Cardinal Health, Inc. (NYSE:CAH) Q4 2023 Earnings Call Transcript

Cardinal Health, Inc. (NYSE:CAH) Q4 2023 Earnings Call Transcript August 15, 2023

Cardinal Health, Inc. beats earnings expectations. Reported EPS is $1.55, expectations were $1.48.

Operator: Good day, and welcome to the Fourth Quarter FY 2023 Cardinal Health Inc. Earnings Conference Call. Please note this conference is being recorded. [Operator Instructions] I would now like to hand the call over to Kevin Moran, Vice President of Investor Relations. Please, go ahead.

Kevin Moran: Good morning and welcome. Today, we will discuss Cardinal Health’s fourth quarter and fiscal year end 2023 results, along with our outlook for fiscal year ’24. 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; and Aaron Alt, our Chief Financial Officer. During the call, we will be making forward-looking statements. The matters addressed in these 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 slide at the beginning of our presentation for a full description of these risks and uncertainties.

Please note that during the discussion today, all 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. For the Q&A portion of today’s call, we kindly ask to limit yourself to one question, so that we can try and give everyone in the queue an opportunity. With that, I’ll now turn the call over to Jason.

Jason Hollar: Thanks, Kevin, and good morning, everyone. Fiscal ’23 was an inflection point for Cardinal Health with improved performance, strong execution and notable progress against both our short and long-term plans. We delivered record financial performance, including our highest non-GAAP EPS ever, reflecting 14% growth in the prior year. We grew Pharma segment profit an impressive 13% and generated $2.8 billion of adjusted free cash flow. And in Medical, we drove significant sequential improvement in operating performance from a segment loss in the first quarter to over $80 million of segment profit in Q4. This year, we took decisive action to advance our three strategic imperatives; building upon the resiliency of our Pharma segment, executing our Medical Improvement Plan and maximizing shareholder value creation.

Consistent with what you heard at our June Investor Day, these results were achieved through our team’s commitment to ruthlessly prioritize the core of our business and to better serve our customers so they, in turn, can focus on caring for patients. We simplified how we operate by streamlining our organizational structure, exiting non-core product lines and rationalizing our geographic and manufacturing footprint. We made key leadership changes and governance enhancements, adding talent and key positions across the enterprise and to our Board. We formed and extended the business review committee tasked with evaluating our strategy, portfolio, operations and capital deployment. On that note, we completed our review of the Pharma segment, including announcements at Investor Day to further invest in our Nuclear & Precision Health Solutions business and launched our new Navista Network supporting community oncologists, which I will discuss more later in my remarks.

We recently closed our Outcomes merger with BlackRock’s Transaction Data Systems, which we see as a big win for pharmacies and an important opportunity to accelerate the business’ future growth. We also deployed capital responsibly with a continued eye on maximizing value, and we are positioned with the financial flexibility to continue driving value for shareholders. At Investor Day, we provided preliminary guidance for fiscal ’24. With a strong finish to the year and increased confidence as we look ahead, I am pleased that we can raise our fiscal ’24 outlook. Later in my remarks, I will share further details on our three strategic priorities. But first, let me hand it over to Aaron to walk you through our financial results and guidance.

Aaron Alt: Thanks, Jason, and good morning. I won’t bury the lead. Q4 was a strong finish to a year in which with Jason’s guidance, the Cardinal team made significant progress against our strategic initiatives. We delivered fourth quarter EPS of $1.55 and $5.79 for the full year at the high end of our guidance from Investor Day. For both Q4 and the year, our EPS results reached historical high points. We also delivered stronger than expected cash flow, something I will touch on more later. Let’s start with the Pharma segment on Slide 6. Fourth quarter revenue increased 15% to $49.7 billion driven by brand and specialty pharmaceutical sales growth from existing customers. We continue to see broad-based strength in Pharmaceutical demand spanning across product categories, brand, specialty, consumer health and generics and from our largest customers.

Similar to Q3, GLP-1 medications provided a revenue tailwind in the quarter. Segment profit increased 12% to $504 million in the fourth quarter primarily driven by positive generics program performance. Within our generics program, we saw volume growth and consistent market dynamics, including strong performance from Red Oak. Increased contributions from brand and specialty products along with nuclear were also a positive factor, partially offset by higher investment and operating expenses, including higher costs to support sales growth. Turning to Medical on Slide 7. Fourth quarter revenue was flat at $3.8 billion, an improvement in trend. We saw a decrease in products and distribution sales related to lower PP&E volumes and pricing, partially offset by inflationary impacts, including our mitigation initiatives.

This decrease within products and distribution was offset by growth in at-Home Solutions. In the fourth quarter, we delivered Medical segment profit of $82 million, a nearly $100 million increase from the prior year loss. The results for the quarter were consistent with our Investor Day commentary, composed of approximately $60 million or more core performance driven in connection with the Medical Improvement Plan and approximately $20 million of both seasonality and net favorable onetime items. As expected, we saw an improvement in net inflationary impacts, including our mitigation initiatives and the normalization of PP&E margins, which were impacted by unfavorable price/cost timing in the prior year. Of note, we achieved our target of exiting fiscal 2023 with at least 50% inflation mitigation.

Consistent with the expectations communicated at Investor Day, we were encouraged to see early indicators of an improvement in trend with respect to our Cardinal Health brand product sales. We also saw a positive overall contribution from our growth businesses, including at-Home Solutions and OptiFreight and from our ongoing cost optimization measures. Though with significant profit growth in both segments, we delivered total operating earnings of $560 million, growth of 24%. Moving below the line. Interest and other decreased by $48 million to $16 million due to increased interest income from cash and equivalents and increased income from our company’s deferred compensation plan investments, which, as a reminder, is fully offset above the line in corporate.

Our fourth quarter effective tax rate finished at 27% to approximately two percentage points higher than the prior year due to certain discrete items. Fourth quarter average diluted shares outstanding were 256 million, 7% lower than a year ago due to share repurchases, including a $500 million accelerated share repurchase program initiated in the quarter as we announced at Investor Day. The net result of all of this was fourth quarter EPS of $1.55, growth of 48%. Now, transitioning to our consolidated results for the year. We surpassed the $200 billion revenue mark for the first time. Fiscal ’23 revenue increased 13% to $205 billion and gross margin increased 5% to $6.9 billion, both driven by the Pharma segment. Total company SG&A increased 6% to $4.8 billion, primarily reflecting inflationary supply chain costs and higher investments in operating expenses such as higher costs to support sales growth, which were partially offset by our comprehensive enterprise-wide cost savings measures.

Operating earnings increased 3% to $2.1 billion. Interest and other decreased 46% to $89 million, 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 in the near-term. Our annual effective tax rate finished at 23%. Net result was for fiscal 2023 EPS, $5.79, growth of 14%. As for the segment’s full year results, beginning with Pharma on Slide 10. Pharma segment profit increased 13% to $2 billion, driven by positive generics program performance and a higher contribution from brand and specialty products, partially offset by inflationary supply chain costs. Fiscal ’23 year-over-year growth also included a modest benefit from branded manufacturer price increases, which we are assuming will not repeat in fiscal ’24 as well as a favorable prior year comparison related to higher opioid-related legal costs and costs for technology enhancements in fiscal ’22.

Moving to Medical on Slide 11. Segment profit decreased 49% to $111 million, primarily due to lower products and distribution volumes and unfavorable sales mix and net inflationary impacts, including mitigation initiatives. This decline was partially offset by normalization of PP&E margins. Now, before I turn to fiscal ’24, let’s cover the balance sheet. In fiscal ’23, we generated robust adjusted free cash flow of $2.8 billion with particularly strong cash flow towards the end of the year. We ended the year with $4 billion of cash on hand. At our Investor Day, we highlighted that cash flow optimization was an area of go-forward focus for our teams, and the Cardinal team delivered across our businesses. This effort will continue in fiscal ’24, notwithstanding that it is a tougher calendar from an inflow, outflow days-of-week perspective.

We remain focused on deploying capital in a balanced, disciplined, and shareholder-friendly manner. In fiscal ’23, we invested approximately $480 million of CapEx back into the business to drive future growth, paid down $550 million in debt to reduce leverage and maintain our strong investment-grade ratings, returned over $2.5 billion to shareholders, including through the dividend that our Board increased in May for the 34th year in a row and $2 billion of share repurchases. Now, for our updated fiscal ’24 guidance on Slide 13. Today, we are raising our fiscal ’24 EPS guidance to a range of $6.50 to $6.75. This increase reflects the strong finish to fiscal ’23, particularly within Pharma where we are now entering the year at a higher jump-off point.

We also are tightening our shares range to 250 million to 253 million, which reflects the recent share repurchases as well as our continued expectation of $500 million in base share repurchases over the course of fiscal ’24. As you will calculate, the midpoint of our newly raised fiscal ’24 EPS guidance is 15% above our fiscal ’23 EPS results. There are no changes to the other corporate guidance assumptions provided at Investor Day. Interest and other between $110 million to $130 million, and effective tax rate in the range of 23% to 25% and adjusted free cash flow of approximately $2 billion in fiscal ’24. Our segment outlooks for fiscal ’24 are also unchanged with one exception, a high revenue range for Pharma driven by the continued acceleration of GLP-1s, which, as a branded product category, do not meaningfully contribute to segment profit.

Slide 14 shows our fiscal ’24 outlook for Pharma, our build and grow business. We expect revenue growth in the range of 10% to 12% and segment profit growth in the range of 4% to 6%, which is now on a larger fiscal ’23 reference point due to our strong finish to the year. We are reiterating our key assumptions provided at Investor Day. We expect growth from our generics program with volume growth and consistent market dynamics and positive operational execution against our organic specialty efforts. We are not assuming outsized benefits from branded inflation. In contrast, some of the benefits that we did see in fiscal ’23. On the Pharma fiscal ’24 cadence, we expect the year to follow typical seasonality patterns. As usual, we see our fiscal Q3 being the largest segment profit dollar quarter due to the usual timing of branded manufacturer price increases.

Turning to Medical. I want to recognize the progress that the Medical team made during fiscal ’23, particularly in Q4, and also acknowledge that we still have blocking and tackling to do against the turnaround to both drive demand and improve our cost. For the full year, we are reiterating our assumptions of revenue growth of approximately 3% and segment profit of approximately $400 million for the year, while providing some additional color. Like fiscal ’23, we anticipate segment profit to be significantly back-half weighted. We expect Q1 to be generally consistent with the core performance from Q4 with quarterly sequential improvements thereafter driven by our Medical Improvement Plan initiatives. There are a couple of factors for why Q1 is the low point in the year.

First, keep in mind that Q1 is the seasonal low point for our global Medical products and distribution business due to the timing of volume and cost recognition. Second, while we continue to expect to exit fiscal ’24 offsetting the impact of gross inflation, those improvements are expected to grow over time, making the impact greater over the course of the year. And finally, we continue to plan for slight Cardinal Health brand volume growth that will largely hit in the second half of the fiscal year. So in summary for Medical for fiscal year ’24, continued work in front of us with each quarter improving from our Q1 launching point to get us to the approximately $400 million guidance for the year. Stepping back, we are pleased to see growth across our businesses continuing in fiscal ’24.

Consistent with our messaging from Investor Day, we are targeting a 12% to 14% EPS growth CAGR for fiscal ’24 to 2026, now from the higher fiscal ’23 baseline of $5.79. Now regarding our intended deployment of cash, which is consistent with our disciplined capital allocation framework as seen on Slide 18. After investing approximately $500 million back into the business to drive organic growth, making approximately $500 million of litigation payments, including our third payment under the national opioid settlement back in July, and our $1 billion baseline return on capital, we expect to have strong flexibility as we assess further investments in the business, M&A and the possibility of incremental return of capital to shareholders. I want to reiterate that as we shared at Investor Day, neither our fiscal ’24 guidance or our long-term targets reflect potential opportunistic deployment of capital, including M&A, which is difficult to predict in timing or magnitude or additional share repurchases beyond our $500 million of baseline repurchases each year.

We will continue to evaluate both of these levers opportunistically to drive long-term value. To close, the Cardinal team has a lot to be proud of with respect to their accomplishments in fiscal ’23. Jason and I are pleased with the progress our teams have made. We are confident in the plans we have in place, and we are excited for our team to realize the significant value creation opportunities still in front of Cardinal Health. With that, I will turn it back over to Jason.

Jason Hollar: Thanks, Aaron. Let’s now dive deeper into the actions we are taking to execute our three strategic priorities, beginning with priority number one and building upon the resiliency of the Pharma segment. In our largest most significant business, the Pharma segment has been performing well by prioritizing what matters most, focusing on the core and delivering for our customers and their patients. The business is positioned at the forefront of favorable secular industry trends and has also benefited from our specific actions and performance. We are pleased to recently raise our long-term segment profit target to 4% to 6% growth, solidly in the mid-single digits and consistent with the segment profit growth we expect in fiscal ’24.

Our growth is enabled by a scaled, stable and resilient core Pharmaceutical distribution business growing in the low single digits and double-digit growth from our higher-margin specialty and Nuclear businesses. Within the core, our generics program remains a critical component of our overall offering and performance, enabled by Red Oak Sourcing. In addition to its leading scale, Red Oak’s proprietary analytical tools and deep industry expertise puts us in the best position possible whenever product shortages occur to continue servicing customers. We’re committed to providing customer-focused solutions across our many classes of trade as we noted at Investor Day. More recently, we hosted our 31st Annual Retail Business Conference, where we brought together nearly 4,500 attendees from across the country to celebrate the critical role independent pharmacies play in caring for their communities and showcase our commitment to our customers through our newest innovations.

For example, we are offering modern payment solutions through our collaboration with Square to help independent pharmacies seamlessly manage business operations, integrate flexible payment options, and reduce payment processing costs. We’ve conveyed that specialty is our priority area of focus and a key enabler to our long-term growth. We’re continuing to invest to expand downstream across key therapeutic areas such as oncology, rheumatology and other emerging areas. We’re excited to build upon our existing capabilities with the recent launch of our Navista Network, a specific suite of offerings for community oncologists, supporting their growth and desire to remain independent. To ensure the Navista Network’s success in development, we’ve recently appointed new leadership with deep industry and clinical experience and continue to build out the organization with internal and external talent.

We continue to seek input from customers and have created an advisory board. While still early innings, I’m pleased with the engagement from current and potential customers. Upstream in specialty, we’re expecting continued double-digit growth from manufacturer services. In our leading 3PL, we’re expanding our ambient and cold chain space to keep up with our business’ strong growth. At an excess access and patient support, we delivered on a record number of new client implementations and continue to launch new innovative products to streamline the patient journey. We’re also supporting the growth of Pharmaceutical manufacturers in the cell and gene therapy space through our advanced therapy solutions offerings. For example, we’re partnering with TrakCel to bring visibility and tracking capabilities to biopharma companies by helping them navigate cell therapies through multiple stages of development and commercialization.

Overall in specialty, we’re confident that the connection between our downstream and upstream strategies, what we call our specialty growth cycle, will drive double-digit growth well into the future. Our Nuclear business, which is on track to double profits by fiscal ’26 as of our fiscal ’21 baseline, is strategically positioned for growth at the center of precision medicine. We’re further investing in the space with a Phase 2 investment of $30 million over the next several years to expand our center for theranostics advancement and support our manufacturer partners’ projects as they advance through the commercial development pipeline. We’re encouraged to see Pharmaceutical innovation expanding the breadth of conditions that are being addressed with emerging therapies such as cell and gene and precision medicine.

As the future of health care continues to evolve, our breadth of capabilities from Pharmaceutical and specialty distribution, radiopharmaceuticals and theranostics to biopharma and manufacturer services enables us to offer multiple touch points for manufacturers, providers and patients to realize value from these promising new treatment options. Now, turning to Medical and priority number two. When we introduced the Medical Improvement Plan last August, our immediate focus was turning around the performance in the core product and distribution, where we’ve achieved tremendous progress over the past 12 months. We are on track to address the impact of inflation and global supply chain constraints by the time we exit fiscal ’24. This is the number one key to returning to a more normalized level of profitability, and we are now over halfway to our target.

We continue to execute our mitigation initiatives to offset elevated inflation and make progress with our commercial contracting efforts. And we are exploring other offsets with urgency such as our manufacturing excellence and sourcing initiatives. While overall costs remain elevated, international freight has generally returned to pre-pandemic levels, and we expect this improvement to be reflected in our fiscal ’24 results. We’re driving significant progress through our 5-point plan to grow Cardinal Health brand volume and seeing improvements in our leading indicators. This includes better portfolio health for key product categories and higher service levels, customer loyalty index scores and retention rates for distribution. We’re driving enhanced customer experience through investments in product availability and automation while optimizing costs.

At Investor Day, we highlighted our two-pronged approach to portfolio life cycle management, which has enabled us to completely exit our non-health care portfolio. And we are in the process of reducing over 2,000 SKUs across our Cardinal Health Branded product categories to simplify the business. We’re focusing our investments in new product development and capacity expansion in key growth areas such as compression, enteral feeding and incontinence. Within our products that are core to distribution, we’ve seen continued stabilization with PPE, a smaller part of our portfolio but a source of volatility during the pandemic and growth in our pre-sourced surgical fitting category. In our specialty products portfolio comprised of clinically differentiated products and leading brands like Kangaroo, Kendall and Protexis, we’re investing in innovation to meet customers’ needs and drive sustainable growth.

For example, the launch of our new Kangaroo OMNI™ Enteral Feeding system this month. As a result of our combined efforts, commercial momentum is accelerating. During Q4, we renewed several key distribution customers and saw positive net new wins during the quarter. These leading indicators give us confidence that moving forward we’ll participate in the growth from an overall improving medical utilization environment. Outside the core, we’re on track to accelerate our growth businesses. In at-Home Solutions, we’re investing in DC network expansion to keep pace with increased demand as care continues to shift into the home. For example, we’ve recently begun construction for a new 350,000 square foot Greenville, South Carolina, DC. This facility, the 11th in our national network will be fully operational in 18 to 24 months and equipped with advanced automation technology and robotics to drive operational efficiencies.

In OptiFreight, we provide premier logistics management powered by our technology capabilities and expertise. We’re continuing to invest in digital tools to support core volume growth and sustain our strong performance. Finally, we continue to execute our simplification and cost savings initiatives such as optimizing our global manufacturing and supply chain and our international footprint. For example, we exited four additional countries and two additional manufacturing sites this year. In short, we are making progress with our Medical Improvement Plan. While there is still execution in front of us, I’m excited for the business to return to more significant profitability in fiscal ’24. Finally, priority number three, maximizing shareholder value creation.

We’re maximizing shareholder value creation through operational performance, robust cash flow generation and the responsible allocation of capital. At Investor Day, Aaron detailed our new long-term capital allocation framework, which builds upon our long-standing priorities with some notable enhancements. We’re pleased that with our strong cash flow profile and the significant progress we’ve made on our balance sheet, we have the flexibility for share repurchases each and every year. And with the residual cash flow that we anticipate, we’ll continue to opportunistically evaluate disciplined M&A in specialty and potential additional share repurchases. While our team has made significant progress over the past year, particularly in realigning our operations for focus and simplicity, there is still work and opportunity in front of us.

We continue to evaluate additional value creation initiatives, including the progress we are making with our ongoing business and portfolio review. To wrap up, I want to acknowledge our dedicated Cardinal Health employees who are fulfilling our essential role in health care, serving customers and their patients. Thank you for your determination and advancing our key priorities and moving healthcare forward. I’m excited for the opportunities still to come. With that, we will take your questions.

See also 15 Worst Performing Blue Chip Stocks in 2023 and 10 Best Industrial ETFs. 

Q&A Session

Operator: [Operator Instructions] Our first question today comes from Lisa Gill of JPMorgan.

Lisa Gill: Thanks very much. Good morning and congratulations on the quarter. I just really want to start with the GLP-1 comment. So I understand you’re raising revenue by 200 basis points. One, is that all GLP-1? And two, my understanding is that they are a lower margin, but they are contributory to overall margin dollars. Is that not the case when you’re keeping the profit the same and when I think about the Pharmaceutical segment for ’24?

Aaron Alt: Yes. Good morning, Lisa. Thanks for the question. Yes, the primary reason for the raise in the guidance on the revenue is related to the GLP-1. So we did not call out anything else. We saw a strong finish to the year as it relates to that. And looking forward, we see that there’s nothing that we can foresee in the near term that will change those trends. As a reminder, we did call out for the first time GLP-1 as a benefit to our revenue from a year-over-year growth perspective in the third quarter. So we have kind of a — there was growth before that, but not as significant. And so it was more meaningful in Q3 and Q4. So as you look forward to fiscal ’24, you would expect that revenue growth to be stronger in the first half of the year as that’s more of a contributor.

Now of course, we don’t know what that slope is going to look like into ’24, but we would anticipate as you start to lap the second half of 2023 that, that will be more muted in terms of the year-over-year benefit. And I guess what — as it relates to your second part of your question, I would just reiterate that these are branded products. And as such, they’re just not a meaningful contributor to segment profit and just leave it at that. Next question please.

Operator: The next question comes from Eric Percher of Nephron Research.

Eric Percher: Thanks for all the commentary on Medical performance. I want to make sure we’re kind of precise on the core performance and the stepping off point there would be around $60 million, not $82 million. And then, can you define seasonality and one-time benefits this quarter, and any expectation that those will recur as we look at that cadence for fiscal year ’24?

Jason Hollar: Eric, good morning. Good to hear your voice and happy to give you a little more context on that. Look, we were quite pleased with the results for Medical, as you can imagine, delivering that $82 million of results. That was $60 million of what we’re referring to as for performance and $20 million in aggregate combined positive seasonality and one-time items in the fourth quarter. And I called — I call it out purposely that way because it does impact how we think through the cadence of quarters during fiscal ’24. Now before giving you a little more context on the quarterly guidance, I do want to go back and just observe that we are reiterating the $400 million profit target for the Medical segment from the year.

The Medical Improvement Plan, the key components, that remain unchanged from our description at the Investor Day as well. But we are providing a little more color relative to how we see the year playing out, given the number of moving pieces on the blocking and tackling as I referred to in my prepared remarks as we carry forward. So look, from a full year perspective, the way I would have you think about it is this. As I said at Investor Day, if you take $60 million of core performance and multiply that by 4, that gets you to $240 million of profit, right? If you add $100 million of incremental inflation net on top of that, that gets you to $340 million in total. And as we talked about at Investor Day, that leaves about $60 million of contribution from other elements across the year, the simplification of the Cardinal Health brand, et cetera.