Cardinal Health, Inc. (CAH) Earnings Call Transcript & Summary

Okay. Great. Good morning. This is Steven Valiquette, the health care services analyst here at Barclays. Our next company today at the Barclays Virtual Health Care Conference is Cardinal Health. So on the line, we have Mike Kaufmann, the company's CEO; and also Kevin Moran from Investor Relations as well. So I'm going to quickly flip it to Kevin for an opening statement, and then we'll dive into the fireside chat questions. So Kevin, over to you.

Thanks, Steve, and thanks to the entire Barclays team for pulling this off telephonically. During the fireside chat, we will be making forward-looking statements. Our actual results could differ materially from those projected here today. For information about factors that could cause actual results to differ from today's projections, please refer to our SEC filings, which you can find on the investor page of our website.

Okay. Great. And also thanks for your flexibility around this whole coronavirus situation. And speaking of that and also to dive right into that, certainly, top of mind for a lot of investors, so a few questions around that as it relates to the pharmaceutical supply channel. So first of all, the shutdown in China has created some concerns that drug shortages could occur just due to API and bulk material constraints. Just curious if you guys are able to discuss what you're seeing right now in relation to that. And also, I mean, in these situations, with Cardinal and drug distributors perhaps try to stockpile some inventory of key drugs, that you're anticipating some shortages. So let's just start around that dynamic first.

Well, Steve, thanks for having me on the phone, and thanks to everyone joining us. Yes. The coronavirus definitely had its impact across many different ways. One thing I do want to make sure I start with, just because I think it's really important for everybody to know, is besides focusing specifically on our M and P segments related to the impacts of it, we also, as a company, have been working on this now for over a month. As it relates to our own business continuity, with each one of our distribution centers, manufacturing centers and our headquarters to make sure that we have backup systems in place, testing, working at home, backup players to be able to make it into our distribution centers because we do have a higher standard of requirement to make sure that our customers get drugs or medical supply. So I just want to make sure to let everybody know that we're not only looking at our products that we sell but our own people, the safety of them and making sure we can get products specifically to our customers. As far as on the P segment and the tie-in to the coronavirus, we do -- we had anticipated this a while back. So when we first saw it in China, our Red Oak team immediately began looking through our database to see where we either had finished those, what's very little coming from China, but more importantly, where there's any raw materials coming from, in particular, the Wuhan province, where -- was ground zero for this. There are some raw materials at a nearby province. So knowing that, we did stock up on some extra inventory on key products that had raw materials coming from that area very early on to make sure that we understood that we -- what was going on, that we could have some extra. We've done this as it's moved around the world. We constantly use our database to understand if we're going to have any finished good or raw material problems with any of the pharmaceutical items. So we looked in Italy, when it began to hit Italy, et cetera, and we continued to adjust our inventory where we can get extra product to stock up to make sure that we're staying ahead of it. The good news is, through our conversations, and I've had a few myself directly, most of the manufacturers are carrying a few months' worth of inventory on hand. So I feel like, at least for the next few months, we should be fine to be able to get the majority of items that we need. Now if this were to extend past early summer, then I think everyone's going to be looking at some potential supply disruptions not only because of the API materials, but -- one of the other piece that's harder to track because there's so many of them is key starting materials or KSMs, the items that go into the manufacturing of the API. Some of those are -- have some potential disruptions, and so some of the suppliers, again, are keeping their eyes on those, but tell us so far that they hold several months of API and finished dose stock and KSMs and we should -- that we should be okay for a few months.

Okay. Great. Now at the same time, where there's some risk of API shortages, there's also some price increases happening on API. And I know from tracking that side of the industry, in prior times in my career, I can almost guarantee it's probably being passed through by a lot of the finished dose drug manufacturers as well, whether it's brand or generic, but probably more on the generic side. So I guess, I'm curious, how is that being factored into the company's view on the generic market and spot prices within the market? And if there is generic inflation, I'm curious if you're seeing that, and that would obviously help to offset -- I mean, that'd be a positive for a drug wholesaler, would help to offset some of the risk of volume shortages. Just curious how you're viewing the pricing side.

Yes. It's a good question. I would say, so far, we've not seen any material price increases that I would say are related to the coronavirus yet. There are manufacturers that are starting to see some price increases on API. And as you know, we've talked about this in the past. Our goal for Red Oak is to never take any price increases. So we're always going to fight aggressively to make sure that we're getting after the lowest cost. Now there are times when you sometimes do take them if it's the right thing for ourselves and the supplier. And when we do, we are typically able to pass those price increases through to our customers, and the goal there being to maintain our sale margin per unit. So I think it's -- while generally, in the past, I would say it's been true that in an inflating market, you tend to see your dollar margin per unit increase, I'm not sure that, that's -- it's definitely not always the case. We're going to have to see where this goes going forward and what we're able to do based on the items that go up and supply and different things. But it's -- when your costs go up, the key is can you pass through on your sales side an -- at least an equal dollar amount. Sometimes you can pass through a little bit higher dollar amount when you have lower margin rates but higher margin dollars, and sometimes you can't. So it's really about understanding the market, understanding reimbursement, understanding the other pieces of the market to make those decisions. So right now like I said, we haven't seen anything material. We're keeping our eye on it. So it's a little hard to predict at this point in time what we would expect. We don't really have anything built into our guidance at this time that was assuming price increases and increased margins necessarily related to the coronavirus.

Okay. Great. Now sticking with coronavirus, but shifting over to the medical supply distribution side of your business. Same sort of questions. I guess I'm curious whether or not you're seeing any risk of potential supply shortages on certain products. There's been a lot of discussion around masks about 10 days ago. It feels like about a year ago, the evolution of things. But just curious to get your latest thoughts on the overall supply situation for your medical distribution business.

Yes. Medical is an interesting situation. It's a little different than the Pharma. I think with the Pharma, the number of products is limited. At least, it's a population of finished good products that is pretty manageable size of items, and there's some items that are obviously more critical than others that we manage. And then managing and understanding where the raw materials are coming from is a much more manageable tack. On the Medical side, the number of products across the whole Medical segment are a lot more than just the number of generic pharmaceuticals that you're really dealing with on the Pharma side. The second thing, it is a lot more difficult to track and understand where all of the raw materials are coming from on that one. So that one is more fluid, something that we are absolutely monitoring, not just daily, but literally, hourly on how that's going. As far as shortages, so far, what we're seeing is mainly on what you call personal protection equipment, that's surgical masks. Various types of masks and gowns are then the areas where we're seeing the most strain on the supply. We -- while we have so far had enough to continue to manage our customers basically at their historical purchase patterns, we've not had any extra. So we probably get -- oh gosh, we get multiple requests a day for people outside of our customer base from various countries or folks looking for product. And there is no -- we don't have any access to extra, and we don't know of other people that do either. But we have so far been able to maintain our basically historical volumes with that. Now that all being said, we could see some potential down the line that some of the API inputs into those products could be impacted by supplier disruptions. Again, it's a little harder to know, but that's something we're keeping our eye on and anticipate that, that could happen if this continues to go on for a while. And there may be other items in the Medical portfolio that we're just not aware of, again, as broad as it is where all of us could start to see some shortages. But right now, it's not been bad. Like I said, we're allocating, but we're able to provide people at least their historical averages to our current customers.

Okay. We'll get into the gowns and the recall maybe a little bit later on in this discussion. But just around the mask and just, I guess, products like that where demand might be outstripping supply or there's the risk of that. I forgot, is Cardinal actually self-manufacturing all of your own masks or is that all outsourced from third parties? Or is it a combination? Just curious on the self-manufacturing component.

Yes, it's a combination. We both source mask and we also manufacture mask. And so we have ramped up our production where we are manufacturing it ourselves and have ramped that up. But again, we are keeping our eye on raw material inputs because while we ramped it up, if we have some difficulty getting some of the inputs, it may not matter. So we are keeping our eyes on that. And that's one of the things, I think, that all of us are going to have to keep our eyes on, not even just related to the surgical masks, which are in high demand, but I don't know whether there might be other raw materials on other products that wouldn't even necessarily be used in the coronavirus, but raw materials to make those could be impacted. So we're keeping our eye across our entire Medical portfolio. And as I said, right now, we're not seeing any issues other than on being able to get extra masks for the most part.

Okay. And then final question on that for the Medical side, similar to the question I asked on the Pharma side. So for products where maybe demand is outstripping supply, are you able to raise prices? And I mean, these are all commoditized products, so supply-demand dynamics are going to dictate price to some degree, but you are -- I mean, I guess, the question, are you able to raise price on some of this to offset what could be some volume shortages such that it all kind of nets out to be fairly consistent as far as your overall profit matrix?

Well, it's a little more complicated on the Medical side. On the Pharma side, the generic market for the most part is a spot market. Even when you have customers in contracts, it doesn't limit your ability to raise and lower generic prices. And so as you have changes on the cost side, you're able to make some adjustments. On the Medical side, it's more complicated. It depends on the contract. So that's a little harder to anticipate. It's clearly not as simple as on the Pharma side. At this time, I'm not seeing any large increases that I would anticipate will cause us any type of material challenges. But as this -- if this were to go on for a couple of months, it would be something that, depending on the item and depending on the contracts with customers, may or may not be able to be passed on. So it's harder to answer that definitively. But at this point in time, for the items that we're seeing some of the stress on, I'm not anticipating that to have any overall material impact.

Okay. That's helpful. And then tying all this together, and Cardinal has a June fiscal year-end. So within your fiscal '20 guidance ending in June, I mean, the way you see it right now, again, as far as any impact from coronavirus, you're recognizing it's still very early. And even through June, probably will still be kind of early in the grand scheme of things potentially. But can all this be absorbed within your guidance, I guess, as far as any impact that -- basically the way you see things right now.

Yes. Well, nothing specific was in our guidance that we put out about a month ago, and this does change literally on an hourly basis. And it's not only affecting supply ability and supply cost. It's also hard to understand the exact impact on demand. You could argue -- are people going to have -- is there going to be more procedures? Could people be in a hospital for this? Or are the people going to stop doing elected? It's just really hard to understand what the -- more midterm because I don't think this will be a long-term issue. But the more midterm issue will be on demand as well as on supply. But taking all that into account, at this point in time, I don't see why we couldn't absorb it into our guidance range. The impact on the segments might be a little different, maybe a little less on Pharma, a little more on Medical. But overall, I would think, at this point in time, that we should be able to absorb it in our guidance range, but again, I'll reserve the right because it definitely is changing hourly.

Okay. Great. Okay. Shifting gears here a little bit. Yes. Obviously, on coronavirus, there's nothing positive about it at all, but if there's any one positive, it just means that you're getting less questions on opioid litigation. So it might be the only silver lining, but so -- but I need to ask one anyway. So on opioids, so negotiations are obviously still ongoing for a -- what's still being described as a global settlement even though it's not going to include every peptide opioid. But I guess, the question today would just be simply are you at liberty to give your latest views on the progression of any settlement discussions? And I guess, we'll start with that.

Yes. I can't give a lot of updates other than you said it -- well, negotiations are continuing. And like any negotiation, you have bumps in the road. Those were expected. We believe strongly and have reiterated at that point to the folks that we're working with, the AGs and folks that we believe that the deal on the table not only is a deal that makes a lot of sense for the states and counties and cities to be able to get dollars to patients immediately that need them, but it also allows us to work with them to distribute free goods, which can be important to save lives and why we encourage them to get the deal done, that portfolio and then also, to work hand-in-hand with the states and the DEA to look at changes that might be made to the monitoring systems to be able to help them be more efficient and make sure that not only these drugs or any other drugs that may need to be monitored can be monitored in a more productive way. So it's got 3 very important components to it. We continue to stress that, and negotiations continue to happen. And the folks that are supporting our position are continuing to have discussions with other states that are still trying to think it through. And we hope that they'll come to a conclusion that this is fair and we can move forward. If not, we are prepared to go to court here in end of March, if we need to, in New York, and we will do that. And I think that's important for folks to know that we're not afraid to go to court. We prefer to get this done and put it behind us but not to the extent of having to make a deal that doesn't make any sense. And again, what we put on the table, we think, is really fair.

Okay. Great. One other opioid question. So if there is any settlement, obviously, cash flow will be impacted, but the drug distributors have indicated that insurance could cover some of the payments that might be made. I guess a couple of questions around that would just be what's the confidence level that insurance will cover some of your settlement terms the way you see it right now if something were to be finalized. And is there any just rough ballpark percent of any settlement that you think would be covered by insurance, whether it's 10% or 50%? Or are you capped at a certain dollar value of coverage? Just curious if you have any color around all that.

Yes. It's one I wish I could give you a little more color on. But really, at this point in time, it's too premature to really comment specifically on insurance coverage. But as you can imagine, we are pursuing all options to us on the insurance side and will, as things shake out, work hard on that area, but it's just really too hard for me to comment at this point in time on insurance proceeds.

Okay. Great. All right. Well, shifting gears here a little bit. Just on the core Pharma distribution business. The industry saw declines in EBIT for a few years. Trends have definitely gotten better for the sector over the last quarter or 2. Just curious what the company is looking at as far as key factors that are helping, and, hopefully, will still help further get Cardinal back into growth mode within drug distribution, whether it's related to industry trends but also maybe any company-specific actions that you think will help to propel that further from here.

Yes. Thanks for that one. I guess, first and foremost, we are absolutely focused on returning the segment to growth. That's key for us. We know that. We have been highly focused on it for several years, and the good news is we're starting to see some positive momentum across many areas of the segment. We've been seeing many areas working well for a while now and continue to work well but have really been offset by the impact in customer contract renewals and then, obviously, generics. As you know, historically, I've been doing this almost 30 years now. You -- typically, year-over-year, your biggest headwind is always going to be your customer contract renewals, and then you work through efficiencies and growth in the marketplace and all kinds of other things to then offset that and then some so that you can grow as a business. Really, what had happened over the last couple of years is you still had your customer contracting rules as an ongoing headwind. But generics, which typically would be a tailwind, was one that flipped to a headwind over the last couple of years. And we called our overall generics program versus trying to comment on inflation because you really have to look at all 4 components of generics to understand it. You can't just talk about sell side deflation without talking about buy side deflation because people often ask me is, if you got from, say, minus 10 to minus 2, does that mean all of a sudden you make money? I said, "Well, on sell side is -- well, it depends on where cost deflation was." You could be at minus 10 on sale and minus 25 on cost and you could be improving your margins, but you could be at minus 2 on sale and only minus 1 on cost and you're going to be declining margins. So the 2 really have to work hand-in-hand in addition to new launches and volumes overall. And what we've seen is the mix of those 4 things over the last couple of years turn to a negative so that we were not able to decrease costs, improve volumes and have launches that were bigger than the sell side deflation. So our overall program was a net negative. And what we've seen this year as we've seen that begin to flip so that we no longer expect our generics program to be a net headwind for the year, but to be a net tailwind for the year. So that's the first. I think, and really important signal is that you see the generics program be able to manage cost and sell so that your margin per unit stays at least roughly consistent per year, which means you're not having the -- have a second large headwind. On top of that, we've seen strong growth in our specialty segment. We're doing some really interesting things in our nuclear business. We're seeing some growth in that business. We're also making investments in our connected care businesses, which build connectivity between manufacturers, payers, pharmacies and patients. So the key here is managing customer contract renewals with generics programs and the other components, obviously, to be a net positive, and that's what we are aggressively working on.

Okay. Great. Last question, just back on the Medical side for a minute. Just curious if you have any updates on the recent surgical gown recall. I mean where do we stand right now as far as are there any continued supply constraints? What's the latest, either positive or negative feedback in relation to the recall? And then -- or are things back to normal? I just want to get a quick snapshot of what's happening there.

Yes. First, I'll start with, we never want to have situations like that where we make life tough for our customers because we always -- want to do everything we can to make sure we're treating our customers right so they can take care of their patients. But as far as it specifically relates to the gown recall, we've been working incredibly hard to get back on track with that. We've seen incredible efforts by our teams working with customers in the field. We've seen ramp -- we've ramped up production from our suppliers, and folks have been working with us to get us more products. So we've been managing that, I would say, very effectively. Still have struggles, and we don't want any customer to have even 1 minute of concern or wasting energy around this. So we are highly focused on being customer-focused on this. But we are making progress. I would say the biggest challenge for us is that the sales commercial restructuring that we did in our Q2 and we're finishing up in Q3 has been delayed. I thought we would really be full steam ahead as I had mentioned before in our Q1 of this coming year. That's probably delayed by a quarter or 2 because we've had people pulled out. But we still like what we've done. It's still going well. We think we're adding some great talent, we believe, in the structure that we've done. But that may be -- the benefits may be a little bit delayed and -- as we work through finalizing and cleaning up the efforts around the gown recall.

Okay. Great. All right. Well, with that, I think we're out of time. So I certainly want to thank Mike and Kevin for their time today and enjoy the rest of the virtual conference.

Thanks a lot. Take care.

Thank you.

Thanks again. Bye.