Cardinal Health, Inc. (NYSE:CAH) Q2 2023 Earnings Call Transcript

Cardinal Health, Inc. (NYSE:CAH) Q2 2023 Earnings Call Transcript February 2, 2023

Operator: Hello, and welcome to the Second Quarter FY2023 Cardinal Health Earnings Conference Call. Please note, this call is being recorded. And for the duration of the call, your lines will be on listen-only. However, you will have the opportunity to ask question at the end of the call. I will now hand over to your host, Mr. Kevin Moran, VP of Investor Relations, to begin today’s conference. Thank you.

Kevin Moran: Good morning and welcome. Today, we will discuss Cardinal Health’s second quarter fiscal 2023 results, along with updates to our full year outlook. You can find today’s press release and earnings presentation on the IR section of our website at ir.cardinalhealth.com. Joining me today are Jason Hollar, our Chief Executive Officer; Trish English, our Interim Chief Financial Officer; and Aaron Alt, who will take over as our Chief Financial Officer beginning February 10. During the call, we’ll be making forward-looking statements. The matters addressed in the statements are subject to the 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.

Please note that during our discussion today, our comments will be on a non-GAAP basis unless they are specifically called out as GAAP. GAAP to non-GAAP reconciliations for all relevant periods can be found in the schedules attached to our press release. During the Q&A portion of today’s call, we please ask that you limit yourself to one question so that we can try and give everyone in the queue an opportunity. With that, I’ll turn the call over to Jason.

Jason Hollar: Thanks, Kevin, and good morning, everyone. Before we dive in, I’d like to take a moment to welcome Aaron Alt to Cardinal Health as our incoming Chief Financial Officer. We’re excited to have Aaron on board. He brings a breadth of financial and operational experience to our organization, including a background in distribution and he’s already hit the ground running in his first few weeks. I’m confident he will be a valuable addition as the leader of our finance organization, contributor to our executive committee and a seamless fit with our company culture.

Aaron Alt: Thank you, Jason. Good morning. I am excited to be part of the team here at Cardinal, particularly at such an important time not only for our company but for the entire health care industry. What attracted me to Cardinal Health was the broad portfolio, the overall culture and the leadership team that is motivated to win. While still early days for me, I can already tell that while there’s work to do, Jason and the team have a plan and there are significant opportunities for value creation in front of us. I look forward to interacting with all of you further in the weeks and months to come as I continue to ramp up.

Jason Hollar: Thanks, Aaron. Now let’s begin with some high-level perspectives on the second quarter. Overall, our Q2 results demonstrated continued momentum against our plans. In Pharma, we’ve seen ongoing stability in the macro trends and underlying fundamentals of the business. In the quarter, we saw particular strength in overall pharmaceutical demand and strong performance from our Generics program. We’ve seen an increase in contributions from Specialty products, which is a key strategic area of focus. And we continue to effectively manage through the inflationary headwinds affecting industry supply chains. In short, Q2 was another data point that Pharma is a resilient and growing business. In Medical, we remain highly focused on our medical improvement plan initiatives.

Overall, despite some puts and takes, Medical’s Q2 results were consistent with our prior commentary, and we were pleased to see a return to profitability in the quarter. We continue to take actions to drive more predictable financial performance, in line with this business’ underlying potential. At an enterprise level, we continue to see benefits below the operating line from our capital deployment actions and favorable capital structure. With the first half of fiscal 2023 behind us, we are pleased to raise our full year EPS guidance and outlook for the Pharmaceutical segment. Our team remains focused on executing our three key strategic priorities of executing on the medical improvement plan, building on the growth and resiliency of the Pharmaceutical segment and maintaining a relentless focus on maximizing shareholder value.

I will update you on these priorities in a few moments. Before I turn it over to Trish to review our results from the quarter and revised outlook, I’d like to thank her for stepping in as interim CFO over the past six months. Trish has brought leadership and continuity to the organization and will be instrumental in ensuring a seamless transition with Aaron. Thanks Trish.

Trish English: Thank you, Jason, and good morning, everyone. I’ll begin today with our consolidated second quarter results. Total company revenue increased 13% and gross margin increased 3%, both driven by the Pharma segment. Consolidated SG&A increased 4%, primarily reflecting inflationary supply chain costs. Benefits from our enterprise-wide cost savings initiatives offset some of this increase. Operating earnings of $467 million were in line with the second quarter of last year, this reflects growth in Pharma segment profit offset by the decline in Medical segment profit, which was anticipated. Moving below the line, interest and others decreased nearly 30% to $18 million driven primarily by increased interest income from cash and equivalents.

As a reminder, our debt is largely fixed rate, resulting in a net benefit from rising interest rates. Our second quarter effective tax rate finished at 23%, approximately 3.5 percentage points higher than prior year, primarily due to net positive discrete items in the prior year period. Diluted weighted average shares were $263 million, 6% lower than a year ago due to share repurchases. In the second quarter, we completed our $1 billion accelerated share repurchase program and initiated a new $250 million program, resulting in a total of $1.25 billion deployed year-to-date. We continue to expect $1.5 billion to $2 billion in share repurchases in fiscal 2023, which reflects our continued focus on maximizing shareholder value. The net result for the quarter was earnings per share growth of 4% to $1.32.

Now turning to the balance sheet. We generated second quarter adjusted free cash flow of $439 million, bringing year-to-date adjusted free cash flow to $781 million. We ended the period with a cash position of $3.7 billion with no outstanding borrowings on our credit facility. As a reminder, we continue to expect to pay down the $550 million of March 2023 notes at maturity with cash on hand. Now I will cover our segment performance, beginning with Pharma on Slide 5. Second quarter revenue increased 15% to $48 billion, driven by brand and Specialty Pharmaceutical sales growth from existing and net new customers. Pharma segment profit increased 9% to $464 million. This was driven by a higher contribution from Branded Specialty Products and Generics program performance, partially offset by inflationary supply chain costs.

During the quarter, we saw strong overall pharmaceutical demand, including from our largest customers, reflecting their strength in the market. To a lesser extent, we also saw year-over-year contributions from the net new customers that we’ve previously mentioned and a more robust seasonality with cough, cold and flu products as others have noted. Regarding our Generics program, we are pleased with the solid execution and consistent market dynamics we continue to see. This includes strong performance from Red Oak Sourcing, not only controlling costs, but also in maximizing service delivery for our customers. Within our supply chain, we continue to effectively manage through the industry-wide inflationary costs being in the areas of transportation and labor.

In the second quarter, these inflationary impacts were generally consistent with our expectations. Similar to last quarter, this headwind was offset by year-over-year tailwinds from our complete ERP technology enhancements and lower opioid-related legal costs. Okay. Turning to Medical on Slide 6. Second quarter revenue decreased 7% to $3.8 billion, driven by lower products and distribution sales, including PPE pricing and volumes. Continued strong growth in our At-Home Solutions business partially offset this decline. Medical segment profit finished in line with our prior commentary, decreasing 66% to $17 million. This was primarily due to lower products and distribution volumes and net inflationary impact, partially offset by an improvement in PPE margin.

During the quarter, the net impact from inflation was in line with our expectations, and we achieved inflation mitigation of over 30%. This sequential improvement from the first quarter was driven by the continued acceleration of our mitigation efforts, including the implementation of additional product pricing actions in the quarter. On our last two earnings calls, we have discussed overall volume softness in our Products and Distribution business. In the second quarter, we saw generally consistent overall volumes on a sequential basis, including our Cardinal Health brand products. With respect to PPE, we did see some slight improvement in volumes on a sequential basis. Additionally, we made significant progress in selling through our higher cost inventory on our balance sheet leading to normalized PPE margins in the quarter.

Now for our updated fiscal 2023 outlook beginning on Slide 8. We are raising our EPS guidance by $0.15 at the lower end and $0.10 at the higher end to a new range of $5.20 to $5.50, which represents 6% year-over-year growth at the midpoint. This update reflects improved outlooks for the Pharmaceutical segment and for interest in other. We now expect interest in other in the range of $115 million to $130 million with the improvement primarily driven by the increased interest income on cash and equivalents. Our expectations for the remaining items listed on Slide 8 remain unchanged. Turning to Slide 9 in the Pharmaceutical segment. We are raising our outlook for revenue to a new range of 13% to 15% growth and for segment profit to a new range of 4% to 6.5% growth, both of which primarily reflect our strong first half performance.

As we look to the second half in pharma, we anticipate the year-over-year profit growth to be fairly balanced between the third and fourth quarters. Turning to medical. We continue to expect a revenue decline of 3% to 6% and segment profit ranging from flat to a decline of 20%. With respect to inflation and our mitigation actions, we continue to expect a net impact of approximately $300 million in fiscal 2023 or a minimal year-over-year impact. On the cost side, while still at elevated levels, we’ve seen a general stabilization across most areas along with improvement in international freight. As a reminder, these product costs are capitalized into inventory and in the current environment of elongated supply chain reflected in our P&L results on an approximate two quarter delay.

Importantly, we continue to expect to exit the year with a run rate of at least 50% inflation mitigation. And finally, no changes to the expected cadence of Medical segment profit. We continue to expect segment profit to improve sequentially and be particularly weighted toward the fourth quarter. This sequencing primarily reflects our assumptions around the net impact of inflation, and to a lesser extent, a gradual improvement in overall volumes and the continued implementation of our cost savings measures. For the enterprise, a key factor continues to be the overall utilization and demand environment. In pharma, we expect continued strength in overall pharmaceutical demand in the second half, albeit, at a more moderate rate than we’ve seen to date.

In medical, we expect a gradual improvement in overall volume, including with Cardinal Health Brand. Therefore, if the trends from the first half of the year continue, we would anticipate segment profit more towards the upper end of our range in the Pharma segment and more towards the lower end of our range in the Medical segment. With that, I’ll now turn it over to Jason.

Jason Hollar: Thanks, Trish. Let me now provide a few updates on our three key strategic priorities for fiscal 2023. First, executing our medical improvement plan initiatives. Importantly, we remain on track with our mitigation actions for inflation and global supply chain constraints, the number one key to returning the business to a more normalized level of profitability. I am pleased with the incremental progress achieved in the second quarter as we mitigated over 30% of the growth impact to our business in Q2. Taking a step back, over the past nine months, we have made a series of widespread temporary price increases across nearly all of our Cardinal Health brand product categories. We’ve also executed supplier distribution fee increases to offset higher transportation, labor and fuel costs, and continue to explore other opportunities for further offsets with urgency.

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We’ll continue to monitor cost trends and work with our industry partners to make pricing adjustments that are reflective of current market conditions. As we have taken a transparent approach working collaboratively with our partners, we continue to make progress on this front by successfully adjusting product contracts as they renew. We are also including language that allows for greater flexibility to respond to future macroeconomic dynamics. We continue to expect to exit the year with a run rate of at least 50% inflation mitigation and to fully mitigate inflation by the end of fiscal 2024. Outside our mitigation actions, we are focused on optimizing and growing our Cardinal Health brand portfolio. As Trish indicated, the market demand environment in medical has been relatively stagnant over the last couple quarters.

Additionally, some of our higher margin Cardinal Health brand categories remain underpenetrated, which we are addressing through target investments to increase product availability, new product innovation and a continual focus on commercial excellence. For example, we recently expanded our sustainable technologies manufacturing facility in Riverview, Florida, doubling the size to roughly 100,000 square feet. This facility will enable us to better meet increasing demand for single use device collections, reprocessing and recycling services, supporting future growth, while also delivering supply resiliency, sustainable solutions and cost savings for customers. We’re also investing to accelerate our growth businesses primarily at-home solutions where we’ve seen strong growth fueled by the secular trend of care shifting into the home.

Our new Central Ohio distribution center equipped with robotics and automation technology will be fully operational soon as we continue to expand our footprint to match the sustained growth of home healthcare we are seeing in the industry and our business. And in our higher margin Medical Services business, OptiFreight Logistics recently expanded its offerings with total view tracking, a new capability offering healthcare providers real-time shipment tracking to enhance supply chain visibility and resiliency. Second, moving to the Pharma segment where we’re building upon the growth and the resiliency of the business. We’re focused on executing in the core and accelerating our growth areas, primarily specialty. In the first couple months, we’ve already seen efficiency and effectiveness gains from our recently combined pharmaceutical and specialty distribution organization.

We’ve seen strong growth across specialty distribution, including within acute health systems and alternate care. Additionally, our recent acquisition of the Bendcare GPO and investment in their managed services organization has been positively received by customers. Part of the recent segment organizational changes, we also created a new sourcing and manufacturer services organization, enabling a more holistic approach to enhance our strong pharmaceutical manufacturer partnerships. This includes strategic sourcing along with the high demand area of manufacturer services. In Q2, we saw double digit growth from manufacturer services where we continued to invest to build upon our capabilities such as our leading specialty 3PL and Sonexus, our access and patient support portal.

And in the area of cell and gene therapy, we are excited about the work we are doing in this emerging space across all of our service offerings, expanding our capabilities and the opportunities we see in the future. We are investing in automation and enhancing technology across our supply chain today in order to drive operational productivity for the future. We’re striving to deliver a flawless end-to-end customer experience supporting our strong and diverse customer base. For example, a recently announced collaboration with Palantir will offer customers a solution that connects diagnostic and clinical data with real-time purchasing and consumption data. By leveraging AI and machine learning, our customers will be empowered to make better purchasing and inventory management decisions for their businesses and patients.

We are privileged to serve and partner with leaders across the various classes of trade, such as retail pharmacy chains, mail order and grocery, as well as retail independence, long-term care and health systems, all of whom provide essential healthcare access for their respective communities. And lastly, a brief update regarding our relentless focus on shareholder value creation. In addition to the shareholder value creation initiatives we’ve already announced such as our governance enhancements and simplification actions, we continue to place a strong emphasis on responsible capital deployment, including the return of capital to shareholders through share repurchases. Our Business Review Committee continues to work through the comprehensive review of our company’s strategy, portfolio, capital allocation framework and operations.

We plan to hold an Investor Day in June 8th in New York City, where among other topics we’ll provide an update on our company’s long-term financial outlook, detail our growth strategies, and share any relevant conclusions from the ongoing review. Before I wrap up, I want to touch on our new ESG report, which was released just last week. This expanded report outlines the steps we’re taking to operate in a more sustainable and equitable world through our established ESG and diversity, equity and inclusion initiatives. We continue to make progress against our long-term targets and are committed to regularly updating our stakeholders. We believe that we can simultaneously drive ESG improvements in support of our ongoing business transformation.

In closing, while there remains work to do, I’m encouraged by our team’s progress to date and excited about the opportunities ahead. I want to thank our dedicated Cardinal Health employees for driving the execution of these critical priorities and who keep our customers and their patients at the center of everything they do. With that, we will take your questions.

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Q&A Session

Operator: The first question comes from the line of Lisa Gill calling from JPMorgan. Please go ahead.

Lisa Gill: Thanks very much and thanks for all the details, Jason. Just on the medical side, one of the things that stuck out to me is you talked about the improvement and you talked about needing improvement in volumes. So as we think about that, can you maybe talk about your expectations around surgical procedures as we move into calendar 2023, the back half of the year? And secondly, has part of the issue on the hospital side been staffing issues? And as they start to resolve that, will things get better for Cardinal as well?

Jason Hollar: Yes. Hi, Lisa. I think you’re connecting all the right points there. That’s what we hear from our customers and broadly from our peers in the industry, is that there continues to be some constraints as to getting to the free level of demand there. And we do think that’s a component of what’s impacting the lack of growth that we’re seeing within medical. It’s impossible to tell definitively, but that’s the anecdotal feedback that we are hearing. To help provide a little bit of color around the impact and that’s why we €“ Trish had made some comments within her commentary there highlighting that we do anticipate a gradual improvement over the course, so not significant, but getting back to closer to more normalized level of growth.

As a reminder, when we provided our medical improvement plan, we highlighted a 3% CAGR total volume growth over the three year period and we anticipated that about half that would be market growth, about half that would be our own innovation and capacity expansion plans for our products. So you’re talking about a couple percent type of growth that would be more normalized and that’s kind of differentiator between our more of a midpoint of our guidance to what would be more in the lower end, and that’s why Trish provided that type of clarity.

Lisa Gill: So is the right way to think about that kind of half of it, Jason, you feel like you have some level of control because it’s new products that you’re bringing to the market, and the other half is you’re going to have to wait to see if those volumes come back? Or do you feel like you really truly have visibility around the whole 3% that you’re talking about?

Jason Hollar: Yes. No, I think you have it generally right. Now remember that a lot of the part that we have control over is new product innovation and fast expansion. So that’s always an element of the three year plan I would expect to be weighted a little bit more towards the later end because it takes time to school up those investments and getting those products into the market. So we didn’t ever indicate it was a linear type of plan. And volumes, we have to be careful too that we’ve had a period here last two to three years that’s been incredibly choppy in terms of the volumes. Obviously down during the beginning of the pandemic and has come back for the most part. The last couple of quarters have been very predictable, very consistent types of volumes, but that’s €“ even that’s a bit of an anomaly from what we’ve had over the last few years.

So presuming that that maintains then that’s the range that we should be thinking about. But if we get back to an increased level of volatility, which at this time we don’t foresee but that’s certainly a possibility as well.

Lisa Gill: Okay, great. Thank you.

Jason Hollar: Yes. Thanks.

Operator: The next question comes from the line of Elizabeth Anderson calling from Evercore. Please go ahead.

Elizabeth Anderson: Hi, guys. Thanks so much for the question. I was wondering if you could talk about a little bit more about the pharma improvement in the back half of the year, specifically like as you’ve had time to sort of think through the pharma reorganization and sort of continued cost cutting benefit is that’s what’s improving the operating profit growth. Are you starting to get pricing in certain places where you hadn’t before? You can help us kind of understand that mix. And then secondly on the interest expense guide, it looks like the back half guide has a big sort of step up versus what you did in the first quarter €“ the first two quarters of the year in terms of interest expense. So is that just sort of changes in cash balance in terms of the net interest contribution or is there €“ are there other factors going on there? Thank you.

Jason Hollar: Yes. I’ll start with your second question there because you nailed it. It’s really about cash balances. We don’t anticipate there being significant differences in the interest size. Let me just kind of step back. We have a very fixed interest expense for our debts. So our interest expense side is quite predictable and known. It’s really the interest income is the part that we’ve seen favorability in year-to-date and our cash balances were higher than anticipated over the first half of the year. We do have the $550 million note coming due here in March that we anticipate to pay down and there’s just a seasonal aspect of our cash flow as well. So we would not anticipate the same lower levels or I’ll say improved interest income that reduces our interest expense in the second half, like what we saw in the first half.

So you should take away that we continue to have a very advantaged balance sheet, especially as it relates to the fixed variables mix of our debt. As it relates to pharma, it’s really more about volume than anything else. We’re not seeing a lot of other key variables underlying the dynamics within the generic business continues to be very consistent. We continue to see very broad-based volume strength. Q2 was certainly very strong quarter as it relates to volume and we saw that broad base, I referenced in my comments between Trish and I, brand, specialty as well as generics. It is a lot of volume drivers within that. And as we think about the growth in the second half of the year, it’s very consistent with what we had indicated at the beginning of the year.

So our second half expectations remain consistent with what we had indicated before. A little bit less growth than what we’ve seen in the first half. And that’s just a reflection of, again, Trish’s comments that we anticipated being closer to more normalized level of growth in the second half. But if we maintain the same level of strength that we’ve seen in the last couple of quarters then there’s some opportunity behind of that. And then just other €“ one other comment there about the Q2, why it was so strong. If you’re thinking about it from a year-over-year perspective, we also just have the added points that we did introduce a new customer in the third quarter of last year. And that has been a nice tailwind for us the last four quarters.

But this will be the last quarter until we start to lap that. So that’s part of the driver from a year-over-year perspective. And then, not significant, but there is an element of cough, cold and flu. That’s a nice little tailwind for the quarter. But at this point we don’t anticipate that being a driver for the full year. In fact, this could be a little bit of a headwind as it relates to Q3 specifically because it looks like the season is ending earlier than normal. So those are all the key moving pieces.