Cardinal Health : 2Q FY2022 Transcript

Q2 FY22 Cardinal Health, Inc. Earnings Conference Call

February 3, 2022 8:30AM Eastern

Operator: Good day, and welcome to the Cardinal Health Inc., Second Quarter Fiscal Year 2022 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Kevin Moran, Vice President of Investor Relations. Please go ahead.

Kevin Moran: Good morning, and welcome. Today, we will discuss Cardinal Health Second Quarter Fiscal 2022 results along with an update to our FY '22 outlook. You can find today's press release and presentation on the IR section of our website at ir.cardinalhealth.com. Joining me today are Mike Kaufmann, Chief Executive Officer, and Jason Hollar, Chief Financial Officer.

During the call, we will be making forward-looking statements. The matters addressed in the statements are subject to the 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 slides at the beginning of our presentation for a 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 reconciliation 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 an opportunity. With that, I'll now turn the call over to Mike.

Mike Kaufmann: Thanks, Kevin, and good morning, everyone. Today, Jason's and my comments will be consistent with the update we provided a few weeks ago. Let me start with a few high-level thoughts.

At an enterprise level, we continue to focus our efforts on 3 strategic priorities: optimizing our core businesses, investing for growth, and innovation, and deploying capital efficiently. We continue to believe the long-term targets we announced in November are appropriate. And, we remain on track to meet our $750 million enterprise cost savings target by FY '23.

Our Pharma business is performing as planned. We've seen volumes continue to improve sequentially, and we are encouraged by the growth we saw again in Q2. Looking ahead, we continue to expect Pharma to realize mid-single digit growth in FY '22.

In our Medical segment, we continue to experience unprecedented inflationary impacts and global supply chain constraints in our core US Medical and Products Distribution business. These impacts, combined with lower-than-expected offsets from pricing actions, will significantly impact Medical segment profit consistent with our update a few weeks ago.

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While we believe these impacts are temporary, the timing of when they will abate remains difficult to predict. Consequently, we are urgently working to mitigate the effect of these external macroeconomic challenges on our business.

We are seeing progress in other areas of the Medical segment, including our lab business in growth areas, and we recently extended several key acute care distribution customers. Looking ahead, I'll elaborate on the actions we are taking to drive performance, particularly for Medical, after Jason reviews our Q2 results and updated outlook.

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

Beginning with total company results, second quarter revenue increased 9% to $45 billion, driven by sales growth from existing Pharma customers. Total gross margin was $1.6 billion, a decrease of 9% primarily due to the Cordis divestiture and elevated supply chain costs in Medical.

Consolidated SG&A was flat to the prior year at $1.2 billion, as the Cordis divestiture and benefits from cost saving initiatives offset IT investments and higher operations expenses.

Second quarter operating earnings were $467 million. Outside of the incremental inflationary impacts in Medical, these results were generally in line with our expectations.

Moving below line, Interest and Other decreased by 30% to $24 million, driven primarily by lower interest expense from debt reduction actions.

Our second quarter effective tax rate finished at 19.4%, six percentage points higher than the prior year due to certain discreet items, which primarily benefited the prior year period. Additionally, our second quarter rate this year included some timing favorability.

Average diluted shares outstanding were 281 million, 5% lower than the prior year due to share purchases. Of note, we initiated a $300 million share repurchase program in the quarter, which was recently completed and brings our total year-to-date repurchases to $800 million.

The net result for the quarter was EPS of $1.27.

Second quarter operating cashflow was strong at $1.2 billion. As a reminder, the day of the week in which the quarter ends affects point-in-time cash flows. We ended the quarter with a cash balance of $3.2 billion and no outstanding borrowings under our credit facilities.

In the quarter, we also recorded a $1.3 billion non-cash,pre-tax goodwill impairment charge related to the Medical segment, which is excluded from our non-GAAP results. This accounting charge primarily resulted from additional inflationary impacts and global supply chain constraints I will discuss shortly.

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

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Revenue increased 11% to $41 billion, driven primarily by branded pharmaceutical sales growth from large Pharmaceutical Distribution and Specialty customers.

Segment profit increased 3% to $426 million driven by generics program performance. This was partially offset by our previously discussed investments in technology enhancements and higher operations expenses, including cost supporting sales growth, such as transportation and labor.

During the quarter, we were encouraged to seek continued, broad-based improvements in pharmaceutical demand consistent with our expectations, including a return of generics volumes to approximately pre-pandemic levels. Our generics program continued to experience generally consistent market dynamics, including continued strong performance from Red Oak. Outside of generics, we've seen brand inflation trending in line with our expectations.

Turning to Medical on slide 6…

Second-quarter revenue decreased 5% to $4.1 billion, primarily due to the divestiture of the Cordis business.

Segment profit decreased 79% to $50 million, primarily due to inflationary impacts and global supply chain constraints in products and distribution. This also reflects the timing of selling higher cost PPE, including the net positive impact from this dynamic in the prior year, and to a lesser extent, the divestiture of the Cordis business.

During the quarter, our products and distribution business continued to be impacted by significant inflationary pressures in the global supply chain, primarily in the areas of polypropylene and international freight. Additionally, in the quarter we saw broader inflationary impacts across the business such as domestic freight and other commodities, as well as global supply chain constraints affecting the volume of some of our higher margin Cardinal Health brand products.

I'll discuss these impacts with respect to our full year Medical outlook momentarily, and Mike will elaborate on the actions we are taking to address these macro challenges and drive performance in our core Medical business.

With respect to COVID-19 and the Omicron variant, we continue to see strong performance from our Lab business, including significant testing demand generally consistent with level seen a year ago. And, despite some impacts from Omicron in various geographies, demand for surgical products related to elective procedures was comparable to both the first quarter and prior year.

Now, transitioning to our updated fiscal 22 outlook on slide 8…

We now expect EPS in the range of $5.15 to $5.50 per share, primarily reflecting our updated expectations for Medical. We also now expect an annual effective tax rate in the range of 23% to 24.5%, and Interest and Other in the range of $140 to $160 million, with the improvement in I&O including deferred compensation favorability which, as a reminder, is fully offset above line in corporate SG&A.

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As for the segments on slide 9…

For Pharma, no changes to our outlook. We continue to expect low-double digit revenue growth and mid-single digit segment profit growth.

For Medical, we now expect revenue to be down low-single to mid-single digits and segment profits to be down 30% to 45%.

Consistent with the financial update provided a few weeks ago, we expect increased inflationary impacts and global supply chain constraints, as well as lower-than-expected pricing offsets, to result in an estimated incremental $150 to $175 million headwind to Medical segment profit for the full year. This, in addition to our November 9th update regarding the pressures in international freight and polypropylene, now reflects a total net incremental headwind of approximately $250 to $300 million to Medical in fiscal '22. While these impacts have persisted for longer than previously anticipated, we continue to believe the majority will be temporary as global supply chain pressures eventually abate. While it will take time, we are committed to mitigating the impacts of inflationary pressures, and will continue to work through these dynamics with our customers.

Now, a few other things to keep in mind in terms of the fiscal '22 cadence…

For Pharma, we expect the year-over-year growth in the back half to be heavily weighted to the fourth quarter due to the lapping of some prior year items, including higher costs for the deployment of IT investments, and the general sequencing of our growth initiatives.

In Medical, we continue to expect an unfavorable year-over-year impact due to timing of selling higher cost PPE in the second half of fiscal '22, though not to same magnitude as in the second quarter. We also will be lapping the large prior year PPE inventory reserve in the fourth quarter.

Finally, to close, a few reminders on capital deployment…

We continue to expect to pay down the approximate $280 million of remaining June 2022 notes at maturity, and continue to expect approximately $1 billion in total share repurchases in fiscal '22.

As we've said, we see our increasing balance sheet flexibility supporting more opportunistic return of capital to shareholders as our debt paydown begins to moderate, enabled by our recent $3 billion share repurchase authorization.

We continue to believe that capital deployment, along with the future growth that we expect in both our segments, will drive the long-term,double-digit combined EPS growth and dividend yield that we are targeting.

With that, I'll turn it back over to Mike.

Mike Kaufmann: Thanks, Jason.

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In Medical, we're continuing to take action to drive performance and maximize the differentiated strengths we have in this business. We are vertically integrated with distribution through our comprehensive Medical products portfolio, which is generally oriented around the Operating Room and the Intensive Care Unit. We also have an advantaged Lab products portfolio and higher margin growth businesses. With our diverse customer base, we cross-sell products and services spanning our portfolio.

To address the challenges in our Medical business, we're focused on 3 things:

First, evolving our commercial contracting strategies and driving mix. Historically, costs have been relatively stable and industry participants have committed to longer-term,multi-year contracts. However, the rapid escalation of today's inflationary pressures demonstrate that our contracting strategy needs to change. We are in the process of working with our customers to adjust certain contracts to ensure we have more pricing flexibility for factors beyond our control.

With regards to mix, as I noted in the prior quarter, we have made important changes to align our commercial organization's structure and incentives. We are under-penetrated in Cardinal Health brand mix relative to our potential, which remains a significant mid to long term profit opportunity as we move past the pandemic and associated supply chain challenges.

Within our Medical products portfolio, we are actively improving our key category product offerings. For example, in our Incontinence product line we have launched a new Cardinal Health brand stretch brief and a comprehensive breathable platform. These enhancements directly support and meet our customers' needs.

Second, we are simplifying our operating model, and optimizing our international footprint.

We remain on track regarding the timing of the previously-announced exits in certain commercial markets, with 35 of the 36 completed to-date.

We are also focused on the modernization of our distribution facilities, including breaking ground on a new distribution center in the Midwest with nearly triple the space of the existing facility enabling future growth.

We believe that a diverse, global sourcing network is important to remain competitive on cost, and are investing in additional self-manufacturing capabilities, including increases in annual production of safety needles and syringes, isolation gowns, and surgical and procedure masks in our own North American facilities. Specifically for surgical gowns, we have efforts underway that will double our North American finished goods production and enhance our supply chain resiliency.

Third, we continue to invest across the Medical segment, including in our growth businesses, at- Home Solutions and Medical Services, which are aligned with industry trends and positioned to grow double-digits in FY '22 and beyond.

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