Cardinal Health, Inc. (NYSE:CAH) Q2 2024 Earnings Call Transcript
Cardinal Health, Inc. (NYSE:CAH) Q2 2024 Earnings Call Transcript February 1, 2024
Cardinal Health, Inc. beats earnings expectations. Reported EPS is $1.82, expectations were $1.56. Cardinal Health, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good day, and welcome to today's Second Quarter Financial Year 2024 Cardinal Health Earnings Conference Call. This meeting is being recorded. At this time, I'd like to hand the call over to Matt Sims, Vice President of Investor Relations. Please go ahead, sir.
Matt Sims: Welcome to this morning’s Cardinal Health second quarter fiscal ‘24 earnings conference call and thank you for joining us. With me today are Cardinal Health CEO Jason Hollar; and our CFO Aaron Alt. You can find this morning’s press release and investor presentation on the Investor Relations section of our website at ir.cardinalhealth.com. Before I turn the call over to Jason since we will be making forward-looking statements today. Let me remind you that 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 description of these risks and uncertainties.
Please note that during our discussion today, the comments will be on a non-GAAP basis, and once they are specifically called out as GAAP. GAAP to non-GAAP reconciliations for all relevant periods can be found in the supporting schedules attached to our press release. For the Q&A portion of today’s call, we kindly ask that you limit questions to one for participants, so that we can try and give everyone an opportunity. With that, I will now turn the call over to Jason.
Jason Hollar: Good morning, everyone. In the last few weeks, we've made several notable announcements regarding our company's continued progress, including yesterday's news on our agreement to acquire specialty networks, which will further our specialty growth strategy and create value for specialty providers, manufacturers, and patients in exciting new ways. And as we highlighted at a recent industry conference, we're continuing to take actions to become a simplified and more focused company with further progress achieved on our ongoing business and portfolio review and our updated enterprise operating and segment reporting structure, which will be reflected in our financial reporting beginning next quarter. We plan to go further into our recent updates with you today, but first, let me begin with a few brief comments on our results.
In Q2, we delivered strong profit growth in both segments, demonstrating continued operating momentum and execution against our strategic priorities. Pharma again delivered strong performance. Overall, the business is performing consistent with our expectations, and we're pleased to reiterate our outlook for 7% to 9% segment profit growth in fiscal ‘24. We've seen ongoing stability in macro trends, including in our generic program, and continued broad-based strength in overall pharmaceutical demand. Our specialty distribution business also continued to see strong demand, including with COVID-19 vaccines in the first part of the quarter. Turning to medical, Q2 segment profit was consistent with Q1, despite the non-recurring adjustments in the second quarter, which we've reflected in our updated fiscal ‘24 outlook for the former medical segment.
We're encouraged by the underlying improvements in operating performance, reflecting further progress with our medical improvement plan efforts, focused on our global medical products and distribution business. Notably, we saw a change in trend in revenue growth for the medical segment in the second quarter. Along with continued growth from at-Home Solutions, we're seeing the effects of our five-point plan to grow Cardinal Health brand volumes yield positive results. And as we continue to optimize not only the performance of our businesses, but also the financial strength of the broader enterprise, we're generating robust cashflow and seeing meaningful benefits below the operating line. As a result of our first-half performance and increased confidence as we look ahead, we're pleased to raise our fiscal ‘24 EPS guidance and our outlook for adjusted free cashflow.
Of course, our customers remain at the center of everything we do, and our team continues to prioritize core operational execution to best serve them and their patients with essential products and services as we drive our company forward. Now let me turn it over to Aaron to review our results and updated guidance in more detail.
Aaron Alt: Thanks, Jason, and good morning. Before we begin let me remind you that our Q2 segment commentary will be according to our former segment structure pharma and medical. Let's start with total company results for the second quarter. Q2 delivered another strong quarter across the enterprise with EPS of $1.82, growth of 38%, which included operating earnings growth of 20%. We also delivered strong cash flow and ended the quarter with $4.6 billion of cash, even following incremental share repurchase activity in the quarter. As seen on slide four, total company revenue increased 12% to $57.4 billion, reflecting growth in both the pharma and medical segments. We drove operating leverage for the enterprise despite incremental investments in the business and higher costs to support sales growth.
Gross margin increased 11% to $1.8 billion, driven by both segments, and consolidated SG&A increased 8% to $1.3 billion. With the strong profit growth in both segments, we deliver operating earnings of $562 million, 20% higher than a year ago. Moving below the line, interest and other decreased by $26 million to $8 million in income due to increased interest income on cash and equivalents from higher cash balances and higher rates. As we've noted, our debt is largely fixed rate, resulting in a net benefit from rising interest rates in the near-term. Additionally Q2 interest and other benefited from nearly $10 million in income from the quarterly revaluation of our company's deferred compensation plan investments, which as a reminder has a matching offset above the line.
Our second quarter effective tax rate of 21.3% was 1.7 percentage points lower than a year ago and better than we anticipated due to positive discrete items in the period. Q2 average diluted shares outstanding were $246 million, 6% lower than a year ago due to share repurchases in each of the last four quarters. And as I mentioned earlier, the net result for Q2 was EPS of $1.82, reflecting growth of 38%. Let's turn to the pharma segment on slide five. Second quarter revenue increased 12% to $53.5 billion, driven by brand and specialty pharmaceutical sales growth from existing customers. We saw strong pharmaceutical demand across product categories, brand, specialty, consumer health, and generics, and from our largest customers. We also continue to see robust demand for GLP-1 medications, which provided a revenue tailwind in the quarter.
Segment profit increased 12% to $518 million in the second quarter, driven by positive generics program performance and the higher contribution from brand and specialty products, including distribution of COVID-19 vaccines. Our positive generics program performance continue to reflect volume growth and consistent market dynamics. With respect to COVID-19 vaccines, we saw the strength and demand from September for the fall immunization season carry into October before peaking mid-month and trending to a much lower run rate as we exited the second quarter. The Q2 increase in segment profit includes a partial offset from higher costs to support sales growth driven by increased pharmaceutical volumes. Turning to the medical segment on slide six.
Second quarter revenue increased 3% to $3.9 billion, which as Jason alluded to, reflects quarterly revenue growth for the medical segment for the first time in over two years. This increase was driven by growth in both at-Home Solutions and global medical products and distribution, with the GMPD growth primarily related to higher Cardinal Health brand volumes. Medical delivered segment profit of $71 million, a $54 million year-over-year increase, driven by an improvement in net inflationary impacts, including our mitigation initiatives. Consistent with the expectations communicated a few weeks ago, segment profit was generally consistent with Q1, despite some non-recurring adjustments in the quarter. We continue to be encouraged by the underlying performance of the business, which through the first two quarters of the year has tracked consistent with our original plans.
Now turning to the balance sheet. We generated robust adjusted free cash flow of $1 billion in Q2, bringing our year-to-date adjusted free cash flow to $2 billion. And as I noted earlier, end of the quarter with $4.6 billion of cash on hand. We remain focused on doing what we said we would, deploying capital according to our disciplined capital allocation framework. Thus far, through the first-half of fiscal ‘24, we've continued to invest against our highest priorities, including investing back into the businesses to drive organic growth with over $200 million in year-to-date CapEx. In the first-half, we have returned $1 billion total to shareholders, which includes our quarterly dividend payments and $750 million in year-to-date share repurchases.
These share repurchases are in excess of our committed baseline repurchases of $500 million. And in January, we made certain opioid settlement prepayments of $238 million at a pre-negotiated discount, which is expected to result in a [gap] (ph) only gain of approximately $100 million in the third quarter. Now for our updated fiscal ‘24 guidance on slide eight, beginning with the enterprise. With our strong first-half performance and positive outlook, we are again raising our fiscal ‘24 EPS guidance. Our new range of $7.20 to $7.35 reflects a $0.45 increase at the bottom end and a $0.35 cent increase at the top end from our Q1 guidance range. And a midpoint which is 26% above our fiscal ‘23 EPS results. We are encouraged by the operating performance of our businesses and our strong cash regeneration, which is certainly contributing to the improvements below the line.
Interest in other is reduced to a range of $50 million to $65 million, which primarily reflects increased interest income from higher than anticipated cash balances. We expect lower average cash balances in the second-half of the year due in part to the seasonal timing of anticipated cash flows. We are evaluating opportunities to refinance our upcoming 2024 debt maturities in the back half of the year. We are lowering the top end of our effective tax rate guidance to a new range of 23% to 24% to reflect the positive discrete items we've seen in the first-half of the year. We also are lowering our shares outlook to approximately $247 million, which reflects the $250 million accelerated share repurchase program we completed in Q2. No additional share repurchases are assumed in our updated guidance for fiscal year ‘24.
Now turning to the fiscal ‘24 outlook for our segments. While we will be transitioning to our new segment structure reporting beginning in Q3, let me start with our former segments as a comparison point for the updated structure. No changes to the outlook for the former pharma segment. We are reiterating the 10% to 12% revenue growth and 7% to 9% segment profit growth. For the former medical segment, the fiscal ‘24 outlook is updated to approximately $380 million a segment profit to reflect the net impact of Q2 non-recurring adjustments. Outside of these, our overall operational expectations are consistent with delivering the prior $400 million in segment profit for the year, as well as the corresponding prior expectation of $650 million in segment profit for fiscal year ‘26.
We have consistently highlighted the back half weighting of the medical guidance, driven by progress within GMPD on Cardinal Health brand volume growth, the cumulative impact of inflation mitigation, and some business specific seasonality. Our expectations there continue. For example, with inflation mitigation, we have strong visibility to overall cost improvements in the second-half of the year, driven by reductions we've observed in international freight, which is a reminder reflecting our income statement on a two to three quarter delay and as we exit January the mitigation initiatives necessary to achieve our year-end target are now largely in place. Now as seen on slide 10, let me comment on how this fiscal year ‘24 guidance translates to our updated segment structure.
To go along with the preliminary recast fiscal ‘23 actuals and long-term targets we provided a few weeks back. Our new structure went into effect January 1. So beginning in Q3, we will report results and provide drivers reporting to the new segment structure, pharmaceutical and specialty solutions and GMPD and separate from these two segments, nuclear at-Home, an OptiFreight aggregated in other. At that time, we also plan to provide a recast of the results for fiscal ‘22 to ‘24 on the new segmentation. Beginning with the pharmaceutical and specialty solutions segment, the guidance ranges are consistent with the former pharma segment, even excluding our higher growth nuclear business. We expect 10% to 12% revenue growth and 7% to 9% segment profit outlook for fiscal ‘24 and a 4^ to 6% segment profit growth CAGR over the long-term.
Turning to GMPD where we remain encouraged by the improvements in this business. For the execution of the medical improvement plan initiatives, we expect to drive GMPD from an operating loss of approximately $165 million in fiscal ‘23 to operating income of approximately $65 million in fiscal ‘24. From the fiscal ‘23 low point, this $230 million year-over-year improvement would position us roughly half way towards our fiscal ’26 target of approximately $300 million for segment profit. Finally we expect the businesses including other, at-Home Solutions, Nuclear & Precision Health Solutions and OptiFreight Logistics to collectively deliver 6% to 8% segment profit growth in fiscal year ‘24. The difference between this fiscal ‘24 growth rate and the long-term CAGR of 8% to 10% for fiscal ‘24 to ‘26 reflects the portion of the Q2 non-recurring adjustments within at-Home Solutions with the remainder residing in GMPD.
Before I close a couple of comments on our recently announced acquisition. We've noted that the specialty category has been our highest priority for potential M&A and a primary consideration for our opportunistic capital employment as part of our disciplined capital allocation framework. Given our financial flexibility and strong presence in the other 60% of the specialty market in therapeutic areas outside of oncology, we have evaluated a range of potential acquisition candidates to further accelerate our specialty strategy. We are thrilled to reach an agreement for specialty networks to become a part of the Cardinal Health family. Jason will elaborate on the strategic aspects of the deal, but we plan to include the expected financial impacts of the transaction in our guidance upon closing, which of course is subject to the satisfaction of customary closing conditions, including receipt of required regulatory approvals.
For general modeling purposes, we expect the deal to be accretive 12 months following close. So, to wrap up, tremendous progress in the first-half of the year with exciting value creation opportunities still in front of us. We are confident in our plans and grateful for the efforts of our team, who continue to drive our ongoing initiatives and prioritize the needs of our customers. With that, I will turn it back over to Jason.
Jason Hollar: Thanks, Aaron. Now for some additional perspective on our strategic priorities beginning with priority number one and building upon the growth of pharma and specialty solutions, our largest and most significant business. Though this segment structure has slightly changed, our focus on executing in the core remains. We're building upon our strong foundation, while investing to accelerate growth in specialty both downstream and upstream. We believe that this new segment structure further enables those efforts by enhancing management focus, leveraging the connectivity between pharmaceutical distribution and specialty, and positioning the business for long-term growth and investment. More on that front shortly. A key component of our strong core foundation is our generics program anchored by Red Oak, which continues to do an excellent job fulfilling its dual mandate, managing both cost and supply.
Red Oak leverages proprietary analytical tools and their deep industry expertise to help maximize service delivery for customers. We're continuing to invest in our business to provide customer-focused solutions and evolve our commercial engagement strategies to prioritize addressing the complex challenges our customers face every day. For example, at Investor Day, we highlighted our first-to-market clinically integrated supply chain, the Cardinal Health InteLogix platform. This innovative solution leverages artificial intelligence and machine learning through the Palantir Foundry platform to help providers reduce costs, optimize drug inventories, and generate actionable insights to simplify and streamline medication supply. We've continued to develop our offerings, such as the contract optimizer tool, which drives savings and value through contract compliance, cost controls, and product alternatives like brand generics, blood plasma, and more.
Key health system customers are already benefiting from these capabilities, and we see opportunities for further future expansion. Shifting to specialty, where we have also been investing to expand our offering into complementary areas. The acquisition of specialty networks is exciting to us on a number of fronts. This is a business with which we were already very familiar, given the long-standing partnership to service their members through our specialty distribution. Specialty networks is a technology-enabled, multi-specialty group purchasing and practice enhancement organization serving 11,500 total providers today, including more than 7,000 physicians across 1,200 independent urology, gastroenterology, and rheumatology practices. We see their service capabilities as accelerating our efforts in critical ways.
First, further extending our reach, expertise, and offerings in key therapeutic areas to provide increased clinical and economic value for specialty providers. Specialty networks is a leader in specialty practice management, research, and technologies that support physicians in lowering costs, operating more efficiently, and delivering best-in-class care to their patients. For example, the company provides solutions that improve clinical and economic outcomes to over 3,000 urologists through its leading euro GPO. Second, creating a platform for our expansion across specialty therapeutic areas. The company's PPS analytics solution is a subscription-based advanced technology platform that utilizes artificial intelligence, such as continuous learning algorithms and natural language processing to analyze data for electronic medical records, practice management, imaging and dispensing systems, and transform it into actionable insights for providers and other stakeholders.
We see this complementing our suite of clinical practice management and distribution solutions to specialty practices nationwide. Specialty networks experience and capabilities and clinical engagement are robust, which also accelerates our upstream data and research opportunities with biopharma manufacturers. Third, enhancing the capabilities of our specialty business, including supporting the ongoing build of the Navista network. Specialty networks have a deep understanding of independent physician practices, and we see capabilities and expertise that will accelerate our ongoing development of the Navista network, which is focused on supporting the clinical and operational needs of independent community oncologists. In summary, this transaction enhances our specialty strategy by providing new capabilities that strengthen the link between our downstream and upstream services, enabling us to create further value for customers, manufacturer partners, and patients.
Turning to priority number two in the GMPD business, where we're executing the medical improvement plan. While the business and portfolio review of GMPD continues, the team continues to prioritize and make significant progress in turning around the operational performance of this business, as Aaron indicated, with our expectation that the business returns to profitability in fiscal 2024. The number one priority remains mitigating supply chain inflation, where we remain on track to address the impact by the time we exit fiscal ’24. As of Q2 we're approximately 75% to target. On the cost side, while overall still elevated, we've seen lower international freight costs reflected in our results as anticipated, and we have strong line of sight to continued improvement in the second-half of the fiscal year.
We've continued to make progress with our mitigation initiatives and commercial contracting efforts and are continually taking additional actions to offset elevated inflation, such as through sourcing initiatives. As Aaron indicated, the work we've accomplished to-date provides increased confidence in achieving our fiscal year-end target as overall cost improvements continue to reflect in our second-half results. We're continuing to invest in the resiliency of our supply chain and our manufacturing and distribution capacity. We have opened three new distribution centers in the past year, adding capacity for growth, while featuring state-of-the-art automation technology to streamline operations. For example, our new Greater Toronto area DC expands capacity to serve Cardinal Health Canada customers, while leveraging autonomous mobile robots to increase picking and packing accuracy and drive efficiencies.
We're also continuing to invest in new product innovation and portfolio expansion in key categories in alignment with our disciplined portfolio management approach. As a result of our team's collective efforts, we're seeing our five-point plan to grow Cardinal Health brand volume result in improvements in our leading indicators and most importantly, strong customer retention and product volume growth. Finally, we continue to drive simplification and optimize our cost structure by exiting non-core product lines, rationalizing our network and streamlining our international footprint. We believe our new structure will further enable our medical improvement plan efforts as we continue to execute the plan and deliver value for customers. Now, priority number three, accelerating growth in key areas.
We are excited about the strong demand we are seeing in our at-Home Solutions and OptiFreight businesses, and our recent determination to further invest in and develop these businesses for long-term value creation as part of our portfolio. In at-Home Solutions, we continue to focus on enabling and supporting comfortable home-based care for patients with acute and chronic conditions. To support the growing demand for home health care, we're investing to expand the capacity of our network, the breadth of our offering, and a new technology to drive operating efficiencies. We recently announced plans for a new distribution center to be built in Texas with increased capacity, advanced automation technology, and robotics within the facility. And our previously announced 350,000 square foot facility being built in South Carolina is on track to open this calendar year.
In OptiFreight Logistics, we're continuing to invest in digital tools to enable healthcare supply chain leaders to better manage their shipping spend and support the core volume growth in our business. We've launched new offerings to give our customers more supply chain visibility, and we are receiving great feedback. For example, we now have more than 1,000 healthcare providers leveraging our total view insights platform to gain valuable insights on their operations. In nuclear and precision health solutions, we're continuing to see above market growth in both our core business and Theranostics, as we're a premier partner of choice due to our strong core foundation and differentiation with pharmaceutical manufacturers looking for commercialization success of their future radiopharmaceutical portfolios.
For example, in Theranostics prostate cancer radio diagnostics are important tools for healthcare providers to assess and properly treat the disease. We saw meaningful year-over-year revenue growth in the first-half of fiscal ‘24 from the ramp up in demand of these diagnostics. From a pipeline perspective, we're investing to expand our Center for Theranostics Advancement with demand from pharmaceutical manufacturer partners currently oversubscribed. And we're investing to expand the capabilities and resiliency of our pet manufacturing network to enable portfolio diversification and accommodate growth from the increasing demand for pet agents. This is driven by trends such as an aging population, cancer prevalence, emerging Alzheimer's therapy, availability and reimbursement and increasing clinical trial needs.
Finally, priority number four, maximizing shareholder value creation. We're continuing to maximize shareholder value creation through our improved operational performance, robust cash flow, and responsible allocation of capital. As Aaron noted, our robust cash flow generation is not only driving benefits below the operating line, it is enabling our opportunistic capital deployment with additional share repurchases in the quarter beyond our baseline plan and our ability to pursue value-creating M&A in specialty. We remain well-positioned with the financial flexibility to continue opportunistically evaluating disciplined M&A not only in specialty, but in our other growth areas and potential additional share repurchases. With our recent conclusions on our business portfolio review, we do not have further updates to share today, but plan to keep you apprised of our progress.
To close, we had a strong first-half of the year and are excited about the many initiatives underway to build upon our momentum. I would like to thank our highly engaged and talented team for driving our progress and prioritizing our customers as we fulfill our critical role as healthcare's most trusted partner. With that, we will take your questions.
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