our branded manufacturer agreements, exclusive of the volume impact.
With respect to generics, we did as expected. We left contribution from new generic launches in this year's quarter versus Q3 of fiscal 2012.
We also had steeper generic deflation sequentially from Q2, but again, overall, our generics program has performed very well during the quarter. Pharma segment profit margin rate increased by 44 basis points compared to the prior year's Q3, a reflection of the strength of our generics programs and our focus on margin expansion and customer and product mix.
In addition, within customer categories, margin expansion in Pharma Distribution was strong across almost all of our customer classes of trade. Finally, our Nuclear business continued to make the necessary adjustments to compete effectively in a tough utilization environment.
Now moving onto medical. Medical revenue growth was up 3% versus last year, an increase of $69 million.
Acquisitions, including AssuraMed and Futuremed, were the primary driver of revenue growth in the quarter. Partially offsetting the segment revenue growth was one fewer sales day in the quarter.
Like many others in the industry have noted, we again saw procedural volume softness in the U.S. market, which had some moderating impact on our segment results.
Given all that, we're pleased to report 12% medical segment profit growth this quarter. Commodity pricing resulted in year-on-year favorability to our current period input costs of $12 million.
Despite the procedural trends I just mentioned, we improved our preferred product mix, which resulted in a positive contribution to segment profit growth in the quarter from these key products. We saw a slight contribution from AssuraMed in the period.
Recall that we closed on March 18, so we only had 13 days of contribution to the quarter's profit. These profit improvements were partially offset by rate compression, driven in part by customer mix.
Let's talk about AssuraMed a little more. Although it's only been part of the Cardinal Health family now for about 6 weeks, we are happy to report that everything is on track.
In fact, AssuraMed's integration of Invacare Supply Group is moving faster than planned, and we're starting to see some of the anticipated cost synergies. In addition, the interest rate on the $1.3 billion debt issuance to fund the purchase price was at the low end of our expectations.
Accordingly, we are increasingly confident in our ability to meet the accretion estimates we provided at the time we announced the deal. I'll wrap up my review on segment performance with a comment on Cardinal Health China, which spans both segments.
Cardinal Health China continued its very strong double-digit revenue growth again this quarter. Our local direct distribution business, which provides products to hospitals and retail pharmacies, reported another exceptional quarter, with 70% top line growth.
Turning to Slide #6, you'll see our consolidated GAAP results for the quarter, which include items that reduce our GAAP results by $0.20 per share compared to non-GAAP. Included in this figure is the exclusion of $0.10 of acquisition-related costs, which reflects $0.05 of amortization of acquisition-related intangible assets.
We also had $0.06 of restructuring costs and $0.04 of impairments and loss on disposal of assets, both largely related to our previously announced restructuring in the medical segment. You may recall that in Q3 of last year, we had a $0.10 benefit in our GAAP results from a reduction in the fair value of the P4 Healthcare acquisition earn-out liability.
Now let's talk briefly about guidance for the current fiscal year. Given our year-to-date fiscal 2013 results and with only one quarter remaining, we are raising and tightening our non-GAAP earnings per share guidance range to $3.57 to $3.71.
Again, please note that this revised range includes the $0.18 tax benefit realized in the third quarter. With the exception of our tax rate and the recent addition of AssuraMed, I would say that our overall second half consolidated result are shaping up largely as we expected, with some shift in the balance between our third and fourth quarters.
Most of the underlying assumptions, including our consolidated revenue guidance, remain unchanged from our previous comments. However, I do want to mention a few points.
First, the medical device tax impact for fiscal 2013 is now expected to be in the $8 million to $10 million range for the 6 months the law have been in effect, which reflects our best estimate, our best assessment of the current regulations. From an accounting perspective, this tax appears as SG&A on our income statement.
Second, as a reminder, our new multiyear contract with CVS is in effect as of April 1 of this year, and this is reflected in our forecast. Third, our revised guidance assumes a non-GAAP tax rate for the fourth quarter fiscal 2013 of approximately 37%.
However, we are in the latter stages of further discussions with state and federal tax authorities on outstanding audit periods, and it's difficult to predict the timing and magnitude of any outcomes, but it is distinctly possible that we could have some discrete tax items, positive and/or negative, that may be reported as early as Q4 as a result of those discussions. To the extent that there are significant in nature, we will plan to breakout those onetime amount in future periods.
Obviously, any material, unusual or discrete settlements in the fourth quarter could impact our forecasted earnings per share in either direction. My final comments regarding FY '13 assumptions are focused on AssuraMed.
We are updating the previously provided fiscal '13 guidance for amortization of acquisition-related intangibles to $120 million to include the closing of AssuraMed. As a reminder, this amount is included from our non-GAAP earnings.
Our preliminary estimates for both goodwill and other identifiable intangible assets have been added to our balance sheet as a result of this deal and the details will be included in our Form 10-Q to be filed next week. Now a word on next year.
George mentioned our preliminary view of fiscal 2014, targeting the upper end of the $3.42 to $3.50 range we provided on March 19. I'd like to reiterate that we are in the midst of our planning processes, and we'll provide more detailed guidance during our Q4 earnings call in August.
Along the way, we haven't taken the necessary actions to improve efficiency and position ourselves competitively for the future. Finally, I want to spend a few minutes on capital deployment, which apply to the balance of fiscal '13, fiscal '14 and beyond.
We anticipate that the expiration of the Walgreens contract will result in a net after-tax benefit to cash flow from operating activities in fiscal 2014 of more than $500 million based on the expected working capital decrease, loss after-tax earnings and other cash tax impacts. Although it is still too early to get into all the specifics as to how we will use that amount or any other capital we'll generate next year, we will remain disciplined on our capital deployment decisions.
Our goals remain the same as they have for the past 4 years. Our first 2 priorities are investing to sustain growth in our existing businesses, and growing the dividend at least in line with long-term non-GAAP EPS growth.
In his latter regard, as George mentioned, our board has approved another increase in our dividend, taking the quarterly amount up by 10% to $0.3025 per share, effective with the July payment. This quarterly dividend per share is over 40% higher than the dividend paid in April of 2012.
Today's announcement brings our dividend yield to approximately 2.8% based on our current stock price. Beyond these priorities, we will continue to evaluate other deployment options, including acquisitions and share repurchases, in a balanced manner to optimize the shareholder return, sustainable growth and our credit position.
I fully expect that we'll be buying back at least $250 million of shares in the coming months, and we'll continue to assess additional opportunities. With that, let's begin Q&A.
Operator, please take our first question.
Operator
[Operator Instructions] Our first question comes from Steven Valiquette of UBS.
Steven Valiquette - UBS Investment Bank, Research Division
So, I guess the updated earnings outlook's definitely helpful and reassuring. I guess I'm also just curious on your preliminary thoughts on the generic pipeline outlook as it lines up with your fiscal '14.
Maybe compare and contrast that with what we're seeing in the current fiscal year.
George S. Barrett
Sure, Steve, I'll take it. This is George.
Yes, I think, we've mentioned this before and we're a few months further along and maybe have a little more color. But here's what we'll say at this stage at sort of the macro level.
When we're looking at generic launch value, I would probably say with our fiscal years, '13 is probably greater than '14. '15, still early to tell.
I would say, right now, it doesn't look all that different than '14, sort of plus or minus. So that would be the quick, very high-level perspective at this stage, Steve.
Steven Valiquette - UBS Investment Bank, Research Division
Is fiscal '13 coming in better than what you thought previously, and that's why when you think about '14 and what you said there, that's -- it's really more of the delta on '13 that's changing? Is that the way to kind of think about that?
George S. Barrett
Yes, so as you know, in generics, there's so many moving parts. '13 is probably coming in a little stronger than we modeled and '14, probably not all that different.
But, I think, again, there's a few little moving parts that can swing these numbers. So you know that's part of the business that's -- it has some -- takes some forward-looking that is not always perfect, but that's our overall perspective at this stage.
Operator
Our next question comes from John Ransom of Raymond James.
John W. Ransom - Raymond James & Associates, Inc., Research Division
Would you mind just recapping? You said the back half of fiscal '13 was lined up how you thought, but maybe some earnings were pushed into the March quarter over the June quarter.
Could you just recap what the key drivers were of that?
Jeffrey W. Henderson
Yes. John, it's Jeff.
I'll take that. Yes, as I said, overall, the second half of the year is largely coming out on a consolidated basis, as we expected, back earlier in the year when we put together our guidance and our forecasts, with the 2 exceptions that I called.
One was the tax settlement that we realized in Q3 and the second was the addition of AssuraMed, which didn't happen until March when it closed. But beyond that, it is largely playing out as we expected, with some slight shift between probably from Q4 to Q3.
And I would say that's largely due to the rate of brand inflation that we saw in Q3, and that impacted our contingent buy margin. It was probably a little bit higher than we expected and perhaps a slight shift from Q4 to Q3.
I would say that was primarily the major factor that resulted in a bit of a shift.
John W. Ransom - Raymond James & Associates, Inc., Research Division
And I jumped on a little bit late so I may have missed this. But is there any commentary -- there's been a lot of talk in the market about oncology and the sequester?
Has there -- anything notable in your oncology businesses as a result of the sequester?
George S. Barrett
Yes, John, it's George. We've got very limited exposure at this point.
So the sequestration, certainly, has been a material issue for the oncology and specialty community, but reimbursement pressures have been sort of building over this past year so it's not a particularly new thing. But for us, again, our model is a little bit different.
We've been sort of focusing on sort of a different, different approach, and as you know, working very heavily at sort of this collaborative effort between the payers and providers to create value and alignment there. So our direct exposure to that sequestration impact is somewhat limited.
Operator
Our next question comes from John Kreger of William Blair.
Roberto Fatta
This is Robbie Fatta in for John today. First, a quick question on the Medical Business Transformation initiative, which I don't think we heard much about in the prepared comments.
What was the impact this quarter and what do you think the benefit to 2014 might be at this point?
Jeffrey W. Henderson
Yes, Robbie, thanks for the question. One of the reasons we didn't talk a whole lot about it is because the medical system that we implemented last year is now very much integrated into the overall business, and really, the focus now is we'll continue to optimize our use of it, and using it as a platform to grow other parts of the business.
But that all said, from a pure financial standpoint, it was slightly positive in Q3 in terms of the year-on-year impact of the implementation, including the impacts of depreciation netted against the benefit that we realized. Year-to-date, the benefit -- combined benefit is slightly negative, reflecting particularly Q1 when we had some issues related to change management that we're addressing.
For the full year of fiscal 2013, we're still targeting for it to be a net positive for the medical segment. And then I would say going into fiscal '14, I won't give specific numbers, but we do expect to continue to drive the benefit from the transformation.
But again, it's less about getting the system to work, which is it at this point and that's largely behind us. That is behind us.
It's about now using the system to drive, for example, increased penetration of preferred products with our customers to bring down inventory levels to optimize pricing. So we do expect a significant benefit heading into 2014.
Roberto Fatta
Great. And one other one if I may.
You made a couple of comments on capital deployment, and now you mentioned the buyback as part of the overall deployment strategy. Can you talk about how aggressive you might be with a buyback like that?
Could you do something, perhaps, accelerate it or is that not really in the cards?
George S. Barrett
As we look to implement our share buybacks, we consider all options and look at what make sense from a timing and execution standpoint. I never want to get too specific about mechanisms or timing.
Obviously, you never want to total -- totally signal to the market when you're going to be in the market buying back shares, but I will reiterate what I said, that we do expect to buyback at least $250 million worth of shares in the coming months, and that expectation is reflected in our targeted guidance for next year.
Operator
Our next question comes from Robert Jones of Goldman Sachs.
Stephan Stewart - Goldman Sachs Group Inc., Research Division
It's Stephan Stewart, calling for Bob. Just wanted to follow-up on that share buyback comment.
Is that $250 million the only thing contemplated in next year's guidance from a buyback perspective?
Jeffrey W. Henderson
Well, first of all, just to reiterate overall from a capital deployment perspective, there's a number of things that we have looked at and will continue to look at. Obviously, we've got a significant increase in the dividend, which, as I said in my prepared remarks, once it's paid in July, will represent a per share payment that's more than 40% above what the April 2012 payment was.
I would say that's a significant decision with respect to our capital deployment, and one that we remain very committed to. We'll continue to invest appropriately in the CapEx in the business.
So we've got some important priorities we'll continue to support, and that investment will continue. And then beyond that, we continue to look at the balance between acquisitions in select strategic areas and share repo, and I would say both of those will be looked in a balanced and opportunistic way.
Regarding the repo, yes, I use the words at least $250 million worth because, again, depending on market conditions and cash availability, et cetera, it's always possible that we could do more, but the reference to at least $250 million is sort of the assumption that's implicit in our guidance for next year.
Stephan Stewart - Goldman Sachs Group Inc., Research Division
Great. And just broadly on the medical segment, you did highlight customer mix.
I know it's an ongoing theme, but can you maybe expand on that a bit and how much of an impact it's having on your rate compression?
Jeffrey W. Henderson
Yes, I would say it's probably been the biggest factor in our rate compression for the past couple of quarters. I'll give you a very specific example of that.
Our Department of Defense contract, both -- the overall volumes, but I would say the types of volumes that we're getting in terms of orders from the Department of Defense are significantly different than both of what we were expecting and even what we realized last year and that's obviously driven in a significant part from the fact that we've had a troop withdrawal from the wars that were going on in Afghanistan and Iraq. And that's changed the mix and the type of customers within the Department of Defense that we're servicing and the products that we're providing.
So that's one specific example, and I would say a fairly big driver of that mix.
Operator
Our next question comes from Eric Coldwell of Robert W. Baird.
Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division
I want to hit on preferred products in medical. I know, recently, you said the mix was around, I think, 24%.
I was hoping we could get an update on that. And also, if you could update us on your recent moves in, say, orthopedics or cardiovascular.
Last night, on the GPO's call, there was a confirmation of the increasing commoditization of what were previously considered only to be physician-preference items purchases, customers being more flexible, et cetera. I'm just curious if you can give some updates on what you're doing as you move up the value chain there?
George S. Barrett
Eric, I think what we'll do is Jeff will reply to the first part of the question, and I'll jump in with a little bit on the second.
Jeffrey W. Henderson
Yes. Just to fine-tune the figure that you quoted, Eric, I think what we said most recently is the preferred products make up about 23% of the medical segment revenues.
That was exclusive of AssuraMed. I would say in the recent quarters, that number continues to creep up as we begin to fully integrate AssuraMed and use our product portfolio and sourcing abilities to drive some of our products -- medical products through AssuraMed.
Hopefully, that percentage will increase as well. But I would say it's still generally around that 23% level, perhaps, a little bit higher based on the last couple of months.
George?
George S. Barrett
Yes, and, Eric, on the broader question, I think we'd concur with the observation that you heard, which is that there is a growing awareness that part of what we see in medical devices is relatively commoditized. And there's a lot of attention throughout the health care system looking at what they call the physician-preferred items.
So again, the providers are under tremendous cost pressure, and so our ability to bring them cost-effective alternative is really important. For us, the starting point has been orthopedics, and particularly in the trauma area.
So we're talking about things like cannulated screws and drill bits and guide wires and then supporting services that complement that. That's been part of our initial launch, again, in collaboration with EMERGE, which we launched about a year ago.
So that's going very well. We're getting a lot of really positive response from customers.
So again, I think we'd concur with that observation. And I think this is going to an ongoing trend if you think about, again, where that bar sits on physician preference items, and, obviously, we're talking very regularly now with our health care system partners on this.
Operator
Our next question comes from Lisa Gill of JPMorgan.
Lisa C. Gill - JP Morgan Chase & Co, Research Division
I just had a couple of follow-up questions. First, George, you talked about CVS and a long-term partnership.
Is there any changes in your new contract versus what services you provided them before?
George S. Barrett
Yes, Lisa. We're going to be somewhat limited as to what we can say regarding that relationship.
I would say that we have a very deep and broad relationship with CVS Caremark, and we're really excited about continuing that. So the exact dimensions of that, the exact lines of business, we can't fully share, but we're longtime partners, very, very creative in looking to each other to find ways of creating value.
Lisa C. Gill - JP Morgan Chase & Co, Research Division
And then you also made a comment around scale because, clearly, the street has been very focused on this whole idea of scale and what the new Walgreens, Alliance Boots, AmerisourceBergen relationship brings. Do you believe that you need to have some kind of international partner in order to gain scale?
And maybe can you just talk from your point of view how manufacturers look at this? Is there a point of diminishing return that you're at a certain size and this is the discounts we're willing to give and if you're 10% bigger than that, the -- it's not 10% incremental savings.
How do I think about that?
George S. Barrett
Yes, Lisa, that's a really good question. There's a lot in that one, and I'm going to be somewhat careful in my reply.
Here's what I would say, again, scale has to be actionable, very important. So again, having lived on the manufacturer's side, I'm really looking for someone who can do the job for me in market, and that's a really important dynamic.
So this has different dimensions on the branded side and on the generics. So on the branded side, what I'm looking for is manufacturers to make sure that my partner can represent my products and get them in and into patients the most cost-effective way.
On the generics side, it has a little bit of a different dimension to it. But again, as I said and I think this is really important, our scale today is really significant, and so, again, I would say this, I've learned over a lot of years never to be dismissive of a competitor or another industry move.
That's not a smart thing to do, but we've studied this pretty carefully, and we feel very comfortable with our scale, our ability to work with a global system and our ability to make markets for our customers. So obviously, we'll be staying close to this and it's early days.
Operator
Our next question comes from Tom Gallucci of Lazard.
Thomas Gallucci - Lazard Capital Markets LLC, Research Division
I guess I had 2 questions in the MedSurg area. Firstly, you mentioned the positive impact of commodities in the quarter after it had been a little bit of a drag in the last couple of years.
How do we sort of line up, Jeff, on a year-over-year basis as we think about the next few quarters? And then the other question was just around reform.
Obviously, you mentioned the medical device tax, but, George, just curious if you had any comments about how you're thinking about the impact of reform on that market? Do you expect volume acceleration or any other things that we should be thinking about?
Jeffrey W. Henderson
Tom, it's Jeff. Thanks for the question.
I'll go first and then turn it over to George. Yes, so for Q4, we expect the positive impact from commodity prices to be relatively small.
Current estimate's sort of in the 4-ish million-dollar range of positive impact year-on-year in Q4. Then heading into next year, based on forward curves of the various chemicals that we buy, et cetera, it's a slight negative, a slight headwind next year, but we're probably talking in the 10-ish million-dollar range.
So at this point, not a huge swing factor. Obviously, that could change quickly, particularly based on where oil prices move, but again, right now, it's about a $4 million positive impact in Q4 and next year, it's like negative to the tune of maybe $10 million or so.
George S. Barrett
Tom, I'll jump in on the second one, which is a little bit harder to answer related to the Affordable Care Act and how that's unfolding. Here's what I would say to you, we're not building into our models additional volume.
That doesn't mean that it may not happen or it's not likely to happen. We just, at this stage, do not know how to model that.
There's a lot of issues still in front of us on the roll out of the act. Obviously, 2014 is a key year.
We're going to have to see how the exchanges are playing out, and how that access issue really plays out. And so for us, I think we just felt it was more cautious just not to model-in any additional volume based on it, but, obviously, we'll be staying very close to it, and as you can imagine, we're quite active in Washington.
Operator
Our next question comes from Ricky Goldwasser of Morgan Stanley.
Ricky Goldwasser - Morgan Stanley, Research Division
I have 2 follow-up questions here. First of all, on CVS, I understand you can't provide much detail.
But just to clarify, you said that the impact from the renewal is embedded in the implied guidance for fourth quarter, and then is it also included on your fiscal year '14 initial target of being at the high end of the $3.42 to $3.50?
Jeffrey W. Henderson
Yes, Ricky, it's reflected in both.
Ricky Goldwasser - Morgan Stanley, Research Division
Okay. And when we think about the -- just the sequential delta between the -- what you reported in the third quarter versus the fourth quarter, obviously, you have kind of a brand price inflation benefit there, et cetera, but should we think about that sequential step down as CVS, as part of it as being CVS, and can we just take that and factor it into '14?
Jeffrey W. Henderson
Again, I'm always a little bit hesitant to get too specific on pricing with any particular customer, but yes, the repricing that we put in place for CVS does take effect April 1 and you can assume that continues into FY '14 at about the same rate. Now obviously, you're focused on CVS.
There's lots of other factors into our Q4 numbers and next year's numbers, but with regards to that specific one, I think you got the answer.
Operator
Our next question comes from Glen Santangelo of Credit Suisse.
Glen J. Santangelo - Crédit Suisse AG, Research Division
George, just 2 quick ones for you. First, looking at the industry over the last 18 months, there's clearly been a lot of noise on the contracting front, and the market seems to be very nervous with each sort of -- with these situations.
And while I get it, there seems to be a unique story around each one of these contracts in kind of why they're moving. Is there sort of a bigger picture conclusion that we should be drawing because, clearly, it follows a very extended period of time where we never have these conversations?
And so if you can give us your assessment of the pricing environment, and is there anything sort of significant in your book coming up in the next year or 2 that you're focused on, that would be helpful.
George S. Barrett
Yes, Glen, let me -- the second part, the last part of it, there's nothing that we would call out in the near-term horizon. Going back to your beginning observation, here's what I would say, I'm not sure I completely agree that this is not a conversation that's happened before, and again, during my tenure here, big contract renewals get big attention, and we understand that.
So I don't think I would say -- now obviously, there's been a big industry move in these last few months, so let's not dismiss that. But independent of that dynamic, I'm not sure I would characterize the market as materially different.
It is true that, actually, every contract has discrete characteristics, very unique terms, lines of business. So for us, contracts like CVS Caremark and Walgreens were very large contracts.
I think it's understandable that they would get a lot of attention and -- but I would not say that, that alters the day-to-day dynamics that we see in the marketplace, if that's helpful.
Glen J. Santangelo - Crédit Suisse AG, Research Division
Okay. Maybe if I can just ask one follow-up on AssuraMed.
It kind of sounds like you're very positive on the fundamentals with the demographic shifts, et cetera. It also sounds like the integration's going very well, but from the market's perspective, I think there's been some incremental concerns that potentially this acquisition exposes the company to some different sort of regulatory or reimbursement environment that it hasn't had that historical exposure.
And so I'm just kind of curious if now that you've been living with the acquisition for a little bit, is there a way that you can sort of sum up what you think the potential reimbursement exposure is, whether it be competitive bidding or more direct government reimbursement? And how should we think about that risk when thinking about the growth of this acquisition?
George S. Barrett
Sure. Yes, Glen, as you can imagine, when we did our analysis, we thought very carefully about the dynamic around reimbursement, and we adjusted for that in our modeling as we approached this business.
That's number one. Number two, our exposure on diabetes, DNE, for example, is very limited.
So this business has very carefully positioned itself to limit exposure in areas that were particularly heated, and we feel very good about our positioning there. Again, it's an opportunity to really be in a market-leading position in a segment that we know is going to grow and we're going to have to be very, very efficient doing our work, but I would say, today, our exposure to those dynamics are somewhat limited.
Operator
Our next question comes from Ross Muken of ISI Group.
Ross Muken - ISI Group Inc., Research Division
George, it's obviously been a bumpy last 6, 7 months or so and that comes off of a period where you did a lot of transformational things for the business. As we think about sort of what AssuraMed brings now to the asset group and sort of how the mix, at least, on a profit basis is sort of shifting, I realize you're still have a very big, very powerful profitable Pharma business, but the complexion of the asset seems to be going in sort of the opposite direction and just in terms of where, at least, you're looking to acquire.
And so when we think about Cardinal going forward, I mean, do you feel like the historical view of what this asset was is still kind of what the future view is going to be? Or do you feel like we're moving into some of these growthier maybe higher-margin areas, and so the mix and complexion over time is probably to change?
George S. Barrett
So, Ross, a really good question. For me, this not about going in the opposite direction.
It's not a departure from a business. It's sort of a turning of the wheel a little bit, an expansion of business.
We are very proud to have a market-leading distribution business. It's an important anchor for us in the Health System.
It allows us to touch every part of the system and we'll continue to invest in it and make sure it's vibrant and healthy. Having said that, we do think that there's evolution in markets, and it's very important for us to evolve with it and, ideally, ahead of it to see what's in front of us.
And so the decision to move into the AssuraMed business really was thoughtful, and it wasn't just about an exciting healthy business. It was about direction of the market that is inescapable that care is going to be shifting.
We want to be in a position to deliver our products and perhaps services into those markets. Our business of distribution today is heavily wrapped in a service component.
So I'm not -- I wouldn't describe this as a departure or moving in the opposite direction. We've seen ourselves, and I think you've heard me describe this, as a broad-based health services company.
I will continue to articulate it in that way, and we're excited about the movement, but we're very keen on driving our core business and making sure that we're doing a good job for our customers.
Ross Muken - ISI Group Inc., Research Division
Yes, I'll ask this in sort of in a delicate way. If you look at the stock price, it's obviously been flattish now for some time, and I'm sure you're kind of disappointed with sort of the performance, but a lot of it is actually sort of a compression in the multiple versus your peers.
And so as you think about sort of what the market is implying on your future growth despite the fact you've sort of raised the dividend consistently, which has sort of been a positive bias for the market, what do you think the disconnect is? And when you sort of look forward to the kind of growth profile of this asset now that we've gotten through this period of kind of customer attrition, once we get past that difficult '14 comp, how do you think about sort of the free cash or the free cash potential or sort of the growth potential of the pro forma asset once we get through that?
George S. Barrett
So let me try to go back to the beginning. It's always tricky to be commenting on how people view your stock price, so I'll give it some care, but here's what I'd say.
There's no question that it has been a very noisy last 6 months with large customer renewals, and as you know, an extra ordinary amount of chatter about how that was going to play out or not play out and some big industry moves. So we understood that, that affect has affected the way people saw us for a while.
We now are through that period, and, as I said towards the end of my comments earlier, our track record at this point is pretty clear and the progress, I think, has been pretty consistent. We are very optimistic about the future and positioned really well to drive value in a system unfolding in a lot of different ways.
So as I said, the last 6 months have certainly been -- or 9 months have certainly been noisy around these industry events and certainly around our renewals. But I feel very excited about our positioning in medical business, around China, around our generics offering, about our growing position in specialty and around the opportunity now to bring value to the home.
We have a unique value proposition to our customers and our ability to touch so many products, so many lines of business and so many of those channels is really important. So I feel very good about that and I'll leave it with that.
Operator
Our next question comes from Rob Willoughby of Bank of America.
Robert M. Willoughby - BofA Merrill Lynch, Research Division
George, can you possibly speak to some of the opportunities you see to expand AssuraMed sales channels? Can you do more with the CVS, and is the Walgreens maybe out of the picture in this respect?
George S. Barrett
Bob, so again, I'll be a little bit careful about what we can do with whom. I will say this, the business we acquired has performed very well.
We're excited about it, but we also see this as a platform. We have already been working in areas -- for example, our oncology team is in offices.
Those offices needs support and medical supplies. We're able to think about how to link that together.
We're in urological offices. We have to then be able to follow that patient to the home with supplies.
So we see the opportunity to link into our specialty business. We see the opportunity to support our retailers, many of whom have loyal customer followings that need products in the home and they use us for fulfillment.
We see products expansion opportunities here. And so we do see it as more of a base.
Now, our early priority right now is making sure the integration is going perfectly and that we're executing, but we see this probably in bigger dimensions than the business that we acquire.
Operator
Our next question comes from Charles Rhyee of Cowen and Co.
Charles Rhyee - Cowen and Company, LLC, Research Division
Another question on the medical, I think, last quarter, Jeff, you called out, I think it was a $5 million in prior period gains recorded in the quarter. Can you give us an update?
Was there any type of prior period adjustments that were recorded here in this quarter? I'll start there.
Jeffrey W. Henderson
Yes, thanks for the question, Charles. No, there were no out-of-period adjustments of any note in our Q3.
I think we cleaned up most of the issues we needed to in Q1 and Q2. As we sort of went through the implementation and went back to make sure that everything was ticking in tying exactly right, there was a little bit of clean up in Q1 and Q2.
But at this point, I believe that's behind us so there were no further adjustments in Q3.
Charles Rhyee - Cowen and Company, LLC, Research Division
Okay, great. And then on the distribution side, obviously, a very strong performance in the margin, much better than we had expected in the growth -- sorry, EBIT growth.
All of your competitors have talked about tough sort of generic comps, given last year. You had Zyprexa and Lipitor.
I mean, is that -- did you face that same sort of tough comp issue there? And what were some of the things that helped you kind of get over that?
George S. Barrett
Yes, I'm sure we did face many of those same issues, and from a generic launch perspective, this Q3 was less than last year's Q3. But I think the fact that we still grew generics 11% and posted the type of profit performance and margin expansion that we saw in Q3 is a testament to the strength of our overall generics portfolio and the Pharma Distribution business.
As we've often said, clearly, we have to try to forecast generic launch impacts, et cetera, et cetera, but the goal here is not to rely on the launch impact. It's to build a large, growing, sustainable generics business that can drive value well beyond initial launch period for a generic.
And I think you're seeing an example of that in our Q3, where our sales performance, our penetration, our generic sourcing efforts are all contributing to a very robust portfolio that can sustain growth even with the ups and downs of generic launches.
Operator
Our next question comes from David Larsen of Leerink Swann.
Chris Abbott - Leerink Swann LLC, Research Division
This is Chris Abbott, in for Dave. I'm looking at your pharmaceutical operating margins and you obviously posted some strong growth this quarter.
As we think of the large customers rolling off, you've now transitioned Express Scripts and you've obviously got Walgreens coming up next year. Does that take a few quarters to kind of fully optimize the expense structure?
I mean, was there more sort of benefit to the margin this quarter than last or was it really more about generic launches?
George S. Barrett
Yes, I would say -- if you're talking specifically about Express Scripts, I would say there was very little, if any, incremental expense impact, operating expense impact, in Q3 versus Q2. We had largely made whatever adjustments we needed to make in the Q2 period so that was not a driving factor in Q3.
Regarding Walgreens, clearly, until the contract ends, we will service that business to the best of our ability and would never take any actions to jeopardize that. Obviously, once that runs out at the end of August, we'll begin taking the necessary actions to reduce the variable expenses associated with that and then certain fixed expenses in the company as well.
But that will happen beginning after August 31 and you'll see the impact of that, really, in Q2 of next year.
Operator
Our last question comes from George Hill of Citi.
George Hill - Citigroup Inc, Research Division
Kind of following up on the generic -- I'm sorry, on the drug distribution performance in the quarter looks pretty strong. Can you -- when you think about the margin improvements, can you give us any color on how much of it was performance in the generic programs, how much of it was customer mix, how much of it was just underlying business mix, brand versus generic, that kind of led to the improvement?
Jeffrey W. Henderson
Yes, I'm not going to break it out specifically. I would say it is across the board.
I think the generics performance and performance under our branded contracts, excluding the volume impact, those are the 2 biggest factors that we called out and they drove the biggest year-on-year improvement. But I would say everything you mentioned was a factor.
Obviously, not having Express Scripts versus last year improves the margins just given the size of that account and the relatively low margin nature of the bulk business. I would say -- but even beyond that, our overall customer and product mix has continued to improve.
So they all drove it, but the 2 biggest factors were generics and branded margin.
George Hill - Citigroup Inc, Research Division
Okay. And then, George, just maybe a strategic question.
I suspect with given some of the changes that are going on in the market, we're going to hear about volatility in the channel, in the highly profitable independent pharmacist channel. Can you talk about the stickiness of those customers, especially as we think of who's the real independent and who's the franchisee of the 3 large wholesalers?
I don't think the franchisee guys are not likely to bounce around a lot. The independents might be more likely to bounce.
I guess, can you provide us a little more color into that market, especially the franchisees versus the non-franchisees?
George S. Barrett
Yes, George, it's a good question that requires, really, some segmentation. This is a very large pool of customers and what we've learned, and part of the reason I think we've gotten better at serving them, is to recognize it's not a one-size-fits-all.
You have some independent pharmacy and pharmacy groups that really have tied in closely to your services. They see high value in them.
We're a very, very close partner and stickiness is quite high. There are other parts of the market that are much, much transactional...
[Technical Difficulty] Yes, guys, I think we reconnected, and for those of you who are still on the call, George Hill asked a question about the independents, and given the dynamics of the market, how do we see that playing out and a little bit about the stickiness. And my observation was that this is a market that actually has many subcomponents and part of the reason, I think, that we've done very well in recent years is to understand that, is to target the unique needs of different sub-segments of the independent market.
So some of them work as groups of independents, with high service requirements. We're very targeted to addressing those needs, and then there are independents that tend to be -- move much more frequently.
I would say we've experienced very good stickiness in our customer base of independents, and I think the better that we do of understanding the unique needs of each of those independents, the greater the stickiness is. I would also add that things like the acquisition of AssuraMed, that allows us to go to them with yet another service offering to say, "Look, we can help you do fulfillment with your patients who need products in the home."
That just enhances our value proposition with them. So again, we feel very good about the stickiness here.
But again, I would argue that there are subsets inside that large group of independents and, hopefully, that answers it. And hopefully, some of you are still on the call.
To the extent that you are, I thank all of you for being here and look forward to seeing many of you at the upcoming conferences. Have a great day.
Operator
Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program.
You may all disconnect. Everyone, have a great day.