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

CEO, Jason Hollar; and CFO, Aaron Alt. First off, thank you both for joining us today. Now Jason, you've been with the company since COVID began, and we're finally entering a more normalized operating environment. And I guess as we sit here today, what are you most excited about for the next year?

Yes. Thanks, Allen. Great to be here. Thanks for having us. Real quick, if I could just take care of a little quick housekeeping item. We will be making forward-looking statements today, which are subject to risks and uncertainties that could cause our actual results to differ materially from those projected or implied. For a description of these factors, please review our SEC filings, which can be found on our Investor Relations website at ir.cardinalhealth.com. Thank you for your patience. Yes, so there's -- I put everything into 2 key buckets in terms of our excitement. First of all, just the underlying utilization in the industry continues to be very strong. Ever since Covid, as you mentioned, but even during Covid, it showed the resiliency, especially of our largest, most significant business, the pharma business, having such strong demographic trends underlying the utilization. The aging America will continue for at least the next 40 years, more and more adults over the age of 65 that drive the health care industry. Those trends as well as secular trends, whether it's Precision Health, Care into the Home, things of that nature, innovation in general, as a really strong foundation, ballast underneath this industry, which volume is the key thing that drives our opportunity to leverage that scale to make our products even more competitive, more value for our customers and ultimately, our patients to their patients. And so the industry dynamics continue to be quite robust and quite consistent with an environment that allows us to invest into it and to grow our business, which is the second piece of it. We continue to grow in all aspects of our business. Within our pharma business, excited about that resiliency that continues to play through about our individual performance within the marketplace continuing to be strong, certainly a testament to this year's results. The recent acquisition of Specialty Networks shows an opportunity to grow organically as well as inorganically with that acquisition. Within our GMPD business, the biggest piece of the former Med segment, there's a lot of opportunity still with that segment. We've demonstrated fantastic growth this year. Our guidance is for a $230 million improvement from last year's results, driven by the improvement plan there to mitigate inflation and to drive Cardinal brand health products. And then to top it all off, we have these 3 very interesting growth businesses within our Other segment, each of them riding a different wave of the secular trends within health care. That's some strong areas, each of them leaders in their space. So our Nuclear business, at-Home Solutions and OptiFreight Logistics, all well positioned to continue to grow well into the future. And so when you look at the operational results, you add it all up, what we're also just really excited about is the free cash flow that comes along with that has allowed us to really invest into organic as well as inorganic growth, but also gives us a great opportunity to return capital back to shareholders. So we're going to continue to be really focused on that and responsible with that back to our investors to make sure that all benefit.

That's great. And I want to start with the pharmaceutical business. And you recently reiterated 4% to 6% long-term segment profit growth recently. And we're entering -- or we're not entering, we're kind of getting through this post-COVID normalization period where revenue and operating profit growth is really normalizing for -- after some of the things we saw during COVID and even more recently, maybe a little bit slower growth in GLP-1s. As we entered this normalized environment, can you talk about the high-level drivers that are impacting this growth algorithm and how we should think about it or how you're thinking about 4% to 6% operating income growth as we see some of these things that are changing in real time, things like GLP-1 growth, insulin pricing and then, obviously, there's operating expense growth in there as well. So just how do you kind of -- what are the building blocks to that 4% to 6% growth?

Yes. So I think the most important message is the algorithm behind that 4% to 6% growth and the actions behind it are unchanged from what we've been talking about since the Investor Day about a year ago. That 4% to 6% growth, why we reiterated it more recently is that those drivers and those actions are largely unchanged. And so to build out a little bit further, within the largest part of our business, again, in our Pharma segment within that, the pharmaceutical distribution, the PD non-specialty side, we expect that to continue to grow in the low single-digit type of growth. That goes back to the utilization that I just referenced, that there is this rising tide of volume and needs from patients that, that business will be able to continue to satisfy. But as I mentioned, both organic growth with Navista, with our other specialty assets, the more recent inorganic growth with specialty networks, all enablers to further grow our specialty business, which has historically grown at double-digit type of rates and where we expect that to continue growing above the market type of rates and close to that double digits as a result of that ongoing demand from the market, but also those investments that we're making. So that blended average gets you into that 4% to 6% type of range. And those are all the same actions that we talked about a year ago. Now more recently, we've highlighted that key customer nonrenewal, we expect that growth to be a little bit less in fiscal '25. Our guidance right now is for at least 1% growth in '25. But you still have that 4% to 6% over the course of those 3 years because of the very significant mid-point guidance that we have for '24 of 9%. So it averages out to that same type of growth. And we think those investments in each of those areas will continue to drive that growth well into the future.

Now, the -- I would say the competitive environment from COVID was relatively stable. You referenced a competitive shift from one of your customers, and there's been a couple of others that we've seen in the market. As we think about the growth algorithm of the industry and your business, what's the biggest risk to the -- or for disruption of that growth algorithm as you sit here kind of thinking forward maybe a year or 2 years, what are the things that could go wrong?

Well, first of all, I think the underlying competitive dynamics are relatively unchanged. There's always been a competitive yet stable type of market, and that's where we still see it. And what is most important to us and what we hear is most important to our customers is the value that they are receiving, and so that's why these investments, both organic and inorganic investments are very important to make sure they're getting the tools, the capabilities for them to be competitive, and that's where we're most focused. Examples being our InterLogix and Atrix platforms to help health systems be more competitive and manage their business better back to Specialty Networks. These are tools that not only help physicians operate their businesses more efficiently, more productively, but more importantly, they're helping their patients to have better outcomes -- their customers, patients, have better outcomes. And so all of these are, again, investments that are helping our customers treat their patients better, create more value for them. And that's the moat that is built around any successful business. And there's a lot of opportunities for us to continue to differentiate. A lot of the business model questions that we get on this topic of what can change whether it's IRA or whether regulatory this or that. What I keep coming back to is our mandate to safely, securely and efficiently deliver pharmaceutical products to our customers. That has never changed, and we create a lot of value in the health care ecosystem in service of that. And none of these models to date have demonstrated a desire or even the intent to take out that very valuable source in the middle of this infrastructure that does add value, both upstream with the manufacturers as well as downstream to the customers. And I continue to see each one of these evolutions of the model, really relying on the distributors, and that's where our role is to continue to invest into it and be even more relevant.

I wanted to talk about the Specialty Business. You mentioned Navista and the acquisition of Specialty Networks before. But I think when I -- we were talking a little bit beforehand, when I started covering Cardinal 12 years ago, I think the Specialty Business was sub $1 billion in revenue or around $1 billion in revenue. So you guys have done a phenomenal job growing that. As we think about the growth opportunity for Specialty and why community oncologists want to partner with Cardinal, what are your conversations like with them? How can -- and also how can Cardinal Solutions help them remain independent? And then just what are those conversations like?

Yes. Well, first of all, there's a bit of a self-selection in the marketplace. Those 2,000 community oncologists that are dependent, are independent probably for a reason at this stage. So there are other solutions for them. And when we talk to them, that's exactly what we're hearing. They're fiercely independent because they're wanting to be more entrepreneurial, they're wanting to solve those patient challenges and issues themselves, and they want to be driving all aspects of their business. So just like what we've done with other parts of our business and what we've done with the retail independents as one specific example, we are looking to build the infrastructure behind them so that they can continue to be independent and give them even more tools and capabilities to be successful well into the future. So what we've done with Navista is a great example of that, where we didn't start with what we had. We started with talking to those current and prospective community oncologists customers and said, what is it that you're looking to accomplish? Yes, we know you want to be independent, but what are the capabilities, the specific capabilities, the specific value drivers that you need support with. And then we'll go out there and either build it or we'll partner with someone else. You don't have to have all aspects, but you need to work with partners that are strong in each of these areas. And that's what we've done with building of Navista is to create the solution for their challenges and for their opportunities and not just give them what's already on the shelf and we're trying to sell them. And so that's really appreciative by those oncologists and why? Ongoing, we are getting a lot of pull from them to continue to listen and continue to act on other opportunities that may exist for them. Now as you mentioned, we've also expanded outside of that inorganically with Specialty Networks, more in neurology than in oncology, but those types of capabilities, specifically PPS Analytics is a great example of a technology that's at the heart of that business that today provides a lot of value by taking that EMR and other medical record data and providing actual insights, both upstream with the manufacturers, as well as downstream with the providers to run their business better and to create better outcomes for their patients. Those are examples of the type of technology capabilities, partnerships even within our own company that we'll be leveraging to make sure that community oncologists have the full access and benefit from the leverage and the scale that we can bring.

That's great. And Aaron, I want to bring you in as well here. As we think about brand inflation, generic inflation, I think on your call, you talked about insulin prices impacting revenue growth and obviously, GLP-1s impacting revenue growth. But I guess the more important factor here is really gross profit dollar growth and if there's any change in that. So as you think about the different drivers impacting the U.S. Pharmaceutical business from a top line perspective, GLP-1s, insulin prices, brand inflation, generic inflation. What are the biggest drivers that you see? And how is that, if at all, impacting gross profit dollar growth in the business?

Sure. It's a great question. Let me cover a little bit of ground here. First, from a top line perspective, we are very supportive of innovation across the industry. And so we're looking for the new therapeutics, the new drugs to work their way through the distribution channels. We want to put the right drugs in the right place at the right price for the patients that are supported by our ultimate customers. GLP-1 is a great example of that. It's innovative. It's been driving significant profit growth. We called out in Q3 that it was about 200 basis points revenue growth story. We called out it was about 200 basis points of the growth in the quarter, but it's not a real contributor to the bottom line for us. And so we have to meter and measure what we're supporting from an industry growth perspective relative to how it supports our bottom line. Now you asked in your question about the brand inflation, right? It is a practical reality that our fiscal Q3, the calendar Q1, that is where we see most of the brand inflation in any given year. And this year was as there was not a lot of new news, and that was as we expected it would be, where it did not achieve the heights that we saw in fiscal '23, which was a higher point, if you will, but it was otherwise as expected. And similarly, from a generics perspective, we are pleased with the relatively stable macro there. The prescription demand has been strong. Volume has been strong. And we like to talk about consistent market dynamics. And indeed, we manage our business to the -- on both the buy and the sell. And so long as we have consistent market dynamics, which is effectively average -- stable average price per unit -- or profit per unit rather. If volume is growing, then things are going well for us. And that's what we're seeing in the industry.

Yes. That makes sense. I appreciate all the color there. One question for either of you. It's a question that I've been starting to ask more, and I feel like it's too early to get a real quantitative answer here, but the Inflation Reduction Act is obviously becoming -- it's coming into scope here. How do you think about this legislation as it pertains to your business? Are there opportunities? Are there threats? Does it create more of an opportunity to work upstream with your manufacturer partners? I'm just curious if there's anything that you've identified from the legislation that could impact your business in one way or the other?

Yes, the short answer is, is not really. Now that's kind of the end answer to everything. Let me step back that there's a couple of references we made already today. We like affordability in the industry. We like transparency. We like innovation. These are some of the themes that we've already been talking about this morning. These are all -- why we like them. Well, first of all, it's good for the patient. And ultimately, it was good for the patient, backs up and requires additional volume, then that's good for our business. And then, of course, we like that health care is actually solving more and more problems for patients. So with IRA, that's an example of, yes, there's going to need to be some price changes that work its way through the industry. But as I already mentioned, safely, securely and efficiently delivering products to our customers and ultimately the patients is our role. That role has a certain amount of value that's somewhat irrespective of the actual price. And we've demonstrated over long periods of time that evolutions and pricing structures and mechanisms, ultimately, it essentially gets translated as to a fee-for-service for the role that we play for a lot of our business. Now certainly, there's some services in other parts of our business that are outside of that question. But as it relates to the core part of the distribution, there's a very valuable service that we provide, and we expect to continue to receive the appropriate compensation for that in the future and be adaptive to whatever model evolution occurs.

Got it. Fair enough. So one area that is a relatively small part of the distributor business in terms of customers is the independent pharmacy cohort. But obviously, they're a very important customer cohort for you and your peers. I think Cardinal's Medicine Shop has about 400 independent pharmacies in the franchise. Can you just talk high level how you think about these pharmacies? Where they fit within your business and whether or not this is an area where you're focusing on growth, if you're focusing on improving the user experience, what's the strategy for that cohort?

Yes. There's a lot of correlations to this discussion as with the community oncologist discussion that we just had recently as well. First of all, the 400 of medicine shop, that's a small subset of the retail dependence that we service. So there's about 8,000 strong that we service today. And I would put them all in the same categories. That again, they are very entrepreneurial, they're very business savvy and minded, but they also have their customers, the patients' interest in mind first and foremost. And so we support them just like what we're doing with Navista on the oncology side. We help them operate their business more efficiently. We give them capabilities to leverage our volume and scale in the way that makes them more competitive and be able to be of more value to their patients. Areas like back-office support, with dispensing capabilities with inventory management, things of that nature. One new project -- relatively new, we announced about a year ago that we're really excited about is our new consumer health hub, which will benefit other classes of trade, but it will probably benefit most of the retail independents by taking on all of our over-the-counter products, our consumer health products and centralizing them into one location with very high automation capabilities in inventory levels will allow us to even better service those customers into the future. So these are just some examples of the investments that we have made and continue to make that will continue to drive that class of customer well into the future.

And I think the last question I have here on the pharma side. The generics program, Red Oak, has been wildly successful, and it's still contributing -- it's still a tailwind to earnings. Is there any way to quantify how material the incremental benefits are from Red Oak here? And kind of what the outlook looks like for that business. Is your expectation that Cardinal can continue to gain margin from this business over time? Or are we getting to a point where maybe it's going to be less likely moving forward?