Cardinal Health Inc (CAH) — Q3 2023 Earnings Call Transcript

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 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 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 give everyone in the queue an opportunity. With that, I'll now turn the call over to Jason.

Thanks, Kevin, and 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 a 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. The 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. Medical, we remain confident in our medical improvement plan target of at least $650 million 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 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 the 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.

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 and 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, and gross margin increased 6% to $1.8 billion, both driven by the Pharma segment. Consolidated SG&A increased 4% to $1.2 billion, primarily reflecting inflationary supply chain costs, which were offset in part by our comprehensive enterprise-wide cost savings initiatives. Operating earnings of $606 million 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. Moving below the line interest and other decreased 32% to $28 million, 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 of cash on hand. The business generated robust adjusted free cash flow of $1.3 billion in the third quarter. Year-to-date adjusted free cash flow is $2.1 billion. 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 of maturing March 2023 notes with cash on hand consistent with our plans. We also extended our $2 billion revolver of backup liquidity until February of 2028. Earlier in my remarks, I referenced return of capital to shareholders. During the quarter, we returned $378 million to shareholders through a $250 million accelerated share repurchase program and payment of our long-standing dividend. Year-to-date, we've returned $1.5 billion through share repurchase and made nearly $400 million in dividend payments. Now I will cover our segment performance beginning with Pharma on slide five. Third quarter revenue increased 14% to $47 billion, 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. We were pleased to see that this progress was driven by both positive generic program results, including volume and mix, and by a higher contribution from brand and specialty products. Within our generics program, we continue 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 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 six. Third quarter revenue decreased 5% to $3.7 billion, driven by lower products and distribution sales, primarily due to expected PPE volume and price declines. Medical segment profit decreased 66% versus prior year to $20 million, 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 improvements 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 savings initiatives such as in our manufacturing and supply chain. Now for our updated fiscal '23 outlook beginning on slide eight. 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 midpoint, this represents a $0.35 cent increase 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 long-term segment guidance for our upcoming Investor Day on June 8th, 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 eight. Based on year-to-date performance, we now expect interest and other in the range of $95 million to $105 million, a non-GAAP ETR of approximately 22% to 23% for the year and adjusted free cash flow generation of $2 billion to $2.3 billion for the year. We expect diluted weighted average shares outstanding in the range of 262 million to 263 million, reflecting our year-to-date repurchase activity and continued expectation of $1.5 billion to $2 billion in total share repurchases in fiscal '23. Finally, we now expect capital expenditures of approximately $450 million, reflecting the timing of our continued investment to drive organic growth. Turning to the segments on slide nine. In Pharma, with 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 previous 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. First, third quarter actual results, as I've already discussed. Second, updated assumptions around Cardinal Health brand volumes, namely that we will see relatively consistent demand patterns for the remainder of the fiscal year. Third, delayed realization of lower costs, which we have previously incurred primarily related to international freight. Based on our updated volume expectations, we now expect some of the previously anticipated fourth quarter improvements in the P&L to shift into fiscal '24. As a reminder, on the cost side, we've seen significant improvement in incurred international freight costs, which are capitalized into inventory on our balance sheet. These costs are then recognized in our P&L results on a delay as we sell through the products. We continue to have strong line of sight into this eventual benefit. However, due to timing, the impact to our fourth quarter results will be more modest than previously assumed. Importantly, we continue to expect to exit the year, offsetting at least 50% of the gross impact from inflation. Looking ahead to the fourth quarter, the approximate $60 million sequential improvement in Medical segment profit embedded in our guidance primarily reflects the combination of three items. First, the normalization from the non-recurring adjustments from Q3. Second, continued improvement in progress on our mitigation initiatives, including the benefit from the previously incurred international freight costs. Third, and to a lesser extent, normal seasonality improvements in the fourth quarter. So in financial summary, an excellent financial quarter overall, our raise to guidance with opportunities still in front of us. With that, I'll now turn it back over to Jason.

Thanks, Aaron. Now a few key updates on our three strategic priorities for fiscal '23. First, executing our medical improvement plan initiatives. We remain on track with our mitigation actions for inflation and global supply chain constraints, and I'm pleased with our continued incremental progress on this critical front. We've now mitigated over 40% of the gross impact to our business through our mitigation initiatives. This includes widespread temporary price increases across nearly all of our Cardinal Health brand product categories, supplier distribution fee increases to offset higher transportation, labor, and fuel costs, and our focus on other offset opportunities such as additional sourcing efficiencies. We continue to work collaboratively with our industry partners to make pricing adjustments that are reflective of current market conditions on our path to fully mitigating this headwind by the time we exit fiscal '24 through these collective actions. By taking a transparent approach, we are also advancing our re-contracting efforts, successfully adjusting long-term product contracts as they renew, and including language that allows for greater future flexibility. While costs generally remain significantly elevated relative to pre-pandemic levels, we've seen a stabilization across most areas, along with improvement in international freight. We believe we are now past peak overall cost levels as the improved international freight costs will begin to be reflected in our fourth quarter results. We remain committed to our mitigation efforts, as highlighted earlier. To drive growth outside our mitigation actions, we are focused on optimizing and growing our Cardinal Health brand portfolio, accelerating our growth businesses, and driving simplification and continued cost optimization. As Aaron indicated, demand for our Cardinal Health brand products has remained generally stagnant over the first three quarters of fiscal '23. We believe market demand will improve in fiscal '24 and '25 coinciding with our ongoing initiatives to increase product availability, drive new product innovation, and implement other commercial improvements. As an example of product innovation, we recently unveiled the new Kangaroo OMNI Enteral Feeding platform at the ESPEN Congress. OMNI is the only enteral pump cleared to accurately deliver thick formula and is designed to meet enteral feeding needs from the hospital to home, from infancy to end of life. OMNI has received very positive feedback from both clinicians and patients, generating excitement for the launch in early fiscal '24. Outside of US product and distribution, we're driving growth in other key areas of the segment. In at-Home Solutions, Medical Services, including OptiFreight Logistics and WaveMark, and international products and distribution. For example, in at-Home Solutions, we are expanding our footprint to match the sustained growth of home health care we are seeing in the industry and our business. Our new Central Ohio distribution center is now operational. This new location is the next step in supporting our growth strategy and will be equipped with systems and automation capabilities to improve safety, service, and operational efficiencies. A new audited storage and retrieval system will increase throughput and capacity. An ideal technology for at-Home Solutions facilities that are primarily focused on direct-to-patient fulfillment. In OptiFreight Logistics, we are accelerating our growth as a leader in tech-enabled logistics management by driving best-in-class customer experience and continually diversifying our product offerings. And we continue to take action to drive simplification across our Medical business by optimizing our distribution and global supply chain network and through our active approach to product life cycle management. Next, in Pharma, we're building upon the growth and the resiliency of the business. We are privileged to serve and partner with a broad customer base, providing essential health care services in their respective communities, including leaders in retail pharmacy, mail order, grocery, and health systems among the many classes of trade. We support our customers by bringing significant scale and leading offerings to market, including our comprehensive generics program anchored by the capabilities of Red Oak Sourcing. To keep pace with the strong and resilient demand we are seeing from our customers, we continue to focus on strengthening our core operations by continually developing customer-focused solutions and investing in new technologies across our supply chain. Our goal is to continue providing innovative tools that address the unique challenges of our customers while unlocking value and further efficiencies across our distribution supply chain. We're also prioritizing the area of specialty through our actions and investments. Our new organizational design is driving efficiencies and further effectiveness, enabling us to move quicker and better prioritize the needs of our customers and manufacturer partners. Downstream, we've seen continued double-digit growth across specialty distribution, including in health systems and alternative care. And in the physician office channel, our acquisition of the Bendcare GPO and investment in their MSO continues to drive a differentiated engagement model for rheumatologists through our expanded capabilities. Upstream with biopharma manufacturers, we again saw double-digit growth for manufacturer services in the third quarter. Our leading specialty 3PL continues to win new business, including in the area of cell and gene therapy. Through Q3, we supported 27 product launches with double-digit launches anticipated in the fourth quarter. And in our nuclear business, we're seeing a growing demand pipeline for our Center for Theranostics Advancement in Indianapolis. We've seen strong volumes from recent Theranostics launches, such as radiopharmaceutical supporting prostate-specific PET imaging. With the continued success of the business, combined with the innovation that's occurring in the space, we continue to be excited about this very promising area. And lastly, a brief update regarding our relentless focus on shareholder value creation. We have placed a strong emphasis on responsible capital deployment, including the return of capital to shareholders. This is evident through our plans to return over $2 billion to shareholders in fiscal '23 through dividends and share repurchases. We will continue to pursue opportunities for additional shareholder value creation. Our management team has made significant progress in realigning our operations to drive focus and simplicity. Our work is ongoing and we continue to work through a comprehensive review of our company's strategy, portfolio, capital allocation framework, and operations with the support of our Board and the business review committee. Given the importance of this work today, we announced that the Board has extended the term of the committee for an additional year through July 15, 2024, and we have also extended the term of the cooperation agreement with Elliot. We are very much looking forward to our upcoming Investor Day on June 8th in New York City and the opportunity to further articulate why we believe Cardinal Health is well positioned for long-term success and our plans to maximize shareholder value. Among other topics, we plan to detail our growth strategies and provide updates on our long-term outlook, capital allocation framework, and the ongoing business and portfolio review. Before I conclude, I want to thank our Cardinal Health employees who are advancing our key strategic priorities and fulfilling our essential role in health care, serving customers and their patients. While there's still work to do, I am encouraged by our team's continued progress and excited about our future opportunities. With that, we will take your questions.

Good morning and thanks for taking the question. Maybe if I can just dig in on the Medical side and just get an understanding, especially given the bridge dynamics between where you're run rating versus the build to the $650 million in '25. Is there any way you can go into more detail about what the quantitative and qualitative components of what led to the nonrecurring piece that's been absorbed within the segment? And then as you think about the dynamics behind that, how does that roll off over time as part of that build towards the longer-term multiyear targets?

Sure. Thanks, Michael. Yes. Let's break down the inflation into the components as a way of giving you the pieces I think you're asking for there. And we've given you enough of this, you can back into these numbers, but let me just be really explicit around the impact of inflation across the quarters in fiscal '23 and what that then implies for '24 and beyond. And I think that will get at most of your questions. So the first half of the year, namely within Q2, somewhere around Q1, Q2, we saw the peak net impact of inflation, gross inflation net of the mitigation actions. And then specifically in Q2, we had about $100 million included in our reported Medical segment earnings. Now we have had improvements over the course of the last quarter. So in Q3, we saw both the ongoing pricing dynamics as expected and the costs continue to be incurred at lower levels as expected. And what that did then was drove a P&L benefit related to those mitigation actions of $20 million to $30 million for the quarter. The difference in the quarter is that both Q3 as well as Q4, our volumes are now expected to be lower. So what we see in the P&L is a little bit less than what we had anticipated. But what we're spending on those incurred costs are coming in as expected. So again, that's Q2 to Q3, a $20 million to $30 million improvement in the net impact. And then we expect pricing to continue to improve as we roll over more and more contracts into the new permit structure. And then we have ongoing international freight especially continue to roll through our P&L, again, at a slower pace than originally anticipated, but we still expect that benefit in the fourth quarter, and that's another $20 million to $30 million. So as you think about that Q2 to Q4 journey, that's $40 million to $60 million or let's call it about $50 million of benefit just related to the mitigation actions. So again, the actions are entirely consistent with our expectations. It's just that volume component is effectively delaying the benefit of what we see until some of it spilling over into fiscal '24 more than what we had anticipated. So that's the biggest part of the bridge because our guidance implies an $80 million-ish type of run rate in the fourth quarter. And so getting that Q2 to Q4, $50 million of that, that kind of gets you there. Now to your point, in Q3, there were some nonrecurring items, some puts and takes that we don't anticipate will continue on into Q4, let alone 2024 and 2025. So that's kind of in and out and not really something to think about so much in terms of that overall bridge. Now the last part of this story then is, okay, so that gets you to the run rate of about $80 million in the fourth quarter. As I said, we started with $100 million at the beginning of the year, Q2 impacted because of inflation. The $20 million to $30 million each quarter takes you down to the $50 million in Q4. That implies that in that $80 million of profit as we exit the year in our Q4 results, still includes $50 million for the quarter related to the net impact of inflation. That's the opportunity that we remain committed to. Nothing we're talking about here is different than our expectations. I continue to expect us to fully mitigate through pricing of the ongoing renewals as well as this cost will continue to come down in terms of what impacts our P&L. We do not anticipate significant further reductions in other commodity areas, but we do expect that international freight will stay at the low levels that it currently is at. Next question please.

Thanks very much and thanks for all the detail. Jason, I know you're going to talk about this at your Analyst Day around the portfolio review. But there's been some speculation around your nuclear business. Can you just talk about the contribution that, that had maybe overall thus far this year and how you see that? Is that a core component of your business going forward? Or is this something that you would think about when you think about your portfolio review? And any insights you have around nuclear would be helpful?

As you would expect, Lisa. First of all, good morning. I'm not going to comment on any of the rumors or speculation. What I'll say is nuclear is a fantastic business. In our segment footnote, we break out the revenue that's trending a little above $1 billion. It did increase a bit here because of some RevRec changes that's taking our revenue growth at well over 30%. But the kind of the normalized level of revenue growth has been in the low double-digit type of revenue growth. So it's been growing nicely. We've never broken out the margin, but we have indicated it's a higher than average margin. So it's a growing business. It's a strong business and a great secular area. And that's all that we're going to say about that. Next question please.

Thank you for taking my question. I appreciate the details about the Medical side. However, I'm a bit confused about why market demand for your products has remained stagnant over the past few quarters. Given that public hospitals seem to be performing better, is there a geographic issue at play? Are there customer-related factors contributing to the lack of increased demand? Has purchasing behavior changed at the hospital level, or is it related to your product portfolio? What is actually happening in the marketplace that has resulted in stagnation for your private portfolio?

Yes. There's a few components I can provide some additional color on. First of all, we've highlighted the some of the categories. So PPE, we've highlighted the destocking situation still. So we're not seeing anything new or different there. We have some other categories like our lab business, which is actually seeing a little bit of a headwind sequentially. Nothing too significant, but it's certainly with COVID originally and then with flu testing, we had some pretty good volume over the last couple of years, and that's getting more normalized. So we have some headwinds like that. For the other non-PPE type of Cardinal Health brand categories that are important to us, especially from a margin perspective, what we have to go back to is just highlight that a couple of years ago, last year, we saw some very significant supply chain constraints. And at that time, we were not able to get our customers the products that they needed. Fortunately, we've been working very hard on that. Our product availability, our product health, and our customer service levels are at levels we've not seen since before the pandemic. So we're in really good shape now, but we were not getting all the products to our customers that they needed over that period of time. And we lost some opportunity as a result of that. So that's why we're not benefiting from as much of the growth right now. I do think that the underlying utilization is improving. We're not getting our fair share of that. And that's where we're very focused on further investments in our capacity, further investments and product innovation, but also just making certain that we keep our service levels ever increasing to levels that are really exciting our customers, so that they want to buy more and more of that product from us. And we're in the best position we've been in, in years and have more confidence that we'll get there. This is an important part of the medical improvement plan, right? It's one of the four pillars of growth. And so we are anticipating further improvements. It is about 20% of the actions necessary for us to hit the $50 million-plus target. That's why we're very focused on the other actions as well to see if we can over deliver and derisk this. But we do believe that utilization will continue to improve overall for the market, and we are better positioned now than we've been in a long time to participate in that, and I feel good about our prospects to see that growth, especially as we get into fiscal '24.

Hi, everyone. I appreciate the question. First, thank you for the information about the Medical business. I would like to know if you could provide clarity on the contribution or impact of one-time items in the quarter for Medical. Additionally, could you discuss the factors influencing Pharma's operating profit in the fourth quarter? It seems like there might be some conservatism there, and I want to ensure we understand all the dynamics. Thank you.

Okay. So I'll make a comment on your first part of your question, I'll turn it over to Aaron for the second one. It's nothing that we've explicitly quantified just wanted to highlight the words that we used, again, that it was a modest net negative impact in Q3. So it's one component. It's a number of puts and takes within there. I did highlight that as an example, one of the types of items are some costs for further simplification actions. We had some of that in the first quarter as well. So we're constantly looking at our portfolio and taking action to improve our ongoing profitability and that required us to take some further adjustments within the quarter, but nothing else to really highlight there other than the key is that we just don't expect them to continue, certainly not the long-term or even into the rest of our guidance for fiscal '24. Aaron?

Good morning. Happy to talk about the Pharma business. First, just let me repeat a little bit of what I said in my prepared remarks, which is we are really pleased with the performance of the Pharma business and what the team is accomplishing in that core part of our business. The resiliency and the strength that they showed in Q3 based on the progress on the generics platform as well as some strength in the brand portfolio and the double-digit growth in specialty allowed us to be able to lean forward and raise our guidance for the year for the Pharma business. I want to highlight a couple of things as you think about Q4, which I think was the point of your question, which is, while we expect to see continued good news relative to the operational performance and a stable macro environment, with the strong underlying fundamentals we laid out, it is important to note that Q4 last year was a strong quarter for us, and so we're lapping a higher point. It's also the case that we'll have less benefit from some nonrecurring items that we called out in our prepared remarks earlier as well. And so overall, strong performance in Q3, looking forward to a good Q4. But careful in our expectation setting.

Thank you. Staying on the Pharma side, I wanted to ask whether the changes we're seeing to list prices around the insulin products and the potential for more changes in front of the AMP Cap Sunset next year is significant. I understand this is a change to fee-for-service economics, and that gives you a right to renegotiate. But how would you characterize renegotiations that type when they come up? And are you confident you can maintain absolute profit or something close to it?

Yes. In short, I am very confident that we'll continue to appropriately be compensated for our activity-based value. So this is not any different than the various other types of adjustments we've had to make over the years, and it's something that I think we've demonstrated makes sense to make the appropriate adjustments. The other thing I'd highlight is the starting point for a product like this is not real strong margins to begin with. So there's not a big profit pool from which to draw value from. We do expect to be compensated for the value that we provide, and we'll continue to monitor and follow. One thing we had talked about in the past on this type of topic is where I have the most concern is when we don't have sufficient visibility to changes, and that something would just kind of fall in our lap at the last minute because it does require some renegotiation, restructuring in some cases of how the arrangements are made. This one is a little bit more straightforward, and we feel like we can negotiate the appropriate outcome for it. And we certainly have the time for it. But the distinction is if there's ever any really short-term type of impact, and that would need to be addressed separately.

Good morning, guys, and thanks for taking the question. I guess, first, as it relates to the Cardinal Health branded products in Medical, I guess, Jason, is there any way to evaluate whether or not you guys are losing wallet share with customers and that guy is impacting volumes? And I guess my quick follow-up on that would be as we know that you guys have historically looked forward at commodity-based products. I guess is there any way to provide any more color around the timing of when Medical in flex as it relates to kind of the forward buying and the commodity impact in the inflation mitigation? Just trying to think about when we kind of like when we see the inflation as it relates to these lower costs really pulling through.

Yes. Looking back at our volume, we experienced a decrease in Q3 and Q4 of last year due to a significant amount of PPE being released, which caused us to lose market share. That segment is a commodity business for us, essential for our customers, and while we participate as necessary, it's not our main focus. Our priority is meeting customer needs. We also noticed some weakness in non-Cardinal volume, which I previously attributed to supply chain constraints. Other providers gaining capacity resulted in us losing share as well. There hasn't been much change since then. Our service levels and product health have significantly improved throughout fiscal '23. I haven't observed any new developments related to our new contracting that differ from our expectations for this year. However, we continue to feel the effects from challenges faced over the last couple of years. Regarding your second question about commodity impacts, the main factor has been international freight, which decreased significantly about six to nine months ago. This is why we are on the verge of seeing a favorable impact on our profit and loss, as we typically hold two to three quarters of inventory. The reason this benefit is spilling into '24 is that our volumes have been lower than we had projected, prolonging our recognition of that benefit. I haven't identified any significant shifts in other commodities. While there has been movement—some improving and others not—we are experiencing consistency with our expectations. We anticipated a slight improvement across the board, but aside from international freight, we haven't seen much change. Certain categories, like nonwovens, remain elevated, influenced by geopolitical factors beyond just raw material costs. This underscores the necessity for flexible pricing structures in our contracts to accommodate potential future shocks. Overall, while other commodities remain stable at high levels, they're not fluctuating enough to alter our overall message. As those prices change, our pricing will be adjusted accordingly. Our goal is to offset costs rather than aim for a margin. If prices decrease more rapidly, we anticipate adjusting accordingly. Currently, we are absorbing costs of about $50 million to $75 million per quarter, which is why we need to continue raising prices until these two lines align, which we expect will closer to the end of fiscal '24.

Thank you. Most of mine have been covered, but I did want to hit on the generics pricing topic. I know you've made some positive comments during the call, but also suggested that market dynamics are generally consistent. We've seen some generic pricing deflation improvement over the last few months. I'm curious if you're seeing the same thing. And what your outlook might be on that front moving forward? Thank you.

Thanks, Eric. We called out favorable volume and mix and consistent market dynamics. As we've highlighted many times before, it's important to look at the total of both sides, buy and sell. And we continue to think those overall dynamics are fairly well balanced. And there will be ongoing volatility on one direction or the other, one side or the other, but it's the importance of Red Oak Sourcing and continue to deliver the best-in-class service levels as well as cost. And we feel very good about our competitive positioning there and why we think the margin per unit will continue to be as expected and not as much a part of the story than as the volume in the mix.

Great. Thanks. Good morning. You might have just touched on this a little bit, but I guess I was curious more just for the overall Pharma segment. You've had obviously a bunch of consecutive quarters now of double-digit top line growth, including 14% this quarter. And you talked about brand inflation, brand volume, generic specialty, all being strong. So I guess my question was related to.

Yeah, thanks for taking the question. I had a similar question, but more on the EBIT for Pharma. Nice raise obviously this quarter. But I'm curious if you can kind of break out for us the nonrecurring items in a little more detail in the Pharma EBIT raise and how much will be recurring in fiscal '24? Thanks.

The advantage of the nonrecurring items is that they won't happen again in fiscal '24. If your question pertains to Q4, the response is similar. In the Pharma segment, we demonstrated strength overall with a stable macro environment and solid underlying fundamentals. Our operational performance was strong as well. We experienced some modest benefits from price increases by branded manufacturers, and this being our third quarter, we do not expect these to repeat moving forward. Overall, the narrative for Pharma has been positive this year and particularly in Q3. We have raised our guidance for the year, and we will provide more information regarding fiscal '24 and our long-term expectations for the business during our Investor Day on June 8th.

Yes. And I will just add that Aaron's remarks accurately reflect the situation regarding nonrecurring items. The only one we could consider in that category would depend on your assumptions about brand inflation for next year, which is expected to be modest. Additionally, we noted that our costs related to opioid legal fees and our ERP implementation are running lower than we anticipated, contributing positively to our year-over-year growth rate. This is nonrecurring, meaning we have reached a more normalized level sooner than expected. Therefore, I do not foresee significant further reductions in those costs over the coming years. We will continue to monitor this and provide updates as necessary. This is why our implied growth rate for Q4 appears more normalized, and we are not making any changes to our longer-term targets at this time. We will revisit this topic during our Investor Day on June 8th. Overall, we are seeing positive trends with new customers, brand inflation, and various cost drivers moving in the right direction, suggesting we are normalizing our operations moving forward. As such, you should expect more normalized margins from this point onward.

Thank you for taking my question. I wanted to follow up on Eric's inquiry regarding insulin pricing and how you might address that. Can you explain how your fee-for-service contracts are generally structured? Specifically, how do they relate to insulin, particularly with the recent changes? I would have expected that much of the relevant language is already included in your contracts to help manage and maintain the services you provide. Additionally, you mentioned earlier that Red Oak is performing well in generics. Is there any effort happening at Red Oak regarding biosimilars to improve economics in that area as well? Thank you.

I'm not going to delve into the details of product-level contracts and their structure. I want to emphasize our confidence in our processes, our experience, and our history with any changes that may arise in other products. As a distributor, we are responsible for moving products from manufacturers to those in need. There will always be changes in the structure and our approach, but the current environment is not different from what we've experienced over the last 50 years. We will continue to adapt and evolve, and that's all there is to say on that matter.

Regarding biosimilars, we believe we are well positioned to support the next phase of growth in this expanding therapeutic area over the coming years. We expect that most of this growth will come from products that have a stronger presence in retail or specialty pharmacies, which aligns with our strengths, as well as from new therapeutic areas like immunology and ophthalmology. Therefore, we anticipate that this will positively impact our performance as we move towards the end of fiscal year '23 and into the future.

Thanks. It's Jonathan Yong on for A.J. here. Just going back to Medical again. I appreciate the comments on the cost improvements that you're doing and how that's going to set up a good framework for '24. But I guess given some of the volume constraints that you're kind of seeing and not seeing the same flow through, how much of improvement related to the cost side, especially on the freight line is tied to actually improving that volume side that you kind of need to flow through. Thanks.

Well, so it depends on the time frame we're talking about, but for fiscal '25, our ultimate goal of the $650 million that volume impact we're talking about will not materially impact at all the recognition of the inflation mitigation. That is something that does have some volatility quarter-to-quarter, which is exactly what we highlighted as one of the drivers in the guidance change for this year. But it's not something that will impact significantly the future quarters, let alone when we get to fiscal '25. And so I think about volume, the volume component of the order of magnitude of the impact and the benefit that we expect for growing this volume is that $75 million that we have on one of the slides in the presentation, that volume pillar of growing Cardinal Health brand products, that is the order of magnitude we're talking about. And so I do not believe long-term that, that spills over and impacts the mitigation and the cost side of that. So you can think about those as independent as it relates to the longer-term impacts, they are a bit more mixed in the terms of the short term and what that does to how quickly we recognize that lower cost, but that is very much just a short-term timing effect.

Hi, this is Kristen Shuman for Brian. And you might have mentioned this earlier, but I just want to clarify. So could you just give some guidance around how much of the Pharma segment EBITDA guidance range is expected to recur in fiscal '24? Thank you.

Well, we have not provided fiscal year '24 guidance. We're pleased to report the strong performance in Q3. As we've talked about, and indeed, we did raise our guidance overall for Pharma. For the year, we're now expecting the profit guidance to be 10.5% to 12% for the full year. That's in contrast to our earlier guidance of low single digit to mid-single digit. So we are expecting a good finish to the year from this business, and we're excited to see you all on June 8th at our Investor Day presentation.

Yes. Great. Thank you, and thank you, everyone, for joining us today. I know that we threw a lot out at you today, but we have a lot going on as an organization and just wanted to share the progress with you and give you more insight to a lot of the key drivers. If I step back and just think about what we went through, certainly, feel terrific about the progress that we're making across the enterprise. Pharma has, of course, a fantastic quarter, a fantastic year, broad-based as we talked. On the Medical side of the business, we have opportunity. We're very, very focused on driving the medical improvement plan. We feel really good about the progress we made are clearly making in three of those four pillars. We have work to do on the underlying volume. We'll have more confidence in where the market is going for that volume also have confidence in the leading indicators that will take for us to get our fair share of that volume. Of course, also, we're very pleased with the cash performance that we had and that we talked about today and that raising that guidance, narrowing the guidance as well. It highlights both the strong cash management that we have, but also the responsible capital deployment that's going along with that. So just again, thank you for your time today and look forward to seeing all of you at the Investor Day on June 8th.