Cardinal Health, Inc. (NYSE:CAH)

Acquisition of Leading Patient Product Portfolio from Medtronic PLC

April 18, 2017 08:30 AM ET


Sally Curley – IR

George Barrett – Chairman & CEO

Don Casey – CEO Medical

Mike Kaufmann – CFO


Charles Rhyee – Cowen & Co

Lisa Gill – JP Morgan

Eric Percher – Barclays

Ross Muken – Evercore ISI

Michael Cherny – UBS

Steven Valiquette – Bank of America Merrill Lynch

John Kreger – William Blair

Ricky Goldwasser – Morgan Stanley

Robert Willoughby – Credit Suisse

Matt Dellelo – Leerink Partners

Eric Coldwell – Robert W. Baird

Garen Sarafian – Citi


Good day, and welcome to the Cardinal Health Conference Call. Today’s conference is being recorded.

At this time, I would like to turn the conference over to Sally Curley, Senior Vice President Investor Relations. Please go ahead, ma’am.

Sally Curley

Thank you, Kyle, and welcome to this morning’s call to discuss Cardinal Health Planned acquisition of Medtronic’s Patient Care, Deep Vein Thrombosis and Nutritional Insufficiency businesses as well as our preliminary thoughts and our future outlook. With me today, our Chairman and CEO, George Barrett; Medical segment CEO, Don Casey and CFO, Mike Kaufmann. Gorge and Mike will have some prepared comments and then we will move into Q&A where Don will join.

Before I turn the call over to George, since we will be making forward-looking statements. We need to remind you that matters addressed in these statements are subject to risk and uncertainties that could cause actual results to differ materially from those projected or implied. Please refer to the SEC filings and forward-looking statements slide at the beginning of the presentation found on the Investor page of our website for a description of risks and uncertainties.

We’ll be ending today’s conference call promptly at 9:30 AM Eastern. To more efficiently get through our Question and &Answer queue please limit your questions to one only with one follow-ups. I know we have a lot of cover this morning and if we don’t get to your questions the Investor Relations team will be available throughout the day as always to answer anything you may have.

Thank you. And now I would like to turn the call over to Cardinal Health Chairman and CEO, George Barrett. George?

George Barrett

Thanks Sally. Good morning, and thanks for joining us this morning. It’s an important day for all of us here at Cardinal Health. As you saw in our press release, we’ve announced the definitive agreement to acquire some of the assets of Medtronic. For clarification, these product lines were part of the patient recovery business in Medtronic’s patient monitoring and recovery division. But some of you might also know these product lines as [indiscernible] medical supplies plus their compression businesses.

As we talk about the business today, we refer to this as the Patient Recovery Business. This is the product line that has been in our radar for many years. The business which we have always felt would be in strong and confident hands at Cardinal Health given our strategic focus and extremely important to our customer base. The product categories embedded in this transaction fit naturally into the work that we’re doing across the continuum of care from acute care to service centers, to long-term care into the retail setting and even to the consumer.

These are product areas and channels with which we have anonymous experience going all the way back to our legacy in American hospital supply. What does this acquisition do for you?

One, it broadens and deepens our reach particularly the OR, the ER, the nursing station and the prosecute facility, and the products stand side by side with the products we already produce and source. In many ways, these are the staples of the health care delivery system.

Two, our ability to operate such a broad line of products and services allows our customers to standardize reducing redundancy and improving efficiency.

Three, the scale that some of these products bring to our manufacturing facilities and the addition of some very high quality manufacturing operations heavily weighted in the U.S. will help us reduce cost.

Four, these products with some important household names like Curity and Kendall improve our connection to our customers and patients and stand for quality at a time when quality matters.

Five, this expands our reach in product lines in global markets, offering us the opportunity to leverage some of the capabilities we’ve been building in our international Quartos operations.

Six, the addition of the patient recovery portfolio improved the balance of our overall enterprise, which is so important at a time of great change.

Seven, the transaction is highly accretive, while noting that in the first full year, we will have to absorb in the inventory step up as we did with the Quartos acquisition and we expect synergies to be in excess of $150 million exiting FY ’20.

Eight, this business is highly stable and generates strong cash flows.

Nine, we will bring more than 10,000 talented associates into the Cardinal Health family and our leadership team with decade of experience with these products and customers.

We have a long standing and strong relationship with Medtronic, and appreciate that we are working getting us to this stage, they are a valued partner and we look forward to working even more closely with their team going forward, particularly in that we’ll be providing some ongoing services to one another.

This acquisition of the Patient Recover Portfolio continues a journey that we embarked on some eight years ago. That journey is focused on bring efficiency, quality and safety to healthcare system undergoing meaningful changes. Every line of business in which we compete is valuable in today’s environment and perhaps even more important as our population ages these businesses will be increasingly valuable, as healthcare continues to evolve toward a more patient-centered value based system. This portfolio increases the relevant to these offerings and in fact adds an element of patient familiarity that will only serve to reinforce the strength of our brand.

With that in mind the picture of Cardinal Health today looks quite a bit different than you saw in 2009. Our customer base is larger. The mix of our product lines is broader, deeper and more balanced. Our geographic footprint is considerably larger and our capabilities in talent base is significantly stronger. Today we are one of the very few companies in the healthcare space who can address both the pharmaceutical and the medical sides of the industry.

With that as the overall framework, I would like to make a few comments about the second press release we issued this morning. In this release we provided some commentary on the balance of our fiscal 2017, and some early thoughts on our expectations for our fiscal ’18 which begins on July 1. As many of you know we haven’t yet reported our third quarter of FY ’17, but as we absorbed the planning around this acquisition we have taken considerable time to analyze the overall environment and model our portfolio. We do not have a finished budget for FY’18 and as you know we typically provide more detailed information about the upcoming year in our August report.

Having said that we do have some general observation which we felt were important to share with you at this stage. We expect to see continued strong growth in our specialties solutions group and increasingly important line of business given what is happening in pharmaceutical innovation. We are very pleased to have grown this business to more than $10 billion in annual revenues and are extremely excited about our capabilities here and our growths prospects going forward.

As you have seen over this past year we are continuing to experience very solid growth across the Board in our medical segment. We have virtually all lines business outperforming the market. This is a strongest fundamental performance that we have seen in the medical segment at any time during my tenure. Our medical surgical business is growing its customer base. Our broad line of Cardinal Health products is increasing in size and gaining penetration. We are expanding our ability to serve patients in the home and are working prosecutes acute and discharge management is growing fast and creating real value for our customers. And the addition of the Patient Recovery Product lines will be a major contributor to our growth plans.

Our pharmaceutical distribution business is however going through a challenging phase, and let me put this in some context. We have seen in the last few years and are likely to see in the coming years, breakthroughs that will change the life of patient and their families. We are proud to be a part of process helping to bring this medicine to patients and in our role as pharmaceutical distributor we are indispensable in making this happen efficiently and safely. And of course, we will expect to be compensated fairly for this value. At the same time the public discourse around access and price is important.

I know that many of my collogues around the pharmaceutical industry wrestle with the tension between funding the innovation necessary to create these breakthrough, and making sure these products are accessible to the patients who need them meet them. Each company has its own view as to how best reconcile this.

At the same time, the generic segment of the industry is going through its own dynamics. Generic manufactures are working hard to bring more affordable medicines into the market, while competing at a stage of the lifecycle where reimbursement pressures are significant, and at a time where there is low in the number of branded products losing patent expiration — patent protection, excuse me. And while the opportunities is to launch bio-similar and even generic biologics offers exciting future promise, this part of the industry is still at an early stage of evolution.

So how does this translate practically to us? Based on the market conditions we see today, particularly around pricing, we expect to finish our fiscal 2017 at the bottom of the guidance we provided in February. Acknowledging that this is still very early in our annual budgeting process, we are modelling cautiously for 2018 given the overall pricing environment and at least $0.50 per share of Cardinal Health specific headwinds, approximately half of which flow through to the pharmaceutical segment. Given this, our early model to suggests that our pharmaceutical segment could be down high single digits nest year. Mike will cover this in more detail in his commentary. Mike brings a unique perspective given his history leading our pharmaceutical business.

Let me be clear here, we are seeing the vast majority of a business lines growing and our revenues are strong. Our pharmaceutical distribution business continues to grow its units as a strong and stable customer base as an outstanding driver of long term value in that outsourcing, and is an excellent generator of working capital. But the sheer size of the pharmaceutical distribution will have a disproportionate impact on the overall performance of the enterprise in the near term.

Based on this, we could see non-GAAP earnings per share flat to down mid-single digits in fiscal 2018, recognizing that we will have to absorb the inventory step-up from this acquisition. These are not the kind of numbers you’ve come to expect in Cardinal Health, nor are the number we expect of ourselves. We have been and are taking the actions necessary to bring efficiencies for business. At the same time however, we are committed to investing in critical initiatives that will help drive and sustain our growth over the long term. We are still refining our numbers, but we felt that it was important to give you additional clarity and transparency around our current expectations.

Let me brighten the picture somewhat. Looking beyond 2018 and into 2019, we expect Cardinal Health’s non-GAAP earnings per share to grow at least in the high single digits on a business which has a better margin profile, is even more balanced has a broader geographic footprint and it’s driven by an organization, not only possessing world-class supply chain capabilities, but also an organization with deep clinical expertise and strong analytical tools. This is what we are were saying right now, and has been are approach with you we want it to be as plain speaking as we could.

Make no mistake, we continue to be extremely positive about overall portfolio and our prospect for growth. Our enterprise is enhanced with the acquisition of the Patient Recovery Business. Our lines of business are on the right side of healthcare, we are extremely — we are executive extremely well. We are very efficient at generating cash and we are well positioned in the market. There is a lot to digest today.

So I’ll turn the call over to Mike who will walk you through the mechanics of the acquisition and our early thoughts on fiscal ’18 and ’19. Mike?

Mike Kaufmann

Thanks George, and good morning everyone. As you would expect, we are excited about the transaction we announced this morning. As George noted, we’ve had our eye on this product portfolio for many years and know we can create meaningful value with it. I’ll come back to the acquisition in a few minutes, but let me first discuss our other press release from this morning which addresses the balance of our year and some early thoughts on our fiscal 2018 and 2019. I know this is top of mind for all of you and so I want to address it upfront.

Let me begin by reminding you that it is very unusual for us to try to give any kind of guidance this early. We haven’t yet reported our third quarter of fiscal 2017, but in light of today’s acquisition announcement, and given our current insights into the pharmaceutical distribution market, we felt it was important to provide you with some early thoughts.

During my second quarter prepared remarks I noted the most significant moving parts for the second half would be generic market pricing, taxes, and brand inflation. Taxes are expected to be better than anticipated and brand inflation slightly lower. Generic market pricing, while less deflationary than what we saw in the first half is still lower than we modeled. Based on this dynamic we are revising our generic drug pricing assumption from high single digit deflation to low double digit deflation for the full fiscal year.

As a consequence of that, we now expect a full-year 2017 non-GAAP earnings per share from continuing operations to be at the bottom of our previously communicated guidance range of $5.35 to $5.50 with the EPS update attributable to expected fourth quarter results. We will provide you with more details on our third quarter earnings call scheduled for May 1st.

Moving on I’d like to share our preliminary thoughts on our expectations for the year ahead. Using the bottom of our fiscal 2017 non-GAAP earnings per share guidance range as a base, we are currently modeling fiscal ’18 non-GAAP earnings per share to be flat to down mid-single digits.

Let me provide some color. We continue to expect excellent growth across most of our businesses, including double-digit growth in Specialty Solutions and Nuclear. The medical segment profit, even before factoring in the impact of today’s proposed acquisition, is expected to grow at least in the high single digits. However, the impact of several discreet items in addition to ongoing dynamics in generic market pricing will create significant headwinds.

Let me take a minute to talk about these discreet items which can be bucketed in the four areas. First, in fiscal 2017, we have had a number of positive discreet tax items. In addition we recorded a number of favorable reserve adjustments none of which individually were significant. We do not expect these items to repeat next year.

Second, as it is normally our practice, our models for fiscal ’18 will include assumptions that we fund employee incentive compensation at targets, which creates a headwind versus our assumed actual for fiscal ’17.

Third, during fiscal ’18, we expect to make incremental investments in areas that we believe will be valuable and important to our long-term strategic positioning.

Fourth, we continue to invest in our multiyear information system refresh in the pharmaceutical segment. Over the last several months, our initial launch efforts for this project have been very successful in several key areas.

Thus, depreciation expense begin this quarter as the system became operational. This expense combined with next year’s investments in [indiscernible] will create a headwind for fiscal ’18. This IT system refresh is critical to our pharmaceutical distribution customers. It will enable us to maintain the excellent service, they have come to expect from Cardinal Health, provide us with the ability to expand in a cost efficient manner and better enable enterprise behavior.

In total these four areas will create a headwind of at least $0.50 per share or about 10 percentage points of growth. Note that about half of these discrete item pertain specifically to the Pharmaceutical segment, while the remainder apply to taxes with the Medical segments. On top of these discreet items we expect generic inflation to moderate from low double digit this year to mid-single digits in fiscal ’18, which still creates a headwind for the pharmaceutical segment.

While there are a lot of moving parts and there is still work to be done, when we take into account all of these items, we are currently modeling the pharmaceutical segment to be down high single digits and medical to be up significantly resolving in total company earnings per share of flat to down mid-single digit. Again, I would remind you that it is very early in our planning processes and we would not normally provide our preliminary thoughts on next year at this time.

Our fourth quarter fiscal ’17 call later this year, when we have complete our budget process, we will share more specific details about our fiscal ’18 guidance and segment assumption. Looking towards fiscal ’19 and beyond, let me give you some thought on why we believe the growth trajectory of the company’s non-GAAP EPS will be at least in the high single digits. First, we expect the pharmaceutical segment profit to grow in the low to mid-single digits. This will be accomplished through a combination of continued strong growth in specialty solution and nuclear as well as work in our pharmaceutical distribution business to better balance a generic deflation area environment with customer reprising, brand and generic sourcing and improved mix. This is an incredibly resilient business and I’m confident we can make the needed changes.

Next on the medical side, when you combine the strong growth in the distribution post-acute and service business with the accretion, synergies and scale from the planned acquisition, we expect significant growth. Both segments as well as corporate will stay disciplined on expenses, but not be afraid to invest for the future. And we will continue to have a balanced approached to capital deployment. We plan to continue to invest in our businesses, maintain a 30% to 35% dividend payout ratio and balance as appropriate M&A and stock repurchases. Note that our outlook for high single digits growth assumes share repurchases roughly equal to dilution from options, hopefully this helps paint a picture for fiscal ’19 and beyond.

Now let’s turn back to the planned acquisition. As I mentioned before we have evaluated this opportunity for some time and like the rest of our team, I’m excited for it to become part of our world class portfolio. Since George has provided the strategic rational I’ll cover the deal valuation and financing plans. As you know we are acquiring the Patient Recovery Business of Medtronic for $6.1 billion in cash and expect cash tax benefits of at least $100 million. Thus we anticipate the net price to be slightly less than $6 billion. We intend to finance the acquisition with the combination of $4.5 billion in new senior unsecured noted and existing cash on hand. We have secured bridge financing, but plan to issue public debt to fund the transaction prior to closing. We do not intend to draw on the bridge facility.

We will be monitoring the debt markets and we’ll be ready to execute the best possible financing to secure attractive financing cost for the company. Given our current ratings the margin accretion is strong cash flows of the new business. Our commitment to repay $1.5 billion of this debt over the next three years and our long history of prudent capital deployment we fully expect to de-lever to an adjusted debt to non-GAAP EBITDA ratio of slightly greater than two times by the end of fiscal 2020.

The planned acquisition of the Patient Recovery Business will add a robust earnings contributor to Cardinal Health. We expect this transaction to provide at least $0.21 of accretion to our non-GAAP EPS in fiscal 2018. This assumes a first quarter fiscal ’18 closing and inventory step up of approximately $100 million and interest expense from the incremental financing of up to $0.39 per share subject to change based on our ultimate bond pricing and tax rate. Remember due to the requirements of purchase accounting we will need to revalue inventory to its fair value, which will result in an unfavorable impact to cost of sales. We expect this step up to occur during the first couple of quarters post close. We will be sure to provide update to these assumptions as actuals become available.

In fiscal ’19 non-GAAP EPS accretion should rise to more than $0.55 per share and continue to grow from there. One driver of its earnings contribution will be synergies. By the end of fiscal 2020 we assume operational synergies will exceed $150 million annually. From the GAAP perspective, it’s too early in the process to provide any specific guidance on the intangible asset amortization. Once the transaction closes and the fair value estimates are complete we will provide additional details. Any amortization will of course be included in our future GAAP results but excluded from the non-GAAP financial consistent with our past practice.

Now I’ll walk you through the closing process at a high level. The support of successful integration our experienced team will work with the highly knowledgeable patient recovery business team to operate this business both in the U.S. and globally. Outside the U.S. there will be back office transition support from Medtronic that will help us to stand up these businesses without interruption. In addition Medtronic will provide extended manufacturing facility support in some locations.

Furthermore as part of our agreement we will be providing two Medtronic some manufacturing and service support. While we will ensure optimal business cautionary and efficiency, our general objective is to transition the various function to our complete control as quickly as possible. Thus the timelines for transition and the length of the agreements governing this support functions will vary. The Patient Recovery Business will be reported in our medical segment and based on the margin profile of the planned acquisition and assuming there are no other changes in mix, we are confident, we will meet or exceed our medical segment target margin rate of 5.75%.

In summary, this acquisition is a good strategic, cultural and financial fit, it creates scale and is one we feel confident, we can execute on as it is at the core of what we do well today. We expect our entire company along with our customers, partners and shareholders to see sustainable benefits from this transaction. Let me close with two thoughts, first, we always want to be as transparent and clear as we can be. I hope you found this information helpful. Second, I am convinced we are doing the right things at the right pace and are positioned well for the future.

I want to thank you for your time and participation today. And we will now turn the call over to Sally for Q&A.

Sally Curley

Kyle, let’s open the call for Q&A as you could just make couple of remarks.

Question-and-Answer Session


Thank you [Operator Instructions] And we will take our first question from Charles Rhyee with Cowen & Co.

Charles Rhyee

George, when we think about the business that you are taking on and when we think about couple of years, I know you guys were — had your eye on it, is everything in this business today what you had been looking for, or is there anything that Medtronic is keeping that was in the convenient business that you might have thought you could have guide back then, which you are not getting today? Thanks.

George Barrett

Actually, this turns out to be the portfolio we really hoped we would have access to. As you know it’s been part of a couple of different companies and so we are really thrilled that these lines are the lines that fit Cardinal Health, they are sort of down the middle for us. So we are pretty excited about that mix.

Sally Curley

Next question.


We will take our next question from Lisa Gill from JP Morgan.

Lisa Gill

First congratulation, I think this is good deal, but I just really wanted to ask as specific around the guidance and the thoughts around generic pricing going into ’18, can you talk about what visibility you have at this point? And Mike, I think you talked about repricing in the market place, is this still highly competitive especially in the independents and with the GPOs, is that what you were talking about, or taking about pricing especially on the generic side going into next year?

Mike Kaufmann

Yes, thanks Lisa for the question. I’ll step back as you know we have mentioned earlier the year that what we saw early in the year was a lot more deflation area than we expected and then when we started to see was some improvement into December January timeframe. And so what we mentioned last time, we spoke we said it was a little early to tell you what that meant as far as a trend, but that it was not quite as same as what we saw in the fall. And so that is what we were seeing, it’s still competitive, it will always be a competitive marketplace, but what we’re seeing as far as on the sell-side to the customers and I think you are about right and mainly in that independent resell space, it’s still a little bit more aggressive than we had modeled which is again better than what we saw and that’s what causing our discussions around both FY17 and why we want to give you some thoughts around FY18.


And we will take our next question from Eric Percher with Barclays.

Eric Percher

Again congrats on the acquisition, but I think I want to focus on the pharma side. Last quarter you came out with what was a fairly unique definition of generic deflations. I know they includes both the manufacturer side and your sell-side. Could you talk a little bit about how much that steps down from the prior guidance is what you are seeing with the manufacturers versus you’re the comment you just gave us on the sell-side. And also I think you’ve talked about your secondary business given your insight into the market place. How much of this is impact from secondary versus kind of primary?

George Barrett

Yes, thanks for the question. Yes, I would say this is more on the customer sell-side than on the manufacturer side. We still continue to see the type of launches and deflation that we were expecting from manufacturers and we still continue to see excellent performance from Red Oak to be able to go out and work with our manufacturing partners to make sure that were having an excellent cost position, so I still feel very good about what they are doing.

So this is where really the sell-side downstream to the customers is still a little bit more than we’ve modeled, again it’s getting better than what we saw and I think hopefully the market is beginning to understand this dynamic and as I also mentioned in my script there is a lot of different levers that we have to think that are coordinated which is more than just Red Oak which would be also making sure that we drive our mix, making sure that we execute our launches really well, make sure that our pricing is exactly where we need it to be, but again overall it is a deflationary environment and we expect this year to be down low double digits and next year, our early look is that we would be in the mid-single digits in a total deflationary environment.


We will take our next question from Ross Muken with Evercore ISI.

Ross Muken

I want to stick on the pharma business because it seems like that’s where all the questions already, I know obviously a great transaction. Helps us understand — again I’m not asking for long-term guidance, but obviously, we talked about the trajectory in the ’19, help us understand the cadence or the assumptions that go into your view of how pharma will trend throughout ’18 and then the jump-off into ’19, and what is some of the key points they are looking for to kind of get confidence that that business which has been under pressure now for 12 to 18 and 24 months depending on how long the declines last.

Your assumptions for that returning to even flattish growth or a flattish results or maybe even modest growth, what sort of needs that happen in the end market environment. How many of those sort of discreet items, truly are discreet for this year and then maybe the growth next year? We’re just trying to compartmentalize, again, I had realize giving my growth percent numbers, I’m not looking for, but more directionally and qualitatively, help us think about that cadence, the ramp and then the confidence in sort of the components in ’19 and beyond.

George Barrett

Ross, its George, why don’t you let Mike start and then I can jump in.

Mike Kaufmann

Thanks George, its little again early to give you tones of detail because that something for sure we’ll do on our fourth quarter call, is we’ll give you a lot more clarity around that. But let me see if I can help. First of all, I think it’s important to note about the $0.50 one timers or I call discrete items probably is actually a better word and what I mean by those is that, let me just walk you through them.

Some of them were as I mentioned in my script was the tax and reserve adjustments and what these are is, we had some favorable onetime tax items that again, we could have favorable items next year or unfavorable items next year or this year, but so far through this year we’ve been in a net favorable tax position, which generally means our tax rates is a little lower this year than we would expect it to be. All the things being equal for next year because of these individual discreet tax items and then we always have — every single quarter we have a lot of individual adjustments to various reserves that we would have. Some will go favorable, some will go unfavorable, and this year what we’ve seen is the netting of all those reserve adjustments.

Again, none of them individually significant which is why you haven’t heard us talk about any of them on the individual quarters, but when we take a look at then as we were trying to put some work together for everyone. The net of all those, net is to be a positive item that we felt was important to combine with the tax and call that out. That would be the largest item of that $0.50, those combine.

And then after that, it’s the other thing I mentioned which would be concentration related adjustments based on what we’re performing this year, where we go back to our normal practice, accruing at 100%. Investment that we plan to make next year in the business because we were very disciplined this year around managing our invests and we see some areas next year that we think will be important and that we’ll invest in the business. And then our team modernization IT project, which we’ve been talking about for about over a year that would have five or so year plan on. The scheduled investments that we’re making that and the cost that were associated with that were part of it.

So those are, first of all the elimination those is an important thing, then let me talk about the positive things that, when you don’t have the year-over-year from those discrete items. We continue to feel excellent about specialty in nuclear, we’re in both of those business in the P segment are going to continue to grow significantly. The acquisition alone in ’19 will add a least $0.34 if you assume that it added at least 21 than it would growth of 55. So that’s going to grow at least $0.34. Than the medical core growth has been excellent, so even if you take out the acquisition, what medical has been doing with services, distribution, the post-acute space, add home, we’ve got a lot of good initiatives, that business is going to continue to grow well.

And then finally, the former distribution team, I’m confident they’re going to do, the thing they need to do, so an excellent group, as you know I’ve worked with many of those over the years and they’ve got a lot of work on around models, brand and generic sourcing and mix management that I think are going to be driver. So, George just let me kick it back to you for comments.

George Barrett

Yes Ross, let me just add little bit to this. We sort of got to get through this reset, is sort of the way we see it in terms of the price and as Mike said some one-timers. Revenues are strong, our customer base is strong, and we’ve got limited big renewal exposure. Our enterprise selling is creating value across both segments, Red Oaks sourcing is a really powerful engine. So I think we feel very good about that, really what happened is, as we came to this announcement and we got our early role outs, we just wanted to be transparent about what we were seeing. And I think it was important for us to do that, but I think our long-term view about the pharma distribution business is quite optimistic. We think it’s an important business for the market, for our customers and for us. So that’s sort of the general perspective I’d give on this.


We will take our next question from Michael Cherny with UBS.

Michael Cherny

Good morning guys, and thank you for all the details so far. I know it’s a lot about the pharma questions, so I’ll ask a question on the Medical side. As you think about integrating the business and you think about the synergy captured you have, the strategic rational you have. How do you think about the continued evolution of the medical segments in terms of positioning what’s a growing, private label, self-branded products and how you sell that both within your own channel as well as through other channel partners, and how you position that appropriately so you are not offending some of your other supplier relationships, while also positioning it appropriately within some of the other channel partners, given that obviously these are not product that you want to keep simply within the Cardinal Medical customer base?

Mike Kaufmann

So Michael let me start and Don is here and I’d really love Don to sort of kick in. So let me just do it real quickly. First of all, just as a reminder we do report in two segments, but increasingly the way that we — the value proposition that we offer to customers is about the overall portfolio. And that is incredibly important at a time where there is a lot of change in conversions.

The second thing I would say to you, and I’ve said this in a number of public settings, is that, we often find throughout our business, we have business partner with whom we compete on one aspect of business but where we partner on other, or we’re a supplier to one, our customer of another.

So we are sort of used to dealing at this point with an environment in which our business partners and Cardinal Health know each other well, and we help navigate those things. But let me let Don just sort of give you a little bit more framework on the overall Medical side. I just wanted to make sure I highlighted that we really work together at pharma and med. Go ahead Don.

Don Casey

I think it’s a great question first. Look we believe these brands as well as Cardinal Health brand can be pushed out internationally as well as to other channels here within the specific acute channel today where we start as on the foundation of an outstanding distribution company. We have to make that distribution process relevant our national brand partners. And we believe day-in and day-out we offer an outstanding distribution service that gives them cost efficiency. It makes them more affective with their customers. And as long as we are doing that as we will be providing novel solution and providing them value, we expect to be able to work with them in a number of different ways.

As we look out over the next couple of years and we integrate this business I think we view yourselves as a solutions company, not as a product company, not as a distribution company and that service that we provide to national brands is relevant most importantly to our acute care customers. So when we go to an acute care customer we can say, look we have a broad portfolio of products and services that we provide and we are also helping bring efficiency in the system through some of our national brand partners. So we look at that model as sustainable and providing excellent growth because it delivers value to all parts of the chain — all parts of the value creation chain.

Mike Kaufmann

Mike, I’ll just add to that, those acute care partners are often a highly-integrated system now and so our ability to work across their whole system as Don said, it just turbo charges the value proposition.


And we will take our next question from Steven Valiquette with Bank of America Merrill Lynch.

Steven Valiquette

Just curious on the revised guidance on pharma distribution and generic deflation, does this assume that you are maintaining your market share within the independent retail pharmacy customer base, and just the profitability is being lowered again, or are you assuming maybe some customer attrition within that independent retail category?

George Barrett

No, we are assuming that we will maintain our share and it’s just that, as you said our profitability would be squeezed a little bit as we work through the transition to begin to drive other opportunities like mix and more share of wallet and those types of things.

Steven Valiquette

Okay, I mean there are some independent retailer, GPO mergers that seem to be happen in the market place, I am wondering if that was playing a role in your revision as well, but it sounds like that’s not really a factor?

George Barrett

No, we don’t really see that, at least so far with the ones that have happen is any factor for us specifically. Thank you.


We will take our next question form John Kreger with William Blair.

John Kreger

Question for Don, Don can you give us a sense about how many of your big IDM customers have sort of embraced your Cardinal branded product strategy and where you would hope to take that penetration over the next few years?

Don Casey

So to be specific in that question if you look at, within our channel and we define it within our channels is where we are the prime distributor. The penetrates has been excellent. And as we’ve rolled out expanded — our expanded product portfolio, I would say that it’s almost every one of them that were a prime distribution partner with them has embraced either some point of product or service as in an expanded way now that we offer them.

More importantly overtime, we look to expand our channel and with wins that we have that win talked about like Kaiser Permanente, you can begin to see that we are looking to expand our channel and once we build that distribution relationship, than you can have the different kind of conversation with those IDM — this integrated IDM partners about what services whether they’re pharmaceutically based, whether they are about post-acute space or other areas, we can have those conversation expanded.

Not everyone takes every single thing that we offer, but what we are finding is that the broader portfolio certainly gives us a number of different touch points within this integrated IDMs that we like to thing make this more relevant to them and really a partner in how they are going to approach this huge transition of them going from fee-for-service to a fee-per-value.

George Barrett

And Jon, I would add, I think the opportunity expands that share of wallet is really there particularly as we add more product lines and today’s announcement helps us.


We will take our next question from Ricky Goldwasser with Morgan Stanley.

Ricky Goldwasser

So one question and one follow up. First, Mike going back to your prepared remarks, I think you said high single digit EPS growth would apply to fiscal ’19 and beyond. Is this in your long terms guidance for high single digit EPS growth, is it sustainable long term guide for the combined business? That’s question one.

And question two, when we think about the pharma distribution margins, the guide that you give today implies distribution margins with contract back to about where you were in 2012, back in the envelop we get to around 1.6%, 1.7%. So is that the right context for us to think about where distribution margin should go to a stable, should we go back to that kind of period prior to generic inflation environment and prior to the relation with Red Oak, it seems that now we might have to give some of that upside back to your clients? Thank you.

George Barrett

Thanks Ricky for the question. There are just so many moving parts and the business is so different today than it was in 2012. I think it’s really hard to talk about at one-for-one type of trade, when you look at mix on schedules pricing, the way that fee-for-service model has changed and so at this point, I really can’t make any comments on where we would expect the pharma distribution margin rates to settle out, that’s something we’ll take a look at and consider when we give more color around our ’19 guidance and our ’18 information when we get to our fourth quarter call.

But as far as the long-term guidance and whether saying that ’19 will be at least high single digits and whether you should interpret that as our new long-term guidance it’s still just the little bit too early also for that, that’s something that again we’re going to evaluate over the long-term and take a look at and will come out with some more clarity at our fourth quarter call. We were just trying to give you some color here, so knowing what we talked about it in ’18, we felt it important to give you at least some insight into ’19 for now.

Mike Kaufmann

And again just, today’s call wasn’t really meant to update long-term guidance. We’re trying to provide some clarity on ’18 and we have some visibility on ’19 at this stage and will go to our budget process and then normal course will continue to provide information as we look at our long-term perspective.


Thank you. Will take our next question from Robert Willoughby with Credit Suisse.

Robert Willoughby

CapEx, you to envisioned the Medtronic assets will add to your business and can you speak to any synergy’s outside of the 150 that you mentioned from reducing inventory stock or bricks and mortar investments here?

George Barrett

Yes, thanks for the question Bob. Yes, couple of comments about the new acquisition first of all it is a very nice cash generating business, as I mentioned in my prepared remarks. The margin rates are obviously very accretive to us and this will help us meet or exceed our 5.75% goal from medical. The synergies are for the most basis they’re cost based synergies, we do feel there are some revenue synergies, obviously, as you heard Don talked earlier, we tend to have accounts when we have a distribution business, we penetrate our Cardinal Brand, and very well this will now be part of the Cardinal Brand portfolios, so we would expect some revenue synergies, but the 150 I talked about was the vast majority there was cost synergies, which we would be looking at all the various avenues and that you can get at whether it would be a supply chain, sourcing cost and all those types of things we feel really good about being able to execute on those based on where we are at today.

Robert Willoughby

What’s your annual CapEx?

Mike Kaufmann

Yes, on CapEx obviously when we inhered a series of manufacturing assets we’ve got to evaluate where they fit. But our modeling of this does include a significant chunk of CapEx in two areas, both from the manufacturing as well as some of the business are a little bit different in terms of the pump business as a rental business, so that’s kind of how we are looking at it.

George Barrett

Yes, we’ll definitely gets you a little bit more color on that as we move forward because we haven’t yet had a chance to really, as you can imagine getting to the weaves of on each one of the facilities and meet with the team to understand their needs. I don’t have any concerns that there will still be a net cash generating business, for sure after CapEx, but we still have a little bit of work there to do to give you a little bit of color on that.


We will take our next question from Matt Dellelo with Leerink Partners.

Matt Dellelo

Mike, can you give us a little bit more color around the sell-side pressure? For example, it was my understanding that they were really like five large GPOs on independent side, that reprised maybe six months to a year ago. Do they reprise again or where there terms in those contracts that caused the selling rates to come in sort of below expectation and then is there risk that, seeing sort of the same thing happened in six months. And did this potentially reprising; challenge spread to other segments of the market like some of the large chains or position groups or hospitals, something like that? Thanks a lot.

Mike Kaufmann

Let me see if I can help out a little bit there, first of all I would say that as we’ve mentioned for the spreading as you say to the other, if that really happened earlier in the year but the rest of it, it was pretty quick. I don’t think that’s really what’s causing this year, as far as the overall reprising of those agreements, again, a lot of that happened earlier in the year, so I think that’s would flow through, but as we’ve said before generics are spot market and so you don’t fix a price and have the same price for 3, 4, 5 years, the length of the contract. You will set your rebates in a base price, but then every day you got to be competitive in the market place.

And so what we’re really seeing now is just the normal day to day competitiveness in that generic market place that you have to have to be able to compete and maintain your share and we again as I mentioned earlier, full expect to maintain our share and we’ll do what it takes to do that and luckily, we’re in a great cost position to do that. We’re just seeing a little bit more pressure on that side, on that day-to-day reprising than we anticipated, but I don’t see any really big reprising coming or that being the cause of what I’m talking about here.

George Barrett

David, its George, the only thing I would add to that it, you also probably, you working of a sort of a lower base. So I think part of that work is essentially we have to go through this reset in the fall and that’s part of I think what’s at work.


We will take our next question from Eric Coldwell with Robert W. Baird.

Eric Coldwell

So thanks for the comments on the independent and not seeing major reprising comings in general, I do want to add on to that, do you have any customer losses that would be notable or work calling out built into your fiscal ’18 outlook, number one. Number two what is your brand inflation outlook given that you highlighted that maybe you slightly over modeled that again here in the fiscal ’17 what’s your brand pricing outlook for ’18? Thanks.

George Barrett

I guess first of all from a customer prospective note, we don’t have any wins or loses baked into those ’18 numbers we feel we’re in great position with our customers today and I really modeling that to be a factor one where the other. And as far as the brand pricing, it’s just a little bit early to give you what we’re modeling. My guess is we probably won’t model anything higher then what we see. This year when we complete the year, but whether we model a little bit lower, we were trying to give ourselves a little bit of conservatives in our numbers to be able to model that if we wanted to a little bit lower than where we were.

But again even if we do model it a little bit lower, as I’ve mentioned, we plan to continue to move to even a higher percentage to the fee-for-service agreement, and would expect that overtime that brand impact would continue to decrease. So again the real driver of ’18 besides the one time discreet items is really the generic deflation, not our thoughts on brand.


We will take our final question form Garen Sarafian with Citi.

Garen Sarafian

Mike and George, thank you for all the commentary on the sell-side you guys have mentioned in the past that it’s difficult to model generic pricing and its very dynamic. But is there anything more just on a broad level, as to what specifics function just changed. You mentioned just a slightly more pricing, but was it mix in the generic, was it a certain region of the country that you were expecting a pricing structure that changed, Or just sort of a delta between where you were at before and in broad terms versus now.

And then a quick follow up is, with your agreement with CVS and Red Oak, there was a step up in the payments that were being made from Cardinal because you were exceeding benchmarks and targets. So just curious, is there a call back at all at any point, where depending on what’s going with the JV that you would start to pay less? Just curious if you could elaborate on that, thanks.

Mike Kaufmann

Good questions, on the Red Oaks, I’ll cover it first just because it’s easy, you know there is no call back that is now mix which is a positive thing because there actually are metric around that is around our ability to sustain savings and stuff and we still feel great about that. The folks at Red Oaks continue to just do fabulous work, the relationship with CVS couldn’t be stronger and I wouldn’t any of this on Red Oaks [indiscernible] knowing everything that we ask.

I would say, you know the one thing I probably haven’t mentioned and might be a little bit helpful on the generics is, there are a discreet set of some item within the generics that were probably, not probably, that we saw some greater deflation this year. So they were items that had limited competition at the beginning of the year, they were more expensive type of generic items. We saw some additional competition on those items this year from generic manufacturers which I think than created some deflation in the market. A lot of those items we think of settle out to areas where we don’t expect to deflation on those few key items to be the same as next year. And so that’s one of the reasons why we believe next year we won’t see the same level of deflation that we saw particularly early this year, because those few key items won’t be out there having that same impact.

George Barrett

So before we finish up, let me just add real quickly, It’s an important question and I think we are being completely transparent here. We actually feel really good about that business. Pricing has been lower than we expected as we looked in our core models. And that in the one-timers as Mike said primary as the dynamic, customer retention is good, strength the back base, strength of Red Oak, we feel very good about that. So we are really trying to be as transparent as we can on this. So I hopefully that’s clear.

I think we are going to finish up the call, so let me just do this. I would like to thank everyone for joining us today. We will look forward to speaking to all of you again, soon actually on our May 1 earnings call. If you have any questions on today’s release please reach out to our IR team. Thank you all for your time this morning. And we look forward to speaking with you.


And this does conclude today’s conference call. Thank you all for your participation. And you may now disconnect.

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