Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The discussion and analysis presented below refers to, and should be read in conjunction with, the consolidated financial statements and related notes included in this Form 10-K. Unless otherwise indicated, throughout this Management's Discussion and Analysis of Financial Condition and Results of Operations, we are referring to our continuing operations.

Overview

We are a healthcare services company providing pharmaceutical and medical products and services that help pharmacies, hospitals and other healthcare providers focus on patient care while reducing costs, enhancing efficiency and improving quality. We also provide medical products to patients in the home.

We report our financial results in two segments: Pharmaceutical and Medical.

During fiscal 2014, revenue decreased 10 percent to $91.1 billion largely due to the previously disclosed expiration of our pharmaceutical distribution contract with Walgreen Co. ("Walgreens") on August 31, 2013.

Gross margin increased 5 percent to $5.2 billion reflecting the positive impact of acquisitions and strong performance from generic programs, offset in part by the impact of the Walgreens contract expiration.

Operating earnings increased to $1.9 billion and earnings from continuing operations increased to $1.2 billion due primarily to an $829 million ($799 million, net of tax) non-cash goodwill impairment charge related to our Nuclear Pharmacy Services division in fiscal 2013.

Our cash and equivalents balance was $2.9 billion at June 30, 2014 compared to $1.9 billion at June 30, 2013. The increase in cash and equivalents during fiscal 2014 was driven by net cash provided by operating activities of $2.5 billion, which includes the decrease in our net working capital associated with the Walgreens contract expiration. Net cash provided by operating activities was deployed for share repurchases ($673 million), acquisitions ($519 million) and dividends ($415 million). We plan to continue to execute a balanced deployment of available capital to position ourselves for sustainable competitive advantage and to enhance shareholder value.

Walgreens Contract

The Walgreens contract expiration unfavorably impacted period-over-period comparisons of revenue and operating earnings for fiscal 2014, but favorably affected net cash provided by operating activities due to a significant reduction in net working capital. Because revenue from Walgreens was $3.3 billion during the first quarter of fiscal 2014, we expect the

contract expiration to have an adverse impact on our period-over-period comparisons of revenue and operating earnings during the first quarter of fiscal 2015.

Joint Venture With CVS Caremark

In July 2014, we established Red Oak Sourcing, LLC (“Red Oak Sourcing”), a U.S.-based generic pharmaceutical sourcing entity with CVS Caremark Corporation (“CVS”) with an initial term of 10 years. Both companies have contributed sourcing and supply chain expertise to the 50/50 joint venture and have committed to source generic pharmaceuticals through arrangements negotiated by it. Red Oak Sourcing will negotiate generic pharmaceutical supply contracts on behalf of both companies, but will not own products or hold inventory on behalf of either company. We are required to pay 39 quarterly payments of $25.6 million to CVS commencing in October 2014 and, only if certain milestones are achieved, to pay additional predetermined amounts to CVS beginning in fiscal 2016. The fixed payments of $25.6 million will be expensed evenly commencing with the ramp-up of the venture, which we expect to begin by the end of the first quarter of fiscal 2015. No physical assets were contributed by either company to Red Oak Sourcing, and minimal funding has been provided to capitalize the entity.

Acquisitions

We have completed several acquisitions since July 1, 2011, the largest of which were AssuraMed, Inc. ("AssuraMed") in fiscal 2013 and Access Closure, Inc. ("AccessClosure") in fiscal 2014.

On May 9, 2014, we completed the acquisition of AccessClosure for $320 million in an all-cash transaction. We funded the acquisition with cash on hand. The acquisition of AccessClosure, a manufacturer and distributor of extravascular closure devices, expands the Medical segment's portfolio of self-manufactured products.

On March 18, 2013, we completed the acquisition of AssuraMed for $2.07 billion, net of cash acquired, in an all-cash transaction. We funded the acquisition through the issuance of $1.3 billion in fixed rate notes and cash on hand. The acquisition of AssuraMed, a provider of medical supplies to homecare providers and patients in the home, expands Medical segment's ability to serve this patient base. The AssuraMed division is now known as our Cardinal Health at Home division ("Home division"). This acquisition increased revenue and operating earnings during fiscal 2014. The increase in amortization and other acquisition-related costs during fiscal 2014 was primarily due to intangible assets from this acquisition. We expect the amortization of acquisition-related intangible assets to continue to be a significant expense in future periods.

See Note 2 of the "Notes to Consolidated Financial Statements" for additional information on these acquisitions.

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Goodwill

As part of our annual goodwill impairment test during fiscal 2013, we concluded that the entire goodwill amount of our Nuclear Pharmacy Services division was impaired, resulting in a non-cash impairment charge of $829 million ($799 million, net of tax). This impairment charge did not impact our liquidity, cash flows from operations, or compliance with debt covenants. See Note 5 of the “Notes to Consolidated Financial Statements” for additional information.

Restructuring

On January 30, 2013, we announced a restructuring plan within our Medical segment. Under this restructuring plan, among other things, we have reorganized our Medical segment, moved production of procedure kits from our facility in Waukegan, Illinois to other facilities, and consolidated office space in Waukegan, Illinois. In addition, we are selling property in Waukegan, Illinois, and we are exiting our gamma sterilization business in El Paso, Texas. We currently estimate the total costs associated with this restructuring plan to be approximately $74 million on a pre-tax basis, of which $18 million and $51 million was recognized in fiscal 2014 and fiscal 2013, respectively.

Trends

Within our Pharmaceutical segment, pharmaceutical price appreciation on some generic products positively impacted our margins during fiscal 2014, but the frequency and magnitude of future generic product price appreciation is uncertain and the impact on earnings may be less in fiscal 2015 than in fiscal 2014.

Results of Operations

Revenue

	Revenue												Change
(in millions)	2014				2013				2012				2014			2013
Pharmaceutical	$	80,110			$	91,097			$	97,925			(12	)%		(7	)%
Medical	10,962				10,060				9,642				9	%		4	%
Total segment revenue	91,072				101,157				107,567				(10	)%		(6	)%
Corporate	12				(64		)		(15		)		N.M.			N.M.
Total revenue	$	91,084			$	101,093			$	107,552			(10	)%		(6	)%

Fiscal 2014 Compared to Fiscal 2013

Pharmaceutical Segment

Revenue for fiscal 2014 compared to fiscal 2013 was negatively impacted by the Walgreens contract expiration ($16.9 billion) and by the expiration of our pharmaceutical distribution contract with Express Scripts, Inc. ("Express Scripts") on September 30, 2012 ($2.0 billion). This decrease was partially offset by sales growth from existing pharmaceutical distribution customers ($7.1 billion).

Medical Segment

Revenue for fiscal 2014 compared to fiscal 2013 reflects the benefit of acquisitions ($816 million).

Fiscal 2013 Compared to Fiscal 2012

Pharmaceutical Segment

Revenue for fiscal 2013 compared to fiscal 2012 was negatively impacted by the expiration of our pharmaceutical distribution contract with Express Scripts (approximately $6.7 billion). Revenue from existing pharmaceutical distribution customers decreased by approximately $3.6 billion, primarily as a result of brand-to-generic pharmaceutical conversions. The decrease was partially offset by increased pharmaceutical distribution revenue from new customers (approximately $3.8 billion) and revenue growth within our Specialty Solutions division ($961 million).

Medical Segment

Revenue for fiscal 2013 compared to fiscal 2012 reflects the benefit of acquisitions ($459 million).

Cost of Products Sold

As a result of the same factors affecting the change in revenue, cost of products sold decreased $10.2 billion (11 percent) and $6.8 billion (7 percent) during fiscal 2014 and fiscal 2013, respectively. See the gross margin discussion below for additional drivers impacting cost of products sold.

Gross Margin

	Gross Margin												Change
(in millions)	2014				2013				2012				2014			2013
Gross margin	$	5,161			$	4,921			$	4,541			5	%		8	%

Fiscal 2014 Compared to Fiscal 2013

Gross margin increased during fiscal 2014 compared to fiscal 2013 ($240 million), reflecting the positive impact of acquisitions ($221 million).

Gross margin for fiscal 2014 was positively impacted by $32 million due to sales growth, which primarily reflects growth from existing customers, and was largely offset by the impact of the Walgreens contract expiration.

Gross margin rate, apart from the impact of the Walgreens contract expiration, was flat for fiscal 2014. Gross margin rate was positively impacted by strong performance from generic programs, including the impact of generic pharmaceutical price appreciation, and was adversely impacted by customer pricing changes.

Fiscal 2013 Compared to Fiscal 2012

Gross margin increased in fiscal 2013 compared to fiscal 2012 driven by strong performance in our generic pharmaceutical programs ($350 million) and acquisitions ($131 million). Increased margin from branded pharmaceutical distribution agreements (exclusive of the related volume impact) also had a positive impact on gross margin ($81 million). Pricing changes, including rebates (exclusive of the related volume impact), adversely impacted gross margin ($211 million), driven in part by customer and product mix. The adverse impact of these

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pricing changes was offset by sourcing programs and other sources of margin. As a result of significant market softness, gross margin from our Nuclear Pharmacy Services division decreased by $71 million in fiscal 2013.

Distribution, Selling, General and Administrative ("SG&A") Expenses

	SG&A Expenses												Change
(in millions)	2014				2013				2012				2014			2013
SG&A expenses	$	3,028			$	2,875			$	2,677			5	%		7	%

SG&A expenses increased during fiscal 2014 over fiscal 2013 primarily due to acquisitions ($129 million).

SG&A expenses increased during fiscal 2013 over fiscal 2012 primarily due to acquisitions ($84 million) and investment spending ($17 million).

Segment Profit and Consolidated Operating Earnings

	Segment Profit and Operating Earnings												Change
(in millions)	2014				2013				2012				2014			2013
Pharmaceutical	$	1,745			$	1,734			$	1,558			1	%		11	%
Medical	444				372				332				19	%		12	%
Total segment profit	2,189				2,106				1,890				4	%		11	%
Corporate	(304		)		(1,110		)		(98		)		N.M.			N.M.
Total operating earnings	$	1,885			$	996			$	1,792			89	%		(44	)%

Segment Profit

We evaluate segment performance based upon segment profit, among other measures. See Note 15 of the "Notes to Consolidated Financial Statements" for additional information on segment profit.

Pharmaceutical Segment Profit

The increase in fiscal 2014 over fiscal 2013 reflected the positive impact of sales growth, which primarily reflects growth from existing customers, and was largely offset by the impact of the Walgreens contract expiration. The impact of gross margin rate, apart from the impact of the Walgreens contract expiration, was flat for fiscal 2014. Gross margin rate was positively impacted by strong performance from generic programs, including the impact of generic pharmaceutical price appreciation, and was adversely impacted by customer pricing changes.

The principal drivers for the increase in fiscal 2013 over fiscal 2012 were strong performance in our generic pharmaceutical programs and increased margin from branded pharmaceutical distribution agreements. These benefits were partially offset by the unfavorable impact of pharmaceutical distribution pricing changes and significant market softness in our Nuclear Pharmacy Services division.

Medical Segment Profit

The principal driver for the increase in fiscal 2014 over fiscal 2013 was the positive impact of acquisitions.

The principal drivers for the increase in fiscal 2013 over fiscal 2012 were the positive impact of acquisitions and decreased cost of commodities used in our self-manufactured products, partially offset by the unfavorable impact of pricing changes, driven in part by customer and product mix. Segment profit was also moderated by softness in procedural-based utilization. The 2.3 percent excise tax on certain manufactured or imported medical devices that became effective January 1, 2013 had a slightly unfavorable impact on segment profit.

Corporate

As discussed further below, the principal driver for the change in Corporate in fiscal 2014 and fiscal 2013 was an $829 million non-cash goodwill impairment charge recognized in fiscal 2013 related to our Nuclear Pharmacy Services division.

Consolidated Operating Earnings

In addition to revenue, gross margin and SG&A expenses discussed above, operating earnings were impacted by the following:

(in millions)	2014				2013				2012
Restructuring and employee severance	$	31			$	71			$	21
Amortization and other acquisition-related costs	223				158				33
Impairments and loss on disposal of assets	15				859				21
Litigation (recoveries)/charges, net	(21		)		(38		)		(3		)

Restructuring and Employee Severance

In addition to other restructuring activities during fiscal 2014 and 2013, we recognized restructuring costs of $10 million and $40 million, respectively, related to the restructuring plan in our Medical segment. We also recognized $11 million of employee-related costs related to a restructuring plan within our Nuclear Pharmacy Services division during the fourth quarter of fiscal 2013.

Amortization and Other Acquisition-Related Costs

Amortization of acquisition-related intangible assets was $187 million, $118 million and $78 million for fiscal 2014, 2013 and 2012, respectively. The increase in amortization during 2014 and 2013 was primarily due to intangible assets from the acquisition of AssuraMed. We also recognized transaction costs associated with the purchase of AssuraMed of $20 million during fiscal 2013.

Amortization and other acquisition-related costs for fiscal 2012 included income recognized upon adjustment of the contingent consideration obligation incurred in connection with the Healthcare Solutions Holding, LLC ("P4 Healthcare") acquisition ($71 million). In early fiscal 2013, we terminated and settled the remaining contingent consideration obligation for $4 million.

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Impairments and Loss on Disposal of Assets

During fiscal 2014, we recognized an $8 million loss to write down property in Waukegan, Illinois in connection with our Medical segment restructuring plan.

Also in connection with our Medical segment restructuring plan, during fiscal 2013 we recognized an $11 million loss to write down our gamma sterilization assets in El Paso, Texas.

During fiscal 2013, we recognized an $829 million ($799 million, net of tax) goodwill impairment charge related to our Nuclear Pharmacy Services division, as discussed further in the Overview section and in Note 5 of the "Notes to Consolidated Financial Statements". We also recognized an $8 million loss during fiscal 2013 to write down commercial software under development within our Pharmaceutical segment.

During fiscal 2012, we recognized a $16 million loss to write down an indefinite-life intangible asset related to the P4 Healthcare trade name.

Litigation (Recoveries)/Charges, Net

We recognized income resulting from settlements of class action antitrust claims in which we were a class member of $24 million and $38 million during fiscal 2014 and 2013, respectively.

Earnings Before Income Taxes and Discontinued Operations

In addition to the items discussed above, earnings before income taxes and discontinued operations were impacted by the following:

	Earnings Before Income Taxes and Discontinued Operations												Change
(in millions)	2014				2013				2012				2014			2013
Other income, net	$	(46	)		$	(15	)		$	(1	)		N.M.			N.M.
Interest expense, net	133				123				95				8	%		29	%

Other Income, Net

Other income, net for fiscal 2014 included a $32 million pre-tax gain related to the sale of our minority equity interests in two investments.

Interest Expense, Net

The increase in interest expense, net for fiscal 2014 and 2013 was primarily due to $1.3 billion of notes issued in connection with the AssuraMed acquisition in fiscal 2013.

Provision for Income Taxes

Generally, fluctuations in the effective tax rate are due to changes within international and U.S. state effective tax rates resulting from our business mix and discrete items. A reconciliation of the provision based on the federal statutory income tax rate to our effective income tax rate from continuing operations is as follows (see Note 8 of the "Notes to Consolidated Financial Statements" for a detailed disclosure of the effective tax rate reconciliation):

	2014			2013			2012
Provision at Federal statutory rate	35.0	%		35.0	%		35.0	%
State and local income taxes, net of federal benefit	2.2			2.5			2.3
Foreign tax rate differential	(1.2	)		(4.0	)		(2.2	)
Nondeductible/nontaxable items	(0.2	)		(0.5	)		—
Nondeductible goodwill impairment	—			33.2			—
Change in measurement of an uncertain tax position and impact of IRS settlements	(0.4	)		(5.7	)		0.9
Other	(0.1	)		1.8			1.0
Effective income tax rate	35.3	%		62.3	%		37.0	%

Fiscal 2014 Compared to Fiscal 2013

The fiscal 2014 effective tax rate was impacted by net favorable discrete items of $37 million, which reduced the rate by 2.1 percentage points. The discrete items include the favorable impact of the settlement of federal and state tax controversies ($80 million) and release of valuation allowances ($12 million) and the unfavorable impact of remeasurement of unrecognized tax benefits ($65 million), primarily as a result of proposed assessments of additional tax.

Fiscal 2013 Compared to Fiscal 2012

The fiscal 2013 effective tax rate was unfavorably impacted by 33.2 percentage points ($295 million) due to the nondeductibility of substantially all of the goodwill impairment which was partially offset by the favorable impact of the revaluation of our deferred tax liability and related interest on unrepatriated foreign earnings as a result of an agreement with tax authorities ($64 million or 7.2 percentage points).

Ongoing Audits

During fiscal 2014, the U.S. Internal Revenue Service ("IRS") closed audits of fiscal years 2003 through 2005. The IRS is currently conducting audits of fiscal years 2006 through 2010.

Liquidity and Capital Resources

We currently believe that, based upon available capital resources (cash on hand and access to committed credit facilities) and projected operating cash flow, we have adequate capital resources to fund working capital needs; currently anticipated capital expenditures, business growth and expansion; contractual obligations; tax payments; and current and projected debt service requirements, dividends and share repurchases. If we decide to engage in one or more additional

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acquisitions, depending on the size and timing of such transactions, we may need to access capital in addition to cash on hand and our existing committed credit facilities.

Cash and Equivalents

Our cash and equivalents balance was $2.9 billion at June 30, 2014, compared to $1.9 billion at June 30, 2013. At June 30, 2014, our cash and equivalents were held in cash depository accounts with major banks or invested in high quality, short-term liquid investments.

The increase in cash and equivalents during fiscal 2014 was driven by net cash provided by operating activities of $2.5 billion, which was deployed for share repurchases ($673 million), acquisitions ($519 million) and dividends ($415 million). As anticipated, net cash provided by operating activities benefited from a net working capital decrease in excess of $500 million as a result of the Walgreens contract expiration.

During fiscal 2013, we deployed $2.2 billion of cash on acquisitions, $450 million on share repurchases and $353 million on dividends. During fiscal 2013, we received net proceeds from long-term obligations of $981 million.

During fiscal 2012, we deployed $450 million of cash on share repurchases, $300 million on dividends, $260 million on capital expenditures and $174 million on acquisitions. During fiscal 2012, we received net proceeds from long-term obligations of $290 million.

Our working capital can vary significantly depending on factors such as customer payments of accounts receivable, the timing of inventory purchases and payments to vendors in the regular course of business. The decrease in net working capital at June 30, 2014 compared to June 30, 2013 is primarily a result of the Walgreens contract expiration.

The cash and equivalents balance at June 30, 2014 included $420 million of cash held by subsidiaries outside of the United States. Although the vast majority of this cash is available for repatriation, permanently bringing the money into the United States could trigger U.S. federal, state and local income tax obligations. As a U.S. parent company, we may temporarily access cash held by our foreign subsidiaries without becoming subject to U.S. federal income tax through intercompany loans.

Credit Facilities and Commercial Paper

On October 15, 2013, we reduced our committed receivables sales facility program through Cardinal Health Funding, LLC ("CHF") from $950 million to $700 million in light of the Walgreens contract expiration. In addition to our committed receivables sales facility program, our sources of liquidity include a $1.5 billion revolving credit facility and a commercial paper program of up to $1.5 billion, backed by the revolving credit facility.

We had no outstanding balance under the revolving credit facility at June 30, 2014 and 2013, except for standby letters of credit

of zero and $43 million at June 30, 2014 and 2013, respectively. We had no outstanding borrowings from the commercial paper program at June 30, 2014 and 2013. We had no outstanding balance under the committed receivables sales facility program at June 30, 2014 and 2013, except for standby letters of credit of $41 million and zero at June 30, 2014 and 2013, respectively. Our revolving credit facility and committed receivables sales facility program require us to maintain a consolidated interest coverage ratio, as of any fiscal quarter end, of at least 4-to-1 and a consolidated leverage ratio of no more than 3.25-to-1. As of June 30, 2014, we were in compliance with these financial covenants.

Available-for-Sale Securities

During fiscal 2014, we purchased $100 million of marketable securities, which are classified as available-for-sale.

Long-Term Obligations and Other Short-Term Borrowings

At June 30, 2014, we had total long-term obligations and other short-term borrowings of $4.0 billion compared to $3.9 billion at June 30, 2013.

Capital Expenditures

Capital expenditures during fiscal 2014, 2013 and 2012 were $249 million, $195 million and $260 million, respectively.

We expect capital expenditures in fiscal 2015 to be between $335 million to $365 million primarily for growth projects in our core businesses as well as information technology projects.

Dividends

During fiscal 2014, we paid quarterly dividends totaling $1.21 per share, an increase of 18 percent from fiscal 2013. On May 7, 2014, our Board of Directors approved a 13 percent increase in our quarterly dividend to $0.3425 per share, or $1.37 per share on an annualized basis, which was paid on July 15, 2014 to shareholders of record on July 1, 2014.

On August 6, 2014, our Board of Directors approved a quarterly dividend of $0.3425 per share, or $1.37 per share on an annualized basis, payable on October 15, 2014 to shareholders of record on October 1, 2014.

Share Repurchases

During fiscal 2014, we repurchased $673 million of our common shares. We funded the repurchases with cash on hand. At June 30, 2014, we had $727 million remaining under our current repurchase authorization which expires December 31, 2016. On August 6, 2014, our Board of Directors authorized an additional $1.0 billion under this share repurchase program.

Interest Rate and Currency Risk Management

We use interest rate swaps, foreign currency contracts and commodity contracts to manage our exposure to cash flow variability. We also use interest rate swaps to protect the value of our debt and foreign currency forward contracts to protect the

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value of our existing foreign currency assets and liabilities. See "Item 7A: Quantitative and Qualitative Disclosures About Market Risk" below as well as Notes 1 and 12 of the “Notes to Consolidated Financial Statements” for information regarding the use of financial instruments and derivatives as well as foreign currency, interest rate and commodity exposures.

Off-Balance Sheet Arrangements

We had no significant off-balance sheet arrangements at June 30, 2014.

Contractual Obligations

At June 30, 2014, our contractual obligations, including estimated payments due by period, are as follows:

(in millions)	2015				2016 to 2017				2018 to 2019				There-after				Total
Long-term debt and short-term borrowings (1)	$	800			$	787			$	560			$	1,796			$	3,943
Interest on long-term debt	155				236				151				562				1,104
Capital lease obligations (2)	1				23				2				3				29
Other liabilities (3)	3				2				—				—				5
Operating leases (4)	97				140				76				74				387
Purchase obligations and other payments (5)	275				293				236				513				1,317
Total contractual obligations	$	1,331			$	1,481			$	1,025			$	2,948			$	6,785

(1)	Represents maturities of our long-term debt obligations and other short-term borrowings excluding capital lease obligations described below. See Note 7 of the “Notes to Consolidated Financial Statements” for further information.

(2)	Represents maturities of our capital lease obligations included within long-term debt in our consolidated balance sheets.

(3)

Represents cash outflows by period for certain of our liabilities in which cash outflows could be reasonably estimated. Long-term liabilities, such as unrecognized tax benefits and deferred taxes, have been excluded from the table above because of the inherent uncertainty of the underlying tax positions or because of the inability to reasonably estimate the timing of any cash outflows. See Note 8 of the “Notes to Consolidated Financial Statements” for further discussion of income taxes.

(4)	Represents minimum rental payments and the related estimated future interest payments for operating leases having initial or remaining non-cancelable lease terms as described in Note 9 of the “Notes to Consolidated Financial Statements.”

(5)

A purchase obligation is defined as an agreement to purchase goods or services that is legally enforceable and specifies all significant terms, including fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and approximate timing of the transaction. The purchase obligation amounts disclosed above represent estimates of the minimum for which we are obligated and the time period in which cash outflows will occur. Purchase orders and authorizations to purchase that involve no firm commitment from either party are excluded from the above table. In addition, contracts that can be unilaterally canceled with no termination fee or with proper notice are excluded from our total purchase obligations except for the amount of the termination fee or the minimum amount of goods that must be purchased during the requisite notice period. Purchase obligations and other payments also includes 39 quarterly payments of $25.6 million that we are required to pay CVS commencing in October 2014 in connection with the establishment of Red Oak Sourcing, but does not include contingent payments that may

become payable under the joint venture. See Note 1 of the “Notes to Consolidated Financial Statements” for additional information.

Recent Financial Accounting Standards

See Note 1 of the “Notes to Consolidated Financial Statements” for a discussion of recent financial accounting standards.

Critical Accounting Policies and Sensitive Accounting Estimates

Critical accounting policies are those accounting policies that (i) can have a significant impact on our financial condition and results of operations and (ii) require use of complex and subjective estimates based upon past experience and management’s judgment. Other people applying reasonable judgment to the same facts and circumstances could develop different estimates. Because estimates are inherently uncertain, actual results may differ. In this section, we describe the significant policies applied in preparing our consolidated financial statements that management believes are the most dependent on estimates and assumptions. For additional accounting policies, see Note 1 of the “Notes to Consolidated Financial Statements.”

Allowance for Doubtful Accounts

Trade receivables are primarily comprised of amounts owed to us through our distribution businesses and are presented net of an allowance for doubtful accounts of $137 million and $134 million at June 30, 2014 and 2013, respectively. We also provide financing to various customers. Such financing arrangements range from 270 days to 5 years, at interest rates that are generally subject to fluctuation. Interest income on these arrangements is recognized as it is earned. The financings may be collateralized, guaranteed by third parties or unsecured. Finance notes and related accrued interest are reported net of an allowance for doubtful accounts of $18 million and $17 million at June 30, 2014 and 2013, respectively, and are included in other assets (current portion is included in prepaid expenses and other) in the consolidated balance sheets. We must use judgment when deciding whether to extend credit and when estimating the required allowance for doubtful accounts.

The allowance for doubtful accounts includes portfolio and specific reserves. We determine the appropriate allowance by reviewing accounts receivable aging, industry trends, customer financial strength and credit standing, historical write-off trends and payment history. We also regularly evaluate how changes in economic conditions may affect credit risks.

Our methodology for estimating the allowance for doubtful accounts is assessed annually based on historical losses and economic, business and market trends. In addition, the allowance is reviewed quarterly and updated if appropriate. We may adjust the allowance for doubtful accounts if changes in customers’ financial condition or general economic conditions make defaults more frequent or severe.

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The following table gives information regarding the allowance for doubtful accounts over the past three fiscal years:

(in millions, except percentages)	2014				2013				2012
Allowance for doubtful accounts	$	156			$	152			$	143
Reduction to allowance for customer deductions and write-offs	51				34				30
Charged to costs and expenses	51				41				22
Allowance as a percentage of customer receivables	2.8		%		2.3		%		2.2		%
Allowance as a percentage of revenue	0.17		%		0.15		%		0.13		%

A hypothetical 0.1 percent increase or decrease in the reserve as a percentage of trade receivables and finance notes receivables at June 30, 2014, would result in an increase or decrease in bad debt expense of $6 million.

We believe the reserve maintained and expenses recorded in fiscal 2014 are appropriate. At this time, we are not aware of any analytical findings or customer issues that might lead to a significant future increase in the allowance for doubtful accounts as a percentage of revenue.

Inventories

A substantial portion of our inventories (61 percent and 65 percent at June 30, 2014 and 2013, respectively) are valued at the lower of cost, using the last-in, first-out ("LIFO") method, or market. These are primarily merchandise inventories at the core pharmaceutical distribution facilities within our Pharmaceutical segment. The LIFO impact on the consolidated statements of earnings in a given year depends on pharmaceutical price appreciation and the level of inventory. Prices for branded pharmaceuticals generally tend to rise, which results in an increase in cost of products sold, whereas prices for generic pharmaceuticals generally tend to decline, which results in a decrease in cost of products sold.

The LIFO method presumes that the most recent inventory purchases are the first items sold, so LIFO helps us better match current costs and revenue. Using LIFO, if there is a decrease in inventory levels that have experienced pharmaceutical price appreciation, the result generally will be a decrease in future cost of products sold as our older inventory is held at a lower cost. Conversely, if there is a decrease in inventory levels that have experienced a pharmaceutical price decline, the result generally will be an increase in future cost of products sold as our older inventory is held at a higher cost. We believe that the average cost method of inventory valuation reasonably approximates the current cost of replacing inventory within the core pharmaceutical distribution facilities. Accordingly, the LIFO reserve is the difference between (a) inventory at the lower of LIFO cost or market and (b) inventory at replacement cost determined using the average cost method of inventory valuation.

The remaining inventory is stated at the lower of cost, using the first in, first out method, or market. If we had used the average

cost method of inventory valuation for all inventory within the Pharmaceutical distribution facilities, the value of our inventories would not have changed in fiscal 2014 or 2013. Primarily because prices for our generic pharmaceutical inventories have declined over time, inventories valued at LIFO were $98 million and $97 million higher than the average cost value at June 30, 2014 and 2013, respectively. We do not record inventories in excess of replacement cost. As such, we did not record any changes in our LIFO reserve in fiscal 2014 and 2013.

Inventories presented in the consolidated balance sheets are net of reserves for excess and obsolete inventory which were $44 million and $40 million at June 30, 2014 and 2013, respectively. We reserve for inventory obsolescence using estimates based on historical experience, sales trends, specific categories of inventory and age of on-hand inventory. If actual conditions are less favorable than our assumptions, additional inventory reserves may be required.

Business Combinations

The assets acquired and liabilities assumed in a business combination, including identifiable intangible assets, are based on their estimated fair values as of the acquisition date. The excess of the purchase price over the estimated fair value of the net tangible and identifiable intangible assets acquired is recorded as goodwill. We base the fair values of identifiable intangible assets on detailed valuations that require management to make significant judgments, estimates and assumptions. Critical estimates and assumptions include: expected future cash flows for customer relationships, trademarks, trade names, developed technology and other identifiable intangible assets; discount rates that reflect the risk factors associated with future cash flows; and estimates of useful lives. When an acquisition involves contingent consideration, we recognize a liability equal to the fair value of the contingent consideration obligation at the acquisition date. The estimate of fair value of a contingent consideration obligation requires subjective assumptions to be made regarding future business results, discount rates and probabilities assigned to various potential business result scenarios. Subsequent revisions to these assumptions could materially change the estimate of the fair value of contingent consideration obligations and therefore could materially affect our financial position or results of operations. See Note 2 of the “Notes to Consolidated Financial Statements” for additional information regarding our acquisitions.

Goodwill and Other Intangible Assets

Purchased goodwill and intangible assets with indefinite lives are not amortized, but instead are tested for impairment annually or when indicators of impairment exist. Intangible assets with finite lives, primarily customer relationships, trademarks and patents, and non-compete agreements, are amortized over their useful lives.

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Financial Review (continued)

Goodwill impairment testing involves a comparison of the estimated fair value of reporting units to the respective carrying amount, which may be performed utilizing either a qualitative or quantitative assessment. A reporting unit is defined as an operating segment or one level below an operating segment (also known as a component). If the estimated fair value exceeds the carrying amount, then no impairment exists. If the carrying amount exceeds the estimated fair value, then a second step is performed to determine the amount of impairment, if any. An impairment charge is the amount by which the carrying amount of goodwill exceeds the estimated implied fair value of goodwill. We estimate the implied fair value of goodwill as the excess of the estimated fair value of the reporting unit over the estimated fair value of its net tangible and identifiable intangible assets. This is the same manner we use to recognize goodwill from a business combination. Goodwill impairment testing involves judgment, including the identification of reporting units, the estimation of the fair value of each reporting unit and, if necessary, the estimation of the implied fair value of goodwill.

We have two operating segments, which are the same as our reportable segments: Pharmaceutical and Medical. These operating segments are comprised of divisions (components), for which discrete financial information is available. Components are aggregated into reporting units for purposes of goodwill impairment testing to the extent that they share similar economic characteristics. Our reporting units are: Pharmaceutical operating segment (excluding our Nuclear Pharmacy Services division and Cardinal Health China - Pharmaceutical division); Nuclear Pharmacy Services division; Cardinal Health China - Pharmaceutical division; Medical operating segment (excluding our Home division); and Home division.

Fair value can be determined using market, income or cost-based approaches. Our determination of estimated fair value of the reporting units is based on a combination of the income-based and market-based approaches. Under the income-based approach, we use a discounted cash flow model in which cash flows anticipated over several future periods, plus a terminal value at the end of that time horizon, are discounted to their present value using an appropriate risk-adjusted rate of return. We use our internal forecasts to estimate future cash flows and include an estimate of long-term growth rates based on our most recent views of the long-term outlook for each reporting unit. Actual results may differ materially from those used in our forecasts. We use discount rates that are commensurate with the risks and uncertainty inherent in the respective reporting units and in our internally-developed forecasts. Discount rates used in our reporting unit valuations ranged from 9 to 12 percent. Under the market-based approach, we determine fair value by comparing our reporting units to similar businesses or guideline companies whose securities are actively traded in public markets. To further confirm fair value, we compare the aggregate fair value of our reporting units to our total market capitalization. Estimating the fair value of

reporting units requires the use of estimates and significant judgments that are based on a number of factors including actual operating results. The use of alternate estimates and assumptions or changes in the industry or peer groups could materially affect the determination of fair value for each reporting unit and potentially result in goodwill impairment.

We performed annual impairment testing in fiscal 2014, 2013 and 2012 and, with the exception of our Nuclear Pharmacy Services division in fiscal 2013, concluded that there were no impairments of goodwill as the estimated fair value of each reporting unit exceeded its carrying value. For our fiscal 2014, 2013 and 2012 testing, we elected to bypass the optional qualitative assessment. With the exception of our Nuclear Pharmacy Services division in fiscal 2013, if we were to alter our impairment testing by increasing the discount rate in the discounted cash flow analysis by 1 percent, there still would not be any impairment indicated for any of these reporting units for fiscal 2014, 2013 or 2012. As discussed further in Note 5 of the “Notes to Consolidated Financial Statements”, during the fourth quarter of fiscal 2013 we recognized an $829 million ($799 million, net of tax) non-cash goodwill impairment charge related to our Nuclear Pharmacy Services division, which is included in impairments and loss on disposal of assets in our consolidated statements of earnings.

We review intangible assets with finite lives for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. Determining whether an impairment loss occurred requires a comparison of the carrying amount to the sum of the undiscounted cash flows expected to be generated by the asset.

Vendor Reserves

In the ordinary course of business, our vendors may dispute deductions taken against payments otherwise due to them or assert other billing disputes. These disputed transactions are researched and resolved based upon our policy and findings of the research performed. At any given time, there are outstanding items in various stages of research and resolution. In determining appropriate reserves for areas of exposure with our vendors, we assess historical experience and current outstanding claims. We have established various levels of reserves based on the type of claim and status of review. Though the transaction types are relatively consistent, we periodically refine our methodology by updating the reserve estimate percentages to reflect actual historical experience. Changes to the estimate percentages affect the cost of products sold in the period in which the change was made.

Vendor reserves were $82 million and $66 million at June 30, 2014 and 2013, respectively. Approximately 68 percent of the vendor reserve at the end of fiscal 2014 pertained to the Pharmaceutical segment compared to 60 percent at the end of fiscal 2013. The reserve balance will fluctuate due to variations

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Financial Review (continued)

of outstanding claims from period-to-period, timing of settlements, and specific vendor issues, such as bankruptcies.

The ultimate outcome of specific claims may be different than our original estimate and may require adjustment. We believe, however, that reserves recorded for such disputes are adequate based upon current facts and circumstances.

Loss Contingencies

We accrue for contingencies related to disputes, litigation and regulatory matters if it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Because these matters are inherently unpredictable and unfavorable developments or resolutions can occur, assessing contingencies is highly subjective and requires judgments about future events. We regularly review contingencies to determine whether our accruals and related disclosures are adequate. The amount of ultimate loss may differ from these estimates. See Note 9 of the “Notes to Consolidated Financial Statements” for additional information regarding loss contingencies.

Provision for Income Taxes

Our income tax expense, deferred income tax assets and liabilities, and unrecognized tax benefits reflect management’s assessment of estimated future taxes to be paid on items in the consolidated financial statements.

Deferred income taxes arise from temporary differences between financial reporting and tax reporting bases of assets and liabilities, as well as net operating loss and tax credit carryforwards for tax purposes. The following table presents information about our tax position at June 30:

(in millions)	2014				2013
Net deferred income tax assets	$	444			$	510
Net deferred income tax liabilities	1,653				1,638
Loss and credit carryforwards included in net deferred income tax assets	191				158
Net valuation allowance against deferred income tax assets (1)	94				88

(1)	This valuation allowance primarily relates to federal, state and international loss carryforwards for which the ultimate realization of future benefits is uncertain.

Expiring loss and credit carryforwards and the required valuation allowances are adjusted annually. After applying the valuation allowances, we do not anticipate any limitations on our use of any of the other net deferred income tax assets described above.

We believe that our estimates for the valuation allowances against deferred tax assets and unrecognized tax benefits are appropriate based on current facts and circumstances. However, others applying reasonable judgment to the same facts and circumstances could develop different estimates. The amount we ultimately pay when matters are resolved may differ from the amounts accrued.

Tax benefits from uncertain tax positions are recognized when it is more likely than not that the position will be sustained upon examination of the technical merits of the position, including resolutions of any related appeals or litigation processes. The amount recognized is measured as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon settlement. See Note 8 of the “Notes to Consolidated Financial Statements” for additional information regarding unrecognized tax benefits.

If any of our assumptions or estimates were to change, an increase or decrease in our effective income tax rate by 1 percent would have caused income tax expense to increase or decrease $18 million for fiscal 2014.

Share-Based Compensation

Share-based compensation to employees is recognized in the consolidated statements of earnings based on the grant date fair value of the awards. The fair value of restricted share units and performance share units is determined by the grant date market price of our common shares. The compensation expense associated with nonvested performance share units is dependent on our periodic assessment of the probability of the targets being achieved and our estimate, which may vary over time, of the number of shares that ultimately will be issued. The fair value of stock options is determined using a lattice valuation model. We believe the lattice model provides reasonable estimates because it has the ability to take into account employee exercise patterns based on changes in our stock price and other variables and it provides for a range of input assumptions.

We analyze historical data to estimate option exercise behaviors and employee terminations to be used within the lattice model. The expected life of the options granted is calculated from the option valuation model and represents the length of time in years that the options granted are expected to be outstanding. Expected volatilities are based on implied volatility from traded options on our common shares and historical volatility over a period of time commensurate with the contractual term of the option grant (up to ten years). As required, the forfeiture estimates are adjusted to reflect actual forfeitures when an award vests. The actual forfeitures in future reporting periods could be higher or lower than our current estimates. See Note 16 of the "Notes to Consolidated Financial Statements" for additional information regarding share-based compensation.