Cardinal Health, Inc. ($CAH)

Good morning, everyone. Welcome to this session of Leerink Global Healthcare Conference. I'm Mike Cherny, the health care tech distribution analyst. It's my absolute pleasure to have the Cardinal Health management team here with us. Aaron Alt, no longer still new-ish CFO, now you're just the CFO. Matt Sims in Investor Relations and other asserted strategic efforts and then David Frost, who will be the additional IR person sitting in the front row here. So I believe Matt has an opening statement and then...

Yes. Well, thanks for hosting us, Mike. It's great to be here, as always. Not a bad view. So before we begin, just a little housekeeping. We will be making forward-looking statements today, which will be 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. All right. Let's get started.

Awesome. Thanks, Matt. So Aaron, maybe -- let's level set here. You've had now a number of quarters of continually increasing momentum across the business. And you always keep talking about being very broad-based. I'm not asking you to rank order or go any deeper, but when you think about the broad-based nature of the outperformance, can you give us a little bit more of the why and in particular, how you think about where the market has developed versus the actions that Cardinal has taken to make sure to execute on the market.

Well, to talk a little bit about the path forward, I need to, of course, talk about the year-to-date so far, we're 2 fiscal quarters in. We're in the middle of our third quarter. And while I'm not going to provide a specific update on Q3 today, certainly, you can take some observations from my comments. And if you think about our Q2 results, which we released several weeks ago, all 5 businesses grew profit double digits plus, right? And that was driven by the combination of strong demand, right, stronger than we had anticipated demand. I'll come back to that in a second, as well as great execution by the teams really across the board as well as the benefit of the investments we've been making over the last couple of years. And so that has really come together and put us -- put Cardinal in a position of strength relative to our business and the environment in which we're operating. Now it's equally true that we saw a strong performance of our other businesses, OptiFreight, Nuclear and at-Home, right? Strong demand there as well, good operations, the benefit of M&A in those categories as well. And then GMPD, a business we don't talk a lot about these days, delivered a great result as they continue to take cost out and drive success in the Cardinal Health brand part of the portfolio. And so across the enterprise, we have seen year-to-date good success driven by the demand, driven by the operating excellence and driven by the delivery on the strategies we've now been deploying for a period of years. As we think about how that carries forward and really to the point of your question, what I would tell you is we're always careful to guide strong demand. We lean in, in that way. But I'm also very careful to always say, look, if things are just exceptional, we aren't guiding that, right? We're guiding strong demand. If demand is outsized, that would be opportunity for everyone in that way, particularly around our Specialty business. Pharma has been driven so far this year and indeed, the plan for the year is good core growth within core Pharma, Specialty growing faster than the rest of it. I think we recently announced Specialty we'll be hitting $50 billion plus this year. That's a result of Specialty distribution as well as the biopharma services, the MSO businesses, all the places we've been leaning in. And we're very pleased with how that business is developing over the course of the year. I would also, of course, for those that are less familiar with the story, keep in mind that we have a first half, second half dynamic from a guidance perspective as well, where in the first half, we were benefiting from the second part of the new customers that we onboarded in the second half of last year and by the fact that we had not yet lapped most of the acquisitions we've done. So while growth in the second half of the year for the Pharma business will be mid-teens, I think we've said from a guide perspective, it won't be as high as it was in the first half because of those 2 very important factors as we carry forward. Look, at the end of the day, demand has been good, supported by the demographics in the industry, the American consumer, where 99% of our revenues are generated, is growing older. They're taking better care of themselves. The Specialty dynamic is important. We are benefiting from that as we have doubled down in Specialty as well. And that's also carrying forward into the other parts of our business as well. You take Nuclear where the innovation pipeline coming there, 70-plus therapeutics, a lot of them in the Specialty areas we're investing in, in Pharma, urology and oncology, right, you really start to see how the pieces are knitting together across the Cardinal portfolio to carry us forward.

I find it fascinating, and we've talked about this that Cardinal -- the Cardinal today is leading with Specialty. It's something that's been a very distinct portfolio improvement portfolio investment that you've made over time. As you think about the growth of Specialty and the high level of $50 billion of revenue is great, how do we parse through what's driving the growth of the distribution side versus the MSO assets you've acquired? And along the second part, what is Cardinal able to do to make the MSO assets that you've acquired better businesses where you've been able to execute so well against them?

Yes. It's important to keep in mind that we view the Specialty business as really 3 larger parts. You have the Specialty Distribution, which is heritage Cardinal. We have traditionally had strength in the other ologies, the urology, the rheumatology, nephrology. We've doubled down on those areas and certainly increased our exposure in areas like oncology as well. I'll come back to that in a second. Then we have the downstream elements like the investments in the MSOs we've been making, which we're super excited about because that isn't -- for us, that isn't about the drug spend. The drug spend is what we do otherwise. It's about the ancillary services, the office visits, it's the diversified revenue streams at a higher margin that are additive to our overall P&L. That's why we're focused on the MSOs, which I think is a little bit different strategy than some of our competitors. And then there's the BioPharma services parts of the Specialty portfolio, which is more upstream or in the background. In our most recent earnings call, we talked about a particular element of that portfolio, our Sonexus Hub business with significant customer wins organically based on a couple of years of investment in the business and from a team, from a technology and capability perspective. And so as we're leaning in on Specialty because you're right, it's a core part of our strategy. It's not just one of those, it's all 3 of those. And we have a variety of organic investments occurring at all times. We are always open to further inorganic investments in support of the Specialty portfolio, but the pieces are really starting to come together. And maybe to the other point of your question, for us as much now is how do the pieces connect to each other, right? I'd like to use urology as an example, right? We have historically been a strong distributor of Specialty urology products. Our first acquisition was actually Specialty Networks, right, which was a -- historically was a urology GPO-based business that then moved cutting-edge into technology that we then acquired to get the technology and got the urology, the GPO and relationships part of the business. We're then able to leverage that capability, not just in urology, but GIA was a customer of Specialty Networks, right? And so now Specialty Networks -- GIA is using the technology from Specialty networks. Similarly, with Solaris now in the portfolio as well, we're connecting Solaris with the core distribution business as well as now with Specialty Networks. They were a data customer, but not a broader -- not a distribution customer of us. And so you can really start to see how the pieces are coming together.

When you think about what comes next, you talk about the other ologies. What are you finding in terms of -- once you get in there, there's more you can do. And so how do you think about that expansion on the services side in order to make sure that within the ologies, whether it's organic or inorganic investments, you can continue to be more value add. I mean more value add brings obviously more revenue, but like it only works if you're actually adding value.

Yes. Great point. We are starting with the community provider at the core of what we do, right? And so we are relentlessly focused on how do we ensure that incentives are aligned. We are in partnership with the doctors in many respects. They are owners of Specialty Alliance for that matter. And so as we focus on what do they need to better care for their patients where they are the experts, we are not providing care recommendations, right? We are helping them run the business. We are helping to make sure that they have the resources necessary, helping them to run the back office, the stuff that, frankly, they don't want to do and shouldn't have to spend their highly educated time doing, right? That's really where we are focused. And so what we're bringing to the table there, for instance, we're able to bring scale and better expertise on technology, right? And we're able to do that across the scale of 3,000 providers in 30-plus states at this point. And so you can see that, that can lead to some benefits. We're able to bring expertise and scale on how do you run a back office, how do you do scheduling across 5 doctors, 50 doctors, 500 doctors, right? That's a capability that we're able to bring. We're able to bring a better cost of capital, right, to the practices as we carry forward. We're able to, of course, bring better distribution economics. We negotiate with the doctors on those. I think the contracts we've picked up, they've been quite pleased with the deal that we've put on the table with them in that way. And so really, as we think about the core economics, it's all about how do we enable the clinical practice of medicine so that they're able to do what they do best while we do what we do best. Now there's some additional benefits that are second circle effects, if you will, of the acquisitions. I'm going to go back to my urology example as well. With us now being the majority owner of the largest urology MSO in the country, think about the benefits that the Solaris and Specialty Alliance-related urologists get from being partnered with Cardinal and our Nuclear Precision Health business with the number of the diagnostic and theranostic products that are out there with our scale across the country, right, we're able to teach and train, we're able to make therapeutics accessible to them, we're able to provide best practices from a practice perspective. We're really starting to see the benefits of that accreting to the doctors as well as to Cardinal Health.

Maybe thinking about the core Pharma business, you kicked off the year with some -- at least for this market, fairly significant changes with the first change in the IRA negotiated prices. You came out and said flat out, we've recontracted, and we feel good about where we stand. Can you maybe just give us a reminder on how exactly those changes go about, how automatic they are in nature versus the work that you have to do to make sure that the unit economics that you deserve -- you feel you deserve are appropriately reflected in the contracts?

Sure. I don't want anyone to walk away with the impression that this is easy because every contract between Cardinal and one of the suppliers manufacturers is unique to that particular counterparty. But what we have is 50-plus years of experience and relationship working with each of the counterparties. What we have is we are the backbone effectively of the pharmaceutical distribution business such that it's hard -- it's not like there's a lot of alternatives where someone can go to. And it's not like the manufacturers themselves want to set up a national distribution chain across temperature classes to serve their specific drugs. What we do is we buy the drugs from thousands of manufacturers, and we distribute it to tens of thousands of locations every day. And that requires scale, that requires expertise. And so when we have a conversation on an annual or a biannual basis, it all goes down -- it comes down to the fact that we're going to be compensated for the value of what we provide or we won't provide it, right? And we have that conversation every year, every time there's a contract renewal. And 50 years later, we're still doing what we're doing because we've gotten to be experts. And our peer set is in a similar position in that way. Now most of our contracts actually have a provision in them, which says that if there is a dramatic change in the ecosystem like IRA, we have the right to renegotiate. So that is true. It's not -- there's not an automatic escalator or de-escalator tied to what's going on with WAC. But what we showed and the proof points I would give you first with insulin and more recently with the 2026 IRA changes, we expressed confidence going into it that it would be fine. We would be compensated for the services we're providing. And indeed, that was the result that we were able to confirm on our last earnings call that those negotiations had ensued and resulted as we expected. I am sure the same question is going to come up in connection with 2027. We're already seeing some of the news around Ozempic with Novo. My answer is not any different, which is we will be compensated for the services that we're providing in connection with that high-growth drug. And I'm sure we'll get to the same question in 2028 when we get to Part B as well. And maybe I can just jump there quick in case it was coming, which is...

It was.

We also expect that, look, the Part B changes, the administration isn't out to stick it to the community physician, right? They're all about ensuring affordability. They're about ensuring access, they're about ensuring innovation. And we expect that just like we have with Part D in '26 and '27 that by the time the 28 changes actually roll out, we will have negotiated the appropriate compensation certainly for Cardinal and for the docs that are part of the broader MSOs with whom we're partnered.

And when those negotiations go on, one of the things I've always found is like trying to level set and look at the role that you and your 2 peers play in the market and try to break down the profit pool of how much money you make versus what you actually do against the economic benefit. Like are those the discussions that you're having. You always talk about the whole fair share dynamic, and I tend to agree with it, and maybe that goes more than just a margin percent rate, but it's more a -- is there that broader discussion about the fee-for-service versus the economic value of what we touch? Like how do those negotiations play out? I'm not asking, obviously, for a specific discussion point with a customer, but that's not easy, so.

I've got an easy answer. We're a 1% margin business on core distribution. And so if someone wants to look at what we do and buying from thousands and selling to -- and moving to 10,000 on a regular basis and tell us that earning a 1% margin is egregious on our part, I will encourage them to look right back at their own gross margin structure and explain to me the relative fairness of that and indeed the return on capital that comes with it. And so these are -- we are all sophisticated counterparties. They're all the conversations or negotiations you would expect ensue. But at the end of the day, what it comes down to is the fact that Cardinal and our primary peer group, we provide an essential service. We do it safely. We do it securely. We do it efficiently. We have a modest margin in exchange for doing that. And frankly, we do it well, right? And the American health care system needs us to continue to do that. And at the end of the day, contract negotiations aside, right, reasonableness prevails, right, in that way. That's what I would really -- why I would answer the question of why Cardinal has been successful in doing this for the last 50-plus years and why we have great confidence that notwithstanding everything else going on in the industry, the world, et cetera, that we are an essential backbone to the American health care system, and we will continue to be successful doing what we do day in, day out.

So you're primarily U.S. domiciled business, but one that is subject to world geopolitical strike. Obviously, top of mind right now besides AI is oil prices and potential inflation on raw materials and other items. Can you just remind us roughly how your contracting works and how to think about pushes and pulls on changes in commodities such as oil and potentially others?

Sure. My short answer is going to be it depends. My longer answer is as follows. First, let me get some of the details out of the way. 99% of our revenue is in the U.S. We have very small revenue into the Middle East, and we have no actual operations on the ground in the Middle East. We work through distributors for sales of our products largely through GMPD into the Middle East. And so we have no direct exposure from a business operations perspective. Similarly, given where our manufacturing or sourcing operations are located, we don't move much, if anything, through that part of the world. And so as we think about transportation costs, ocean logistics, et cetera, we're in the Pacific, not in Strait of Hormuz or the Red Sea in that way. And so we are, again, not directly exposed to the cost of shipping through that part of the world. Of course, we do move stuff, right? And so we pay very careful attention to price of gas. And we have a variety of contractual provisions around that as well. And we manufacture stuff, and we manufacture stuff that uses petroleum as a base. And I would observe as follows. The first is that I anticipate an immaterial impact across our enterprise to fiscal '26. We're in our Q3. That's driven by the fact that we have contracts that allow us based on some metrics to actually pass cost increases along to the extent that our costs increase. We have contracts that actually give us some room where we don't actually suffer the pain until costs increase beyond a particular level. It's also the case that we're negotiating every day, and we have expert teams that are very carefully watching the commodity environments as well. And so while, of course, we're carefully watching what's going on with oil, we don't believe it's going to have a short-term impact on us, and we believe we'll be able to manage through it in the longer term once we get past fiscal '26. I should also observe you asked me about how it works. I will observe that anything which goes into our input costs, particularly from a manufacturing perspective, we won't realize for 7 or 8 months as we carry forward. So that would push us into '27 to the extent that our input costs were elevated for the long term.

And obviously, Cardinal had some push and pulls and headwinds back during the COVID period and some of the freight challenges on the West Coast shipping, in particular, at that time period. Is there anything that could be learned from customer engagements, customer negotiations then that can inform -- obviously, we don't know how long this -- the commodity spike will last. But is there any lessons learned that are brought forward now? Or does that just go back to the point about you're constantly negotiating and building room et cetera?

There are absolute lessons to be learned. And the good news is we've learned them, right? And I think you can see the proof point of that we've learned many of the lessons with a couple of quarters of good results from the GMPD business in particular. Most of our global supply chain is where we are responsible is tied to the GMPD part of the business, which is a very small part of our profit profile, of course. But the way we've leaned in on better managing our supply chain, the way we've leaned in on the location of our sourcing, the contracts we have with our inputs, the contracts we have on ocean transport, that is all -- those are all things that we've taken to heart and part of why the GMPD team has been successful in delivering good profit growth over the last couple of quarters. And whether it's Jason or Steve Mason or the broader GMPD team, we are very focused on that.

I might come back to farm and the MSO side, but I want to make sure we have some time to talk about the other assets because I feel like at times, they're not talked about.

Affectionately not as other.

It's the best unit name I thought. We kind of do the math on when you closed the ADSG deal, but how -- where are you in the integration of that asset and of the ability to basically position it within the AssureMed platform and make 1 plus 1 more than 2.

Yes. At the time we announced the deal, I used words something like we have a reasonable integration and synergy plan with opportunities to overperform. I may have got a word or 2 wrong there. But the point was is we were very careful in building a detailed integration and synergy realization plan, but also very focused on we wanted to do better than that. And what I can tell you is we're doing well, right? We are at or above our initial expectations for the integration of ADSG. A couple of proof points. The first is that the first thing we could see is we could ingest all of their volume on top of our platform. It would raise our sales by something like 30%, but only use 2% of our capacity. that gives you a sense of just how immediately synergistic it was as we made that transition from their provider into ours. We've been equally focused now in the background of integrating the back office, right, the technology, the sales teams, the contracts, et cetera, all that work is underway and proceeding well. And we're excited because, of course, when you go into a new environment with the administration creating new rules and regulations as well, you want to be the player at scale. You want to be the player with a great compliance program. You want to be the player who can bring benefits to the industry, who can bring benefits to the manufacturers. And certainly, with our focus -- with our larger focus on CGM and diabetes, we believe that the combination of the 2 assets is going to put us in a great position to do just that, which is deliver great service to the ultimate patient in the home, but also a great business model, whether it's direct to the home or, of course, we also service some distributors on the other side of the at-Home business. So we're really excited about what the ADSG acquisition has done for us so far. It's been a key part of our results, but also what the opportunity in front of us to further mine the synergies coming from that acquisition.

As you think about the mining of the synergies, how much of it is on portfolio expansion? I mean diabetes, obviously, is an extremely wide category. It has a fairly nice, almost direct overlapping link with the stuff that you do on the Pharma side. Like where does that push and pull come to make sure that you can continue to maximize the value because you can expand that portfolio?

Yes. What I would observe is opportunities like Continue Care, which we announced in our last quarter, that wasn't part of our business case, right? That's an opportunity that as we have increasingly looked at how do the various parts of our organization work together, we identified as something that we could blow out. And so that's an upside to our business case, and we continue to look for opportunities like that.

And for something like that, how long do you think it takes before you could tangibly see the results that's working?

Of course, it's hard to answer without talking about a specific driver in that way. But ContinuCare is something where we saw the technology, we saw the relationship. It took a couple of phone calls to then deploy our sales team to work with partners like Publix on, we've got this great idea for you. It's additive to everything we're doing for you as a new customer already. And obviously, the result was that they blew it out across their network, and now we're benefiting from that, both from a relationship perspective and stickiness perspective, but then serving the need that they had and ultimately, their patients had. Part of what Jason and the leadership team at Cardinal is doing really well these days is not being constrained by how have we always done it in the past, right? There's a relentless focus on where do we have opportunities to do more with what we've got before we then also talk about what else do we need in that way. And so that's part of why I'm excited and why we're confident in the future of Cardinal Health, notwithstanding everything else going on in the dynamic world around us is as we look at the opportunities within the portfolio already tied to the strong demand we've seen, tied to the operating excellence that the team has been showing. And that's what gives me heart about me confidence as we carry forward.

Thinking about the Nuclear and Precision Medicine business, like how do you think about your growth environment against the pipeline of potential new radiotherapies coming to market? And obviously, I think for many, many reasons, we're all waiting, hoping that we have a broader adoption of Alzheimer's drugs, given it's been a tough category to crack. Like how do you think about your role against that pipeline potential and the push and pull on investing in nuclear business, which obviously has a great market position already?

We are very excited about the nuclear Precision Health business. I mean it is, to a degree, Specialty on steroids, pardon my unintended pun in saying it that way. If you think about where the distribution -- where the innovation pipeline is coming from, 70 -- more than 70 different therapeutics, theranostics, diagnostics are in the development pipeline. Our guidance does not require all 70 to hit. Our guidance requires a handful of those to hit, right? And some of the ones that we're particularly excited about are in urology and in oncology, areas that you know we've been investing in pretty extensively so far. And so given that, right, we are -- we actually are investing in the MPHS business. We're investing in the pet network. We announced a substantial investment there. We're investing in the theranostics part of the portfolio. Of course, depending on the therapy area, we are either the manufacturer or the distributor or the commercialization partner, in some cases, all 3. And so what we love about that is that because we're bringing the assets we have, the capital we've already invested and are investing more in, we're bringing that to the manufacturers. That makes us the partner of choice and provides us with even more opportunity across that very Specialty ecosystem we were talking about before.

Because we run out of time, I'm going to jump back to the MSO side. And you referenced it a bit, the Specialty Networks acquisition being the first Specialty capability. I've long thought about it as being kind of a nice overarching platform to make everything else work well together. Like what does Specialty Networks bring to you from an analytical capability, from a connectivity capability, from a GPO capability? And how easy is it to layer the Specialty Networks assets into an MSO that you've acquired?

Right. I would describe the magic of Specialty Networks in a couple of ways. The first magic is they had 2 technology platforms, PPS Analytics and SoNaR, which are doing a couple of things. First thing is they're doing is they're reading 42 EMRs across thousands of doctors, whether they're partnered with Cardinal or not, whether we have anything to do with their distribution or not, they may be customers of Specialty Networks, and we have access into their EMRs. And so we are reading the data, the practice notes, et cetera, aggregating it and we're able to then share that with manufacturers and innovators, right? At the same time, between PPS Analytics and SoNaR, we're actually also sharing practice recommendations back to the doctors, which creates stickiness because the doctors are -- they know their systems are into the broad -- feeding into the broader hole, but we're actually saying to them, you've got this patient here. By the way, there are 5 other patients who are presenting similarly, not part of your practice group, but over here, and this is what's been effective for them. Keep that in mind, investigate that further. It also leads -- it also supports the studies, the real-world evidence that's out there. And so we're super excited about what Specialty Networks brings and how it can be additive for the MSOs because, again, I'll go back to -- it's not just our MSOs that are customers of Specialty Networks. It's a broader group of MSOs and physician practice groups that are not unaffiliated with an MSO that are benefiting from this activity. Now I referenced that because, of course, you may have caught that I referenced that GIA -- a GI MSO was part of Specialty Networks, which was largely focused on urology historically. That's because Dr. Weber and the GIA team could see what they were building with PPS Analytics and SoNaR and they wanted that for the GIA practices, and they were building it. And we have completed that build. And as practices are coming into the Specialty Alliance, both for GI and for urology, now they are integrating into those systems and taking advantage of the Specialty Network systems within urology, which brings me to a larger point as well just on the customer base side. The value of Specialty Networks from an industry exposure perspective, from an industry relationship perspective, the fact that the doctors know that part of Cardinal perhaps before they know Specialty Alliance or before they know Cardinal as well is of value to us because it makes us part of a broader industry collaboration that we think we can drive -- bring further value to certainly through all the capabilities we're building, but also that we can partner with as we carry forward.

We just spent out of time. Last quick question. You did a bunch of M&A, all of it value add. You got back your target leverage, I think, faster than most anticipated. What comes next?

We are sticking to our knitting. It is called a disciplined capital allocation framework for a reason and that we are going to continue to do exactly what we said we would, which is invest every dollar we can or need to organically. That's $600 million, $650 million of CapEx this year. Good news is we've got great high ROI projects. We protected the balance sheet, as you pointed out. We have returned capital. And with any incremental cash, we have the opportunity to look for more M&A that fits our strategic needs or to provide an incremental return of capital to shareholders. And that's the conversation that Jason and Matt and I are having on a weekly basis. And unfortunately, we have to stay tuned as to where exactly that goes as we push ahead. But I do want to end on this note. There's a lot going on in the world, but demand has been strong, right? Performance, the operating execution by our management teams has been strong as well, and we continue to invest for the future so that the profit opportunity is not this quarter or next quarter, but next year, 2 years, 3 years, 5 years here or there. And that's what we're going to continue to do, notwithstanding what's going on in the broader world.

Awesome. Great way to end, Aaron, Matt, thanks so much for being here.

Thanks. Cheers.

Thanks, everyone.