Good day and welcome to the Cardinal Health’s First Quarter Fiscal Year 2017 Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Sally Curley. Please go ahead.

Thank you, Ashley and welcome to Cardinal Health’s first quarter fiscal 2017 earnings call. As a reminder, during the Q&A, please limit your questions to one and one follow-up, so that we may get to everybody in queue. We will do our best this morning to get to everyone, but if we don’t, then please feel free as always to reach us at the IR team after this call with any additional questions. Also today, we will be making forward-looking statements. The matters addressed in the statements are subject to risks and uncertainties that could cause the 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 and reconciliations to GAAP are included at the end of the slides. In terms of upcoming events, we will be webcasting our 2016 Annual Meeting of Shareholders on November 3 at 8:00 a.m. Eastern and our presentation at the Credit Suisse 25th Annual Healthcare Conference on November 8 at 8:30 Mountain Time. Today’s press release and details for any webcasted 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 hope to see many of you in upcoming events. Now, I would like to turn the call over to our Chairman and CEO, George Barrett. George?

Thanks Sally. Good morning, everyone and thanks to all of you for joining us. Allow me to start by being direct. Our first quarter of fiscal 2017 certainly had its share of challenges, but it came in much as we suggested to you that it would, with healthy and growing revenues up 14% versus the prior year and non-GAAP operating earnings down 9% versus the first quarter of last year. I will focus my commentary on the broad outlook for our business and our future and Mike will walk you through our financials for the quarter with more detail and specificity. Let me frame the start to our fiscal year with two lenses: one, the operating performance of our integrated business lines and the other, the environment in which we compete. Our teams continue to demonstrate their commitment to strong operating performance. Our service levels are extremely high. We are experiencing very high rates of customer retention. And our enterprise-wide customer reach is expanding, including the on-boarding of some very strategically important customers in the med segment. We also continue to launch new products and service offerings, increasing our value to our customers as they navigate significant change in the industry. And as is embedded in our DNA, we are taking a disciplined and determined approach to managing our working capital. But make no mistake this is a very challenging near-term environment. This is particularly true for our Pharmaceutical Distribution business. The public discourse around drug pricing has at least for the moment had a significant impact on the way pharmaceutical companies are pricing their products on both the branded and generic side. Combining this with limited generic product launches and significant reimbursement pressure on our customers, the competitive intensity has increased. As a result, price erosion during the period…

Thanks George and thanks to everyone joining us on the call today to discuss the first quarter. I would like to begin by reviewing our first quarter financial performance and then walk through our full year fiscal 2017 expectations. Please note that with all of my comments, I will begin with GAAP and then provide the comparable non-GAAP figures. The slide presentation on our website should be a helpful guide throughout this discussion as it includes our GAAP to non-GAAP reconciliation tables. Our first quarter fiscal 2017 results were about as we expected, with GAAP diluted EPS at $0.96 and non-GAAP EPS at $1.24, a 17% and 10% decrease, respectively. In our August call, I mentioned this would be due to some challenging trends and some tough year-over-year comps, particularly on some key generic items in our Pharmaceutical segment, as well as discrete tax items, partially offset by strong performance in the Medical segment and that’s largely what we saw. I will discuss both segments in greater detail later, but let me start with the consolidated company results. Revenues increased 14% year-over-year, totaling $32 billion. Total company gross margin dollars were up 1% versus the same quarter in the prior year. Consolidated SG&A increased 9% versus the prior year, primarily driven by strategic acquisitions. If you exclude acquisitions, SG&A was favorable for the quarter. Both consolidated GAAP and non-GAAP operating earnings declined versus the prior year by 14% and 9%, respectively. Moving below the operating line, net interest and other expense was approximately $41 million in the quarter, a decrease versus the prior year. The GAAP effective tax rate for the first quarter was 37.3%. Our non-GAAP effective tax rate this quarter was 36.4%, which is 3.5 percentage points higher on a comparative basis, primarily due to several favorable discrete…

Thank you. [Operator Instructions] And we will take our first question from Bob Jones with Goldman Sachs.

Great. Good morning. Thanks for the questions.

Good morning.

Good morning. George, you talked about the moderation in the pricing environment, but I think your comment seems largely focused on the buy side part of the business. I have just obviously want to get your views on the sell-side side of the business given your peer last week talked about more aggressive pricing in the retail independent channels? So, I just wanted to see what you are seeing there currently?

Hi, Bob. Good morning. Yes, actually my comments really were about the overall pricing environment. So, I was talking about sell side as well. And here is my perspective, there are, as I mentioned, number of factors coming together to make this a bit of a unique moment. So, we are not going to overreact to that moment. Our position, our plans for growth really aren’t different than today than they were 6 months ago. Our value proposition is very clear. We are an extraordinary attentive partner to our customers. We have a unique ability to follow the patient across the continuum of care. The service offerings are extensive, that’s what is part of our positioning. So, that’s I think important to stay upfront. But no, I think we are describing some similar characteristics to what you described.

Okay, great. And then I guess, Mike, if I could just go over to the guidance. Overall, it looks like the range is coming down by $0.11 at the midpoint. You talked a lot about generic inflation getting a little bit worse than previously thought and then modestly less branded inflation. But if I look at the guidance for the Pharma segment specifically, it seems like that take down in what you are assuming around profit margins there or overall profits there, mid to high single-digits, would actually indicate something more in the $0.25 to $0.40 headwind. So just trying to square those two things relative to the overall amount coming down compared to what you are suggesting is going on with the Pharma segment for the rest of the year?

Thanks Bob. Let me hit a few different things. I think, first of all, just to be clear, when we talked – when I was talking about generic pharmaceutical pricing, I wasn’t really talking about the headwind tailwind you used to hear over the last couple of years of inflation and deflation on generic products, because that’s about where we model it to be this year. We are not really seeing that. We expected it to be a net deflation environment and that’s what we are seeing. So, that’s not really the driver. What we are talking about is more the downstream pricing component of our generic pricing. That’s where we are seeing the uptick in competitiveness or a little more erosion than we had expected to be, and that’s really is the main driver of us taking down our Pharmaceutical Distribution numbers. As I mentioned a couple of times, to a lesser extent, brand inflation. So, we have said about 10% before on brand inflation. We are now modeling in the 7% to 9%. That impact, I guess I will put it this way. If that were the only thing going on this year, then it wouldn’t probably be adjusting guidance. It’s more the combination of the generic pricing and then that on top of that. But I think that’s the first thing I want to say. The second thing, I can understand why you maybe have a little trouble with your numbers. I can’t quote exactly or comment on exactly what the number should be. But remember, I did make a comment in here that we have some significant initiatives around expenses and other initiatives that will be captured in our corporate numbers. And so those aren’t going to show up in the segment numbers, because we don’t push those down at the end of the year, so probably the piece that you are missing as you try to reconcile having Pharma down, capital deployment up, midpoint down, the last bucket that you are missing is that the corporate numbers we are going to have savings there that will be in the overall corporate bucket.

And our next question comes from Charles Rhyee with Cowen & Company.

Hi, Charles.

Hello.

You may need to take your phone off mute.

Hearing no response.

Hey, operator, yes let’s go back to Cowen if they get back in queue. Let’s go to the next.

Okay. Our next question comes from Garen Sarafian with Citigroup.

Good morning everyone. Thanks for taking the questions. So Mike and George, you guys just commented a little bit on the downstream, the sell side dynamics, but on the independent front, you guys aren’t as active as some of your peers, so just wondering, what specific segments are you seeing that and if you can you just give a little bit more flavor as to sort of the more recent trends into this month as to sort of the dynamics and how they are trending, that would be great?

Garen, good morning, let me start and then Mike jump in. Actually, we have a very strong position with independents and have for quite some years. So the dynamic Mike described, we are seeing in that segment. So I don’t have to add to that. Mike, anything?

Yes. I mean we have a lot of programs, services. We continue to stay very, very focused on that bunch of customers. We continued to have very high retention rates. And so we feel really good about where we are positioned in the generic independent space.

Okay. I guess do you sort of – are you seeing that in other segments other than just the independents or sort of the [indiscernible] kind of lead to or is it still just focused specifically and only on that segment?

Let me try. I think it’s probably been the most intense there. We often have to deal on it. This is sort of a normal thing with re-pricing of contracts. Thankfully, as you know, we have not had a lot of big contracts up for renewal. But I think it has been a distinctly noteworthy environment in independents, would you say, Mike?

Yes. I would totally agree with that. And I think you have to think about the way contracts are written and just certain customers contracts are written in ways that the generic pricing or the way it works is one way in the other areas, it’s much more competitive for they haven’t committed to buy all their generics and so they are constantly shopping them and that’s where you are going to see and that’s typically in independent space. And that’s where you are going to see some more of these competitive pressures.

Okay, that’s useful. And then I just have a follow-up, on the upstream, on the branded inflation side with the branded manufacturers, the moderating inflation has been sort of a fact that has been discussed in prior quarters and I thought that at some point, there was an opportunity to go back to the branded manufacturers and sort to readjust and realign the contract so it benefits all, so I am wondering have you done that in between contracts yet or is it sort of still waiting until the contract renews where those conversations come up again? And I will stop...

Yes. Thanks. Good questions. And I would say that’s really kind of across the board. It just depends on the individual manufacturer. As you know, about 15% of our branded margins are based on a contingent basis, which means that generic or a branded inflation is a piece of the driver of the value that we receive. And every one of those where we are not getting the value that we believe we should be compensated for the services that we deliver. We are having discussions with the manufacturers. Some of those are going to move quicker than others depending on contract date and based on prior discussions with those manufacturers on how those deals will arrive. And so you can imagine with every manufacturer where we believe we are being compensated less than we should have been or should be we are working with those manufacturers.

Next question.

We now have Charles Rhyee with Cowen & Company. Please go ahead.

Yes. Sorry about that earlier. Yes. Thanks George. You were talking in also your comments about – sorry, Mike, you were talking about your comments making the second payment to CVS as related to Red Oak, how much – can you kind of help us understand how much more of a benefit do you think you are getting right now this year on your generic procurement and how much of a benefit can we anticipate that we should get the rest of this year. And I guess the point I am trying to get at is, you talked about your overall estimate on generic deflation, how much is this procurement benefit do you think is helping offset, because I think George, in relation to your earlier comment to Bob’s question, you did kind of mentioned that you are starting or you are seeing a similar kind of characteristics in the market relative to comments from last week? Thanks.

Yes. I would say clearly, the number one offset to what we are seeing in the competitive pricing generics has been and should continue to probably be Red Oak Sourcing. I continued to be impressed with the team there, the depth of talent that we have on the team, the way they are looking at things, the creative ways they are working with manufacturing partners. And CVS Health couldn’t be a better partner working together with us to drive value at Red Oak. So Red Oak would continue to be a positive driver for us when it comes to offsetting that.

And then is there any other things that we can think about that can be offsets or – I guess the other way I would say it is, when you think about the impact that you are seeing potentially in the independents, does your guidance kind of extrapolate out potentially what that might look like throughout your entire book of business or are you only kind of anticipating what you are seeing currently? Thanks.

Yes. We have said that we have lots of different things. One of the things that I think is really helpful for Cardinal in general is our broad portfolio. So while we are seeing pressure from generic pricing and as I have said, to a lesser extent, branded inflation, when you look across the rest of the P segment, whether it would be how we are performing particularly in specialty, how we are getting in working through with Nuclear and some of our other components within that business, we continued to drive value in other areas. As you can imagine, when you are in a challenging environment like that, everyone, whether you are in P, M or corporate, is focused on expense control and making sure we are very diligent on those types of things. And so we have that benefit. As I mentioned, Medical is continuing to do very well. We expect them to have a very good year. And they are going – moving along as planned. And so I do think our broad portfolio of having Medical being able to drive some initiatives at a corporate level, which are going to show up at the end of the year, as well as some of the other parts of Pharma, are what we will be able to use. And using our balance sheet too, from a capital deployment standpoint through M&A and stock repo is how we are going to continue to manage the rest of the year.

Great. Thank you.

Our next question comes from Eric Percher with Barclays.

Thank you. I am going to return to the question of the independents and pricing, it feels like there is a pretty big difference in the magnitude of pressure that we see in your guidance as compared to one of your peers. And Mike, I know you have been willing to go into some of the mechanics on items like brand inflation in the past, if we think about the mechanics of independent contracting, could you tell us a little bit about how much of the book is truly small and mid-size customers versus larger buying groups of independents and do you see significant differences in those. And maybe the last part of that would be do you have any major contracts that may be coming up or how much – how important are those?

Yes. Let me try a couple of things and feel free to follow-up with another question if I miss it, but a couple of different things. First of all, I hate to ever comment on our competitors’ numbers. Well, I just want to be careful with those. But remember, mix matters. And what I mean by mix is how much of their mix may be brand and generic versus our mix. If you look at the other components of our Pharmaceutical Distribution segment with our growth in specialty, nuclear and other things, so it’s hard to comment on all the various moving parts of any of our competitors on what’s in those segments. Second of all, I think you hit on something which is customer re-pricings and we didn’t have very few – we have basically a very few major re-pricings this year and obviously, over the next couple of years, we don’t have a ton of those. We are in pretty good shape, particularly with some of our larger customers. And I think that may be a different thing as where we are seeing some of our competitors may or may not have more large re-pricings with some of their customers, which can affect each one of us in different timing within the years. And so I think it really gets back to mix of customers, timing of re-pricings. And those types of things can drive differences between each one of us, as well as maybe the expectations that we originally set at the beginning of the year and how we looked at things.

That’s helpful. My follow-up would just be having exposure to telesales and Harvard, has that changed your insight into the market and/or your exposure to the market?

Yes. I think in some ways, a little bit of both, because a lot of their sales are into the independent market. You can imagine we are seeing some competitive generic pricing against our telesales business, which obviously is a little bit of a headwind for that group. But on the flipside, because we do have so many contacts into the independent and the regional chain space with our telemarketing business, it gives us a lot of competitive intel on what market price is. And we stay very focused to try and make sure that we are pricing at that market price and not trying to do anything outside of that, because we believe we have a great service offering that we don’t need to price below market in order to win and compete effectively.

Very helpful. Thank you.

Our next question is from Ross Muken with Evercore ISI. Please go ahead.

Good morning, guys. So, you guys compete on the pharma side, right and the industry structure primarily is an oligopoly, right? So for many years, we haven’t seen these sorts of spurts of aggressive competitiveness. And obviously, it’s a tough environment. But when you look back at prior periods and talk to folks in the organization have been looking at this longer than probably myself. What are the key telltale signs of sort of the end of that, right? So looking for, okay, we saw flare up, something happened and then behavior returned back to more normal. I mean, is it – and then, so one, what should we be looking forward to judge whether or not this is sort of temporal? And then secondarily, how do you ultimately go back to that customer group and recapture some value, right, because inherently your business model has been delivering a ton of value to the independent base for a very long time. Obviously, the margin levels take a hit and then historically they have come back. And so help us think about those the sequence of sort of what happens next, I guess?

So Ross, why don’t I start? First, let me start by saying we always operate in a competitive environment. That is the nature of our business. Obviously, I have been doing this as is Mike for quite some time. We have lived through multiple cycles for me and multiple parts of the industry. You see these periods. I mentioned that this is a bit of a unique moment. You have got all of the public discourse around healthier sides in Pharma, it’s loud and it’s emotional. And at the same time, healthcare is going through some changes. So, I don’t think it’s shocking that there is some near-term disturbance. Experience – my experience tells me that over time, you see some shifting out and just essentially settling of the dust. Sometimes, when aggressive moves don’t result in a much change or a value creation, then things just sort of stabilize. And so we have lived through different cycles in the past and that’s what I would expect here. For us, again, the important thing is for us to be creating new value sources for our customers and our manufacturer partners. And we work – you have heard the positioning that we have had over these last 7 or 8 years, it’s really been about broad value creation and we will continue to focus on that as our priority. And I think ultimately, the reason that our business has been improving in recent years is, essentially, they build and create value. And so we will continue to focus on those dynamics. But we have seen occasionally these kinds of cycles for me over, unfortunately, many decades in different parts of the industries. So, that’s my general point of view.

That’s helpful. And maybe just quickly, Mike, on the balance sheet, I mean you guys are in a pretty strong position here. You talked about dislocations a bit in some of the pharma service part of the market, I am assuming to private and other competitors that’s they are also painful, I mean, what about the M&A pipeline at this point? And obviously, you are doing a lot on the repurchase and you have a healthy dividend, but there is a lot of balance sheet capacity there. Could we see you guys get more active again?

Yes. Couple of comments. I think it’s good to hear you mention the dividend, because that’s something I would like to stress, because I think we have a very differentiated dividend and it’s something that we continue to be committed to our 30% to 35% payout. And I think that is a very much a differentiator between us and others. And so I agree with that on one side. Again, I would tell you that when it comes to the deployment of capital, we would love to find great M&A targets that’s probably where we would lean overstock repo, but we are going to stay disciplined. If we can’t find the right target at the right price and it has the right culture that fits into our business, then we are not going to move forward. And if that means there is some excess cash on the balance sheet, then we will take a look at deploying that in the stock repo. So, I think our pipeline is still decent right now. As you can imagine, we look at dozens of items before we ever purchase one. And so it’s always hard to tell exactly when something might come out of that, but we continue to be very active in the M&A front, but won’t trap cash on the balance sheet either if we can’t find the right opportunities.

Thanks Mike.

Next, we have Ricky Goldwasser with Morgan Stanley.

Yes, hey, good morning. So, couple of questions here. First of all, does your guidance assume any additional step down in distribution sell-side pricing offering independent books? So, did you assume that a step-down in the pricing that you are seeing in the marketplace today will spillover to your entire independent book?

Well, I guess the only way I can respond to that is, as I mentioned in my remarks, our guidance includes not only what we saw in Q1, what I have kind of foreshadowed in Q2, but also that it was based on some of the trends we are seeing in Q1 and in Q2. So yes, it does include some continued challenges with generic pricing and branded inflation.

Let me just add to this, Ricky. I mean generally, market price is a very effective market, very efficient market. So, the market just tends to be the market. And so you can’t think of this as necessarily individual customers.

So – but George, doesn’t that mean if there is risk that you may have to lower your prices in the future to match a new lower price point in the market volume? So, I guess the question is, is there any lower price point in the market?

We are always lowering our pricing in the generic market. It always has been that way. And so generally, you constantly are competing on generics. All we are saying is that, right now, it’s just a little bit of an unusual period of time where we are seeing a little more aggressive re-pricing. But there is always some re-pricing built into your go forward. We are always going to price the market. We are not ever trying to leave the market down, but we are in the – we believe the best competitive position from a cost standpoint that we can always stay competitive.

Our next question comes from Greg Bolan with Avondale Partners.

Great. Thanks, guys. So, if I could just maybe qualify what you said here is, on the distribution side, your margins on the buy side are about the same, your margins on the sell side downstream have got a little bit worse. And so that’s a). And then b), Mike, if we could go back to this time last year, I mean, if I remember correctly, you guys were already kind of dealing with a little bit of a difficult comp on the distribution margin side. If I remember correctly, you guys got about, I think called out $0.08 of incremental tailwind from generic pricing this time last year, and I think about $0.03 from synergies from acquisitions. So, could you maybe talk a little bit about that and kind of how much of this year-over-year difficult comp kind of played into 1Q? Thanks.

Yes, thank you. I did mention that in my remarks that part of the reason for our Q1 is the comps and that’s why we called out Q1 being down was. And you were right on with that. We did have $0.08 last year that we called out favorability largely from benefits related to certain competitive dynamics on a few key generic items that we thought we are going to deflate last year that didn’t and they stayed up. And since then, they have deflated. And then, as you mentioned, $0.03 on accelerated integration of some acquisitions. So those were favorable items last year. As well as from an overall basis, remember, we had a favorable tax component last year too. And then in last year, we did see the first quarter branded inflation was a little higher than we had anticipated. So, that’s right. Those were the positive things. You also summarized accurately the generic piece. When you really break it down into two components, one is the manufacturing actions, which is then either raising or lowering price. We are seeing, for instance, less inventory inflation on generics, but it’s really no different than we had originally anticipated. As you mentioned – as we mentioned in the past, FY ‘14 was a good year, ‘15 was a solid year and then it started coming down in ‘16 and we kept calling down and we said we expected that to be down and that’s how we essentially budgeted and looked at it for this year. So again, we are not seeing anything real different when it comes to what the manufacturing actions are related to inflation and deflation. It is the competitive environment downstream in our actual pricing out for the customers.

That’s great. And then just real quickly, if I kind of think back to Kinray 6 years ago now and what you guys have been able to do there, what Kinray and other kind of worked in or sort out on the community pharmacy side, I think you guys are now one of the largest, if not the largest, in the independent pharmacy space, with high 20% market share. And then as I think about the competitive dynamics around that market, I mean you guys have kind of lived in a world where you have been constantly trying to take share and been successful at that, it doesn’t sound to me like this – it certainly doesn’t sound as to what you are saying today is as draconian as maybe what we were kind of – what I was set up for going into the weekend and so – I mean is – if you think about – you keep saying short-term, you think it’s transient, George, I mean what needs to happen over the next say, years for you guys to kind of maybe mitigate this – on the downstream margin side and kind of how you are positioned to continue to maintain or even grow market share going forward? Thanks.

Yes. So Greg, let me start. This is really important. Our market share, I mean our independent has grown over years basically. It’s not a sudden phenomenon. Actually, right now, it’s relatively stable. So it’s possibly growing over the 7 years of this team’s leadership here. Obviously, the Kinray acquisition gave us a very significant boost there. So that’s not a sudden thing. It’s been a thoughtful and purposeful strategy to make sure that we have a good balance to our business. And we really feel like we create a huge amount of value for those independents to the service offerings and product lines, especially as the world is unfolded as it is. So start by that. I don’t think there is a discrete moment of change. We are obviously in the middle of a lot of things. So the election cycle clearly is creating an enormous amount of discussion and noise, which I do think has an effect on the way people behave. I do think generic cycles come in lumps and we see that they tend to have some cyclicality. We will see some growth coming from biosimilars, which will affect the market probably each product differently. And I think again, most times in competitive moments, you have companies just adjusting to what’s working and what’s not. And so that’s my experience over a lot of years. And so I think at the moment, right now, has a lot factors coming together to make for a tough environment, but we are going to stick to our value proposition and our long-term view as to how we compete in the market and how important service and product offerings are.

Our next question comes from Lisa Gill with JPMorgan.

Thank you and good morning. George, I just want to go back to your comments around the branded side and that primarily everything today is driven more on the generic side and pricing competition, but you brought the branded expectation down from roughly 10% down to the expectation of 7% to 9%, can you talk, is that what you are seeing right now, is that kind of your future look, we have heard from a number of manufacturers that they are lowering their expectation into what their price inflation will be in calendar ’17, so I want to understand that, number one. And number two, I just want to understand because the way that I have historically thought about this is that 15% that’s on a contingent basis was probably more profitable than a fee-for-service contract and so drug price inflation would have a bigger impact on that component of the business, I just want to know if I am thinking about that correctly?

Mike, do you want to start on this one and then I can jump in?

Sure. So actually, the 15% piece was margin dollars, it wasn’t number of contracts. So it was assumed to be – of our margin dollars generated. I wouldn’t say that, that group was a lot more profitable. A lot of the folks that are in there are obviously the smaller manufacturers, but so it’s going to have an overall a little higher average rate because just by the nature of being smaller manufacturers. But I don’t think that’s a big component of it. As far as what we have seen so far, I would tell you that what we have seen so far has been pretty light when it comes to manufacturer inflation. But that all being said, really January, as you know, our Q3 or the first quarter of our calendar year is always a big quarter for the branded manufacturer price increases. And the 7% to 9% is really an average for the entire year. So while it’s a little lighter than we would have expected now, that’s what we are building and to why we are lowering is that we would expect it hopefully after election and looking all those other components, we will see a little bit more normalcy, probably not as high, obviously as what it used to be, but we think we will get back into that 7% to 9% range. If that adjusts much differently than that, then we will have other updates after that. But right now, that’s what we are expecting.

Our next question comes from George Hill with Deutsche Bank.

Hey. Good morning guys and I appreciate you taking the questions.

Thank you.

I guess Mike first off, if we think about the change in the guidance on the generic side, are you able to quantify I guess kind of from down mid-single digits to mid to high single-digits, how much of that change is due to the underlying pricing environment of the drugs themselves, the deflationary environment versus how much of that is the sell side margin pressure. And then my second question would be you started to run down the rabbit hole of purchasing compliance a little bit, I guess could you talk about what you are seeing in the contracting environment and how that help – how pricing is leading into – how pricing is tying into the purchasing compliance discussion?

Yes. So as far as the adjustment from mid singles to mid singles to mid to high single-digits net deflation, really that entire adjustment is due to what we are seeing in the generic pricing environment. As I have mentioned, we are not really seeing the inflation-deflation piece to be significantly different than what we modeled. So you can assume all of that is essentially related to the generic pricing. And then as far as...

The sell side part?

The sell side part, that’s right. And as far as compliance goes, that’s highly contract dependent, when we have customers, we are very diligent about the way we write our contracts. So if we have a customer contract that says that they have got to buy x percent of the generics from us, then we monitor that and we make sure that they do. And on the piece that they don’t have to directly buy from us in order to make that deal work, they can shop that piece and we have always known that. And so that’s the component that we would see, obviously some more pricing pressure on.

Okay. And maybe if I could just still a real quick follow-up for George, when we talk about this increase in the sell side competitive environment, I guess how far off the normal are we if you think about historical spikes and when we have seen heightened competition?

I don’t think I am able to give you a specific number here. What I can say is the kind of erosion that we have seen typically and it’s been relatively predictable, has just been different over these last couple of months. And so it is different and noteworthy and I think is the largest component as to why we are adjusting our model for the year. The branded part, as Mike said, is much smaller. But I can’t quantify that for you, George, but it is noticeably different.

Okay, thank you.

[Operator Instructions] And we will take our next question from Michael Cherny with UBS.

Good morning guys and thanks for the details so far.

Good morning, Mike.

So I think those pharma questions have been kind of be in the desk, so all these facts got on the Medical side, you guys talked a little bit about the recent share gains you have, obviously Kaiser is a very notable contract win, can you maybe talk, especially with Cordis anniversary over the last year, as you think about now your go-to-market strategy versus maybe 2 years ago, what are the biggest differences, obviously Cordis is one component, but in terms of being able to gain a competitive scale, what’s changed the most or at least most improved your competitive win rate?

Michael, thank you for the question. So, you are making Don happy on a question about Medical. So let me just give you a perspective. Our go-to-market model over recent years has really been focused broadly on a couple of really important changes. A lot of our customers are getting much more complex. They are bigger systems. So what historically might have been a single hospital is now a academic medical center plus some community hospitals, plus a few surgery centers and oncology clinics and now some doctors offices. That requires a different partner. I think our ability – and we have seen this. We have built our business around that expectation. And I think what’s happening is our ability to serve across that continuum of care to create value in different ways or systems the are much more complex than they once were is important. And one of the shifts I want to describe is a little bit more of an elevation of those conversations, away from the purely departmentally driven ones into a conversation that’s more broadly at the system level. I think that’s playing to our strength. Now again, we have to be very strong in each of the departments. We have to be content experts and we are still that. But I do think that the reason that we have been growing, I think is largely that we are positioning well to adapt. And we anticipated these changes in the way that these big health systems were going to look and I think that’s been beneficial to us.

Yes. I think the only thing I would add to that is I think a part of that growth is the really measured and smart approach I think we have taken to expanding our portfolio in the medical segment. And so our reps are able to leverage a lot more products in the bag. And so when we call on a customer, we have more to sell them, we can leverage our expense structure, we can be more meaningful to them. And I think it would be – I don’t think we should also ignore the fact that we have given a lot of energy to the Cordis business. So, we have put some great people in charge there. It’s a business that we are paying a lot of attention to. Don himself has a lot of experience in this area as David Wilson who is running it. And so I think there is a lot to be said for when you have people that are excited know you are investing in the business, really are committed to that and we have hired some great people. I think that’s driving some of the things we are seeing in Cordis, too.

If I could I just want to add one more piece, because we are talking primarily in this context about the medical, but it does connect our pharmaceutical business and our medical business and many of these customers are part of that overall offering. So, I didn’t want to miss the opportunity to share that.

Thanks, guys. I will let you go with rest of the queue.

Thanks, Michael.

Thanks, Michael.

Our next question comes from David Larsen with Leerink.

Hi. Mike, can you talk a bit about your efforts to improve your cost structure in the corporate division? What’s going to drive that? And any sort of quantification could be around that would be very helpful? Thanks.

Yes. So, good question and I mentioned that it is a big driver when you think about that EPS bridge, as we mentioned with the generics slightly are going down and net customer activity staying the same. We needed to actually have a real focus on that expense initiative. So, a lot of us – lot of the corporate departments across the company are all located in corporate. A lot of the initiatives and things that we fund, we fund out of corporate. And so all of those things we are taking really good hard look at, making sure we are investing in the right things. We are being very targeted on those things. And just driving discipline throughout our corporate departments in all lines of our P&L to make sure that we can help contribute to offsetting some of the decline we are seeing on generics pricing.

Okay, great. And then can you just remind me again sort of the 2Q operating income expectations for the pharma division? Pretty significant change there relative to commerce last quarter, just could you remind me what’s driving that? And then what’s going to sort of cause the reacceleration in growth in the back half of the year?

Yes. So, Q2 was really being driven by the same trends that we discussed. When we take a look at that, the trends that we saw in Q1 related again to generic pricing as well as branded inflation rates being lower than we had anticipated are the two key drivers in Q2 and why we gave you some early information that it would be similar to the percentage decline we saw in Q1. As far as what’s going on back half weighted, some of it has to just do with comps and things that are going to happen in the Cordis, like branded inflation tends to always be stronger in our Q3. And we have a lot of other initiatives that we are working on that we believe will deliver value in the second half. Remember, we have the step up in Cordis that impacted our Q2 and Q3 last year that doesn’t impact our Q2 and Q3 this year. Plus, we will have a full year of growing and getting after that business as well as on-boarding some other customers. So, we think we have enough initiatives in the back half to be able to get us to where we need to for the year.

And our next question comes from Bob Willoughby with Credit Suisse.

Good morning, George and Mike. While we know absolutely no one speculates on inflation anymore, it did appear your competitor bought some inventory in the inflationary market last year, liquidated this year. You bought less year-over-year, maybe the medical skews that somewhat. But isn’t it safe to assume there are some pocket of profits that have fallen out of the model here year-over-year?

Well, I think in the sense of – if we are relating it specifically to branded manufacturing, when you do have less branded manufacturer inflation, you do as I have mentioned a couple of times, when that happens quickly, you have those immediate adjustments where that 15% of your portfolio that is dependent upon that inflation sees less inflation. So, you do have to go through and renegotiate your agreements with manufacturers, but – so, that’s the first important piece. As I mentioned, we are doing that with manufacturers. Any time you see a sudden change, you have to go do that. As far as specking on generics or on brand, again, that was something that we could do a long time ago, several years ago because of the nature of our relationships with generic manufacturers, on the – with Red Oak as well as our agreements on the branded side specking is minimal to almost none of an impact.

And Mike, can you reaffirm a cash flow target for the year or is that not to call today?

Yes. We don’t as you know give cash flow targets for the year, but again, there was nothing I would say that when I look at what’s going on in our business that would make me think that we are not going to be able to deliver strong cash flow this year.

Thank you.

Thanks Bob.

And our next question comes from John Kreger with William Blair.

Hi, thanks very much. Could you give us an update on what’s sort of brand inflation you are seeing within the specialty bucket and what sort of assumption you are making in guidance for that category?

Yes. We don’t break that out specifically. Generally, inflation on specialty tends to be a little bit lower, because they are higher priced items than in the overall bucket. But our overall 7% to 9% target is across the board for all branded pharmaceuticals, including specialty and what’s going through our normal Pharmaceutical Distribution bucket.

Thanks Mike. And one other one on the medical front, can you give us a sense about what your organic revenue growth was in the quarter? Now that you are lapping quarters, we are thinking about 6%, is that about right?

I can’t give you the exact number, but I would definitely tell you that we were positive growth in the medical segment without Cordis. We do still expect Cordis to deliver $0.15 for FY ‘17. And so yes, if you were to back Cordis out, you would still see nice growth, a healthy growth in the medical segment.

Great, thank you.

Thank you.

And we will take our final question from Steven Valiquette with Bank of America.

Thanks. Just one more here on the sell side customer pricing, I guess I am just curious, is there any evidence that a change in the actual price methodology in the market being offered by some wholesalers? And the reason why I ask was that there was some chatter about maybe a shift to a cost plus pricing model on generics as opposed to just random spot pricing? Thanks.

Mike?

Well, I think all the time people are always trying to be creative on how they price and how to work with customers and different customers have different needs. So, I don’t see a wholesale change though in the way people are pricing in the market. The majority of the areas where we are seeing the pricing pressure just in that normal day-to-day pricing, whether or not that’s changing our larger deals, it’s hard for me to speak to our competitors on how they might be doing that. And deals can get often very complicated on how you compare one to another, but I wouldn’t notice any notable change at this point in time.

Okay, great. Okay, thanks.

And that concludes today’s question-and-answer session. At this time, I would like to turn the conference back over to George Barrett for any additional or closing remarks.

Well, at first, thanks to all of you for your good questions and for joining us today. I know that we will be seeing many of you in the coming weeks and we look forward to that. And with that, we will close the call. Thank you, all.

And that concludes today’s presentation. We thank you all for your participation and you may now disconnect.