Cardinal Health : Q2 2023 Earnings transcript

Q2 FY23 Cardinal Health, Inc. Earnings Conference Call

February 2, 2023, 8:30AM Eastern

Operator: Hello and welcome to the second quarter FY 2023, Cardinal Health Earning Conference Call. Please note, this call is being recorded and for the duration of the call, your lines will be on listen only. However, you will have the opportunity to ask questions at the end of the call. This can be done by pressing star one on your telephone keypad. I will now hand over to your host, Mr. Kevin Moran, VP of Investor Relations, to begin today's conference. Thank you.

Kevin Moran: Good morning. And welcome. Today we will discuss Cardinal Health's Second- 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, our Chief Executive Officer, Trish English, our Interim Chief Financial Officer, and Aaron Alt, who will take over as our Chief Financial Officer beginning February 10th.

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.

Before we dive in, I'd like to take a moment to welcome Aaron Alt to Cardinal Health as our incoming Chief Financial Officer.

We're excited to have Aaron onboard. He brings a breadth of financial and operational experience to our organization, including a background in distribution, and he's already hit the ground running in his first few weeks. I am confident he will be a valuable addition as the leader of our finance organization, contributor to our Executive Committee, and a seamless fit with our company culture.

Aaron Alt: Thanks Jason, and good morning.

I am excited to be part of the team here at Cardinal, particularly at such an important time, not only for our company but for the entire healthcare industry. What attracted me to Cardinal Health was the broad portfolio, the overall culture and a leadership team that is motivated to win. While still early

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days for me, I can already tell that while there is work to do, Jason and the team have a plan and there are significant opportunities for value creation in front of us.

I look forward to interacting with you all further in the weeks and months to come as I continue to ramp up.

Jason Hollar: Thanks, Aaron. Now let's begin with some high-level perspectives on the second quarter.

Overall, our Q2 results demonstrated continued momentum against our plans.

In Pharma, we've seen ongoing stability in the macro trends and underlying fundamentals of the business. In the quarter, we saw particular strength in overall pharmaceutical demand and strong performance from our generics program. We've seen increasing contributions from specialty products, which is a key strategic area of focus. And, we continue to effectively manage through the inflationary headwinds affecting industry supply chains. In short, Q2 was another data point that Pharma is a resilient and growing business.

In Medical, we remain highly-focused on our Medical Improvement Plan initiatives. Overall, despite some puts and takes, Medical's Q2 results were consistent with our prior commentary, and we were pleased to see a return to profitability in the quarter. We continue to take actions to drive more predictable financial performance in-line with this business's underlying potential.

At an enterprise level, we continue to see benefits below the operating line from our capital deployment actions and favorable capital structure.

With the first half of fiscal '23 behind us, we are pleased to raise our full year EPS guidance and outlook for the Pharmaceutical segment.

Our team remains focused on executing our 3 key strategic priorities of executing on the Medical Improvement Plan, building on the growth and resiliency of the Pharmaceutical segment, and maintaining a relentless focus on maximizing shareholder value. I will update you on these priorities in a few moments.

Before I turn it over to Trish to review our results from the quarter and revised outlook, I'd like to thank her for stepping in as interim CFO over the past six months. Trish has brought leadership and continuity to the organization, and will be instrumental in ensuring a seamless transition with Aaron. Thanks, Trish.

Trish English: Thank you Jason, and good morning everyone.

I'll begin today with our consolidated second quarter results.

Total company revenue increased 13% and gross margin increased 3%, both driven by the Pharma segment.

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Consolidated SG&A increased 4%, primarily reflecting inflationary supply chain costs. Benefits from our enterprise-wide cost savings initiatives offset some of this increase.

Operating earnings of $467 million dollars were in-line with the second quarter of last year. This reflects growth in Pharma segment profit, offset by the decline in Medical segment profit, which was anticipated.

Moving below the line, Interest and Other decreased nearly 30% to $18 million dollars, driven primarily 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 second quarter Effective Tax Rate finished at 23%, approximately 3.5 percentage points higher than prior year, primarily due to net positive discrete items in the prior-year period.

Diluted weighted average shares were 263 million, 6% lower than a year ago due to share repurchases. In the second quarter, we completed our $1 billion dollar Accelerated Share Repurchase program and initiated a new $250 million dollar program, resulting in a total of $1.25 billion dollars deployed year-to-date. We continue to expect $1.5 billion to $2 billion dollars in share repurchases in fiscal '23, which reflects our continued focus on maximizing shareholder value.

The net result for the quarter was Earnings Per Share growth of 4% to $1.32.

Now, turning to the balance sheet.

We generated second quarter adjusted free cash flow of $439 million dollars, bringing year-to-date adjusted free cash flow to $781 million dollars.

We ended the period with a cash position of $3.7 billion dollars, with no outstanding borrowings on our credit facilities. As a reminder, we continue to expect to pay down the $550 million dollars of March 2023 notes, at maturity with cash on hand.

Now, I will cover our segment performance, beginning with Pharma on slide 5.

Second-quarter revenue increased 15% to $48 billion dollars, driven by brand and specialty pharmaceutical sales growth from existing and net new customers.

Pharma segment profit increased 9% to $464 million dollars. This was driven by a higher contribution from brand and specialty products and generics program performance, partially offset by inflationary supply chain costs.

During the quarter, we saw strong overall pharmaceutical demand, including from our largest customers, reflecting their strength in the market. To a lesser extent, we also saw year-over-year contributions from the net new customers that we've previously mentioned and more robust seasonality with cough, cold and flu products, as others have noted.

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Regarding our generics program, we are pleased with the solid execution and consistent market dynamics we continue to see. This includes strong performance from Red Oak Sourcing, not only controlling costs but also in maximizing service delivery for our customers.

Within our supply chain, we continue to effectively manage through the industry-wide inflationary costs seen in the areas of transportation and labor. In the second quarter, these inflationary impacts were generally consistent with our expectations. Similar to last quarter, this headwind was 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.

Second-quarter revenue decreased 7% to $3.8 billion dollars driven by lower Products and Distribution sales, including PPE pricing and volumes. Continued strong growth in our at-Home Solutions business partially offset this decline.

Medical segment profit finished in-line with our prior commentary, decreasing 66% to $17 million dollars. This was primarily due to lower Products and Distribution volumes and net inflationary impacts, partially offset by an improvement in PPE margins.

During the quarter, the net impact from inflation was in-line with our expectations, and we achieved inflation mitigation of over 30%. This sequential improvement from the first quarter was driven by the continued acceleration of our mitigation efforts, including the implementation of additional product pricing actions in the quarter.

On our last two earnings calls, we have discussed overall volume softness in our Products and Distribution business. In the second quarter, we saw generally consistent overall volumes on a sequential basis, including our Cardinal Health Brand products. With respect to PPE, we did see some slight improvement in volumes on a sequential basis. Additionally, we've made significant progress in selling through higher cost inventory on our balance sheet, leading to normalized PPE margins in the quarter.

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

We are raising our EPS guidance by $0.15 at the lower end and $0.10 at the higher end to a new range of $5.20 dollars to $5.50 dollars, which represents 6% year-over-year growth at the mid-point.

This update reflects improved outlooks for the Pharmaceutical segment and for Interest and Other.

We now expect Interest and Other in the range of $115 to $130 million dollars, with the improvement primarily driven by the increased interest income on cash and equivalents.

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

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Turning to slide 9 and the Pharmaceutical segment…we are raising our outlook for revenue to a new range of 13 to 15% growth and for segment profit to a new range of 4 to 6.5% growth, both of which primarily reflect our strong first half performance.

As we look to the second half in Pharma, we anticipate the year-over-year profit growth to be fairly balanced between the third and fourth quarters.

Turning to Medical...we continue to expect a revenue decline of 3 to 6% and segment profit ranging from flat to a decline of 20%.

With respect to inflation and our mitigation actions, we continue to expect a net impact of approximately $300 million dollars in fiscal '23, or a minimal year-over-year impact.

On the cost side, while still at elevated levels, we've seen a general stabilization across most areas, along with improvement in international freight. 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.

Importantly, we continue to expect to exit the year with a run rate of at least 50% inflation mitigation.

And finally, no changes to the expected cadence of Medical segment profit. We continue to expect segment profit to improve sequentially and be particularly weighted towards the fourth quarter. This sequencing primarily reflects our assumptions around the net impact of inflation, and to a lesser extent, a gradual improvement in overall volumes and the continued implementation of our cost savings measures.

For the enterprise, a key factor continues to be the overall utilization and demand environment. In Pharma, we expect continued strength in overall pharmaceutical demand in the second half, albeit at a more moderate rate than we've seen to date. In Medical, we expect a gradual improvement in overall volumes, including with Cardinal Health Brand. Therefore, if the trends from the first half of the year continue, we would anticipate segment profit more towards the upper end of our range in the Pharma segment and more towards the lower end of our range in the Medical segment.

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

Jason Hollar: Thanks Trish. Let me now provide a few updates on our 3 key strategic priorities for fiscal '23.

First, executing our Medical Improvement Plan initiatives.

Importantly, we remain on track with our mitigation actions for inflation and global supply chain constraints, the number one key to returning the business to a more normalized level of profitability. I am pleased with the incremental progress achieved in the second quarter, as we mitigated over 30% of the gross impact to our business in Q2.

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