Cardinal Health : 1Q FY2023 Transcript

Q1 FY23 Cardinal Health, Inc. Earnings Conference Call

November 4, 2022, 8:30AM Eastern

Operator: Good day and welcome to first quarter Fiscal Year 2023 Cardinal Health Earnings Conference Call. Today's call is being recorded. I will now hand the call over to Kevin Moran, Vice President of Investor Relations. Please go ahead, sir.

Kevin Moran: Good morning. And welcome. Today we will discuss Cardinal Health's First-Quarter Fiscal 2023 results along with updates to our full year outlook. You can find today's press release and earnings presentation on the IR section of our website at ir.cardinalhealth.com. Joining me today are Jason Hollar, Chief Executive Officer, and Trish English, Interim Chief Financial Officer.

During the call we will be making forward-looking statements. The matters addressed in the statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected or implied. Please refer to our SEC filings and the forward-looking statement slide at the beginning of our presentation for a full description of these risks and uncertainties. Please note, that during the discussion today, our comments will be on a non-GAAP basis unless they are specifically called out as GAAP. GAAP to non-GAAP reconciliations for all relevant periods can be found in the schedules attached to our press release.

During the Q&A portion of today's call, we please ask that you try and limit yourself to one question, so that we can try and give everyone in the queue an opportunity. With that, I will now turn the call over the Jason.

Jason Hollar: Thanks, Kevin, and good morning, everyone.

Now that I've had a couple months to settle into the CEO role, I am feeling even more energized and excited about the opportunities in front of us.

My recent conversations with customers, suppliers, employees, and shareholders have reinforced my perceptions that: Our company's role in healthcare and our mission to improve the lives of people every day remain as critical as ever. Our customers and their patients rely on us to deliver the right products, to the right places, at the right time. And yet, there's also a collective recognition of the need for simplification, focused execution, and clarification of our company's strategic direction.

Our goal today, along with reviewing our recent results, is to summarize the key near-term priorities and progress to-date on our plans, which I will discuss later in my remarks. However, before I turn it over to Trish, let me share some initial perspective on the first quarter.

Overall, our performance in the first-quarter demonstrated continued stable fundamentals in our largest business, and tangible progress in Medical.

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In Pharma, we tracked slightly ahead of our expectations, as we delivered growth while managing industry-wide inflationary headwinds. We are encouraged by the ongoing stability in prescription volumes and strong performance of our generics program.

In Medical, the quarter's results were also a little better than expectations we announced in September. While I am pleased with our team's efforts in the quarter to achieve these results, there is more work to be done to drive better, more predictable financial performance in-line with the underlying potential of this business. We are highly-focused on executing our Medical Improvement Plan initiatives, which I will cover in greater detail later in my remarks.

Across the company, our team is operating with urgency to drive our businesses forward and committed to creating value for our shareholders.

Now, I'll turn it over to Trish to dive deeper into our results and outlook.

Trish English: Thanks Jason, and good morning everyone. It's great to speak with you all.

Today I'll share details on three areas of focus - our consolidated first quarter results, the key drivers underlying our segments' performance, and our updated fiscal '23 outlook before turning it back to Jason for final remarks.

First quarter total company revenue increased 13%, driven by Pharma segment sales growth.

Gross margin decreased 2% to $1.6 billion due to net inflationary impacts in Medical and one month's impact of the Cordis divestiture, partially offset by our Pharma generics program performance.

Consolidated SG&A increased 7%, reflecting inflationary supply chain costs and other operating expenses such as higher costs to support Pharma sales growth. This increase was partially offset by the Cordis divestiture and benefits from enterprise-wide cost savings initiatives.

Operating earnings decreased 20% to $423 million, reflecting the decline in Medical segment profit, primarily due to net inflationary impacts, and partially offset by growth in Pharma segment profit.

Now, moving below the line, Interest and Other decreased 25% to $27 million dollars, primarily driven by increased interest income from cash and equivalents. As a reminder, our debt is largely fixed rate, resulting in a net benefit from rising interest rates.

Our first quarter Effective Tax Rate finished at 16.9%, approximately 7 percentage points lower than prior year due to certain favorable discrete items.

Diluted weighted average shares were $273 million, 6% lower than a year ago due to share repurchases. We are focused on balanced, disciplined, and shareholder-friendly capital deployment and in mid-September, we initiated a $1 billion dollar Accelerated Share Repurchase program that we expect to complete in the second quarter.

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The net result for the quarter was Earnings Per Share of $1.20.

Now, turning to the balance sheet.

We generated first quarter operating cash flow of approximately $25 million dollars. This includes total litigation payments of approximately $390 million dollars, primarily consisting of the second payment under the national opioid settlement. Adjusted free cash flow in our first quarter was $342 million dollars.

We ended the period with a cash position of $3.5 billion dollars, with no outstanding borrowings on our credit facilities.

Now turning to the segments, beginning with Pharma on slide 5…

First-quarter revenue increased 15% to $46 billion dollars, driven by branded Pharmaceutical sales growth from existing and net new Pharmaceutical Distribution and Specialty customers.

Pharma segment profit increased 6% to $431 million dollars, driven by generics program performance and a higher contribution from brand and specialty products, partially offset by inflationary supply chain costs.

During the quarter, we were pleased to see strong execution and continued consistent market dynamics in our generics program, including Red Oak.

As we've previously noted, inflation continues to impact supply chain costs across the industry, particularly within transportation and labor. We saw an approximate $20 million dollar year-over-year headwind from these areas, which was consistent with our expectations. This headwind was effectively offset by year-over-year tailwinds from our completed ERP technology enhancements and lower opioid-related legal costs.

Okay, turning to Medical on slide 6…

First-quarter revenue decreased 9% to $3.8 billion dollars driven by lower Products and Distribution sales, primarily due to PPE pricing and volumes, and to a lesser extent the Cordis divestiture. Continued strong growth in our at-Home Solutions business offset some of this revenue decline.

Medical segment loss of $8 million dollars was due to net inflationary impacts in Products and Distribution as well as a lower contribution from PPE, both of which I will discuss in more detail.

Importantly, these results reflect approximately $20 million dollars in total inventory charges related to our previously-announced simplification actions. This includes the sale of our gloves portfolio that is primarily utilized in non-healthcare industries.

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As a reminder, this non-core product line has been a source of volatility and distraction in recent years. These actions, despite the one-time costs, are an example of our ongoing commitment to strengthening the Medical Products and Distribution business through simplification.

During the quarter, the gross impact from incremental inflation in our Products and Distribution business was in line with our expectations, of approximately $150 million dollars, and we successfully achieved our inflation mitigation target of 25%. Our mitigation efforts have continued to accelerate, most notably with the implementation of the second wave of product pricing actions in July. Jason will elaborate on our plans for further mitigation shortly.

Now, a quick update on the overall utilization environment. We've previously noted some overall volume softness in our Products and Distribution business, including a lower demand for PPE, which we believe primarily reflects customers' higher inventory levels. In the first quarter, we saw generally consistent overall Products and Distribution volumes sequentially, including with PPE. While we do anticipate gradual improvement in volumes relative to these recent lows, we continue to expect choppiness in demand levels going forward.

Now, for our fiscal '23 outlook, beginning on slide 8…

We are reiterating our EPS guidance of $5.05 dollars to $5.40 dollars. This includes our updated Medical Segment outlook, which has been adjusted for the impact of simplification actions in the first quarter, and a few below-the-line improvements. Based on the first quarter performance, we are confident in lowering the top end of the ranges for Interest and Other, our Effective Tax Rate, and diluted weighted average shares for the fiscal year. We now expect I&O in the range of $140 to $160 million dollars, an ETR between 23% and 24%, and diluted shares between $262 to $264 million.

Our expectations for the remaining items listed on slide 8 remain unchanged.

We are also reiterating our fiscal '23 outlook for the Pharma segment, seen on slide 9. We continue to expect revenue growth in the range of 10% to 14% and segment profit growth in the range of 2% to 5%.

Before transitioning to Medical, two key call-outs on the Pharma cadence:

First, with a stronger start to the year, we now expect more balanced year-over-year profit growth between the first and second halves of fiscal '23. And, specifically for the second quarter, we expect segment profit dollars to be similar to the first quarter.

Turning to Medical, we expect segment profit ranging from flat to a decline of 20%, which as I indicated, reflects the impact of the simplification actions in the first quarter.

With respect to inflation and our mitigation actions, there is no change to our expectation of a net impact of approximately $300 million in fiscal '23, or a minimal year-over-year impact. The macroeconomic environment remains dynamic, and while we've seen some decreases in spot rates of certain cost drivers such as international freight, other areas, such as commodity costs, remain

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significantly elevated. As a reminder, these product costs are capitalized into inventory, and in the current environment of elongated supply chains, reflected in our P&L results on an approximate two- quarter delay. While we now expect gross inflation in the second quarter to be similar to what was seen in Q1, we are implementing additional actions and working proactively to mitigate these pressures. It's important to note that we continue to expect that as we exit the year, the run rate of our mitigation actions will offset at least 50% of the gross impact from inflation.

On Medical's quarterly cadence…

In Q2 we expect similar segment profit dollars as the first quarter, excluding the impact of the first- quarter simplification actions. As we have noted before, we continue to expect the substantial majority of segment profit to come in the second half of fiscal '23, and particularly in the fourth quarter. This sequencing primarily reflects our assumptions around inflation, inflation mitigation, and PPE.

With that, I'll now turn it over to Jason.

Jason Hollar: Thanks Trish.

I concluded our August earnings call with 3 key takeaways that I'd like to provide updates on.

Number one: Improving the underlying performance of the Medical segment through our Medical Improvement Plan initiatives.

The key driver to achieving our segment profit target of at least $650 million by fiscal '25 is our mitigation actions for inflation and global supply chain constraints. Though elevated inflation has persisted in the macro environment for longer than expected, we are on track to exit fiscal '23 offsetting at least 50% of the gross impact on our business. As I've previously mentioned, we plan to fully address the impact of inflation and global supply chain constraints through mitigation initiatives by the time we exit fiscal '24.

Our third wave of price increases went into effect on October 1st, and we are planning additional actions for the third quarter. To date, we have adjusted product categories representing nearly 90% of US Cardinal Health Brand sales, excluding PPE. Additionally, we've successfully adjusted language in product contracts as they've renewed to allow for greater pricing flexibility to respond to macroeconomic dynamics. We've also executed distribution fee increases to offset higher transportation, labor and fuel costs, and continue to explore other opportunities for further offsets with urgency.

Outside of our mitigation actions, we expect the largest contributor to our growth to be our ability to optimize and grow our $4.6 billion Cardinal Health Brand portfolio. This will be achieved through new product innovation and increased product availability as a result of targeted investments.

Additionally, I am confident in our ability to optimize our cost structure and our sourcing and manufacturing footprints as we focus on driving simplification across the Medical organization. The team is energized by the goals we have laid out in the Medical Improvement Plan and has already hit the ground running on execution.

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