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

Perfect. We'll get started here. Good morning. Welcome to this session of the Leerink Partners Global Healthcare Conference. I'm Mike Cherny, the health care tech distribution analyst. It's my extreme pleasure to have with us Cardinal Health; CFO, Aaron Alt; and Investor Relations rep, long-time Cardinal exec, Matt Sims. Matt is going to read a couple of disclaimers. Aaron is going to introduce a couple of quick comments, and then we're going to jump right into Q&A. So Matt?

Great. Mike, thanks for hosting us. It's great to be here. So before we begin, just some brief housekeeping. 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, Matt, and thanks for having us. On behalf of Jason Hollar, our entire management team, we're delighted to be here engaging with all of you again. I want to make a couple of brief comments upfront just to say that I hope you had a chance to listen to our earnings call -- our Q2 earnings call at the end of January or read the transcript. I'll come to that in a second. We'll next release earnings in about 6 weeks, 1st of May, I believe, Matt, with our Q3 results. We're not going to provide a lot of substantive updates today from our Q2 earnings. Many of the themes remain the same, and I'm sure that's where many of our questions will be. But I do want to highlight a couple of things that we said at Q2 about our business, which certainly are true about our year, which is we have been blessed through a lot of hard work, a lot of determination and an excellent team at Cardinal, as we've been working through our multiyear journey to develop some momentum, right? And so as you look at our Q2 results, what you heard us say, indeed, what has been true is that the business has been hitting on all cylinders. The momentum is clear for us, certainly supported by a robust demand environment, right? Jason commented during our Q2 earnings call that we were seeing demand across brand, across specialty, across generics, in our consumer health business. We are seeing strong demand in the other businesses, our Nuclear and Prescription Health, at Home and Optum. We also saw revenue growth in GMPD in the second quarter as well. And so we, as a team, continue to do what we said we were going to do. Thinking all the way back to our strategic statements at our last Investor Day, our plan has not changed, right? Our to-dos have not changed. We are putting one foot in front of the other, doing what we said we would do, reporting back and then going back and doing it again. That continues to be the theme. What has resulted, as a result of all that, is we have clarity of purpose, clarity of strategy, clarity of execution plan, which has led to fair amount of resiliency in the business. So even with everything going on around us from an industry perspective, from a regulatory environment perspective, the business has developed resiliency, which we're pleased with, also driven by strong operational execution. For those of you that have not met Debbie Weitzman or Steve Mason or the leaders of our other key businesses, right, they are strong operators who are very focused, as I said, on putting one foot in front of the other and delivering every day for our customers. Because one of the things that has helped us to develop that resiliency, that has helped us to develop that momentum is the operational execution, right? The fact that we are better able to serve our customers this year than last year, last year than the year before, really means that when we have things come at us like the customer transition, who will not be named in this conference by me at least, it means that we see -- we make that an opportunity, right? And we serve our other customers better, which then allows us to actually raise our game and drive our sales notwithstanding that. And so there are a few companies, I think you could say, that having lost the second largest customer, to see profit dramatically increase even in the face of that. We take that as a badge of honor. We have to continue to execute against it every day. So that -- those are my opening remarks. Sorry, I almost forgot the most important thing. There is one piece of new news. We did want to confirm that in our third quarter, which we're currently in, we did execute an ASR to complete our as-committed share repurchase program. We committed to do $750 million of share repurchase in the year, and we did launch that ASR in the third quarter.

Perfect start, Aaron, and new news is always welcome. I want to go back to what you framed it. It was almost a year ago that you announced the pending departure of your second largest customer. I think everyone knows who that is, but we'll just call it the second-largest customer. And I think the official comments were, "We are committing to grow our pharma segment in fiscal '25." Fast forward a year, and your guidance is for 10% to 12% adjusted operating profit growth for that segment. You touched on execution, we'll get into that a bit. But from a market perspective, robust demand is one thing, but where you're seeing some of the other potential sources of contribution, of upside, in particular, with the continued expansion of your speciality business, how important is specialty as growth driver to the overall Cardinal engine from here?

It's a great question. And like I said, we are very pleased with the progress in driving the profit growth in the business. It's coming from a couple of areas. Certainly, the robust demand that we've seen through the first half helps that. It's also coming from the fact that we don't lose sight of the opportunity it presented to us with the capacity that was freed up and the complexity that was eliminated by virtue of the transition in customers for us to actually drive growth by better serving our existing customers. Not necessarily new business from existing customers, but filling more demand, being more responsive to their ask. And so that has certainly helped us as well. The -- we were -- we had a plan for whatever was going to happen in that case, and the operational changes that the team leaned into quickly, which were preplanned for whatever the result was going to be, we executed on those relatively flawlessly. And that put us in a place where we were able to set ourselves up for success to support the business, that growing business, at the same time of taking cost out where we could. So that was a key contributor. And lastly, I would tell you, this really goes to the specialty part of your question, which is our investment profile has been clear to us since before our Investor Day about 2 years ago, which is we needed to continue to invest everywhere we could operationally and organically in our specialty portfolio, growing 14% plus over, on a CAGR basis, but also making sure that we had our eyes on the horizon about where do we need to be investing inorganically as well and putting the constituent pieces together. And so during our Q2 earnings call, you would have heard us reference that one of the key profit drivers in Q2 was actually biopharma services, including Specialty Networks. If you look back over our earnings transcripts, that is not the usual way we lead in, right? It's a good sign that part of our specialty business is contributing more than historically to our overall profit profile. And certainly, with the investments we're making organically and inorganically, we hope that, that continues.

And if someone had been frozen a time capsule for 5 years and came out, they wouldn't expect, especially in biopharma services, to be what Cardinal was leading with. Your historical strengths were in other areas. But clearly, the investments made, both organically and inorganically, are starting to pay off. As you think about what will be your specialty playbook going forward, once ION is integrated, once GI is integrated, where do you think you still have the greatest opportunities to further expand on your specialty capabilities? And with the pieces on the field right now, where do you see the best sources of leverage above and beyond where your current portfolio sits?

The specialty part of the industry continues to be higher growth and higher margin than the core part of the Pharmaceutical Distribution business. It's also an area of higher margins and higher growth in biopharma services, the other parts of the portfolio that are not core to who Cardinal historically was. And so we are being purposeful in raising our game, both on having access to the right Specialty and Pharmaceuticals in the right way with the right economics, but also the services upstream, to the manufacturers, things like real-world evidence and the data flows, and I'll come back to that in a second, as well as in downstream into the actual practitioners as we carry forward. And so our investments organic and inorganic are designed to ensure that we're getting more than our fair share of that as we carry forward. Now we are very reflective of the fact that there are -- we are a little bit later to the party than some of our competitors around the focus on particular parts of specialty. And so we often are asked about oncology, and McKesson is doing that now for over a decade. Our goal is not to beat McKesson in oncology per se, it's to be relevant in that space, so that we're -- our customers have access at the right economics to the deals. But we have traditionally been stronger in the other ologies, right, in the places outside of oncology. And so while we are investing in oncology, we're making significant investments there. Our goal is not to become McKesson. Our goal is to be relevant there and to run our playbook really in the other ologies, which is why you've seen us invest first in Specialty Networks, which was a technology-heavy urology, rheumatology, gastroenterology focused GPO plus. We bought it for the technology and the plus piece of it, not just the GPO. And then also then, the investments we're making in GI Alliance, both for the GI platform as it is, but more importantly because the backbone of what is GI Alliance is already becoming a multi-specialty platform for us, where we will leverage that great leadership team. We will leverage their capabilities or, by the way, they're already integrated with Specialty Networks because they were a long-time customer there, we will leverage flow of data, the flow of the AI-driven platforms, et cetera, to empower, again, the specialty biopharma services up to the manufacturers across multiple other ologies and while, at the same time, providing a better distribution set of capabilities across the enterprise. And so we see all sorts of opportunity in the other ologies, the gastro, the uro, the rheum. We've named a couple others over time, but I don't want to limit ourselves to that. There are other places we may well go because the platforms and the investments we're making in technology, MSO services, real-world evidences, they're scalable across multiple specialty areas.

That's certainly helpful. Turning back away from specialties to the rest of the Pharma business and Brand and generic, I've heard the term from you operational excellence numerous times. Can you give us a little bit more flavor on what exactly operational excellence looks like in terms of translating into the outperformance on brand and generics? And how do we think about it in terms of an underlying core driver for the Cardinal and the long-range targets that you currently have out?

The first thing you have to understand is that we historically have been a very complex organization. It's part of the -- we're a relatively simple industry, but it's complex operation given the number of manufacturers and customers that we deal with in different categories. And the first change that Jason made upon naming the operators that are on his leadership team was to lay out and enforce a strategy of simplification, which is we will be better able to serve our customers, we will be better able to achieve the value creation for our stakeholders if we have absolute clarity on what we're trying to get done and we eliminate some of the noise around it. And so under Jason's leadership and Debbie's leadership, we have done just that. That involves both how do we simplify our offering to be more responsive to our customers, how do we take cost out because it's unnecessary. A less complex organization just by definition is more efficient. And certainly, we are seeing the benefit of that. Taking a couple of hundred million dollars of cost out every year just -- it's just part who we are and what we do now every year. And so that has certainly helped from an operational execution perspective. And then the old adage is what gets measured gets done. And I can observe in my 2-plus years now, I've watched the rigor of the metrics that we are holding our teams accountable to, that we are being held accountable to by our customers really rachet up. And when you have that dashboard and you see where you have a problem, things get a lot easier relative to identifying, "Okay, where do we have to go next?" And so that's been a key part of the Pharma and GMPD and other team's success in the last year.

And on the Pharma side, how does that manifest itself in terms of your working relationship with CVS, your largest customer, versus your working relationship with some of your larger independent customers, maybe to drive the scale of the services you're providing on each end that can make the relationship more efficient and obvioously drive greater profit growth for Cardinal?

Yes. We don't view the customers as being in conflict per se. And indeed, the service offering that we provide to large customers like CVS versus our strong presence in the retail independent can be complementary, right? Of course, we are buying at scale through Red Oak on the generic side of the house. We are also buying at scale on the branded side of the house. And -- but the services we provide, how we deliver to the integrations and the systems, et cetera, is different between the retail independent and CVS. And so we believe that, over time, we've developed a relationship with each of those classes of customers and the health systems and the others that we serve that we're able to serve their individual needs to push that ahead. So we are not prioritizing one over other, although I will say we are very appreciative of the very strong relationship that we have with CVS Health. They are a partner with us in the Red Oak buying relationship, which we believe is a competitive advantage for Cardinal. They're a partner with us in some of the biosimilar efforts that you've heard us talk about over time through the form of Averon. And we have a variety of other great engagements with that team and believe they have a bright future ahead for them as well.

We might come back to Pharma depending on timing, but the topic that you're obviously tied to your business is tariffs. Tariff has -- have some moving pieces across different segments of your business. Maybe just start with GMPD and then we'll circle back. But what are some of the proactive approaches Cardinal has been taking to potentially mitigate any risks the tariffs could create? And how should we think broadly about what areas of GMPD have the most tariff exposure?

Sure. Happy to talk about it. As we think about the environment we're operating in, one of the great unknowns is exactly how the tariff environment will play out. Every day or hour that passes, there is the opportunity for a change, And certainly, one of the nice things about the change we've been going through is our ability to rapidly react to changes significantly higher than it was in previous years. And so that has been a helpful factor. Our business is much more resilient than it was. That -- and we're much more flexible. And so the -- that is also supporting the overall effort. I'd also observe that health care is relatively defensive. And so while we'll talk to the impact of tariffs in a second, I will observe it's not like people's health care needs are going to go away in aggregate, depending on what the tariff regime happens to be. And so that is a positive factor in the overall environment. Now you asked me specifically about GMPD. Of the $12 billion or so of revenue of that business, 2/3 of it, we are not directly impacted by tariffs. Because it's the distribution part of the business, we take title in the U.S., right, and so our economics are post the impact of the tariffs. And so that -- 2/3 of the business is not a real challenge in that way. And that leaves the remaining third of the business, which is our Cardinal Health Brand business, which is a more profitable part of our business. And so we're absolutely paying very careful attention to the tariff environment and what's evolving there. What I would observe to you is, I think it's just over 50% of the business is actually sourced or produced in the -- in North America, largely the U.S. and Mexico. And so take the U.S. piece of that. Canada is relatively immaterial. I should go outside North America for a second. China is less than 10% from a sourcing perspective. We don't actually manufacture in China anymore. And so as you think about North America, part of that resiliency I was talking about earlier is we got ahead of it, to a degree, and we actually where we could started bringing production back into the U.S. And so 90% of our syringe capacity, for instance, is now domestic production. We opened 2 new syringe lines opportunistically in the last 6 months or so because there was a market need. We had the capacity. And so we affirmatively decided to get ahead of any tariff challenges and open those buildings. That's an example of something we're doing to address it. We are also much more resilient and able to address tariffs by our ability to move production around the U.S., much more so than we were around the world, I should say. And so while it's not instantaneous, right, our ability to move a category production between countries in Asia into Latin America back into the U.S., we are far more flexible than we were. But that said, tariffs still are -- still can have an impact, particularly as it relates to Mexico. And a couple of observations on that. First, again, that resiliency we have does allow us to do some plan around that. You heard recently that there was at least a temporary relief on tariffs provided to some of the categories that are subject to the, I always get the name wrong...

USMCA.

The USMCA, right? And so most, but not all, of what we move back and forth across the border benefits from that current exemption. Of course, if that is extended under the deal that President Trump signed in his first administration, that would be good news for us. Not all of the product is actually subject for that because we actually, like our largest competitor, have some assembly that happens in Mexico with constituent pieces that are sourced all over the world, right? That would not necessarily be subject to that exemption. And so that puts us back in a place, which I think you're really asking about, which is so what are you going to do? And the answer is, we run a 1% to 2% margin business and we will take price, right? We believe -- we will take price. We believe our competitive set will take price. That's for them to decide. But the point is, is that part of our journey over the last couple of years has been to put us in a place where we are not left holding the bag. If you go back a couple of years when the GMPD business was losing $150 million a year, right, part of that was driven by the fact that the supply chain was disrupted, and we were -- we did not have the ability to take price to reflect the input cost, transportation, et cetera, that were negatively impacting that business. We're in a better place from a contract perspective. We have better relationships with the customers. We have better contracts with the customers. I want to be clear, we don't want to take price, right? And so we are going to hold out for the last minute, and we're going to do everything we can from an operational efficiency perspective to bring our cost down, to move things around where we can. But at the end of the day, if tariffs do stick, we will have to take price, just reflecting the reality of the industry in which we operate in and the overall terms. Matt, did I miss anything important there?

No, I think that was well said. And as you think about -- this is one where the details are important, and they've obviously been highly dynamic and so we'll continue to work through those. The analysis the team has been doing is going category by category, looking in terms of where our footprint is, where we have exposure and making sure that we're positioned accordingly with the rest of the industry. And we feel good about the overall diversity of our supply chain. With that said, there are some areas, as we think about some of the exemptions that's in place and the relatively -- the components of items like our surgical kitting, some of that may or may not fall under that. And so those are all the things that we're still working through. But in terms of our overall footprint, we feel good about that. But as we've said a number of times, the extent that we see those impacts, we are in a position as a 1% operating margin business to absorb those, and we need to price accordingly.

And Aaron, you brought up a couple of important points here, I think, about relative to the potential tariff impact. Obviously, no one actually knows if it's going to happen. But you went through a period of the need to recontract during the supply chain disruptions, be it on product inflation, be it on freight costs. Is there anything that can inform the conversations you're having with your customers now and the potentially tough conversations you have to have about the need to potentially take price, aside from what's been rebuilt contractually based on what you learned last time where you were absorbing a lot of costs basically on their behalf, and that drove some of the recontracting that you now sit in?

Yes. Look, we believe that it's better to have a strategic relationship with the customer than to have a transactional relationship with a customer. And so that has been part of the evolution of our business over the last couple of years as well. And the GMPD team certainly has been leaning into that with their customers as well, while reinforcing the very important point that we don't want to take price, right? And we are doing everything we can to avoid having to have those conversations with those customers. But also reflecting the fact that we need to be a viable competitor in the marketplace and get the right economic return, even as a 1% to 2% operator. And the -- this is a story that will continue to evolve over the coming months as we see what the administration does. I commented at dinner last night, I was on Capitol Hill last week. I met with 16 Republicans over the course of the day. I got 16 different versions of what I thought was going on and 14 different agendas. And the -- from that, I would tell you, there's a lot of sympathy for business. There's -- but there's also a belief that the story is yet to be written. And so all we can do is continue to rely on the resiliency that we've built over time and do the right thing by our -- all of our stakeholders to be able to drive that progress as we carry forward.

And how should we think about the tariff impact -- the potential tariff impact relative to the Pharma side of the business?

The vast majority of what we buy, certainly the branded world, we take title in the U.S. And so the tariffs don't impact us directly, and we are a fee-for-service model. I have been asked, "Well, what about the inflation component of it?" Yes, that's a small part of our overall profit model on the brand side of the house, but I don't think it's material. It's certainly not causing us to have the same consideration set that we are taking on the GMPD part of the business. And on the generics part of the business, in the cases where we do perhaps take title outside the borders, that is a place where our industry-leading scale with Red Oak, our insulin access, our industry-leading influence on locations and source of production and the great relationships we have with the generic distributors also give us some ability to help mitigate the impact of anything that happens. It's also the case, though, that from a policy perspective, I know the administration is talking about bringing production -- they would like to bring production back onshore, that's not something that happens overnight, right? And so we believe we can be a positive voice in that conversation with the administration, with the industry around what does the future of pharmaceutical production looks like.

Sure, Mike. Go ahead.

In terms of the [ onshoring economics ] to the extent that the administration drops the tax rate to 15% of domestic manufacturing, would that tilt the economics away from Mexico? And then I have another one.

So just for the webcast, it's about the potential for broader and extended tax cuts and what that means relative to the manufacturing relationship and the buy versus build U.S. versus Mexico.

Yes. Great question. Good to see you. The -- I guess, my observation is that a change to the corporate tax rate is a blunt instrument that may be successful in some industries. It's certainly something we pay attention to. We're investing -- we have long-cycle investments. As I commented earlier, if the administration were to drop the tax rate next week, it would still take us years to influence the source of location of individual production. And so while we are investing heavily against our business, it's our top use of our capital is the significant amount of money really across the portfolio. The tax rate alone wouldn't be enough to drive it. It would be the overall economics of the return on the capital investments we would be making. I should be clear, we don't actually ourselves manufacture pharmaceuticals. We are a distributor of pharmaceuticals. We manufacture some medical supplies in the U.S. and outside the U.S. The GMPD business, again, we have opened the syringe facilities. And so it is the case that we have invested in some limited production in the U.S. there, but it would be the overall return on the business case.

I don't want to short-shaft the Other segment, aptly named Other segment, but it seems like it gets forgotten about. But obviously, you've made some inorganic investments there with the ADSG business. As you think about resource allocation beyond that, how are you prioritizing and allocating capital to one versus the other, given what clearly are optimistic outlooks across the board market-wide, but still, obviously, very different times, timing wise, such as -- think about like nuclear and drug launch is very different as well?

We are very excited about the 3 businesses that are in Other, Nuclear and Precision Health, OptiFreight Logistics and the at Home business. And part of the resegmentation we executed a little bit over a year ago was to raise the internal and external profile of those businesses. They report directly to Jason Hollar, and they have -- they're entitled to ask for more capital of us. And so they are on a much more level playing field with the individual constituent pieces of our Pharma business that we manage, that we perhaps don't talk as much about externally or GMPD. And where they present strong business cases in competition with each other and in competition with the broader business, we are more than willing to invest in those businesses. And I'll use the -- I'll use -- I'll give you a couple of examples. The recent announcement of the at Home, the acquisition of ADSG by the at Home business, that was a case where the hurdle level was high for us to be willing to spend that amount of capital on the at Home business. The business case is excellent. We expect great synergies there. We've not provided guidance yet on that. We'll do that when we close. But the point I'm making is because of the operational excellence, the execution that, that team has been driven through their organic investments, we believe combining those 2 businesses together will be very powerful for us from an operational synergy perspective. In contrast, the Nuclear and Precision Health business, we have a market-leading position in that business. We believe we can create significant stakeholder value by continuing to invest in that business largely organically. We are -- as I said, we're one of the largest providers now. And so whether it's investing in Theranostics manufacturing capabilities, whether it's investing in additional nodes of our market-leading PET network, those are all places where, as new therapy areas, as new diagnostics are coming out of the Nuclear and Precision Health industry, we believe we're ideally situated to create value and serve our customers by investing in that business. And then OptiFreight, the logistics business is a -- it's a very different business model for us, but it's been -- customers are excited about what that business can do for them. It fits a need. It's a very low capital business. And so there, again, with the right business case and competition with the rest of the assets, we're more than willing to talk about investing there.

I'm going to get a little ahead of myself, but you mentioned the next earnings date, but more importantly, of the June 12 Investor Day. Obviously, when you and -- when you came in as CFO and Jason moved up to the CEO role, you did Investor Day in June 2023, which felt a lot like a reboot of the Cardinal story, laying out what you had, laying out what the growth prospects are. I don't think at that point in time, anyone expected you to have done 4 acquisitions off of what was a strong [ calendar ] year.

In a year.

In incredibly quick fashion. Obviously, the growth trends have meaningfully outpaced, thanks to market, thanks to execution, all of the above. You're running well ahead of trend. I'm not asking for what we're going to see there. But in terms of setting the stage, how do you want to address the dynamics behind the Investor Day? And what are some of the key themes, whether now or by the time then that you want to make sure it get hammered in as you think about what's going to be the next leg of growth, given that 2 years ago you were still very new to this business?

It's a great question. I appreciate the opportunity to talk about where we're going to go with this. Part of what Jason and I are committed to is telling you what we're going to do and doing it, reporting back and then doing it again, right? And so we view the Investor Day that's coming in June as a second chapter in the continuing conversation, if you will. The agenda will be driven across each of our businesses. We're going to give you a -- what is the current state of the business, what is the current state of the market opportunity, where do we have opportunities to improve, where do we have opportunities to grow, where are we prioritizing the investments that folks are referencing and, importantly, how have the investments we've made over the last 2 years actually played out, right, what has gone well, what do we -- what are we continuing to evolve from a service offering perspective. An important element of that as well will be what is the connective tissue across each parts of the business. Because if you think about my comments on specialty earlier, what we were doing organic investments following the Investor Day on oncology, then we bought Specialty Networks, which, by the way, was technology investment which is applicable across multiple categories then, we were -- then we started making organic and inorganic investments in other therapy areas within specialty. Now think about the impact of Nuclear and Precision Health and how it's serving many of those same specialty areas, either from a diagnostic or a Theranostics perspective, there is some connective tissue there that we'll also reference. And so the agenda will be where are we, where are we going, what is the strategy, what are our operational plans, who are the leaders. We will be providing more access to leaders beyond me. You can cross examine them, instead of me. I'm excited about that. But that's really the day. It will be in New York, I believe, at the Stock Exchange. And Matt will be sending invites out soon. If you're interested in attending, [email protected], the -- so we're excited about it.

And I appreciate the pre-preview, I guess, supposed to be the Investor Day. But we're out of time. So Aaron, Matt, as always, thank you so much for being here. Thanks for filling us in on updates on the story.

Thanks for having us.

Thanks, Mike.