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

Hi, everyone, and thank you for joining us today at Morgan Stanley's Global Healthcare Conference. I'm Ricky Goldwasser, Morgan Stanley's Healthcare Services analyst, and I'm very pleased to have Cardinal's CEO, Mike Kaufmann, here with us today. Cardinal is one of the top 3 drug and medical product distributors in the country. They've played a critical role for the nation during the last 6 months and during the COVID pandemic. And we have a lot to talk about in the next 30 minutes. But before we get started, please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley's employees only. And the webcast is not for members of the press. So if you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative. And with that, I turn it over to Kevin Moran first for some additional disclosures and then Mike for some introductory remarks.

Thanks, Ricky. Thanks for hosting us today. During the fireside chat, we will be making forward-looking statements. 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.

Great. Thanks, Kevin, and thanks, Ricky. Really appreciate the opportunity to speak to you and to everyone today, and thanks to everyone for joining us. In FY '20, we really delivered on our commitments, which is incredibly important to us. We grew non-GAAP operating earnings despite a $100 million net headwind from COVID-19, and we exceeded our EPS guidance range. We surpassed our enterprise cost savings target and are definitely on track to hit our goal of $500 million over a 5-year period. We've made strategic portfolio decisions, and we strengthened our balance sheet during FY '20, which ended June 30. And also, while COVID-19 has been incredibly challenging for everyone in so many different ways, it has made our mission clearer than ever as we have focused on our customers and those who need to get them the medical and pharmaceutical supplies they need. And I'm really proud of our FY '20 performance and really excited about FY '21 and the future of the company. With that, I'll just turn it over to you, Ricky, and let you begin asking whatever questions you would like.

Great. So Cardinal was in a unique position. You have visibility into drug trends at pharmacies, utilization and medical facilities that's captured in your medical and specialty segments. Can you update us on how have volumes across the U.S. business been trending in July, August and September to date compared to pre-COVID baseline and compared to your expectations?

Yes. Thanks for the question. Obviously, this far in the quarter, it's a fair question. We typically don't do any updates during the middle of the quarter? And as you [indiscernible] a lot of moving parts, whether it be our generics program or expense initiatives, et cetera. But I will give you some color on this. As you know, on the medical side, we would say that elective procedures, which we indicated we thought would average high single digits down for the year, enter in the mid-high teens and exit our fiscal year, hopefully, close back to prior pre-COVID levels. Right now, what we're seeing in the first few months of this quarter is things trending a little bit better on the elective side. Now it's definitely lumpy week to week. One week, we'll see it about as expected, next week will be a little bit better. But overall, I would say on the elective side, it is running a little bit better than we expected. On the Pharma side, there's a lot of various data out there. I would say it's also very lumpy there, probably even larger swings on that side week to week. But that one, I would say, is net just a little bit softer than we expected on the Pharma side. So net-net, we're still about where we had hoped to be for the quarter, but a little bit better on the electives and maybe a little bit worse on the Pharma side, but both being lumpy. And so we'll look forward to updating that as we go along through the year and get a sense of where we're going to end up.

And Mike, obviously, we're in a dynamic and a very fluid marketplace and to your quote, it's lumpy. But when you think about recent months, how has the experience shaped your views on the potential trajectory of recovery as we head into the fall and winter session? I know there are different views out there in terms of that shape of recovery. You have been a little bit more, I'd say, conservative than some of the others. So from what you've seen in the last couple of months, has any of that kind of like changed how you think about progression into the next -- into the fall and winter?

Yes. Like I said, I'll touch base on each one of them. Again, on electives, while they're trending lumpy, but in that, a little bit better than we expected, I think the big question for us is, will it get back to pre-COVID levels by the end of our year? It very well could be, and that was our assumption at the beginning of the year. But we're really keeping our eye on really the desire of the patient, consumer, whatever you would like to call them, to be willing to come back into the hospital setting, into the nursing home settings and into those settings again. And will patients continue to put off procedures? Also, we're seeing regional flare-ups here and there. We're also seeing some things. As you know, when I talk to some of the hospital CEOs, there is some of them that seem a little bit concerned that what we're seeing is just the patients that had to have the procedures, which is why we're seeing it maybe come back a little stronger. How long will that continue? And so right now, I would just say we're only a couple of months in, like I said, a little bit better on the elective side. But there's a lot of innings left in this game, and there's a lot of factors that I think we need to keep in mind, including whether the flu season will impact some of this differently than it has historically. So again, we're continuing to just keep our eyes on it but hopeful that we can continue to see this run ahead of where it's been, but it's just way too early to call it for the year. On the -- more on the physician office visit or more particularly to script volume, again, lumpy, but seeing it slightly behind new Rx’, down a little bit. And so again, we're continuing to keep our eyes on that and make sure that, hopefully, patients will be comfortable getting back into the physician's offices. They'll start writing for the appropriate prescriptions, and we'll begin to see that pick up.

And when we think about -- you highlighted the desire of consumers to come back. When you think about just structural changes to behavior, from what you've observed in the marketplace, are there any structural changes to behavior that you can point to from trends, whether it's independent versus national accounts, individual behavior, anything that you can build on when you think about how these changes could open new opportunities that you can build on in a post-pandemic world?

Yes. It's a great question. Clearly, we've seen some structural changes just in the way our customers operate, right, the way you go into a hospital or a physician office visit. Oftentimes, you're waiting in the parking lots where they're only allowing so many people in and those types of things. And so I think throughput continues to be a question that we're going to keep our eyes on for the rest of the year, is to make sure that our hospital customers, physician offices are able to get back to the throughput levels they used to have, even though they have different procedures in place than they have historically. And so we're going to keep our eyes on that. As far as structural changes in our customer base, I would say that our retail pharmacies and retail independents have held up pretty well. They have significant customer loyalty. Our retail independence, as I said, because of their loyalty, they seem to be holding up pretty well. We've seen nursing home volumes obviously be down, some a little bit in those areas with some of those customers. Mail order has been a little bit stronger. Chains have been performing well. I think the chains also, particularly a few of them, some of our larger customers, have done an excellent job of really capitalizing upon being able to be testing centers. I think they're going to do some amazing work around giving vaccines when they're available and they've just done a good job of ramping up and being ready to do those types of things. And so overall, we've seen some changes, but it's still so very early to understand exactly what's permanent or not permanent. We continue to believe that our programs are superior service levels. Particularly in the generic area, it continues to be a real benefit for Cardinal, I think, versus the rest of our competitors. We're doing a really good job there with Red Oak. As far as ourselves as a business, I think the one area where we're really looking at making some structural changes will be in our sourcing area on the medical side. We're continuing to look at the percentage of product we're buying from each country, the -- which countries we are buying from, where we make it or manufacture more ourselves. We've been investing significantly in new mask and gown production, for instance, where we produce, whether it's U.S. or treaty friendly or closer countries has been important. So a lot of things that we're doing in that business to both drive down our expenses but also manage the diversity of our supply chain has been some really important work that the team has been doing.

And Mike, this is a good segue, actually, to talk a little bit about the Medical segment. I mean you've guided for the Medical segment profit to be down in high single digit in fiscal '21. But if we think about normalizing for COVID, that profit, I think you said, would be up mid-single digits. So can you help us just think through in rank order the drivers that make up for the difference?

Yes. The biggest piece, as we mentioned this past year, we had a net $100 million negative impact in FY '20 from COVID-19. It was roughly $30 million of positive in Q3 and $130 million of negative in Q4 to net. We said they would have a similar size down for FY '21. The difference being in FY '20, that negative was relatively evenly split between Medical and Pharma, whereas in FY '21, the majority of the incremental headwind is expected to be in Medical. And it would really be a couple of things that make that up. First of all, we started experiencing higher costs procuring PPE for our customers, particularly masks, gowns and exam gloves. And so those are areas where our cost structure or cost to purchase those products went up significantly, whether it was the finished good or raw materials for ones we manufacture, which created some negatives for us late in '20 and early in '21. Since then, we have been working with our customers. And although we have a goal never to raise prices, our goal is always to keep health care as low as possible for our customers due to the unusual and significant impact that this cost increases have had. We have been working with our customers and began passing through those cost increases in a very transparent and well communicated way with a lot of opportunity for our customers to plan for it and then for us to work with them. So that is something that is creating some extra headwind for us here in the first half of the year. And then second of all, again, any deferral or cancellation of elective procedures for us because of the mix of our products being more skewed to higher end, higher-valued products than PPE that some of our competitors would see as a positive driver for us having the negative, less surgeries in the mix of our products, that headwind has also been a large headwind for us.

So Mike, to that point, just wanted to go back, tied to your earlier remarks about seeing elective procedures doing a little bit better, in Pharma being a little bit lumpier. As we think about that dynamic, that dynamic should be positive for margin. Given that profile that you're talking about. Is that fair?

Well, it depends on which business. Obviously, for Pharma, it would be a negative with volumes down. On Medical, it would be a positive with volumes up. Being one company at this point in time, we don't see anything that would change our overall perspective for the year at this time, but we can continue to monitor this, and it will be something that will absolutely keep our eye on. But we are -- it's nice to see the elective procedures be better and again, particularly for us because we're higher skewed towards the higher-end products that are used in many of these elective procedures, particularly the OR. So yes, in our Medical business, we could see that as a tailwind or a positive for us in the quarter and in the Pharma business, we could see it be slight negative.

Okay. [Operator Instructions] So obviously, vaccine distribution is on top of everybody's mind. The CDC selecting McKesson as a distributor. But how do you think the market will evolve over time? And I think my first question there is how do you think about market evolving, but also the different sites of administration for COVID vaccine compared to the traditional flu vaccine or anything we've seen in the past?

Yes. I think the flu vaccine is a good proxy in many ways, is that as an industry, we've all been distributing the flu vaccine for many years. We all have capabilities. I'm very confident in Cardinal's capabilities to dispense vaccines, a COVID vaccine because we've been doing it with many of the other vaccines for years, whether it's ambient controlled or whether it's all the way to deep frozen, we have the capabilities to manage those. And I think the important component of it is that this is a much significant -- more number of doses potentially if the manufacturers are able to make it. So it's going to be far more doses potentially than the flu vaccine. I think that's one thing to keep in mind. Each vaccine is going to have different types of control that it's going to need on it, again, from a temperature standpoint and reporting standpoint. And I don't think it's -- I think it's something that the entire industry would be willing and able to participate in. And I think it's the smart thing in the sense of making sure that there's no single point of failure for something as important as this. I also think it's really important that our customers select their distributors in a sole -- in a primary way and their systems to receive product, pay for it, track it, et cetera, are set up in ways that make it much easier for them to get it from their current prime distributor. And so we think it would be better both for the customers and the industry that we were all part of this. We understand there'll be some probably limited doses for a while, and there's some really good reasons to do some different things. But as it becomes more available, I think it's best for the ultimate consumer and for the retail chains and independents and other locations that will be distributing the vaccine that they are able to work with their primary distributor. So again, excited that we have the capabilities, and we're willing to do our part in helping as many people as possible.

Yes. It seems striking really the magnitude of scale and scope of the operation and the -- I think the partnership and corporation that's probably going to be needed there. One question that we got from the audience is, how will the approval of a COVID vaccine in a therapeutic help or hurt your business? What would it mean for Cardinal in calendar 2021? And I think that part of the question here is when do you think about the timing of vaccine and how long it's going to take to scale. Do you think that this is a fiscal '21 or more for fiscal '22 impact to your line items?