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

Good morning, and welcome. Today, we will discuss Cardinal Health's Quarter and year-end fiscal 2022 results along with our outlook for fiscal year 2023. 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 Mike Kauffmann, Chief Executive Officer; Jason Hollar, Chief Financial Officer; and Chief Accounting 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 slide at the beginning of our presentation for a full description of these risks and uncertainties. Please note that during our 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 schedules attached to our press release. During the Q&A portion of today's call, we kindly ask that you please 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.

Thanks, Kevin, and good morning, everyone. As I am sure many of you have seen, a short time ago, we issued a press release, announcing that I am stepping down as CEO and as a Board member of Cardinal Health, but will continue to serve through August 31. Effective September 1, Jason will become Cardinal's new CEO. He has also been appointed as a board member effective today. They say timing is everything, and I believe as we start a new fiscal year, the time is right for me to step away as CEO and open the door for a new leader to take Cardinal Health forward over the coming years. I have been blessed to be part of the Cardinal Health family for 32 years. In that time, I've seen our company grow and evolve in many ways. We are truly essential to care, and I'm honored to have been part of it. Jason has been a tremendous partner over the past 2-plus years, and has been instrumental in many of our strategic initiatives. He deeply understands our business, priorities and industry landscape. And the board and I are confident that he is the right person for the job. With that, I would like to turn the call over to Jason.

Thanks, Mike. I really appreciate the kind words and the opportunity to work closely with you these past few years. Let me start by saying how excited I am to be taking on this new responsibility. I am grateful for the trust and the confidence the Board of Directors is placing me. I would also like to thank you, Mike, for the leadership and the many contributions to the company over the years. I hope to preserve the culture that you've helped ingrain into the fabric of our organization, and I look forward to what I know will be a smooth transition. I also want to welcome Trish English, who will be serving as our Interim Chief Financial Officer. Trish most recently served as our Chief Accounting Officer and has been a valuable member of the Cardinal Health family for over 16 years. I look forward to continuing to work with her in this new capacity while we conduct an external search for a permanent CFO. Before stepping into the details of our financial performance for the quarter, let me step back and summarize the key points this past year. Within our Pharma segment, while we experienced the effects of industry-wide inflation and incurred incremental technology investments. We grew the business 5%, consistent with both our original guidance for the year as well as our long-term growth targets. The Medical business was more significantly impacted by these inflationary dynamics, which drove a significant impact on our results. However, we have strong mitigation actions in place, including pricing and will present a plan to you today that mitigates all of the inflationary and global supply chain constraint impacts plus an additional 8% of compounded annual growth by fiscal '25. Underlying these operating results this past year was a significant focus on…

[Operator Instructions]. We will take our first question today from Lisa Gill of JPMorgan.

I want to say best of luck to you, Mike Kaufmann, it's been great working with you all these years. And I look forward to hopefully staying in touch. And congratulations, Jason, on becoming CEO. I really want to start with -- obviously, you talked about this huge ramp getting the medical side of the business back to $650 million of profit. And Jason, you just talked about 4 different areas. I really want to just focus on the first area, and that's growing Cardinal brand products. And obviously, for someone like myself that's followed the company for a long time, has kind of ebbed and flowed as far as the focus of the company? Can you talk about, one, why now you think that you can really accelerate that? Two, I think you talked about nutritional. We've had others that have had problems in that area, right? Why do you think that, that's a good area for Cardinal to go into? And then secondly, when we think about physician preference, et cetera, what are you hearing in the market around private label product to give you some of the insights as to the opportunities that you see here specific to Cardinal brand products. So I'll stop there.

Yes. Great less to start off the discussion. Thanks, Lisa. So first of all, let's start with your first one there about why now. So ebbs and flows. I understand what you mean. And of course, I think what you're referring to is we especially talked about the sales force right before the pandemic. We've made a significant restructuring to have that team very much focused on driving our Cardinal brand mix and then COVID occurred and it went from a sales-focused challenge to now a supply chain challenge. And of course, our sales team as well as our customers were very much focused on PPE and in giving care to COVID patients and the change in the mix was not exactly the highest priority. So I think it's always been a focus of Cardinal, but we recognize that we needed to change our priorities to align with our customers' priority over the last couple of years. But behind the scenes, especially with the pandemic, our medical team realized that we needed to invest in our own supply chain capability, our own products and a lot of the capacity that is necessary for the manufacturing, either whether it's our own products or source products to ensure further resiliency. So now that we are getting a little bit more normalized, and we see that we have to invest in that supply chain, it not only helps provide resiliency to our customers, but also allows us to grow high-margin products where we have the right to win and expand our margins further. So now is the right time as we start to move on and allow our sales team to get reengaged and focus on driving that volume. But of course, we need the capacity and the products to allow them to be successful. You asked a specific question about nutritional. That's just one area, right? We have a very broad, diverse product when we are successful in the category today. The King Group brand is a market leader. So this is not necessary we're getting into it. In fact, that's what gets me so excited about this item, it's opportunity. The 2 items I referenced, the surgical gloves and nutritional are already areas were significant leaders we are with good margins, good growth. We have the opportunity to just get our leadership through additional products and additional capacity. So it's actually a lower with risk strategy than entering in separately. As it relates to your last question, again, we have a very broad, diverse products, and we can manufacture. We can source and we are to use all tools available to us and use that diverse capability, internal external with partners or ourselves and continue to adapt and evolve as the market demands and when we look at the supply chain state that go behind that.

Our next question comes from George Hill of Deutsche Bank.

And Mike, I'll echo Lisa's comments and wishing you well. And I guess, Jason, I don't mean this question to sound insensitive, but I guess given the company's recent performance, could you talk about why the Board choose to not run a process to replace Mike? And why you guys kind of went with an internal promotion? And just kind of -- I don't know if you're able to comment at all, just kind of on the board's perception of company performance and how it kind of wants to evaluate management going forward?

I certainly will not attempt to speak for the Board, but what I will say is that my time both here as well as elsewhere in industry, I'm very focused, very tenured on driving operational performance within the business. I have made a mark within this organization. I've been very focused on capital deployment, driving cash in the company and have made that impact. When I think about what -- why I feel like I'm the right person going forward here, we have a lot of great assets within the organization. We have a wonderful culture. We have wonderful products, leading positions, great growth areas. But with the pandemic has shown us is that we need to go back to some level of basics here in terms of the operational core and driving efficiency, driving simplification, so probably doing fewer things, but doing them better. And that focus and that attention to derisking the model and driving this profit improvement plan for the Medical business. The pharma business has been very resilient. We hit our both short- and long-term goals this year. We need to keep doing more of the same, while also continuing to grow those growth areas, of which, of course, specialty is the largest one. So we're in a very different phase there. And then with this plan today, we're really highlighting how aggressive we're going to be with our capital deployment that when we generate that cash, $3.1 billion in '22, we're going to deploy it effectively. I'm well positioned to take us through those challenges that we've been faced with and I am going to be absolutely focused on taking the next steps here.

We now move to A.J. Rice of Credit Suisse.

It's [indiscernible] on for A.J. I just want to echo my congrats on Jason and Mike as well. So you mentioned the various costs have been coming down within the Medical segment and understanding there is a lag between when the spot prices come down versus when it flows through your P&L. Should we take it that any further decline in the spot prices would be upside to the medical outlook for FY '23 and beyond? And then alongside that, you talked about the 3% revenue CAGR for the Cardinal Health brand products. I guess what are you assuming in terms of pricing growth moving forward and alongside that utilization?

Okay. So to start with the spot prices. Well, that's why we always talk about the net impact is because obviously, there's a gross impact and the pricing and other contracting items that create that net. And so as I think about that dynamic in the short term, as I think you indicated and understand, it depends on what it is, right? It's inventory costs like the freight -- international freight, the product freight or the commodities that will be rolled in and that will be more of that 2-quarter lag. But as it relates to the domestic transportation, that piece, which hasn't moved very much in either direction, that is a little bit more real time. So it kind of depends on what costs you're talking about. Long term, we believe there's going to be a parity to pre-pandemic levels for this. So if costs weaken, get lower then some of the pricing actions may change. In the near term, I don't think pricing is going to change. Under all these pricing scenarios, we're still not covering -- expected to cover more than half of that impact. So overall, we think in the short term, yes, the costs are going to flow more to minimizing the impact of what we have. But again, that would be most likely in the second half of the year. In terms of the 3% CAGR I'm not sure I fully understand the price question there. But within our Cardinal Health, it's specifically related to that $4 billion bucket that I referenced in my comments that the underlying volume is what that's related to. There is pricing that goes along with that. But I would say it's more on the volume side and the pricing side that's driving that type of CAGR. It's not double dipping on the pricing actions. That is presuming a normalized level of inflation in pricing, and so then it would be more a volume driving that incremental value

Moving to Michael Cherny of Bank of America.

And Mike, obviously, same here, but I wish you best wishes as you move on. It's been a pleasure working with you over the years. maybe, Jason, to dive a little bit also into the medical transformation plan as you think about the totality of Cardinal as you step into the CEO seat. As you think about the moving pieces that you have and the drivers to push back towards growth, can you give us a sense as well on how much the linkage between the pharma and medical side will be able to help allow you to hit these targets that you've laid out? And how do you view the synergies, especially among this revamped medical outlook between these 2 segments going forward?

Yes. So when I step back and think about that plan, the area that is -- there's a couple of areas that could be impacted that have connectivity there. Probably the first one is the simplification and continued cost optimization. Those types of initiatives are wide ranging. And as we implement a particular project to reduce cost. It's a lot of cherry picking between the segments and the corporate functions, when one person has a good idea, we push those across all of them. And in some cases, we're leveraging that scale. We're doing a lot of centralization of work to standardize and offshore back-office activities, things of that nature, using digital tools that when we can invest in those types of technologies and capabilities essentially and blow that out to the whole organization. So that's certainly a piece of it. And then when we talk about the -- growing our Cardinal Health brand portfolio, while there's not a lot of crossover selling, we do have the same customers. And so those relationships, those discussions can spot into a variety of different opportunities. So that's not a huge enabler of that type of item, but it could be a component of it. And I would say that, that's probably the areas that there's the most overlap.

We move now to Elizabeth Anderson of Evercore.

Best wishes, Mike and excited to where we see in your new role. As I have a question just in terms of -- you talked about, I think, on the last call that you had gotten sort of 50% of SKUs sort of at a higher you've been able to pass through higher costs there. I was wondering if you could update that because I know you said in your slides, obviously, you were going to have offset about 50% of that gross impact exiting '23, and I know there are a variety of things in there. So I was just wondering if you could update us on that.

Yes. So that reference to 50% of SKUs was reflective of the expected July 1 price increases. So that is effective July 1. Now since then, we've now discussed and are informing everyone of the October 1 increases. I didn't provide that exact number. But remember, that's just the percentage of SKUs that we're touching. I think the more important way to think about it is the percentage of mitigation that we're targeting. So let me kind of walk through the flow and how I think you should think about it for this upcoming year. So as an anchor point, I just walked through in the prepared comments, in Q4 '22, what we just finished is about a 20% mitigation. So we indicated there was a $125 million gross impact with $25 million of pricing. So a 20% mitigation. We expect that 20% with the July increases and phasing in over the quarter, that's going to increase that to 25% average for the first quarter of '23. Now we would expect that to continue to increase each and every quarter over the course of the year as we roll through various other increases. I mean these are the big ways, but there's always going to be other increases along the way and our supplier fees that go along with this, too. And then that 25%, we expect to double by the time we exit fiscal '23. So we expect a run rate of about 50% by the time we exit fiscal '23. And then as I indicated in my comments, we would expect to exit fiscal '24 with 100% mitigation. By the time you get to the end of '24, we would expect that part of this inflation continues to come down. So our growth impact in '24 would trend lower and then our pricing would trend higher until effectively, those 2 numbers offset.

We now move to Steven Valiquette of Barclays.

I also just want to congratulate Mike on rewarding 30-plus years at Cardinal. And Jason here, so you hoping you'll have 30-plus years at Cardinal's well I think it put you in your late 70s, but I think you can do it.

[Indiscernible].

Just the 10% to 14% revenue growth in pharma jumped out is pretty high. I guess I was curious for more color on the drivers of growth within that as for fiscal '23, obviously, more color around the double-digit top line within the pharma

Sure. Well, yes, no, yes, okay. Got it. I think there's a couple of key points. First of all, it's very consistent with what we've done this past year and that was driven by a couple of key drivers. And I think you should think about the drivers as being similar because one of the drivers we've referenced a few times is some net new business that we referenced team in beginning in the third quarter of '22. So that would be a little bit more of a front-end loaded type of revenue benefit as we see fiscal '23. And then we've also been highlighting the strength in our large customers large book PD specialty. And we've seen some really good volume in the brand category. And so as you know, some of that larger customers and some of the brand volume doesn't always bring with it a tremendous amount of margin, but that's one of the reasons why you see very robust revenue growth and still profit growth well within the range of what we've indicated for both our short- and long-term goals. But those are the biggest drivers.

Next, we move to Ricky Goldwasser of Morgan Stanley.

And Mike, on my very best wishes and Jason, congrats and good luck. So a couple of follow-up questions here. So just to get a sense -- and Jason, thank you for clarifying the $150 million in a headwind -- in gross headwind in the first quarter versus the $125 million. So as we think about it seems like you're -- in your guidance, right, you're assuming that the headwinds are going to get worse in the first quarter versus the run rate, the run rate? I just want to make sure that I'm thinking about this correctly, and then we'll will slowly improve throughout the year. As we think about the mitigation, I think your numbers imply about $38 million, right, in mitigation from better pricing in the first quarter. When you're saying 50%, should we assume basically double from that to $75 million. I just wanted to kind of like understand the reference of that 50%. And then an additional question on the the Cardinal brand because it seems that that's a really important part of sort of the longer-term plan. It seems that it's about 29% of revenue for the segment that comes from Cardinal Health brand. So one, how do you envision this revenue mix, what it will be by 2025? And then -- how should we think about sort of the EBIT mix? It's 29% of revenue? What percent is it of profits today?

Okay. Okay. So starting with the pricing. I think you got it fairly close, but let me clarify a few points. Yes, on -- you got the math right for Q1 that would be pretty close to how you should think about it. So yes, the gross impact is increasing a little bit from the $125 million in Q4 to the $150 million in Q1. And that is -- just to make sure we connect all the dots. Yes, spot prices, we see are starting to soften in a few areas, not all areas of some going dose direction too. But generally speaking, there's some benefit there, which but it's not impacting our P&L because it's got that 2-quarter lag. So when you think about when the international trade specifically it started reducing dramatically about 2 months ago -- 2, 3 months ago, there was a really big reduction. So you wouldn't expect that and it didn't reduce -- there's been a consistent reduction over the last several weeks. So it's going to take some time for that to flow through. So certainly, Q1 can see any of that benefit. And that's why you see the growth impact still increasing is because that's from 5, 6 months ago as well. As we think about the exit and you're trying to get the math on the pricing, is the pricing double from that probably not because what you're missing, I think, in your math is that, that $150 million should come down over the course of the year. We are anticipating it will come down in part because of that international freight. So that will begin to come down and then pricing will continue to go up. But by the time we exit, again, that exit rate would be around that 50%. But but lower than the $150 million and higher than the $37 million, $38 million from the first quarter. As it relates to the revenue mix, that's hard to say. I I'm not ready to answer that specifically. The one thing I'll highlight is, as we indicated, $2.4 billion of revenue for at Home is a meaningful number when you look at that. So as a matter of -- are you doing calculations on the full segment or only on medical products and distribution at $2.4 billion of revenue, it's been growing consistently at 10%. We expect to continue growing robustly. And so that will, in a way, have a mix effect, so a percentage of revenue in the total segment, that will be a bigger piece of medical product distribution, most likely the smaller piece. So we'll need a little bit more math before we can respond more clearly on that one.

We now move to Eric Percher of Nephron Research. We move to our next question, Charles Rhyee of Cowen.

Mike, congratulations and best wishes with everything and Jason, I look forward to working -- continuing working with you. I wanted just to maybe follow up, Jason, you talked about really using the cash and deploying it. And obviously, you outlined an amount for share repurchase. When you think about getting to the $650 million sort of target in medical operating profit. Can you talk about maybe sort of M&A or other kind of capabilities that you might want to add? I know that we spent the last few years actually divesting assets. But is part of that growth inorganic as well? And then secondly, producer price index kind of fell below -- was below what people expected. When we think about the gross impact from inflationary pressures, are you starting to see some of that ease as well given sort of this July report?

Okay. So the short answer for the medical improvement plan is no, M&A is not a cornerstone of that plan. We will be looking to always augment, especially our growth businesses. So when I -- when we talk about that second point, accelerating our growth business primarily at Home Solutions, that is very much an organic investment story. We are investing in distribution capacity, that 10% growth does mean that we have some constraints and we need to invest in that to ensure that, that business can continue to grow profitably. So that is not a cornerstone. In fact, I would say maybe a little bit of the opposite. A lot of what this plan is, is very focused on the core. It's very focused on -- we have -- we just increased our CapEx guidance this year from where it's been in the past. That was hinted at and signaled last quarter where we talked about some of these capacity investments that, again, we still are relatively low risk and a good return. So it's more of that type of investment that we're focused on and that we believe is a better balance of risk and return as we drive this plan forward. We won't ever ignore it, and it could be a pillar -- or I'm sorry, it could be an enabler at some point later on, but it's not the focus and not necessary for what we're doing. As it relates to PPI, I think just one maybe I kind of talked about a lot of the pieces, but one area that is often referenced as a key driver for a lot of our cost is just oil in general. That has come down. So PPI in general, I don't pay much attention to. I do look…

We now move to Kevin Caliendo of UBS.

Again, congrats to both you, Mike and Jason. I guess my question is going back to the Medical segment. There's a lot of execution that needs to take place between now and 2025 to hit these targets. Are you happy with the team in place? How do you enhance your probability of success here internally? Is it bringing in new people, more people? Or do you feel the team in place can do it? And the second part of that question is a lot of this is price increases, which you've talked about, how are you competitively position now when it comes to price? You talked earlier about losing some share in medical because of PPE capacity and availability earlier. How are you now positioned competitively when it comes to pricing? And are customers asking for any offsets anywhere else? I know you talked about some guarantees and the like, but I just want to understand the competitive positioning as well.

Yes, I am happy with the team in place. This is our plan. They've been working on this for quite some time. We have shared elements of it conceptually with our investors with you all in the past. What this is doing is putting a finer point on this plan and making it more visible the commitments that we're making. We are leaning into some of the investments I mentioned before, especially on the CapEx. I do think that we need to continue to augment some of the capabilities. We have several very key new team members on that team that when you think about a lot of the supply chain challenges that we're talking about over -- especially this past year and even with last quarter, we have augmented the team significantly with terrific talent, industry relevant talent, but most importantly, product talent, talent that knows the supply chain knows manufacturing that was able to make an immediate impact in finalizing this plan and allowing us to take it over line. So I would not be presenting it this way if I didn't have the confidence that we have the people behind it to actually execute it. The other thing I'll say about a plan like this is I absolutely understand the intent of your question. because there are several things that need to happen here. And one thing I've learned in my 2 years here is that it's not what's on the piece of paper that ends up taking a sideways. It's the things that are unforeseen, like COVID and like inflation. And so with that said, that's why you see after every single one of these actions, at least or $60 million plus or $50 million plus is because our internal plans are definitely more aggressive than…

We now take our last question today from Eric Percher of Nephron Research.

Am I coming through this time?

Yes.

Perfect. So Jason, as you take on the new role, I think a couple of questions came down to what you will do different. And what I heard during the call was you've had a desire to be more aggressive on returning capital to shareholders and opioid settlement behind you, strong balance sheet. We're going to see that I heard the focus on cost management. I want to ask if there are other elements that you think are important for us to understand. And then I want to also ask pointedly, will you reassess the portfolio and consider what hedging needs to be together long term?

Yes. So let me start. Whenever I step into any project let alone a role, it is always about defining we're the best opportunity to create value. Where is the opportunities, what are the challenges? And what is clear to me is that until we can get better evidence of the progress on our medical business, we're going to be challenged. And so that is why I'm so focused on this medical improvement plan, why we provided such clarity on it is that it is absolutely one of, if not my greatest focus especially in the near term. And when you think about kind of any type of process to fix anything, it has to be, first and foremost, defining what the challenge is. And I do want to step back for a moment. When you think about the challenges in the medical, I know there's been a lot of adjustments. I know there's been a lot of noise. But when you think about the vast majority of the issues, they do stem from one very common theme, it is related to the supply chain. Now I can start and highlight all the external influences with that and blame things that have happened to us, and then it's very, very true. But when you think about where we were pre-COVID, this type of business, this type of industry was extremely stable. Our volume is predictable, especially in areas like PPE to think about going up 5x, 10x in terms of demand overnight and then not having a supply chain that could adjust with that, it really impacted our ability to execute in that environment in our diverse, low-cost global footprint what went from a strength to a challenge pretty much overnight. So now we've learned from that. That's what this…

I would now like to turn the call back over to Mr. Mike Kaufmann for any additional or closing remarks.

Thank you. Before Jason ends the call, I would like to say that I appreciate all of your congratulations and comments and enjoyed working with all of you. I look forward to a smooth transition with Jason, and have complete confidence in his leadership. Jason, to you.

Yes. Thanks, Mike. I want to also thank everybody for taking the time to be on the call today and for all your questions. In addition to the leadership succession, I acknowledge that we drew a lot out of you today, including new disclosures, various puts and takes and examples of incremental actions that we are taking. We did all this in an effort to provide additional visibility as we are confident and excited about these opportunities to drive growth. But there are 3 key takeaways I want to make sure that you have, First, we are committed to improving our results as demonstrated by the introduction of our medical improvement plan. Second, we continue to be encouraged by the resiliency of our Pharma segment, which continues to meet both our short and long-term objectives. And third, that we continue to take actions that are in our shareholders' best interest. With that, thank you, and have a great day.

Thank you ladies and gentlemen that will conclude today's conference call. Thank you for your participation. You may now disconnect.