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Cardinal Health Inc (CAH) Q3 2019 Earnings Call Transcript

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Cardinal Health Inc (NYSE: CAH)
Q3 2019 Earnings Call
May. 9, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day and welcome to the Cardinal Health Inc. Third Quarter Fiscal Year 2019 Earnings Conference Call. Today's conference is being recorded.

Now at this time, I would like to turn the conference over to Ms. Lisa Capodici. Please go ahead, ma'am.

Lisa Capodici -- Vice President, Investor Relations

Thank you, Jake. Good morning and welcome to Cardinal Health third quarter fiscal 2019 earnings call. I'm joined today by our CEO, Mike Kaufmann and Chief Financial Officer, Jorge Gomez. During the call, we will provide details on our third quarter results and full-year outlook.

You can find today's press release and presentation on the IR section of our website at ir.cardinalhealth.com. During the call, 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 statement slide at the beginning of our presentation for a description of these risks and uncertainties.

During the discussion today, our comments will be on a non-GAAP basis, unless they are specifically called out as GAAP. Our GAAP to non-GAAP reconciliations for all relevant periods can be found in the schedules attached to our press release. In addition, during the call, we will provide an update to our FY '19 outlook on a non-GAAP basis. We do not provide guidance on a GAAP basis, due to the difficulty in predicting items that we exclude from our non-GAAP earnings per share, and non-GAAP effective tax rate.

During the Q&A portion of today's call, we will ask that you limit your questions to one with one follow-up, so that we may give everyone in the queue a chance to ask question. As always, the IR team will be available after this call. Feel free to reach out to us with any additional questions.

I will now turn the call over to Mike.

Mike Kaufmann -- Chief Executive Officer

Thanks, Lisa, and good morning everyone. Today, I'll begin with some comments on our third quarter of fiscal 2019. And then I'll discuss our progress on a number of fronts to drive future growth. Overall for the third quarter, revenue was up 5% and operating results were in line with our expectations. Non-GAAP EPS for the quarter was $1.59 up 14% from the prior year.

Based on the year-to-date performance and our current expectations for Q4, we are raising the bottom end of our EPS guidance to a new range of $5.02 to $5.17. As I reflect on the quarter, we made progress in several areas including our strategic initiatives and the team is focused on delivering full year expectations as we navigate the current healthcare environment.

As I have recently spent time with our upstream and downstream customers, I am hearing from both that what we do and how we do it are as important today as they've ever been. We have scaled businesses that are important to our customer success as they look for the most efficient ways to deliver high quality care to patients.

Our commitment to innovation and strong customer focus were keys to recent pharma renewals. Most notably, we've extended our distribution agreements with CVS Health for four years beginning July 1st. We look forward to working hand-in-hand with CVS Health to further enhance our relationship with them. In that regard, we continue to work with all of our customers across our portfolio of business, as they balance their commitment to deliver high quality care with the need for efficiency.

For example, retail independent pharmacy customers have navigated years of change in their pharmacies and we've been right by their sides, helping them succeed in learning in the process. We are advancing solutions that help them address reimbursement, manage their inventory, in place the right focus on the front of store. In addition through our connected care platforms, we offer pharmacies medication therapy management services and the ability to communicate with patients to help them follow their prescribed course of care. We continue to develop these types of strategic capabilities as they enable our customers to navigate the evolving pharmacy landscape. We're improving both patient care and the linkage among providers, payers, pharmacies and patients remains critical.

In our generics program, we are seeing market dynamics and program performance consistent with prior quarters. We continue to invest in data and analytics and allocate significant time to improving the overall performance of our generics program, which is key for long-term growth in the Pharmaceutical segment. Our commitment to innovation, our customers and their success is also bearing fruit across the balance of the Pharmaceutical segment, where we are seeing strong positive contributions to earnings from both specialty and nuclear.

Turning to medical, while we have made significant strides, we are disappointed with the segment performance this quarter. We would like to see quicker progress on several initiatives, including our global cost structure. We continue to actively evaluate how we can accelerate our progress here while balancing our commitment to maintain service levels and deliver an outstanding customer experience. We are moving with a sense of urgency to address the opportunities for improvement we've identified in the medical segment.

Importantly, the patient recovery primary TSA exits are now complete. Leaving just a few minor exits and actions. At Cordis, the stabilization program remains on track. We continue to see improving service levels and fill rates, lower back orders and increased cost discipline. Cardinal Health at Home in our services businesses continue to flourish. Services continues to expand its niche providing value-added technology and logistic support to our partners while the at-Home business is capitalizing on a number of larger healthcare trends.

Let me briefly touch on our strategic priorities. As I've shared already this morning, we are making progress in our pharma segment Cordis in Patient Recovery. The team has also made excellent strides on our overall cost structure. And we are already realizing the benefit in our results. Regarding capital deployment, I would note that we continue to execute a very disciplined and thoughtful strategy to fund the future growth of the business, return cash to shareholders and maintain our healthy balance sheet.

And Jorge will share the details. Altogether, we remain highly focused on how we can deliver the greatest value and be nimble in the ever-changing healthcare environment, so that we can respond to our customers' challenges.

We know that our success begins with an emphasis on the longer term a balanced thoughtful approach to how we prioritize and deploy capital and discipline in our cost structure. The team is focused on executing across both our newer and existing businesses, investing and what makes us stronger and continuing our essential role in the healthcare system.

The value we provide to customers and suppliers is as strong today as it has ever been. I want to thank our entire team for the work they are doing. We look forward to continuing to deliver for our customers, shareholders, employees and the communities we serve.

With that let me turn it over to Jorge.

Jorge M. Gomez -- Chief Financial Officer

Thanks, Mike. And thanks everyone for joining us today. Let me start with a quick overview of the quarter. We made operational and commercial progress in both segments, to strengthen our relationships with strategic partners and benefited from a few tax items that drove our effective tax rate below typical levels.

This morning I will focus on our Q3 performance, our view of the current fiscal year and updates on a few of our strategic initiatives. Our Q3 total operating results, which exclude tax were in line with the expectations we had for this period when we updated guidance last quarter. Total company revenue was strong again increasing 5% versus last year to $35.2 billion. Total company gross margin was down 8% from last year to about $1.8 billion. Operating earnings were $667 million. As Mike said, our EPS for the quarter was $1.59 to 14% increase versus last year.

This increase was driven by a lower tax rate and by prudent balance sheet actions, which resulted in fewer shares outstanding, and lower interest expense. Our Q3 effective tax rate was lower than expected at 21.6%, driven by net favorable discrete tax items of $0.06. The largest discrete item was a true-up related to the patient recovery acquisition. In the quarter, we saw a 3% improvement in SG&A due to divestitures and the ongoing benefit from our cost optimization efforts, which I'll discuss when I cover the strategic initiatives.

Interest and our expenses improved 24% versus prior year to about $62 million. This was driven by the change in the value of our deferred compensation plan, which I -- as I explained previously is fully offset above the line in corporate expenses and has no impact on the net income or EPS lines. Average diluted shares outstanding were approximately $299 million about $16 million fewer shares than last year.

We generated very strong operating cash flow of $1.5 billion in Q3, which includes a large benefit from the timing of inventory purchases. Our year-to-date, operating cash flow was $2.2 billion. We ended the quarter with a cash balance of $3.4 billion with about $800 million held outside the US.

Now, I'll turn to segment results. Starting with the Pharma segment, sales to pharmaceutical and specialty distribution customers were strong in the quarter driving segment revenue growth of 6% to $31.4 billion. Although segment profit of $536 million was lower than last year, it was ahead of our expectations from a quarter ago at 10% decrease versus last year, reflect the negative impact from generics program performance, prior customer renewals and opioid litigation expenses. These headwinds were partially offset by a specialty, which again delivered very strong top and bottom line growth.

Of note key customers continue to reward Cardinal Health with the trust of long lasting partnerships. The renewal of CVS Health validates both our strong value proposition and our reputation as a trusted and effective long-term partner.

Turning to Medical. Segment revenue for Q3 was down slightly to $3.9 billion driven by previously discussed divestitures, offset by growth from existing customers. Excluding divestitures and FX revenue was up low-single digits. Segment profit decreased 22% to $155 million driven by the performance of Cardinal Health brand products. Market dynamics in our product businesses as well as incremental supply chain costs contributed to this lower-than-expected performance.

In response to these challenges, we are moving forward with the work that I mentioned last quarter to drive efficiencies across the Medical segment, through refining our commercial, operational and data capabilities. We currently have teams deployed to support each of this pillars of work through activities including global product and geography rationalization, supply chain optimization and selling strategies.

Now, let me share a few updates on some specific business areas. What we referred to internally as a medical solution businesses, which includes patient recovery and our legacy Cardinal Health brand products is experiencing challenges related to market dynamics and supply chain integration activities. However, the team is actively engaged in multiple initiatives to drive greater operational efficiency and to address the below target service levels experienced over the last few months.

As a result of this work, we are seeing improvement in service level trends particularly in the US where the levels are reaching six month highs. At the same time, all our areas of our medical business are showing strong growth. We see a strength in our strategic accounts, which are growing above market rates. Also, Cardinal Health at-Home had another terrific quarter. A customer pipeline for this business is healthy and our cost management was extremely effective producing another quarter of double-digit growth.

National brand distribution had a strong performance as did its services, which delivered above-market growth in Q3. At Cordis, we are seeing top line growth in several geographies most notably in the US, Latin America, Canada and Asia Pacific.

As we move forward with our stabilization plan, we are seeing improvement and fill rates and back orders with Q3 reflecting the lowest back order levels we have seen in 18 months. Also, service levels are improving, due to our work on SKU rationalization and additional technologies will help us better manage both inventory and sales productivity. We also continue to evaluate product mix and partnership agreements. Our key challenge remains our cost structure primarily outside the US, which we're actively working to address.

Turning to our full-year outlook for fiscal '19, based on our most current expectations for our effective tax rate and operating performance in both segments, we are raising the lower end of our EPS guidance from $4.97 to $5.02. Our updated range for the year, it's $5.02 to $5.17. We are making the following changes to our assumptions for the full year. For the segment assumptions, due to the dynamics that we continue to experience in Medical, we now expect segment profit to be down low to mid single digits.

For our corporate assumptions, we now expect our effective tax rate to be in the range of 23.5% to 25.5%. This update reflects a few favorable discreet tax items including the impact of tax reform, the legal entity restructuring work we completed earlier this year and the tax true-up related to patient recovery that I mentioned before. Also, we now anticipate our interest and our expenses as well as capital expenditures for the year to be lower. We expect interest and our expenses in the range of $330 million to $350 million. The new range for capital expenditures is $310 million to $340 million.

I'll now provide an update on some of our strategic initiatives. First, regarding our cost optimization efforts, we will exceed our initial commitments of $100 million in annualized savings by the end of fiscal '19 and the aggregate $200 million by the end of fiscal '20. We will provide more precise numbers when we finish the year. To deliver these savings we have developed a comprehensive data driven approach that expands beyond budgeting and is supported by an organized program structure. Leaders across company are accountable for initiatives that we are rigorously identifying, operationalizing and tracking to support these commitments, and all of this work is enabled by a more agile, power -- forward thinking mindset that we're embedding at every level of the enterprise.

This broad approach is standing across strategy, tactics and culture will enable value creation for our shareholders, customers and employees. We shared previously that we will reinvest some of these savings we generate from these work back into the enterprise. For these investments, we are focused on opportunities to rapidly implement and enable new digital technologies with the goal of streamlining our processes, creating greater efficiencies and optimizing our data capabilities.

We will share updates as a specific initiatives or operational highlights. Second, with respect to capital, we are generating strong cash flow and remain very disciplined in our approach to capital deployment. Our financial flexibility allows us to efficiently fund both current operations and investment operations for long-term growth. As part of this disciplined approach, we plan to use cash on hand to repay $1 billion of debt that matures next month.

Additionally, we maintain a significant level of scrutiny and selectivity regarding our allocations such as capital expenditures and acquisitions with a focus on high threshold for a strategic fit, ability to execute and return assets. Overall, as I look back on the quarter and year-to-date, while internal and external dynamics continue to evolve, we continue to be resilient and agile. We remain totally focused on delivering our commitments as we finish the year.

With that I'd like to open the line and invite your questions.

Questions and Answers:

Operator

(Operator Instructions) We will take our first question from Steve Valiquette with Barclays.

Jonathan Young -- Barclays -- Analyst

Hi. This is Jonathan Young on for Steve today. Just going to CVS renewal. Were there any changes in the contract or anything that we should consider given that you guys got the renewal?

Mike Kaufmann -- Chief Executive Officer

Hey. Thanks for the question, Jon. This is -- first of all, we're really excited and pleased to extend our partnership with CVS, as you know, we've -- they've been a long-term customer for -- of ours. What I can tell you is that the contract is for a four-year period, actually the new pricing goes into effect July 1. And other than that it's about the same business and same typical structure that we've had in the past, nothing that I would call out differently.

Jonathan Young -- Barclays -- Analyst

Okay, great. And then just turning to the Medical business. I guess, kind of, what were the challenges that you're kind of seeing in the business? Some splitter (ph) the supply chain activities, et cetera?

Jorge M. Gomez -- Chief Financial Officer

Let me take that question. Good morning. Yeah, clearly we had a difficult quarter in Medical in Q3. As I indicated in my prepared remarks, the largest driver in the quarter was the performance of our Cardinal brand products. Within that, I think there are two key buckets. The the first one is just the normal market dynamics that we normally overcome through actions around mix and and commercial efficiency and volume. This time and in this quarter, we were not able to offset those dynamics because there were additional challenges from a supply chain cost, integration work that resulted in back orders and higher expenses as we were trying to meet our commitments to our customers.

So those are kind of the two main things. This is what we're doing about that. We clearly have deployed a number of teams to work on the short-term issues around operational efficiency, below target service levels and we are seeing improvements in that. Our service levels and backorder trends toward the end of the quarter that we're improving. And in fact in the US, our service levels are reaching now a six month.

But from a long-term perspective, we have, I mentioned this in my remarks as well, we are working on global product and geography rationalization to simplify our business. We are trying to optimize our supply chain and we are making some good strides on that and working in our selling strategy -- strategies as well.

Obviously, all of these actions have bought different timelines and some of them are being executed very quickly. And as I said before, we are seeing improvements. All initiatives will take a little bit longer. Overall, we are actually encouraged with the underlying demand of this business and we have -- its a very strong conviction about the value proposition, we're bringing to our customers, every single day.

Jonathan Young -- Barclays -- Analyst

Thanks.

Unidentified Speaker

Next question?

Operator

To Lisa Gill with JPMorgan.

Lisa Gill -- JPMorgan -- Analyst

Thanks very much. and good morning. I just want to follow back up as we think about the Cardinal Health brand products on two levels. Just one, when you talk, Jorge, about the supply chain costs. Is that actually commodity cost or is it the actual process as you just described other than the last question? And then Mike, can you talk about the current competitive landscape? It appears that just in the pure US distribution, you have a competitor that's really struggling in the marketplace. I would have anticipated that, that will create some opportunities for someone with a strong balance sheet like Cardinal to continue to gain some market share. So, just some thoughts around the competitive landscape, would be helpful.

Mike Kaufmann -- Chief Executive Officer

Great. I'll let Jorge start, and then I'll answer your question.

Jorge M. Gomez -- Chief Financial Officer

Yes. Thanks, Lisa for the question. The cost challenges I guess expand over kind of, all the areas of the P&L. So from a manufacturing perspective, we have -- as you indicated commodities is actually one of the headwind and there are other elements within cost that are creating some short-term challenges. And then the overall supply chain as we finished integration work and as we continue to improve our network, especially outside the US, we have experienced a higher costs, which essentially stems from the fact that we want to make sure that we balance cost with servicing our customers at the best possible level. So all of those areas of the P&L from a cost perspective impacted the segment this quarter.

Mike Kaufmann -- Chief Executive Officer

And as far as the competitive environment -- environment in the Medical side, we continue to see a competitive environment, no differently than we really have in the past. I obviously don't want to comment on any specific competitor, but I think the dynamics are similar that they've been in the past. We feel really good about our value proposition, and we really want to make sure that we're focused on winning and retaining the customers that appreciate our value proposition, which is being both a strong distribution medical business and a products company that people see as someone that can bring them equal to or better products at lower costs.

Lisa Gill -- JPMorgan -- Analyst

Just so I understand all the comments around this. As we think about this going into next year, Mike, I mean, do you feel like you can really get your arms around these costs continue to win customers based on what you just talked about, or do you think that this is kind of a multi-year challenge as we think about it, and I'll stop there.

Mike Kaufmann -- Chief Executive Officer

Thanks, Lisa. I think Jorge -- from what he said, I think is I mean just I'll emphasize just a few things. First of all, I think there are some things that were very fixable in a short-term period and we put the people on that and we've made very good solid progress, some of the other things, for instance, evaluating our global manufacturing footprint.

Looking at our US distribution footprint. We believe there's areas for opportunity to streamline and maximize the efficiency in both our manufacturing and distribution footprint as well as the overall supply chain. Those aren't going to happen overnight. Those are going to take time as we work through those because ultimately, as much as we'd like to go faster for us. The most important thing is keeping our eye on our customers and we don't want to do anything that would disrupt the overall demand for the products, which we continue to see strong and we still believe in our value proposition. So it's, it's truly balancing what we know our opportunities in our footprints. We are making sure that we don't let any customers down.

Lisa Capodici -- Vice President, Investor Relations

Operator?

Operator

We'll now move to Robert Jones with Goldman Sachs, for our question.

Robert Jones -- Goldman Sachs -- Analyst

Great. Thanks for the question. I guess just to stick there with Medical, Mike, you know, want to make sure I understand it because it does seem like a fairly dramatic shift from last quarter's update. And so does this boil down to really just some fulfillment issues that created higher cost, which I would imagine, obviously, would be within your control to fix? Or is it that plus a bigger issue that you're seeing as far as the -- the macro backdrop in that sector? Just I mean, I know Jorge, you mentioned demand still felt really good for the lines of business here. So just really want to make sure I understand what shifted from last quarter to this quarter and was it really more just around some fulfillment miscues and costs that obviously would be associated with fixing that?

Mike Kaufmann -- Chief Executive Officer

Yeah and thanks for the follow-up. Totally get the question. And it obviously was a significant change on our assumptions for this business. So very fair observation. I would say first of all, we've said several different times that when you exit TSA, they can sometimes be lumpy, I would say the exits that we've had recently have been a little more lumpier and we would have expected, and some of those created some service level unexpected service level challenges, Jorge mentioned, in Q -- in our, in our Q3 and we're still working through those as quickly as possible, but still a little bit of work to do on that. And as Jorge mentioned, we seen some challenges in our cost structure. Some of it's related to commodities and FX, some of its related to some cost initiatives that we hope to get to quicker that we've had to slow down on in order to make sure we don't have service level disruptions. Jorge, would you add anything?

Jorge M. Gomez -- Chief Financial Officer

I know -- Just Bob to be clear, the change in expectations and the segment was mostly driven by volume issues related to our own internal challenges in terms of bill rates, and we had back orders throughout the quarter. So, as I indicated from a demand perspective, we are seeing, we haven't seen any major change -- any changes that since last time we talked about Medical. So, it's mostly related to volume -- volume issues that within our business.

Robert Jones -- Goldman Sachs -- Analyst

That's -- that's really helpful. I guess, just one follow-up, if we could shift over to pharma. You guys mentioned obviously good performance in the quarter, but you did mentioned, you know, one of the negatives being the generic performance the -- the performance of the generic program. Could you maybe just elaborate on what exactly you're seeing there? Is that -- I'm imagining it's more on the sales side, but just the dynamics that led that to be a bit of a negative in the quarter would be helpful to better understand.

Mike Kaufmann -- Chief Executive Officer

Yeah, you know, in generics. We really look at all of the factors, which to us are, you know, the inflation, deflation rate, launches, penetration, the ability of Red Oak to take our cost. And when we look at combining all of those together, we still continue to see our generics program to be a significant headwind for us both in Q3 and for the entire year. So I wouldn't necessarily say that we've seen any one of those components change dramatically within those various components of the program, just that it continues to be consistent with prior quarters versus seeing some of the improvement we would obviously like to see. Next question, please.

Operator

Eric Percher with Nephron Research. We'll have the next question.

Eric Percher -- Nephron Research -- Analyst

Thank you. Jorge, did you say that you had to scale back your ambitions for cost reduction in part because of what was occurring in the Medical business this quarter?

Jorge M. Gomez -- Chief Financial Officer

No, actually our cost initiatives are tracking ahead of -- of our internal plans. What happened this quarter is that some of those savings, we actually had to redirect and reinvest to try to fix up some of the short term challenges that we're seeing in Medical. So that's why we are not seeing the entire benefit of cost savings dropping to the bottom line because we have not been -- we have used those to cover some of the short-term challenges. But the initiatives are very much on track. And in fact we -- every quarter we are gaining more confidence in those targets and we will exceed the target for this year.

Eric Percher -- Nephron Research -- Analyst

Okay, got it. And then on CapEx. I know you reduced your expectation for the year and that had been running low in the first half but seem to normalize this quarter, can you give me a little bit of color on your expectations there?

Jorge M. Gomez -- Chief Financial Officer

I think, nothing really has changed fundamentally. But as we have indicated, we are being extremely disciplined and strict about return metrics and thresholds for investment. And then when you add that to bandwidth and the things that we're trying to -- to take care of in the short term, we believe that the new amounts that we are guiding to is -- is a reasonable fluid amount for this year.

Lisa Capodici -- Vice President, Investor Relations

Operator, next question.

Operator

And the question will come from Stephen Baxter with Wolfe Research.

Stephen Baxter -- Wolfe Research -- Analyst

Hi, thank you for the question.So I wanted to come back to Medical again, more of a big picture question.So if we look at the revised EBITDA outlook for the segment. It looks like it's somewhere around $640 million and based on your previous guidance for Patient Recovery. I would estimate that that's contributing somewhere around near $450 million of EBIT? So if you look at the legacy medical EBIT for Cardinal, it would be something less than $200 million. It would be really helpful to us, if you could rank the decline in terms of drivers over the past few years. It feels like the issues shift slightly from quarter to quarter. And I think really helpful to have sort of the cumulative sense of what's happened in the business over the past couple of years. Thanks.

Jorge M. Gomez -- Chief Financial Officer

Yeah. Let me take that question. The, -- I'd say we have been very, very transparent about the performance of the entire Cardinal brand products this quarter and -- and the issues we are facing with respect to up to volume and that, and that part of the business. Overall, the biggest parts of the business units within the segment. They are performing not too far from where we thought they would be, but certainly we have -- we have some short-term -- short-term challenges that we are facing. We have some businesses within the core legacy business, if you will, that are performing very well, as I indicated before we have at-home.

We have services doing really well and patient recovery, although patient recovery, we are still on track to meet our accretion goal that we set for this year. It's up -- it's probably the projections we have now are probably lower than what we thought due to this volume challenges, but we are on -- on track to meet the accretion goal that we have for fiscal '19.

Stephen Baxter -- Wolfe Research -- Analyst

Thanks. And just a quick follow-up, is it possible to comment on what revenue trends, it look like, sort of ex-patient recovery? Thanks.

Jorge M. Gomez -- Chief Financial Officer

The underlying revenue trends in the segment as I indicated, when you exclude dispositions and FX. The business is tracking very much in line with the market and with the expectation. So, no major changes there.

Lisa Capodici -- Vice President, Investor Relations

Operator, next question.

Operator

We'll hear from David Larsen with Leerink.

David Larsen -- Leerink -- Analyst

Hi. Can you talk a little bit more about the spread you're seeing on the generic side of the house. One of your peers is obviously talking about Pharma operating income growth over the next year. But from your tone or from your comments, it sounds like you're not necessarily seeing an improvement on the generic side, what's the difference in your view, what do you think the difference could be. Thanks.

Mike Kaufmann -- Chief Executive Officer

Yeah. It's hard to comment on other people's views of generics based on the fact that we all have different mixes, and we may be defining and putting different things in various buckets. But I would tell you that we do see it as more consistent with the prior quarters. And again, would not say that we've noticed any one factor, as you know, we've said that the beginning of the year that we expected that all those components to be a net headwind for us, and it has been a net headwind for us for the year and been the most significant one. And other than so far what we're seeing through three quarters is consistent market dynamics. It's really hard for me to comment on ours compared to someone else.

David Larsen -- Leerink -- Analyst

Okay. And when you use the term consistent like is your spread expanding or is it contracting? Is it a consistent rate of contraction in the spread? Anymore thoughts there would be very helpful, Mike.

Mike Kaufmann -- Chief Executive Officer

Yeah. I guess when we're talking about consistent and what we're talking about is that the -- when we take a look at deflation rates we look at the value that we're going to get from launches et cetera. Those are basically tracking where we expected the deflation rate, is. Relatively consistent quarter-to-quarter. And so we're, for us it's, again it's a net headwind. And so we're continuing to see consistent net headwind quarter-to-quarter not necessarily at this point in time, two, three quarters, seeing that headwind reducing.

Lisa Capodici -- Vice President, Investor Relations

Operator, next question.

Operator

We'll now hear from Kevin Caliendo with UBS.

Kevin Caliendo -- UBSA -- Analyst

Hi. Good morning, guys. So not to keep going back to Medical, but as -- if we look and think about your guidance and how it plays through the fiscal fourth quarter, would you consider that run rate as we move into 2020. Is there anything in there that, sort of, one-time-ish or should we think about this is -- as the base of which ex any seasonality in that business that we should be thinking about growing of -- of moving forward?

Jorge M. Gomez -- Chief Financial Officer

Good morning, Kevin. Thanks for the question. As Mike indicated before, at this point, it's too early for us to start out talking about trends going into next year, but obviously we have taken down the guidance for the rest of the year. It reflects what the challenges that I discussed before that we are seeing and we had a good first half to second half of the year, is going to be relatively consistent in terms of the challenges and that's why we've taken the guidance for Medical for Q4. I think it's too early to start talking about the things that we're seeing in -- going into fiscal '20.

Kevin Caliendo -- UBSA -- Analyst

Okay. That's fair. And just on CVS renewal, you said, everything was the same in terms of the businesses, the structure (ph), pricing starts July 1, just a couple of questions around the clinical, but the pricing. Was it -- there's always an incremental step down and you renew a contract we understand that. Was the incremental step down typical with most renewals that you do? And then secondly, does this contract through 2023 also incorporate your relationship with Red Oak or is it simply on the distribution side?

Mike Kaufmann -- Chief Executive Officer

Yeah. This contract was strictly on the distribution side. Our Red Oak agreement still has five years left on that agreement. The first five years will expire here at the end of roughly June 30 and then we have another five years left on that. So there's no current need to address that contract. Although things continue to go really well with Red Oak, love the team and love the partnership that we've had seen with CVS on that.

As far as deal goes, yeah, it is the new pricing does go in effect July 1 for us. And I would say that it was -- there was nothing about it that I would say it was different than what we would expect in the market price -- in the marketplace for customers of this size and importance and how they're growing and we feel that it's a fair and appropriate renewal and are excited to have the business for four more years.

Lisa Capodici -- Vice President, Investor Relations

Operator, next question.

Operator

We'll hear from Michael Cherny with Bank of America.

Michael Cherny -- Bank of America -- Analyst

Thanks for taking the question. Jorge, just to clarify, you just talked about, it's a little early at this point to start giving color clarity on fiscal '20. A, is that for Medical versus the whole business? And then I guess B, when you think about what's changed this year versus previous 3Q's when you've had some visibility and color into the next year. I guess what changed your view on, how you expect or why you decide not to give any color heading into next year?

Jorge M. Gomez -- Chief Financial Officer

Good morning, Michael. Thanks for the question. This is -- we normally don't provide any guidance into next year, at the end of Q3. Our typical cadence for providing color into the next fiscal year is during our August call, so we are not changing that. This is just not consistent with, our typical practices and my comment in terms of not giving color about Medical, it applies to the entire corporation and all the numbers across the enterprise.

Michael Cherny -- Bank of America -- Analyst

Yeah. I know you don't give guidance. You usually give some color on here some headwinds that we expect to persist, here some tailwinds that people are thinking of, I guess at this point, we'll just wait until August to hear on some of those. So thanks.

Mike Kaufmann -- Chief Executive Officer

Yeah. I think just a quick comment on that. Remember last year there was -- we had made an earlier comment around 560 (ph) in the marketplace and then we had decided that it would be because of that we gave a little bit around that last year it was different, but that is not our typical and is not something that we would typically do, we want to stay disciplined to be in and around the -- our August earnings time.

Lisa Capodici -- Vice President, Investor Relations

Operator, next question please.

Operator

We'll hear from Brian Tanquilut with Jefferies.

Bryan Ross -- Jefferies -- Analyst

Hi. This is Bryan Ross on for Brian Tanquilut. When you look at the generic landscape across the buy side and sell side in terms of what you're seeing now versus historical norms. I guess what inning do you think that you're in and getting back to that normalized generic pricing environment. And are you expecting to get back to that over the next year? Or do you think that's further off than that?

Jorge M. Gomez -- Chief Financial Officer

Thanks for the question. You know it's really hard to say. And again, that would be really more around giving guidance and we just want to stay away from that. For us it's just again just want to keep emphasizing that it continues to be a significant headwind for us in FY '19 for us and the market dynamics across our various components have remained consistent, but we'll give some more color to your question in August around not only our results for our Q4 but what our thoughts are obviously around that for our fiscal '20.

Bryan Ross -- Jefferies -- Analyst

Got it. And then just follow-up on -- just a follow-up on the 4Q guidance. Relating last year, somewhat of an easier comp and factoring in cost optimization and some of the actions you're taking in Medical, what are the puts and takes that give you the confidence in the year-over-year ramp implied by the fiscal year guidance?

Jorge M. Gomez -- Chief Financial Officer

You're talking about the Medical segment or --

Michael Cherny -- Bank of America -- Analyst

No, overall just the 4Q -- 4Q in respect to the -- for the full fiscal year guidance.

Mike Kaufmann -- Chief Executive Officer

I guess it's a couple different components. I know Jorge went through the detail here, but we've got, as you said -- as he said, he's got the ETR benefit we've had so far this year. Now we expect it to be higher in Q4. And we've changed our Medical guidance for the year. So we would obviously have taken down we expect our Medical segments earnings to be. And then we mentioned some other opportunities like the Pharma business doing -- obviously, it's going to offset some of that in our expense initiatives. So I think it's just a total of all those, when we look at it, we feel like our new guidance is the best indication of where we think we'll finish for the year.

Lisa Capodici -- Vice President, Investor Relations

Operator, next question please.

Operator

Will come from John Ransom with Raymond James.

John Ransom -- Raymond James -- Analyst

Hi. Yeah, we can look at the generic marketplace just with a handful of public companies and we can look at pricing data but thus the analysis sort of stops there. I'm curious, if you were to compare today to say a couple of years ago. And think about your top 50, 100 drugs. Do you see a material decline and the number of suppliers for, say, a generic Lipitor or some of the larger products? Because what we have, what we've seen with big public companies is they appear to be abandoning me-too (ph) products and the supply and of course, the public drug stores chains are complaining of lack of generic deflations. So is this (inaudible) would be that we just have fewer suppliers and I'm just kind of curious, your perspective on that.

Mike Kaufmann -- Chief Executive Officer

Yeah, it's an interesting question. I would say that I would, I would not say that overall that we're seeing last generic suppliers. There's clearly been a lot of public discussion around some of the larger ones rationalizing their supply chain in their portfolio of products. But at the same time we're seeing the FDA approved generic drugs at a record pace.

We're still seeing suppliers from outside the United States come in both on newer drugs as as well as opportunities on the old, some of the older drugs. And most importantly, you know, whether there's you know 5 or 10 players probably doesn't make as much of a difference for us, because as long as a certain amount of competition. We are going to be able to go get the cost that we need to from a Red Oak perspective and when we've seen it start to get to maybe fewer suppliers on certain specific items than we wanted, Red Oak has done a nice job of working with companies to either get them back in supply or find ways to get agreement to continue to get the cost.

So I wouldn't say that I've been a material difference in the net overall number of suppliers on items, although you can always pick one or two items, where you might see significant changes.

John Ransom -- Raymond James -- Analyst

So if that's true, it's not entirely clear at least to me, where the pressure will be coming from. And certainly you would say there's a lot of distress in the retail channel. So is it you're having to give a little more price concessions downstream because your retail customers need every bit of margin, they can find? Or is there something else that we're missing?

Mike Kaufmann -- Chief Executive Officer

Well, I think that what we've said in the past is that when you look at all of the components, when you take a generic deflation, which we at Cardinal define as sell-side deflation, and you netted against launches, penetration and the ability for Red Oak to go reduce cost on existing items. The net of all that is a net headwind for us for this year and has been for the quarter and for the year so far. So it's kind of exactly, what you're saying is that we are seeing more pressure on the sales side and we are able to offset it with launches, penetration in cost decreases and we're seeing margins shrink. Next question?

Operator

And that will come from Charles -- excuse me, Glenn Santangelo from Guggenheim Securities.

Glenn Santangelo -- Guggenheim Securities -- Analyst

Yeah. Thanks for taking the question. Mike, just to maybe follow-up on the Pharmaceutical segment for a moment, it looks like the headwind that you experienced in 3Q was smaller than what you did in the first and second quarter. So the operating profit was probably better than most people on this call we're looking for. And so if we hear you clearly, it doesn't sound like it came from the generics program at all. And so was there something else within the Pharmaceutical segment that maybe performed a little bit better than what you were or we all would have thought?

Mike Kaufmann -- Chief Executive Officer

Well, remember, Q3 is the quarter that is always going to be the quarter that has a seasonality and at the most seasonality and it related to brand price increases in the January time frame And so while those came in roughly about where we expected, I would say for us, the quarter came in about where we expected it to be in pharmaceutical. So I wouldn't call out any individual item being significantly better or worse than we actually anticipated for the quarter.

Glenn Santangelo -- Guggenheim Securities -- Analyst

And then maybe just a follow-up to that I was kind of curious on how maybe the conversations are trending with the manufacturers, given all the scrutiny around rebates and the HHS proposal and all of that. Is there -- are there any sort of initial what-if type acquisitions or is it just sort of business as usual. Thanks and I'll stop there.

Mike Kaufmann -- Chief Executive Officer

Thanks. It's a good question. I would say, here's what we're hearing from manufacturers. I think we continue to have very open, transparent conversations with manufacturers. We have been as contracts expire. We continue to work through the wording to make sure that we are protecting ourselves in the case of sudden changes in WAC prices that might potentially alter our dollar earnings from those manufacturers.

The conversations with manufacturers around the fact that if there were any changes around that we would need to work together. Because we still need to earn the dollars that we deserve based on the value of the services we provide and so you take that with constantly talking to them about ways to help them reduce their cost, improve their service levels, provide other services. I would say conversations with manufacturers continue to be fruitful positive and very transparent about all the various things that we're seeing out there that could fact impact both of us.

Lisa Capodici -- Vice President, Investor Relations

Operator, next question please.

Operator

Now hear from Charles Rhyee with Cowen.

Charles Rhyee -- Cowen -- Analyst

Yeah. Thanks. Just wanted to follow-up a little bit on Medical. Just -- and I think there was a sterilization plant that were shut down in February and some articles around that, I think it affected some of the manufacturers. And it sounds like maybe affected you. How much of that maybe if, is in this when you talk about, sort of, the internal challenges on fill rates and Jorge you talked about still on track in terms of the accretion for the deal in '19. Does that mean when you guys gave, sort of, the accretion targets for Patient Recovery, you kind of gave numbers not only for '19, but also for fiscal '20 -- or the fiscal '20 sort of, number still intact here from your mind understanding that we've reinvested some of those in the near term. And then also sort of, the $150 million synergy target you initially laid out. Thanks.

Mike Kaufmann -- Chief Executive Officer

Yeah. I'll take the first part on the issue related to ethylene oxide is what I am assuming you're talking about there. And then I'll let Jorge, talk about the accretion part. As far as the ethylene oxide issue that wouldn't really have had a -- an incredibly minor impact on us. For the quarter. Now that being said, it's something we have our eye on. We think it's important. It's used widely across the entire industry to sterilize products.

So it's something that is -- would impact everyone in the industry, including our competitors and manufacturers, so we're all -- it is important to the industry on that, but for the quarter it was immaterial. And like I said, at this point in time, we continue to look at alternatives and make sure that we're prepared in case there's any other changes related to that.

Jorge M. Gomez -- Chief Financial Officer

Charles, your question about Patient Recovery. So I said before that we are on target this year, we are for the disruptions that we experienced in the last quarter or so. We are below what we thought we were going to achieve this year from a, in terms of the -- the growth from Patient Recovery, but again within the accretion targets similar to any other parts of the business at this point, we don't want to get into any trends going into '20. We will do that in August, but as of now. This is how this quarters are trending. Within the fiscal '19, we are trending below what we thought we would achieve with Patient Recovery this year.

Charles Rhyee -- Cowen -- Analyst

If I could follow-up, but you know at the time you did give us fiscal '20 as well. I mean, can we think that understanding that this year, we're trending below what you've initially expected. Is it fair to think, are we still thinking from a sequential basis that you would expect things to continue to improve overall. And then just Mike, just to clarify what you're talking about, when you talk about ethylene oxide, that's the stereogenic plant that we're talking about?

Mike Kaufmann -- Chief Executive Officer

That's right.

Charles Rhyee -- Cowen -- Analyst

Okay. Thank you.

Mike Kaufmann -- Chief Executive Officer

Yeah. That's right. That's the sterilization method that, that plant uses. There are several different types of sterilization methods but that's what that plant is using and that I was referring to.

Jorge M. Gomez -- Chief Financial Officer

Yeah. And Charles going back to your question about Patient Recovery and going into the future. Obviously, the business case was designed and our expectations continue to be that we will improve the results of -- the performance of this business over time, especially as our synergies kick in. The synergies are expected to accrue over a few years. And when we think about those synergies at this point, right now during this fiscal year, we are on track with that trajectory.

Lisa Capodici -- Vice President, Investor Relations

Operator, next question please.

Operator

We'll hear from Ross Muken with Evercore.

Ross Muken -- Evercore -- Analyst

Guys, on the Medical side, I mean is there any incremental thought on sort of the portfolio mix? And maybe as you thought about sort of the longer-term strategy, given some of the volatility you've seen in some of the units and maybe changes in the end market, whether or not sort of you're in all the right markets?

And then secondarily, is there anything else you see on the outside that would be sort of synergistic with it in terms of pivoting in a direction where maybe you've had more success versus some of the areas where pricing and other elements have been more challenging?

Mike Kaufmann -- Chief Executive Officer

Thanks, Ross. I think a couple of things. I do think that when we look at our overall strategy of Medical of being really leveraging our historical distribution routes with having a broad and well-known product portfolio, it's really still the right strategy and important to us. We think that leveraging those two, like I said, is the right thing and important. We still have work to do, as we've said, around how we continue to modify our comp structure and the way we go to market to drive that.

So as we said, we're making the progress we want, but that takes time to change that, and we're continuing to work through that. So from that standpoint, we still feel very good about that. And so there's always opportunities to look at individual products to see if you -- if we need to add or delete from the portfolio. But in general, we feel really good about our portfolio and the overall strategy. Jorge, would you add anything to that?

Jorge M. Gomez -- Chief Financial Officer

Yeah. Ross, just to one of your specific points about certain markets and being in the right place, as we indicated a couple of times in the past and even today, part of the work we're doing is, is looking at our entire global portfolio, looking at geography rationalization opportunities. A few -- a couple of quarters ago, we talked about a few small geographies that we exited, and that is an ongoing work. We will always look at opportunities to improve our footprint. And in some cases, potentially we add and in many other cases, exit in geographies and certain product lines, in certain places. So that is all part of the ongoing strategic work that John and team are doing.

Charles Rhyee -- Cowen -- Analyst

And maybe just on the corporate side. I mean I -- maybe I missed it, but I don't remember anything on opioid travel-related expenses, I know it already appears yesterday. All that obviously a big step up for them into next year. I guess where are you in terms of that headwind? And how are you thinking about that in the context maybe of some of the cost takeouts that you're doing hopefully offsetting maybe some of that incremental pressure?

Jorge M. Gomez -- Chief Financial Officer

Yes. So this year, as you may recall, the number that we have included in our Pharmaceutical segment, which by the way we include all the opioid litigation expenses in Pharmaceutical, those are tracking in line with the guidance we provided a couple of quarters ago. So we are probably -- at some point, we said it was like about $80 million including some taxes (ph) in New York that we ended up unwinding. So we're probably in the $70 million area plus or take -- plus or minus a few million dollars. And so that is a major headwind for us this year. And obviously, we work really hard to make sure that we offset that with our cost-savings initiatives, but it's trending in line with what we were expecting for this year.

Lisa Capodici -- Vice President, Investor Relations

Operator, we have time for one more question.

Operator

And that last question will come from Ricky Goldwasser with Morgan Stanley.

Ricky Goldwasser -- Morgan Stanley -- Analyst

Yeah, hi, good morning and thank you for fitting me in. So two questions here. First of all, if you think about the Pharma segment and we you think about what guidance implies for fourth quarter, it seems that there is still a fairly wide range in your expectations from operating income. And when we kind of, just kind of take a look at the numbers, it seems that at high end, you expect operating income to potentially be up year-over-year versus a scenario where operating income is still down. So can you just help us better understand, what are the swing factors into fourth quarter? Are you expecting generic to do better? Is there anything that you see that would drive that variability?

Jorge M. Gomez -- Chief Financial Officer

Yeah. Ricky, this is Jorge. The drivers for the fourth quarter are the same drivers that we have experienced throughout the year. So obviously, what happens with our generics programs is an important factor. The Specialty business has been trending above expectations for us throughout the year, has done really, really well, and that is a swing factor as well. I think the type of savings, we are able to achieve with our programs -- internal programs, that is another important factor. So there is nothing new that I could point to that is driving the range that you're talking about for Q4.

Ricky Goldwasser -- Morgan Stanley -- Analyst

Okay. And then when we think about just specialty, because you highlight that -- and you highlight Specialty, strong growth in Specialty now helping you for a few quarters. Can you just give us some more -- some context on what's driving Specialty growth. Is it pricing? Is it market share gains, new products?

Mike Kaufmann -- Chief Executive Officer

For the most part, I think the big driver in Specialty is really -- the overall market growth is a big component of it. I mean obviously, we feel very good about our offering and how we're our competing in the marketplace and our discipline around cost structure are -- also our upstream services businesses continue to grow, but I think the biggest factor in Specialty really is really strong market growth that we're able to take advantage of.

Operator

Ladies and gentlemen, this will conclude your question-and-answer session. I'll turn the call back over to your CEO, Mike Kaufmann, for any closing remarks.

Mike Kaufmann -- Chief Executive Officer

Yeah. Thanks, everyone, for joining us today. As you can see we continue to execute on our plans and position Cardinal for future growth. And we really look forward to reporting on our progress with you over the next several months and then particularly, August when we talk about our FY '20. Thanks, and have a great day, everybody.

Operator

Ladies and gentlemen, this does conclude your conference for today. We do you thank you for your participation, and you may now disconnect.

Duration: 66 minutes

Call participants:

Lisa Capodici -- Vice President, Investor Relations

Mike Kaufmann -- Chief Executive Officer

Jorge M. Gomez -- Chief Financial Officer

Unidentified Speaker

Jonathan Young -- Barclays -- Analyst

Lisa Gill -- JPMorgan -- Analyst

Robert Jones -- Goldman Sachs -- Analyst

Eric Percher -- Nephron Research -- Analyst

Stephen Baxter -- Wolfe Research -- Analyst

David Larsen -- Leerink -- Analyst

Kevin Caliendo -- UBSA -- Analyst

Michael Cherny -- Bank of America -- Analyst

Bryan Ross -- Jefferies -- Analyst

John Ransom -- Raymond James -- Analyst

Glenn Santangelo -- Guggenheim Securities -- Analyst

Charles Rhyee -- Cowen -- Analyst

Ross Muken -- Evercore -- Analyst

Ricky Goldwasser -- Morgan Stanley -- Analyst

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