Cardinal Health : Q3 2023 Earnings transcript

Q3 FY23 Cardinal Health, Inc. Earnings Conference Call

May 4, 2023, 8:30AM Eastern

Operator: Hello, and welcome to the Third Quarter Fiscal Year 2023 Cardinal Health Incorporated Earnings Conference Call. My name is George, I'll be your coordinator for today's event. Please note, this conference is being recorded and for the duration of the call, your lines will be in a listen-only mode. However, you will have the opportunity to ask questions at the end of the presentation. This can be done by pressing star one on your telephone keypad to register a question. If you require any assistance during the presentation please press star zero and you will be connected to an operartor. I would now like to hand the call over to your host today, Mr. Kevin Moran, Vice President of Investor Relations to begin today's conference. Please, go ahead, sir.

Kevin Moran: Good morning. Today we will discuss Cardinal Health's Third-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, and Aaron Alt, our 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.

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 will now turn the call over the Jason.

Jason Hollar: Thanks, Kevin. Good morning, everyone.

Overall, we're pleased to deliver another quarter demonstrating progress against our plans, with our Q3 results led by continued momentum and growth in the Pharma segment.

With the strong overall performance in the quarter and our increased confidence in the rest of the year, we are raising and narrowing our fiscal '23 EPS and adjusted free cash flow guidance.

Our Pharma business is a resilient and growing business, where we're well-positioned given our critical role in the pharmaceutical supply chain and strong and diverse customer base.

We've seen ongoing stability in the underlying fundamentals of the business, including consistent market dynamics in our generics program. We've also seen continued broad based strength in pharmaceutical demand spanning across product categories and classes of trade.

Page 1 of 18

Our Pharma team is executing our plans to build upon this growth, both in our core distribution operations and in Specialty where we're focused on capturing the increasing demand for Specialty products and services.

In short, we're pleased with the resiliency and strength of the business and to be able to raise our Pharma outlook for fiscal '23.

In Medical, we remain confident in our Medical Improvement Plan target of at least $650 million dollars of segment profit by fiscal '25, driven by our inflation mitigation and growth initiatives.

While we are making progress, with the second consecutive quarter of positive segment profit, we remain focused on taking actions to drive more predictable financial performance in-line with this business's underlying potential.

For several quarters now, we've seen the demand for our higher-margin Cardinal Health Brand products remain generally stagnant, which we've reflected in our updated fiscal '23 outlook.

We continue to achieve progress with inflation mitigation, the number one key to returning the business to a more normalized level of profitability.

Across enterprise, we are operating with urgency to drive our businesses forward. We're collectively focused on our three 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'll provide some further updates on our continued progress shortly, but first, let me turn it over to Aaron to review our results and updated outlook.

Aaron Alt: Thank you, Jason. I am pleased to join you this morning on my first call since assuming the CFO role with nearly 90 days now under my belt. What I could see from the outside has proven to be true on the inside - Cardinal Health is a business with a strong leadership team, an engaged board, a defined strategy, a strong balance sheet and plenty of operational opportunities to promote value creation for our stakeholders.

I'll begin today with the enterprise's strong results for the third quarter.

Total revenue increased 13% to $50.5 billion dollars and gross margin increased 6% to $1.8 billion, dollars both driven by the Pharma segment.

Consolidated SG&A increased 4% to $1.2 billion dollars, primarily reflecting inflationary supply chain costs, which were offset in part by our comprehensive enterprise-wide cost savings initiatives.

Operating earnings of $606 million dollars were 11% higher than the third quarter of last year, driven by significant Pharma segment profit growth, with opportunities remaining for us to achieve Medical segment profit increases in future quarters.

Page 2 of 18

Moving below the line, Interest and Other decreased 32% to $28 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 third quarter Effective Tax Rate finished at 22.4%, slightly lower than we had expected, reflecting some positive discrete items in the quarter.

Diluted weighted average shares were $258 million, 7% lower than a year ago, due to continued share repurchase actions.

The net result of the progress against our strategy was adjusted Earnings Per Share of $1.74 in the third quarter, growth of 20% versus the prior year.

Now, turning to the balance sheet.

We ended the quarter with strong liquidity, with $4 billion dollars of cash on hand. The business generated robust adjusted free cash flow of $1.3 billion dollars in the third quarter. Year to date adjusted free cash flow is $2.1 billion dollars. Given our cash balances, we ended the period with no outstanding borrowings on our credit facilities.

And in further support of our strong investment grade rating, during the quarter, we paid down $550 million dollars of maturing March 2023 notes with cash on hand, consistent with our plans. We also extended our $2 billion dollar revolver of back-up liquidity until February of 2028.

Earlier in my remarks I referenced return of capital to shareholders. During the quarter, we returned $378 million dollars to shareholders, through a $250 million dollar Accelerated Share Repurchase program and payment of our long-standing dividend. Year-to-date we have returned $1.5 billion dollars through share repurchase and made nearly $400 million dollars in dividend payments.

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

Third-quarter revenue increased 14% to $47 billion dollars, driven by brand and specialty pharmaceutical sales growth from existing customers. We saw strong broad-based pharmaceutical demand, particularly from our largest customers. GLP-1 medications also provided a revenue tailwind in the quarter.

Pharma segment profit increased 23% to $600 million dollars. We were pleased to see that this progress was driven by both positive generics program results, including volume and mix, and by a higher contribution from brand and specialty products.

Within our generics program, we continued to see 'consistent market dynamics' and strong performance from Red Oak Sourcing.

With regards to branded and specialty products, the higher contribution reflects a modest benefit from manufacturer price increases. As a reminder, while over 95% of our overall branded margin is derived

Page 3 of 18

from fixed fee-for-service agreements, the contingent portion is highly concentrated in our fiscal third quarter.

Moving to the key growth area of Specialty, we've seen strong double-digit growth across Specialty Distribution, along with our upstream Manufacturer Services.

Our Nuclear business, which is tracking ahead of plan, continued its double-digit growth, including benefiting from recent launches of novel theranostics.

Within our pharmaceutical supply chain, we continue to effectively manage through the incremental inflationary cost pressures seen industry-wide, and in the third quarter, these net impacts were not material on a year-over-year basis.

Finally, in the quarter we lapped more significant opioid-related legal costs and higher costs related to the now completed ERP technology enhancements.

Now, turning to Medical on slide 6.

Third-quarter revenue decreased 5% to $3.7 billion dollars driven by lower Products and Distribution sales, primarily due to expected PPE volume and pricing declines.

Medical segment profit decreased 66% versus prior year to $20 million dollars, primarily due to lower Products and Distribution volumes and unfavorable sales mix.

Additionally, these results reflect both net unfavorable non-recurring adjustments, including simplification actions, and some modest year-over-year improvement in PPE margins. Similar to Q2, we observed normalized PPE margins in the third quarter.

Regarding the demand environment, we've previously discussed some overall volume softness in our Products and Distribution business, including Cardinal Health Brand. In the quarter, volumes for our Cardinal Health Brand products were roughly flat sequentially.

We achieved inflation mitigation of over 40% during the quarter, driven by our continued efforts. We also saw benefits from our ongoing cost saving initiatives, such as in our manufacturing and supply chain.

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

Our team is working hard and we are seeing positive results in key parts of our portfolio. As we move into the final quarter of the year, we are narrowing and raising our non-GAAP EPS guidance range from $5.20 to $5.50 to a new range of $5.60 to $5.80. At the mid-point, this represents a $0.35 and 13% year-over-year growth.

This update primarily reflects an improved outlook for the Pharmaceutical segment for the year, as well as a more modest short-term outlook for Medical. While we will save commentary or updates on

Page 4 of 18

long-term segment guidance for our upcoming Investor Day on June 8, we are sharing today that we are reaffirming the long-term financial guidance in the Medical Improvement Plan for the Medical segment.

We are also updating some key enterprise-wide assumptions, as seen on slide 8.

Based on year-to-date performance, we now expect Interest and Other in the range of $95 to $105 million dollars, a non-GAAP ETR of approximately 22 to 23% for the year and adjusted free cash flow generation of $2 to $2.3 billion dollars for the year.

We expect diluted weighted average shares outstanding in the range of $262 to $263 million, reflecting our year-to-date repurchase activity and continued expectation of $1.5 to $2 billion dollars in total share repurchases in fiscal '23.

Finally, we now expect capital expenditures of approximately $450 million dollars, reflecting the timing of our continued investments to drive organic growth.

Turning to the segments on slide 9.

In Pharma, with the strong pharmaceutical demand and performance that we've seen to date.

We now expect full year revenue growth in the range of 14 to 15% and segment profit growth between 10.5 to 12% growth.

We are extremely pleased with the ongoing resiliency and strength of the business and our plans to drive double-digit profit growth in fiscal year '23. Yet, when looking at the more normalized performance of the Pharma business, it's important to note our fiscal '23 outlook includes two non- recurring year-over-year tailwinds.

First, as noted, we experienced a modest benefit from branded manufacturer price increases in fiscal year '23 that we assume is unlikely to repeat in future years.

Additionally, relative to the prior year comparisons, our prior fiscal year '23 guidance assumed offsetting year-over-year impacts in total between several non-recurring drivers: higher than usual inflationary supply chain costs, lower opioid-related legal costs and lower costs for technology enhancements compared to fiscal year '22. However, we now expect the in-year comparison to fiscal year '22 for these items to produce a modest year-over-year tailwind unique to fiscal year '23.

We will provide insights into our long-term targets for Pharma during our Investor Day, including some early guidance for fiscal year '24.

Turning to Medical, we now expect a revenue decline of approximately 6% and a segment profit decline of approximately 50% for the year.

This updated outlook reflects three key changes:

Page 5 of 18