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

Good morning, everyone. I'm Jailendra Singh, health care technology and distribution analyst at Credit Suisse. Thanks, everyone, for joining us for this session. Next up, we have Jason Hollar, CFO of Cardinal Health. Cardinal Health is one of the top 3 distributors in the U.S., with leading a pharmaceutical distribution business and medical, surgical distribution manufacturing operations. We are going to do this in a fireside chat format. I have some prepared questions, which I plan to cover. But if anyone from the audience has a question, please e-mail them to me at [email protected]. Jason, thank you so much for doing this. Really appreciate it.

Yes. Thanks, Jailendra, and thank you, everyone, for joining us. It's great to be here this morning with you. Just real quick, before we jump in, one housekeeping item for me if we could. I will be making forward-looking statements today, and actual results could differ materially from those projected or implied. For more information, please see our SEC filings or our IR website. So Jailendra, back to you.

You guys [ released ] your earnings yesterday and left your 2022 EPS unchanged. I know there are some puts and takes to consider, including supply chain costs and new repurchase authorization. Maybe just begin with providing some key highlights from the quarter, some headwind, tailwind across the business you see right now.

Yes. Certainly, Jailendra. Yes, overall, Q1 results were in line with our expectations. As you indicated, there's some new information as it relates to the global supply chain costs. But to start with, we were really encouraged with our Pharma business in the first quarter. Really, no real new information there. We continue to see the ongoing resiliency that, that business demonstrates. We saw the ongoing sequential volume improvement. Obviously, that's been a focus for the business over the last couple of quarters, several quarters as it relates to the COVID impact. So we continue to gravitate back towards that pre-COVID level, slowly but surely. And then in Med, it was the only area that we saw any of those adverse impacts related to the supply chain. It was very focused areas. We certainly see inflation across the business, but most of the inflation is very consistent with what we expected at the beginning of the year. There are only 2 very specific areas that we saw it elevate further in the quarter as well as expected it now be more prolonged than originally anticipated. And that's in international freight as well as in commodities. But we do believe that in both of these areas, that the majority of these costs will be temporary. And that's just simply because they've elevated very, very quickly at a significant multiple higher than where they have been historically. And so given it's a subset of the inflation that's actually in the business, we think that those will be much more temporary in nature. But with that said, we are presuming with this update that those costs stay elevated for the balance of the year. We are taking certainly aggressive enterprise-wide actions to mitigate. And despite those elevated costs, we did reaffirm our fiscal '22 EPS guidance. And to your point, Jailendra, the puts and takes that went on behind that was the lower share count associated with the increase of our share repurchase in the year, from the $500 million to $1 billion, to the high end of the $1 billion. We did also have some lower -- a little lower share tax rate assumption as well as we have ongoing broad-based expense reductions that we included in this update as well that got us back into that $5.60 to $5.90 range. The other key item that came through in the call yesterday and in other dialogues, of course, the $3 billion share repurchase authorization that was received. That is in addition to the remainder of what's in place. So after the $500 million is completed -- was completed in Q1, we have a remaining $243 million for the balance of this calendar year, so for within the second quarter. And then we have the $3 billion on top of that. And then finally, the last piece of, I'll say, new news that came through the quarter is we did clarify and announce our long-term targets. It's fairly consistent with some of the normalized earnings targets that we highlighted last quarter. But now that we have defined the share repurchase authorization as well as kind of like the last component for that combined earnings per share and dividend yield target of double digits, we felt now was the right time to clarify all those points.

Okay. That's a great start. I'll come back to the long-term growth targets, but I want to follow up on the incremental supply -- net incremental supply chain cost you talked about. If you take into account, you already had some costs, how much of that was incremental to your fiscal '22 guidance?

Yes. So the $100 million to $125 million is the incremental piece, and it was the only change that we had for our full year guidance, was specifically related to that, which is specifically related to the international freight and the commodities elements. The other components, like I said, did not change significantly in our part of that core. We didn't break out the piece that was in our original guidance. It's very safe to assume it was less than that $100 million to $125 million. We indicated that it was partially offset by other cost savings actions that we had in place. So it is still significant enough for us to call out last quarter, but not so large that we've defined it. I'd look at this $100 million to $125 million as being that -- again, very incremental, more likely to be even more temporary. But nonetheless, we do think that, that's an appropriate assumption for the full year '22.

Okay. Going back to your long-term growth targets, thank you so much for sharing that. That always helps for us. What do you think are your underlying assumptions across each segment when we talk about low single to mid-single digit for Pharma and mid-single to high single for Medical? If you get a little detail there, like what are the underlying assumptions across each segments?

Yes. I think, generally speaking, it's fair to assume that -- we've talked a lot about that double-digit growth of our growth businesses. So within Pharma, Specialty, Nuclear and Outcomes. And then within Medical, of course, it's at-Home and our Medical Services businesses. So those businesses we would expect to, over the long period, the long term to generate that double-digit growth. The one other area -- a kind of a tidbit of information is we also highlighted our Nuclear business being a -- we believe it can double in the next 5 years. So that would imply a little bit higher type of growth rate as well for that particular business. And that's a bit of a unique business just given that we have -- it's unique in that a lot of investments are long-term investments. It takes a while for that product and those services to be able to be launched and to see the revenue and income. But it also gives us a lot of visibility to that pipeline because it's -- for good or bad, it's a little bit of a slower type of process. So we have good visibility on that business, and we have high confidence that we can continue with at least a double-digit type of rate to allow that business to double within a 5-year period. So those are the key elements that we have broken out various pieces of and talked about it separately. Then when you get into kind of the core distribution elements of both segments, that would imply a little bit lower level of growth, as you expect as those are more mature businesses.

Okay. The other thing I wanted to follow up was around your cost optimization target of like $750 million across 5 years, where you are in terms of that target. And what benefits have you seen in the business as the earlier investments have been put in place?

Yes. So those targets were originally the $500 million. And with the completion of that third year at the end of fiscal '21, we started to approach that $500 million. So we reached nearly that $500 million 2 years early, which is why we've extended it -- the target to the 750 over the same 5-year period to essentially allow us to continue taking out costs at the same rate that we had in the first 3 years. The areas that we're taking out costs are generally the same proportion of where we've taken out before. It is broad-based. It's throughout the enterprise, all businesses as well as in the corporate functions. But with that said, given the type of operational activity associated with our Medical business, more manufacturing, more of that type of logistics and freight that goes behind that certainly as a proportion of the overall value add, it just naturally creates more opportunity for more costs to be taken out. So I would expect -- like what we've seen historically, going forward with that would be the same. That will be overweighted towards our Medical business, and we feel good about the opportunities that are there.

Okay. Let's kind of dig into some kind of key discussion topics across the 2 segments, and I want to start with the Pharma segment. How would you characterize the generic pricing market recently? All the distributors have struck a tone of comparative, but stable quite a while now. Curious what's your thoughts on there? What might make that change? And what would you have in place to mitigate any impacts?

Sure. Yes. So I'll touch on a few of those points. I mean first of all, for the Pharma segment, as I mentioned before, we're pleased with the growth that we saw in the quarter and maintaining our guidance and the cadence of getting that volume back is certainly on track. The one thing that we did highlight that I'd like to just touch on for a moment is we did indicate both segments, that growth is expected to be significantly back-half weighted. And for Pharma, it's good to see growth in the first quarter, but in the second half of the year, we would expect to see that ongoing return to volumes, but we also have -- that technology investment is overweighted in the first 3 quarters. And so there's a first half, second half dynamic there that is important to remember. As you mentioned, generics, key part of the overall cadence and the growth that we will expect to see over the course of the year. There's not a lot of new news to talk about generic pricing, which we're happy about. It continues to be a very -- the very consistent dynamics that we've been talking about for really, the last couple of years. And we continue to focus on the overall margin per unit versus just the sell-side pricing. So we continue to think that that's the right way to approach it. And we also continue to be very excited about the ongoing relationship with Red Oak, having that, of course, last quarter, that agreement extended into 2029 was done for a very specific reason. We feel really good about that relationship and what we can jointly do to continue to create value. So we're well positioned there and feel like the generics business continues to operate as we had expected it to.

All right. Great. You guys always talk about the generics program, not in just one bucket, but in a broader scope, right, including buy-side, sell-side, volume growth. Maybe spend some time there and how you go about picking your spots in the marketplace.

Yes. No, exactly, Jailendra. We -- I'll just -- first of all, the first key piece is that buy side, right? I mean that's exactly what I was just talking about with CVS. We feel really well positioned there, not just with the current performance, but we have the groundwork to ensure that, that team stays focused for the next, I guess, that would be 6 to 7 years. So we're well positioned for that. The other key piece with the generics program, of course, is just underlying volume. We are still seeing that improvement. There's a little bit of opportunity still within there in terms of we still have some COVID headwind baked into our Q1 and our guidance for Q2. We think that will be in place, but by the end of the calendar year, back to those pre-COVID levels. The few of the areas that we continue to call out that's a little bit weaker than what we've seen in the past, pre-COVID, would be the amoxicillin, the AZITHROMYCIN, those anti-infectives and antibacterials. But all those other areas that we talked about in the past that had strength in other parts of the business like the specialty brands and consumer health, all continue to be real strong. But it's just those certain areas of the generics that we continue to see a little bit of that volume challenge. And then back to sell-side pricing. Again, I know everyone is very focused on it, but it is very consistent with what we've seen. So there's no new news to report there and is a part of the overall program as described.

Okay. And you mentioned CVS partnership, relationship with Red Oak. You recently amended the agreement there. Maybe -- can you touch upon some of the future opportunities we should be thinking about there?

Yes. It's tough to get into too many specifics. But I guess the key is that they're a clear leader. They're -- we have a great relationship, a long-standing relationship. And again, now we have that foundation known to extend for a long period of time in front of us. So that allows us both to really invest in the relationship. And they're a huge organization with a lot of needs for products and services. We supply some of those products and services. So of course, we're always going to be wanting to understand what other additional needs they may have as an organization. And if we can help them out, then that's an opportunity for us as well. So we've got a strong baseline foundation and we'll, of course, always want to build upon that.

Okay. The other key growth driver for Pharma business has been around the Specialty growth, which all 3 distributors have reported. I'm wondering if you can provide any color like, what is reflected in your guidance from a Specialty growth point of view? Does your guidance assume any meaningful contribution from biosimilars? And maybe just high-level parts on how you think about the biosimilars as an opportunity for longer term.

Sure. Yes, Specialty, in general, obviously, one of our 5 key growth areas. It is expected to grow at double digits this year. That's all been very consistent with our original guidance and our current expectations. It's also a key part of that long-term growth target of the low to mid-single digits for the Pharma segment is the over-contribution of specialty and the other growth businesses to drive that value. We see opportunity both in upstream and downstream. Downstream continues to have a strong foundation of growth. And notably, we have a strong presence in a few of those therapeutic areas outside of oncology that we have a pretty high share in, a high presence in such as the rheumatology upstream. Also a lot of opportunity where we're expecting strong growth in the higher-margin services that support both the -- or support the biopharma manufacturers. We also have the 3PL that supports a lot of different manufacturers and continues to see further wins and growth in those areas. As it relates to biosimilars, that is a very exciting area, high expectations, high growth prospects. Not as meaningful to our business certainly today, but we are well positioned to take advantage of that growth on both the upstream as well as the downstream as we go forward, especially as the adoption goes beyond oncology. It will be exciting to see that further adaption -- adoption within the rest of the categories. We are confident that we're going to see additional growth with more products coming to market. The FDA is -- their approval for that first interchangeable biosimilar, insulin, that's a really positive sign. It's still early to determine exactly how it's going to roll out and how the manufacturers will approach the market. But it was an important step to where we go next, and we feel really well positioned about those next steps. But there's some uncertainty as to exactly where those paths will go, but we are confident it's going to be a component of that long-term growth that we talked about before.

Okay. Switching to Medical segment. I actually wanted to talk about -- maybe you can spend some time on the -- some of the growth initiatives in that business suggests Cardinal Health at Home and some of your services business, talk about the traction you're getting there and maybe what other opportunities you see in that business.

Yes. And I'll certainly touch on that. I think we should probably start with the core. I want to just highlight that the only item that we discussed of any incremental element is that -- the supply chain. So all the other elements of the core business has remained unchanged. We saw growth in the last couple of fiscal years when you exclude the impact of COVID last year. So the underlying core business remains sound with that business. It's -- we've certainly been having to deal with the COVID elements last year and now this year, more of that inflationary impact. But the long-term growth algorithm of that business is very much hinged on those growth areas that you just referenced. So we do expect to have that ongoing growth with at-Home and then the other services, so the other Medical Services. So at-Home, that's a great business. It's something we break out in our segment footnote. So you can see the growth profile there, $2.2 billion, very consistently growing at double digits. I think we grew this last quarter at around 12%. So it has a very strong history of very consistent growth, and that is something that we expect will continue as the dynamics of health in the home, we expect it to be an ongoing trend that will send more volume and underlying industry strength there. The other Medical Services are -- a lot of that's around our OptiFreight business as well as WaveMark. But Opti has done really well at continuing to expand their product offerings into new areas. And we really service our customers very well with what we've done historically, and we think that we -- kind of similar to the CVS discussion then, there's a lot -- there's a huge market there, a huge opportunity. What we do within it, like Red Oak is very, very strong. And so we think we can take that into other categories.

So as we think about the supply chain pressures, are you moving more into manufacturing your own products? Just wondering how should we think about the mix of sourcing versus making yourself kind of in future?

Yes. So our strategy there is the best cost and final delivery costs. So we're agnostic as to do we manufacture, do we source. It's an ever-evolving answer to that question historically and even more so today. So certainly, we're very focused on the supply chain challenges that's in front of the entire industry. But I would also say that we do see these challenges as temporary. And so we are moving in certain aspects of our production to nearshore or onshore, especially in areas that relate to more of the PPE. However, we won't move everything all the way and have an uncompetitive cost structure. So we continue to balance that and looking at where we believe that right balance is, and we'd like to have capacity somewhat diversified -- more diversified than probably where we were pre-COVID, but certainly important that we still have a very low cost structure to make sure that we're competitive across all the categories. So we'll -- it's a core competency and something that will be an ever-evolving answer.

So I think on the call, you talked about working on with customers currently to change contracts and give you more flexibility when there's certain changes in the supply chain, which will offer you some ability to raise prices. How has been the feedback on that? I mean have customers been receptive to that? And what kind of time line should we think about something like this being implemented?

Yes. So this goes both for our benefit as well as the benefit of our customers. Because what we're really talking about is price volatility, cost volatility that then drives price volatility. So I think understanding the root driver of costs, and therefore, the root driver of price is an important element for our customers. They want quality, they would like price assurance, they'd like delivery assurance. So there's a number of elements that are very important to them. And with a better understanding of what those drivers are and having a mechanism in place so it's not negotiated on a kind of a constant fluid basis is something that is of value to those customers. And then we can jointly discuss, is there changes with the product. Maybe it's a different type of material that should we use so we take away the volatility, maybe it's a type of hedging strategy, maybe -- it's a sourcing strategy that's different. I think what's key is that the supply chain needs to shrink in terms of maybe not necessarily the length of it, but at least in terms of the reaction, the ability to react to different shocks by having a good insight across the supply chain. They'll have better visibility to our supply chain, our inventory and likewise with theirs so that we can hopefully have it be more of a win-win versus having to have an ongoing dialogue. So your question about when and how that works, it's an evolution. A lot of these contracts are multiyear contracts. And we're in the middle, still of a pandemic-ish at this point. So the focus right now is making sure that the customers' needs are taken care of, and these types of contractual items are absolutely a point of discussion as those contracts come up, and then we have that dialogue and ensure that it's the right structure for all parties.

Okay. Maybe a quick question on opioid, anything else new to report there? And looking at your cash balance at the end of the quarter seems to reflect your first annual payment into escrow as part of the settlement. In terms of any next payment you would have to make, if all goes as planned and settlement continues to progress, will you make another payment essentially 1 year from now? Or what are some of the logistics we should be thinking about?

Yes. Okay. Great question. So the -- you're correct that a significant cash payment was made into the escrow fund in the first quarter, and that was reflective of the majority of the prenegotiated global settlement payment. Why I say the majority is that it's reflective of just those states that have signed up. So the 42 states would be proportional to that piece, which is the majority of it. So -- but then the other part of your question is the next payment. So there could be some residual payments if that changes, if more states come into it or just other activity within any type of negotiation that may occur there. There could be some shorter-term payments, but the big payment for this year was made in the first quarter. And then you're correct, it's on an annual basis. And so you would not expect another large payment, all things being equal until the next fiscal year.

Okay. Just maybe on the regulatory front, how are you thinking about some of the recent proposals or ideas coming out of Washington around drug price negotiation? Anything you can share?

Yes. Not a lot to share. Of course, we watch it very closely. It's fairly early to really be able to comment on anything specific. Just I think the key thing there is to remind all of us that 95% of our brand margins do now continue or do now come from the DSA fees, so not inflation based. So that takes away a lot of the gyrations that could occur there. The other key piece is that if there are any other changes, we have a long history of working through them. As a distributor, those types of changes in costs would need to be appropriately passed through. And there's nothing that we're seeing at this point that would indicate that our past experience is not a good indicator of how we'd approach it in the future.

Okay. Maybe from just a capital deployment point of view. Of course, you have the share of repurchase authorization. Maybe just curious, if you can remind us your near-term, longer-term strategy? And with this opioid settlement ongoing, is that impacting your ability to do more aggressive deployment in any ways?

Yes. Not really. And the key reason why is because this is not new news with the opioid settlement, something we've been working for a long time in support of. And so far, it's consistent with our more recent expectations. And so as we've talked about our capital deployment strategy over the last couple of years, the scope and nature of this settlement is pretty consistent with what we had expected at that point. So -- but to answer your question, given the strategy is unchanged, that means that we're still very focused on, first and foremost, investing in the business and the strong organic growth opportunities. So you could think about that as the $400 million to $450 million we've been talking about for CapEx. And you'd also think about it as the $120 million that we're investing this year on the incremental technology investments. The other key pillar, top priority for our capital deployment is, of course, that strong balance sheet. And that's a key area that I've indicated several times now over the last couple of quarters, that as our -- as we start to approach our targeted leverage as an organization, that we can begin to pay down our debt at a more modest pace, essentially indicating that the $850 million that we're paying down this year, which is fairly consistent with what we've spent the last several years should start to reduce as we go forward. And that, I think, is also very consistent with yesterday's announcement about the $3 billion share repurchase authorization. So not necessarily deploying cash in aggregate, in terms of the amount of cash significantly differently, it's where we deploy it. So we'll be paying down debt less, and we'll be increasing our share repurchases. I think, of course, the dividend continues to be a key part of that deployment, but I would not expect that to change materially in the near term. And then, of course, we're always looking at opportunistic M&A, but we've highlighted that we expect that to be more tuck-in. And I think, as you know, we have not done significant M&A for quite a few years. So we'll continue to look at those remaining opportunistic buckets with share repurchases and M&A based upon what opportunities are out there, but we'll continue to be prudent.

Any particular areas or capabilities you will be more focused when it comes to tuck-in acquisitions?

Only in so far as we can just continue to reinforce. It's important for us to grow our growth businesses. So those 5 key growth areas is where we would expect to focus any M&A if it were to occur. So again, the Specialty, Nuclear and Outcomes within the Pharma business and at-Home and Medical Services for the Medical business. So those areas are definitely our priority as we look at potential opportunities. And then, of course, the core is the recipient of a lot of the organic investment as well. So that's where they would get more of that deployment.

There's one e-mail question coming. Let me take that quickly. You did not highlight labor cost, anything inconsistent with what assumptions you made in the previous quarter. Is there still a chance those could catch up to you, taking into account what ABC and McKesson called out in their quarters?

Yes. So we do have elevated labor inflation included in our guidance. And the only reason we didn't call it out in this particular quarter is it's elevated, but not any higher than what we had thought before. So it's not -- that's not new as it relates to the magnitude. It's also -- when you compare it to the impact that we're seeing with international freight and commodities, again, these are items that have increased somewhere between 2 and 10x over the last year or so. Inflationary pressure, of course, we have a very large labor base, and so smaller percentages can move that needle. But the amount of percent change that we believe is at risk here is going to be, we think, quite a bit less substantial than that. So there's a very dynamic labor environment. So I can't say never. But for the time being, we feel like that guidance is sufficient for the pressure that we're seeing in the marketplace. And we still have a very strong engaged workforce that does attrite with a frequency that's not too unlike the overall industry, but we feel really good about how we're positioned there.

Okay. Just to wrap up, last one. I mean maybe any closing thoughts? And also, like as you think about the next couple of years, what are some of the most important areas you are paying attention to from a regulatory point of view, [ optimal ] technology, R&D, rationalizing your geographic footprint? Just help us kind of close on those comments.

Yes. I think the best way of approaching that question is just to go back to our long-term targets. By the nature of your question, it's a long-term type of question. And so when I think about how we achieve those targets, it's -- we talked quite a bit here, more recently, this morning on capital deployment. That's an element of it, right? We have a strong dividend yield, and we have $3 billion now of share repurchase authorization. So that's a nice component to that total EPS and dividend yield growth. But then within the segments, it's really about those growth businesses continuing to fuel that growth, those 5 key areas. Again, first and foremost, organically, opportunistically, inorganically. And then the core business as well. We laid out the areas of focus there within Pharma. We have that core focus to ensure that we continue to improve the underlying operations. And then, of course, you have the growth businesses on top of that. Within Medical, it's very much around the simplification. We took aggressive actions with our businesses already, divesting Cordis. It was adding a lot of complexity to that business. It was the right thing to do to divest that. But then beyond that, you've also heard that we've announced that we're exiting 36 different international locations, international markets in order to further simplify that business, as an example of the types of actions that we're taking as well as rationalizing further our manufacturing and distribution footprint. So we continue to work to simplify. We spent a lot of time in the past talking about the commercial excellence and continuing to ensure that we have not only the right team in place, but the right incentives in place to make sure that we're driving what's best for our customers as well as the favorable mix that comes along with that. And then, of course, we have the growth businesses there for Medical as well. That's a key pillar for that. So those are the areas we're focused on. And this last quarter, certainly, we are very focused on managing the incremental costs associated with inflation, but we're very, very focused on those offsets. Those other actions to ensure that we mitigate as much as possible. We do think it's temporary. But nonetheless, we're on it to ensure that if it is more prolonged, then we have the right actions in place to mitigate it as much as possible.

All right. With that, I think we will wrap up this session. Thanks, Jason. Thanks for the participation, and thanks, everyone else, for dialing in. Thank you. Take care.

Thanks.