Cardinal Health, Inc. (CAH) Q2 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Cardinal Health Second Quarter Fiscal Year 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Sally Curley. Ma'am, you may begin.

Thank you, Shannon, and welcome to today's second quarter fiscal 2013 earnings conference call. Today, we will be making forward-looking statements. The matters addressed in these statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected or implied. Please refer to the SEC filings and the forward-looking statements slide at the beginning of the presentation found on the Investor page of our website for a description of 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 would also like to remind you of a few upcoming investment conferences and events in which we will be webcasting, notably, the Leerink Swann Global Healthcare Conference on February 13 at 10:30 in New York; the Cowen & Co. 33rd Annual Healthcare Conference on March 5 in Boston; and the Barclays Global Healthcare Conference on March 13 in Miami. 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 you at one of these upcoming events. Now I'd like to turn the call over to Cardinal Health's Chairman and CEO, Mr. George Barrett. George?

Thanks, Sally. Good morning, everyone, and thanks to all of you for joining us on our second quarter call today. We've now completed a strong first half to our fiscal 2013. Total revenue for the second quarter was $25.2 billion. Although this represents a decline of 6.8% from the prior year's period, it was not unexpected given this past year's brand-to-generic conversions and the movement of the Express Scripts contract. Most important, our focus on value generation for our customers and our continued attention to portfolio, product and customer mix, along with disciplined performance management by our people, resulted in year-over-year growth in non-GAAP operating earnings of 10.6% to $525 million; non-GAAP EPS of $0.93, growth of 15%. Based on our results for the first half of our fiscal 2013 and the way we see the balance of the year, we are now guiding to the upper half of our prior guidance range with a new non-GAAP EPS range of $3.42 to $3.50. Stepping back for a few moments from the quarter just passed, this really is an extraordinary time in healthcare. It seems clear that powerful forces, specifically the aging of our population, public health challenges and legislative actions to improve access to care for those who've lacked adequate care, will drive long-term demand. It is also clear, however, that unless we can approach things differently as a system, the cost of providing care will present overwhelming economic challenges. While I am largely describing the U.S. phenomenon, this is true throughout the world. It is in this context that our Essential to care tagline is more than a slogan. It drives our strategy and the motivation of our people who serve our customers and drive our performance. Cardinal Health not only represents an essential, seamless and highly-efficient system for…

Thanks, George, and good morning, everyone. Today, I plan to cover the drivers of our second quarter performance and key financial trends, and then make a few comments on our full year outlook. You can refer to the slide presentation posted on our website as a guide to this discussion. Let me begin by saying I'm extremely happy with our strong 15% second quarter non-GAAP EPS growth. This keeps us well on track to achieve our full year goals. As George mentioned, with 6 months completed, we feel good about tightening our guidance to $3.42 to $3.50 per share; over the top half of the previously provided range. Now let's move quickly to the income statement, starting with revenues. As we expected, and consistent with our overall guidance, consolidated revenues were down almost 7% to $25.2 billion due to the nonrenewal of the Express Scripts contract and the continued Pharmaceutical brand to generic conversions. Second quarter EPS growth was driven by 11% non-GAAP operating earnings growth, a slightly better tax rate and a lower share count versus 2012. Gross margin dollars increased 10% with the rate up 74 basis points versus prior year. SG&A expenses rose 9%, driven by recent acquisitions which were worth about 2 percentage points of this growth; an increase in IT cost, much of it related to our Medical Transformation; and investments in certain key strategic priorities, including Cardinal Health China. Our consolidated non-GAAP operating margin rate increased 33 basis points to 2.08%. Interest and other expense was essentially flat to last year as a change in the value of our deferred compensation plan was largely offset by increased interest expense. Our non-GAAP tax rate for the quarter was 36.8%, which is 1 percentage point lower than the prior year's quarter but in line with our…

[Operator Instructions] Our first question is from Ricky Goldwasser of Morgan Stanley.

Jeff, you mentioned that second half guidance includes some assumptions regarding contract renewals, so can you provide us with an update on the status of Walgreen and CVS contracts and where are you now in the process?

Let me start off there. Ricky, thanks for the question, and then I'll turn it to George to make any comments as well. First of all, with regards to my comments about assumptions for contract renewals, as we've always said in the past, we start out each fiscal year -- we do make certain assumptions in our forecast, in our plan related to renewals of contracts, and that's true for both the Pharma segment and the Medical segment. And as part of that, we also make certain assumptions regarding which contract may or may not get renewed early, what the pricing may be on those contracts, et cetera, and that all goes into the total set of assumptions that goes into our forecast and plan for the year and obviously, into our guidance as well. So that's standard procedure not only for this year, but every year in which we are facing contract renewals. Regarding the specific status of the Walgreens and CVS contracts, obviously, it's going to be difficult for us to comment there, but let me just turn it to George to...

Yes. Ricky, there's very little to say at this stage. What I can say to you is that, as you know, the timing is not in our hands. But I would say that just based on the expiration date of the contract and the typical sequence of things, we would expect that during this March quarter, we would get a good indication as to how this would go. Of course, it's unlikely that we'd be announcing anything until contracts are signed, but that's just sort of a lay of the land, but beyond that, it's hard to provide a lot of additional color.

Okay. And then one thought on the comments about the March quarter and the generic comparisons. So obviously, this quarter you've shown, at least based on our back of the envelope, very nice step-up in gross profit for the Distribution segment. When we think about that, taking in mind the generic challenges but also kind of like the fact that historically, March quarter was better due to the seasonality of branded inflation, can you quantify for at what percent of that kind of like uptick in gross profit is -- would be sustainable into the March quarter?

Ricky, I'm not sure I fully understand your question. What I will say, though, is that we do expect a negative compare in Q3 related to the specific issue of the value from new generic launches. Again, as a reminder, Q3 of FY '12 was a fairly phenomenal and unique period with respect to new generic launches because we had 2 very, very large branded products, Zyprexa and Lipitor, that were still in their 180-day exclusivity period and obviously, that was very beneficial for us and the other distributors from a profitability perspective. If you fast-forward a year now, those products are now off exclusivity so you would expect that they will be contributing less to our bottom line, considerably less to our bottom line than they were last year. And as I said, the overall comparison of value from new generic launches, Q3 this year versus Q3 last year, is a negative. So that's probably the one thing I could call out for Q3. Regarding the broader question, again, we don't generally give Q3 guidance, so I'll probably have to stay silent on that, Ricky.

But just to clarify, I think you've spoken about it in the past, but when we think about generics, we think about it as the contribution from new generics but also the generic penetration rates. So I guess the question is, are the generic penetration rates that you've seen year-to-date, should we assume that they are sustainable going forward and should serve as a headwind?

Ricky, let me just sort of comment, and it'll be probably a little more general than you'd like, but that's the way I'll need to keep it for now. So our generic programs are going very well. Our penetration rates are high. Overall utilization in the system is very high. Those pressures that are driving systemwide utilization are not declining and that's all good news for us. And you've probably heard me say this, obviously, the launches are important to us, but we really focus on the notion of value creation throughout the lifecycle of the generic drugs. As you know, that can be a pretty long -- large cycle, so we feel pretty good about where we are and we expect to get continued, real value from our generic programs.

Our next question is from Lisa Gill of JPMorgan. Lisa C. Gill - JP Morgan Chase & Co, Research Division: I just had a couple of questions on the medical side of the business. I think, George, you made some comments around investing in growth areas for med-surg, and I really had 2 questions. One, can you maybe talk about some of the investments that you're making on that side of the business? And then secondly, a question for you, Jeff, would just be around the margins. If I look at your comments on commodities and if I were to back that out and look at year-over-year growth, it doesn't look like margins are really expanding on the med-surg side of the business. Can you maybe just talk about what you're seeing underlying from a competitive standpoint?

So Lisa, why don't I start -- excuse me, Lisa, why don't I start and then Jeff can pick up. So generally speaking, the focus of our medical business has been extending our footprint, which we've been doing, as you know, trying to make sure that our positioning in the ambulatory centers are in the best position possible. We've done, I think, better on the surgical centers than we have in the physicians' office, but I think that area was affected probably most by the conversions we referenced in Q1, and investing very heavily in the preferred products program. We really do believe that this is a long-term value creator for our customers and for us. So those are the 2 areas that I would highlight as we look at the medical benefit and real focus areas. Jeff, do you want to touch on the second part? Lisa C. Gill - JP Morgan Chase & Co, Research Division: Wait. Before you touch on that, Jeff, if I think about this, George, that should be much better margin business as we go forward because, one, your preferred product has a better margin; and two, generally speaking, ambulatory or physician has better margin than the hospital. Is that the right way to think about it?

I think in general, if you look at our priority areas, they tend to be positive to mix. Remember, I talked to you about our focus on not just efficiency but on portfolio mix, and I think what you're saying is largely correct. Lisa C. Gill - JP Morgan Chase & Co, Research Division: And can you give us any idea of how quickly -- what your expectations are over the next couple of years? Do you have growth targets of expansion for private label, as well as ambulatory that you can give us an idea of how to think about this, or is it too early in the process?

It's a bit early for us to give firm goals here externally, but you'll probably hear more from us, Lisa, about this as the program unfolds. But we have internally aggressive targets for growing these areas. We think they really are valuable to our customers. And as you said, they also tend to be margin-accretive to us.

Lisa, I will remind you, at our Investor Day a few years ago, we did indicate that our goal in the medium term was to get preferred products to 30% of our segment revenue. Currently it's in the 23%, 24% range. Obviously, with Don on board, we're continuing to look at our strategy and his focus and efforts to accelerate the preferred products have been considerable, and we expect to continue to drive very aggressively on that front. Regarding your question on margins, I would say there were a number of factors driving margins both up and down in the quarter. I'd say on the positive side, clearly, commodities were a positive benefit, which was good news. After 2 years of facing the headwind, it’s nice to have a bit of a tailwind behind us in that regard. Secondly, I'd say preferred product mix within the overall sales contributed to margin. And then the performance of Canada, including the integration of Futuremed, was a positive. On the negative side, we face the normal competitive environment in terms of pricing, and I would say, nothing to notable to note there other than always, our customers are looking for increased efficiency. Secondly, I'd say there was a slight negative impact from customer mix and that was just more a consequence of who bought what during the quarter. And then the third one, which I will highlight again, is really the impact of utilization. That has several impacts on us as you would expect, but probably most notably, particularly when procedural utilization is down, whether that's inpatient or outpatient, given that the large majority of our preferred products tend to be used for procedures, if we're facing a relatively stagnant utilization environment, that limits our ability to maximize the sales of preferred products. So overall mix in the quarter was probably not what we would have hoped if utilization would've been a little bit more robust.

[Operator Instructions] Our next question is from Robert Jones of Goldman Sachs.

Jeff, just a follow-up on the medical guidance for the operating profit. It sounds like you're still calling for double-digit growth there this year. If I -- even if I include the $5 million out-of-period adjustment, it looks like maybe year-to-date, year-over-year, you're up a couple of percent. Is there some catch-up we should be thinking about in the back half? Is there a benefit catch-up from MedTrend or something else, a tailwind in the back half that can get the back half significantly above year-over-year double digits to make the full year double-digit growth there?

Yes. Great question, Bob. A couple of things I'd point you to. Number one, we'll continue see benefit of commodity prices in the second half of the year. Some of the positive boom that we saw, particularly in Q1, really starts to flow through the income statement in Q3. Assuming we don't see a dramatic movement in rates for the next month or 2, for the second half of the year, commodities will be a significant positive. The second thing I'm going to point to is what you referred to as -- we do expect the benefit from the Medical Business Transformation to continue to accelerate over the course of the year. As we said before, we got a little bit delayed by 3 or 4 months at the beginning due to some change management issues, but we're still very much committed to ramping up the benefit each and every quarter and so, as we would expect, net-net, the benefit to be stronger in the second half of the year. And I would say the continued efforts to drive preferred products, et cetera, they should continue to manifest themselves in our results as well. So those are all positive drivers that we expect, not only for the second half of the year, but beyond. I would say slightly offsetting that, we do have the medical device tax which, although it's lower than we were probably forecasting at the beginning of the year, it's still a negative this second half. And then there's still the uncertainty regarding utilization that -- it has been pretty sluggish in the first half of the year, and how exactly that plays out over the next 6 months remains to be seen. So I would say those are the major moving factors for us as we look at the second half of the year.

My follow-up, Jeff, actually would just be around utilization. It seems like, listening to some of the medical device manufacturers and some of the larger hospital providers this quarter, it sounds like they're actually seeing a slight pickup in elective procedure volumes, into year-end specifically. I mean, did you -- you guys are obviously still very much calling this a very sluggish environment. I mean, did you see anything even directionally sequentially that would indicate that things are picking up? Just trying to reconcile some of the updates that we've gotten across the utilization front this quarter.

Yes, Bob, it's George. Here's what I'd say, it would even be hard to call it utilization trend. Utilization is unbelievably choppy and it -- depending on the month, the setting, and the source of the data, so even sample size on some of this data is quite variable. So we have not seen what I would say is a discernible pattern. We will see a spike and look with enthusiasm in the next months will roll back again. So we've not been able to yet discern a trend, although there certainly have been periods where it looks like it's picking up but then we've not seen a sustained -- sustained trend.

Our next question comes from Glen Santangelo of Credit Suisse. Glen J. Santangelo - Crédit Suisse AG, Research Division: George, I just was kind of curious about some of the comments you made in your prepared remarks regarding generic pricing. You seemed to suggest that in your fiscal first quarter, you saw some very healthy or unusual year-over-year inflation and then that trend reversed in 2Q to more typical rates of deflation. I was wondering if there was anything sort of behind that move or anything we should be thinking about in the back half of the fiscal year as far as generic pricing may be concerned.

Great. Thanks, Glen. Here's what I would say about pricing. Jeff really touched on it. The swing from inflation and deflation was largely a product of this year-over-year lapping of those key product launches and that which resulted in the loss of exclusivity. I would say in general, generic pricing has not changed materially since we last spoke the last quarter. So this was largely as expected; I would not describe any material change. Glen J. Santangelo - Crédit Suisse AG, Research Division: Okay. So maybe if I could just ask one more. In the press release, you seem to suggest the profit from the Medical Business Transformation was negative. This process has been going on for several years now and I'm kind of curious, I mean, can you give us a sense for how much additional money do you think you need to spend on this process? What steps are still necessary? And what do you think the timing is going to be to sort of complete this process?

Just as a reminder for everyone on the call, we went live with the Medical Transformation on February 1, and since that point, particularly through the first quarter of this year, we were in the process of getting used to the new system and getting our customers and suppliers used to the new system, and that really is the change management process that we referred to earlier. So it's really been, in Q2 of this year and beyond that we've been able to focus on beginning to really utilize the value the system brings to us and our customers and our suppliers, and getting back to selling products as opposed to getting used to the new system. So it has taken a period of time to get through that, but as George alluded to in his comments, we do believe that we're largely through that process and back on the upswing. Regarding incremental spend, I would say the vast, vast majority of the spend on these programs is behind us. Are we still spending a couple of million dollars a quarter to fine-tune the system? As you would expect at this stage of implementation, yes. There are certain things we're seeing that could be improved, there are certain things our customers are asking for to improve their interaction with the system, and we're making those continued investments to ensure that this system is as robust as possible. But in the scheme of things, those expenditures are very small.

Our next question is from George Hill of Citigroup.

Jeff, just a point of clarification, a follow-up on Ricky's question. Did I hear it right that we're expecting operating profit in the drug distribution segment to be down and margins to be down year-over-year due to generic comparisons?

No. What I said is in Q3, the value from new generic launches will be lower in Q3 within Pharmaceutical Distribution than it was last year. And that's really a comp issue in that last year's new generic launches were fairly unique and quite phenomenal from a contribution perspective. But that speaks just to the value of new generic launches. As we've said before, generic profitability in total is driven by much, much more than just new generic launches. It's driven by our penetration of existing accounts, our new accounts, our ability to continue to supply better. And regardless of how the year-on-year compare for generic launches necessarily looks, for this full year, we would expect the overall profitability of the generics to be a materially positive in total.

Okay. And then just a quick follow-up in MedSurg, with respect to the most recent restructuring announcement, as I think about just the cash component of that and the employee severance, assuming the company isn't paying severed employees in multiple of their current salary, for fiscal '14, that $33 million figure, probably that figure or greater, you should think about as kind of a earnings accretion component for fiscal '14? Am I thinking about that right?

Yes. I'm not going to get into the specifics of that. That's something we'll cover when we give our guidance for next year. But I will say that some of that severance represents net headcount reduction. But in other cases, it's a relocation of employee headcount. So we are moving some of our production particularly our kitting production, to lower-cost locations. So I would not necessarily say all those employees are going away. They're probably, net-net, we are reducing some employees, but it's really about an overall reduction in product costs related to efficiency of operations and location of production.

Okay, so that $33 million is not like a net salary reduction?

That's something I would comment on -- that's correct. And like I said, we'll talk about the savings when we give guidance for next year.

Our next question is from Charles Rhyee of Cowen and Company.

Maybe moving over the pharma side a little bit here and getting to nuclear, and obviously, you talked about the procedure volume being soft. Can you just remind us, what procedures have cardiologists been using currently if they're not using nuclear imaging? And why would the procedure volumes necessarily come back at this point if they're managing without it?

So, yes. It's an interesting question and I think it's a somewhat interesting systemic question. I think there probably has been some petty oversight when you look at the payers as to how procedures are done, how frequently they're done, what is the pathway that should be followed as it relates to doing procedures. And we're seeing that probably is happening all around healthcare right now. So I think, in general, this is still the tool used, but it's a question of when it's used, at what stage, and I think that's probably what we're seeing. That's why we'd expect, if there's some correction in the system going to the issue of maybe excess utilization, and we're probably seeing this in other areas of imaging, then we might see some correction. I would expect that at some point, we would see a recovery based on the normal demand, based on what's actually happening in cardiac disease.

Okay. And then maybe one follow-up question on the Pharma side, I know you guys just mentioned that the generic, you have a tough compare on the generics side. But one of your peers talked about a brand manufacturer sort of inflation benefit getting pushed into the March quarter. Based on your fee-for-service contracts, do you expect something similar to that?

So again, we're not going to guide by the quarter, but I think what I'd say, generally speaking, is that branded price increases have been relatively robust for our year-to-date. So we won't guide as it relates to what's happening in our Q3 or Q4 specifically. But generally year-to-date, we'd say brand inflation has been relatively robust.

Robust and I'd say generally in line with what we've expected so far. We haven't seen any significant shift versus our expectations.

Our next question is from Ross Muken of ISI Group.

So on specialty, I know, again, we're coming off of a fairly low base, but it seems like the momentum in that business has kind of continued to you. I know it's been a big focus. Are you starting to see the types of wins or the places where you're having more success in terms of the profile of customer change? What's been the sort of network effect of sort of your increased presence there versus where you were virtually out of the market several years ago? How are you just thinking about the trajectory of how well you're doing in that piece?

Well, the trajectory has been good. I think for us, it's been important for us to build scale, which we've been doing. You've seen the growth rate. That was also important in terms of our -- solidifying all those relationships with the manufacturers. They want to make sure they're working with a partner that has good reach, and we've been able to accomplish that. I think our work has really been about expanding, not just that distribution reach but also the services work that we're doing in oncology, in neurology and some work in rheumatology. So trying to provide value drivers for those practices in combination with the work that we're doing in building out our distribution operations has been a good combination. But again, we still have quite a way to go, but progress is encouraging.

And in the China business; again, another area of strength for you. What are some of the new initiatives you're sort of pursuing in that market? Anything on the specialty end? And then where have we been from sort of a tuck-in acquisition standpoint in that region?

Russ, this is Jeff. As I said, we continue to be very excited about the performance of China and maybe even more excited about the future potential of the business. I'll answer your questions in reverse order. In terms of acquisitions, we have now completed the -- we have now signed 6 acquisitions since the original Yong Yu acquisition. So 6 in addition to Yong Yu. Four of those have closed, 2 of those are still in the approval process with the government. I would say all of those deals have been less than $30 million and some considerably less than that, because as I said before, it's not so much about buying large volume, it's about ensuring that we have geographic presence in the key population centers of China, which we view as about 25 locations that are critical to our strategy going forward. So that geographic expansion process continues to go very well, both through those acquisitions and through organic means. At the same time, as you referred to, we're looking to layer additional business models on top of our geographic channel. One of those is the direct-to-patient pharmacies that we've setting up. We now have 6 of those in the country. They're doing very well. And the number of products and the number of manufacturers looking to use those pharmacies to get the products to patients continues to expand nicely. So we're very excited about what we can bring to those pharmacies, which is integrity, compliance and our brand in a way that is very appealing to both the manufacturer and the patient. We also continued to expand our consumer health care business, and this is about bringing over-the-counter health care products mainly from Western manufacturers to retail pharmacy. Just given the nature of the retail pharmacy system in China, it's very difficult for manufacturers to get on the shelf sometimes and get promoted and we provide the opportunity through our distribution and merchandising network to bring products to customers through these pharmacies in a way that hasn't necessarily been possible for Western manufacturers before. So that's very exciting and that's ramping up. We continue to build our med device business. Again, it's somewhat different from our U.S. business given the nature of the Chinese market, but we're having great success dealing with med device and MedSurg manufacturers looking to get their products to market in what is a very complex supply chain in China. So these are all things that we're pushing forward very quickly and I think all have great hope for the future.

Our next question is from Steven Valiquette of UBS.

Just a quick question on the potential market share gains in various channels in U.S. Pharmaceutical distribution. So obviously in the U.S., there's one big PBM customer that was lost, there was one big supermarket retailer that was added. It's been talked about in the investment community. But without naming names, just curious, were there any other material customer wins in the U.S. that maybe helped drive growth in the quarter? Maybe you could talk about it by channel, whether it's retail GPOs or hospitals or whatever. Just trying to get a sense for any other noteworthy customer wins.

Yes, thanks. I would say there's probably not anything that would be noteworthy. Again, our concentration on a couple of key accounts, obviously, is one that people are well aware of. But obviously, our distribution includes whatever, 15,000, 16,000 other customers. And so I would say that the ones that you've highlighted are the ones that are worth noting on publicly. But by and large, nothing else that is moving the needle in some dramatic way.

Okay. Yes, that's helpful. I mean, all we're trying to compare some of the growth across all the companies in this particular segment and your growth was definitely pretty strong versus some of the peers, so I guess I'll just say congrats on a strong execution.

Our next question is from Tom Gallucci of Lazard Capital.

This is Colleen Lang on for Tom. Jeff, can you just talk about your priorities for capital deployment or use of cash for the remainder of year?

Yes. Thank you for the question. I'm not going to put it in the context of the remainder of the year because I think capital deployment is sort of a longer-term strategy. But I would say our longer-term philosophy really hasn't changed from what we've spoken about before. We view it as very balanced and somewhat opportunistic depending on the availability of cash and the opportunities we see in front of us. I think it starts with a commitment to a competitive, sustained and growing dividend payout which we've demonstrated over the past 9 months with a almost 27% increase in our dividend, which I think continues to put us really at the forefront of health care services company in terms of that dividend payout and yield. We're also committed to continuing to fund our organic capital expenditures which, this year, we've guided to being somewhere in the $210 million to $225 million range and most of that tends to be concentrated in the IT space. Beyond that, it really is an opportunistic determination between selective M&A and share repo. We are -- we'll continue to look for nonorganic opportunities to accelerate some of our strategic priorities as we've done in the past and we will continue to opportunistically look to buy back shares depending on the market and our share price and windows of availability, et cetera. In any given quarter, and perhaps in any given year, you could see some fluctuations in terms of the balance. So as you saw 3 years ago, we tended to be tilted towards acquisitions; for the past 2-plus years, we've tended to be tilted towards share repo. But again, that's based on opportunities and availability of cash. Overall, our longer-term philosophy hasn't changed.

Our next question is from John Kreger of William Blair. John Kreger - William Blair & Company L.L.C., Research Division: To the Pharma segment, it's a longer-term question. Can you give us your thoughts -- do you think you can hold or improve the EBIT margin where you're showing some great gains as you move into a period with lower new generic launches?

Yes, good question. But we really do believe that the margin expansion is a product of multiple parts of our strategy. Part of it is the way we've approached customer mix. Part of it is the way that we've looked at product mix, and particularly, the way that we've driven our generic programs. Part of it is our overall approach to efficiency and the services that we're providing and how we get compensated for those services. So in general, I would say the pattern has been pretty consistent over these past couple of years. Obviously, it's our goal is to continue. That direction of margin expansion is a high priority for us. We measure it religiously. But we're really doing it in a way that addresses customer needs and that's the key. So we've been encouraged at the progress and we really will continue to focus on this very heavily. John Kreger - William Blair & Company L.L.C., Research Division: Okay. And then a quick follow-up on Specialty, it sounds like you had very good revenue growth again in that segment. Can you just expand a bit more about what's driving that? Where are you seeing the best traction, which kind of disease categories, what kind of cross-selling are you seeing? Just any elaboration would be great.

I would -- again, I would say primarily, our work has been in -- oncology is where we've gotten the greatest traction. We have had some progress around neurology, which is a relatively new area for us. But again, it's not just the distribution for us. It's building out the technology services. The specialty space has some unique characteristics. Heavy clinical orientation, a bit more orientation around technology, and we've been investing on that. It takes time and it takes the right talent and we've also been building out the right team to do that. So I don't think I'd attribute it to one thing, but I think as you develop the services that enable the practice, it builds credibility. It's a small universe of physicians who talk to one another and we're just generally making progress there. Again, plenty of room to grow, but making good progress.

Just to build on that, as George said, I think right now the dollar growth is coming from oncology. But I would also say we're having great success in penetrating both neurology, as George said, but also rheumatology, and that's really about laying the platform for the future as we see future specialty drugs coming down the platform, particularly RA establishing a strong market share in that area and building on that is very important.

Our next question is from David Larsen of Leerink Swann.

Total revenue from China, is that around $1.5 billion now and do you expect it to continue to grow at a double-digit rate? And can you just comment on operating margins in China? Are those typically better than the book overall?

Yes, thanks for the question. Yes, we think we're at a run rate now of somewhere between $1.5 billion and $2 billion revenue for China. The margin rates do tend to be better than what we see in the U.S. and we expect that to continue over time. In terms of revenue growth rate, yes, we are very much expecting and driving strong double-digit revenue growth for the foreseeable future as we continue to build our presence there. So yes to all questions.

Okay. And then just real quick on the pharma division, the 34 bps of expansion year-over-year, that looks very, very good compared to what we were modeling. Any sense as to how much of that came from Express Scripts sort of rolling off the books?

Obviously, that was a factor and I don't want to get too specific about how much given the competitive nature of our pricing, et cetera. But it was a driver although I don't think was the most important driver for us.

Our next question is from Robert Willoughby of Bank of America Merrill Lynch.

Jeff, the inventory build this quarter was almost negligible relative to prior years despite a better revenue run rate than we were modeling. How much of that was Express Scripts and more generic's or other factors? And what kind of liquidation would you expect to see over the next couple of quarters?

First of all, Express Scripts did have some impact on inventory, obviously, as we unwound that account although you have to look at it in the context of payables and receivables as well. But if you're talking specifically about inventory, yes, the unwind of Express Scripts definitely had a positive impact in terms of reducing inventory for the quarter. I think most of that unwind has happened. I don't see any further impact from the unwind of Express Scripts influencing Q3 or Q4. However, I do see continued efforts from both Medical and Pharma to get more efficient about inventory and that effort won't change in either segment.

Don't you have a seasonal liquidation, though, in the current quarter and the June quarter as well?

Yes, we would expect that, although obviously, receivables and payables would move in tandem with that as well. So -- but yes, we tend to carry a fair amount of inventory at year end. And as you said, that was somewhat dampened this year because of the Express Scripts unwind, but then with that inventory would tend to get liquidated in the Q3 and Q4. I think your question was specifically about Express Scripts but more broadly, yes, you would see that trend. But again, keep in mind, for some of the inventory that we carry at the end of the year, we've also got payables for it so it doesn't necessarily all flow to the operating cash flow line.

Our next question is from Eric Coldwell of Robert W. Baird. Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division: Shifting gears a little bit to overall OpEx, similar to your peers, all year long and also similar to Street views, current level of operating expenses were again a headwind this quarter, coming in at about 16 bps higher than us in the Street as a percent of revenue. You highlighted M&A, IT, strategic investments, et cetera. I guess I have a 2-part question. One, can you give us the firm level OpEx net of these call outs; i.e. would it have been flat nominally, down nominally, et cetera? And then number two, should we be using a permanently higher SG&A to sales ratio and growth rate as we look forward? Or would you expect the leverage on OpEx to reignite in fiscal '14 and beyond, and maybe what the drivers are there?

Yes. Okay, yes, why don't you just take it, Jeff?

Yes, so first of all, for the quarter, if you look at total SG&A last year to this year, and I'm going to talk about non-GAAP SG&A. It's up about $60 million year-on-year. About $12 million of that is related to acquisitions, about $5 million of that related to deferred compensation, which is always a bit of a swing factor in a quarter that can't be forecasted related to stock market movements. $10-plus million of that increase is related to some of our strategic initiatives, including China, especially in preferred products. We've got a little over $8 million of depreciation now related to MBT that flows through each quarter. So I mean, those are the specific things I would call out. I would say the first half of the year, our growth rate in SG&A was fairly robust because of those factors. I would expect that to moderate in the second half of the year. But I would describe the first half of the year as somewhat abnormal in terms of overall SG&A growth rates. But in terms of where it's being directed, I'm actually quite happy that we're placing it in the right places. It's growing into acquisitions which are over-performing. It's going into our strategic priorities. And it's going into our Medical Business Transformation, which we're relying on to drive a great deal of value going forward. So it's very carefully being apportioned throughout the organization.

Eric, I would just add, this is something that we actually track very carefully. So it's not just tracking our SG&A expenses, but it's looking at the allocation of those expenses to the areas internal that we deem to be strategically are very relevant to us. So we try to make sure we're not spending in areas where we don't add infrastructure and we are spending in areas where we think it can create sustainable value.

Our next question is from David Toung of Argus Research.

Yes. Jeff, I think you called out the margin contribution from the China business. You also called out the growth in specialty from a revenue perspective. Can you give some color into the positive contribution from specialty?

Yes. I would say we're not prepared to give the specifics on that. The business is still ramping up. It's still relatively a small portion of our overall profitability. We're happy with where the revenue is going. From a profit standpoint, as we indicated in previous calls, there's some dampening effect from the fact that some of our pharma services revenue that we have been benefiting from previously has dropped off from a unique situation with one of our manufacturer customers. So that's tended to dampen the profit impact over the past few quarters. But we remain excited about the momentum that we're gaining on the sales side and continue to be very focused on how we drive profitability from that revenue into all areas of the Specialty business, but it's probably a little bit too early to comment on the specific profitability from that business.

Thank you. I'm showing no further questions at this time. I would now like to turn the conference back over to George Barrett for closing remarks.

Great. Thank you. Just thanks again to everyone for joining us this morning, and we look forward to seeing all of you, or at least many of you, at the upcoming events and have a good day. Thank you.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day.