CEO of Avery Dennison, John Weiland, former Vice Chairman, President and COO of C.R. Bard. Both bring global management backgrounds and industry-leading expertise to further strengthen our board with a broad array of skills, experience, and viewpoints. We look forward to benefiting from their perspectives. Regarding our senior management team, we are actively engaged in an external search for our next CFO. In the meantime, we have brought on Dave Evans, who will serve as interim CFO, as you may have seen in our filing this morning. I've known Dave for more than 30 years, and he has extensive experience leading finance organizations in large companies, including Scotts Miracle-Gro and Battelle. He has been working with Jorge to get up to speed, and I appreciate his partnership as we conduct our search.
Also, on the topic of senior management, I'm excited to have Steve Mason in his new role as CEO of the Medical Segment. With his leadership, we look forward to building on the steady progress underway in this business. Steve has a track record of positive results in every business he's led throughout the company, and he will empower the team to drive performance and generate long-term growth. To wrap up, we believe in our team, and we are confident that our strategic plans and our near to midterm objectives will enable a future of growth for Cardinal Health. With that, let's now open it up for questions.
Thank you. Ladies and gentlemen, if you would like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, as a reminder, please press star one to ask a question. We'll pause for just a brief moment to allow everyone an opportunity to signal for questions. We will now go on to our first question from Charles Rhyee of Cowen. Please go ahead. Your line is open.
Yeah. Thanks, guys, and thanks for the questions here. I want to talk about the Medical business here a little bit. Mike, you expressed confidence in this business, and you feel like it's going to deliver value for shareholders. Obviously, it's been a struggle over the last few years here. Over the last couple of years, some of the issues have kind of shifted to different spots here and there. Can you talk about sort of where you think you are in that process in kind of right-sizing this business here or really kind of identifying the issues and what kind of gives you sort of the confidence here as we move into the next fiscal year? We think we've identified all the issues now, and we are kind of posed back for growth.
I guess secondly, sir, can you kind of remind us, specify how much of the charge was for Medical, and should we assume all the restructuring charges assumed in the guidance is for Medical as well? Thanks.
Well, I'll address the restructuring charges real quick. The restructuring charges in the guidance are for the entire company. That would be any and all of the expected restructurings across Pharma, Med, and our functions would be covered by those initial restructuring charges. As I also said, we may have additional ones as we continue to get after the $500 million number that I said that we would hit. That's that piece. As far as my confidence in Med, I think a couple things. Some of the more complicated things like working through old agreements, getting through the TSAs, a lot of those things that created a lot of the noise in the Medical segment, we're through those.
We also, as you know, we don't plan to do any product acquisitions in the near future in that space or M&A around products in that space so that we can focus on execution. I have a ton of confidence in Steve. He's been a great operator in all of the businesses that he's run, and he's surrounded by a really good team that Jon Giacomin put in place. It's kind of to your point, a lot of the challenges that we have in Medical have been a little bit self-inflicted, and I feel that where with the people that we've added, the fact that we're through a lot of the complicated transitions and we're focused on execution, that's why we feel confidence. We have seen good underlying demand in the business, and I think that's kind of the key areas at this point in time.
If I just follow up from a modeling standpoint, and we think about the guidance in Medical, should we sort of think about that ramping up through the year, or is that something we could see maybe earlier in the year? Maybe from a cadence perspective, you can give us a little bit of thoughts around that. Thank you.
Yeah. Good question. This year, we really expect the Medical guidance to kind of be, for the segment, to not be as back-end loaded as has been in the past. We really think we have a more normalized, I would guess, cadence for our quarters for Medical this coming year. You're right. You also mentioned earlier, I didn't get to, is the charge that Jorge talked about that affected our Cardinal brand products because it was a Cordis-related charge, and obviously, we don't expect that to reoccur at this point in time.
Great. Thank you.
Next question. We will now move on to our next question from Ricky Goldwasser of Morgan Stanley. Please go ahead. Your line is open.
Yeah. Hi, good morning. My first question is on specialty. It seems to be an important contributor in the quarter. Can you just share with us what's driving the outsized growth? Is it specific products or customers? How sustainable it is? Also, if we think about just the margin in the quarter, if you exclude specialty contribution, would distribution segment margin, operating margin, be up year-over-year?
Yeah. I'll give you a couple of comments on that. I'm not going to be able to split out the margin component, but we're really proud of the performance of our specialty business. Victor and Joseph DePinto and the whole team have done a very nice job there, and we do expect that business to continue on a trajectory of strong growth. The growth is a lot coming from just our customers growing and new items in the market, growth of the items already in the market. A lot of it is just positive growth in specialty overall. I wouldn't say that it's massive changes in share and those types of things. It's really just the segment is growing well, and we believe that that will continue to happen, particularly as it relates to our more downstream customers.
When I look at our upstream services to pharma, we continue to see very good progress in growth in those businesses too for us this past year, and we'll continue to look forward to seeing those grow going forward.
Okay. One follow-up, Mike, on your opioid comments. Obviously, we've seen some press in the last couple of days around potential settlements. Thinking about that and in line with earlier comments about paying down debt, from your standpoint, is it feasible to resolve all the existing and potential litigation in a manner that's not financially manageable for the company?
Well, there's a lot to take into consideration there, but at this time it's so early and we've got a, as I commented on opioids, where we stand, we feel good about the work that we've done historically. We believe that we operate an outstanding system to manage this. We have always and will continue to report all those things that we do, we feel strongly about. Specifically commenting on any litigation or settlements, I don't think would be appropriate at this time.
Operator, next question.
We will now move on to our next question from Michael Cherny of Bank of America Merrill Lynch. Please go ahead. Your line is open.
Good morning. Thanks for all the details. Just to go back quickly to the comment you made, Mike, about the charge. Is there any way to just give a size bit or magnitude relative to the impact it had on the quarter?
Yeah. That charge itself basically was the difference between our Medical segment hitting our expectations for the quarter and missing expectations. That is the primary contributor of not delivering on that. Just to give you a little more color, it was a charge related to an exclusive distribution agreement with a Cordis supplier. It was entered into over two years ago, and other than that, it really wouldn't be appropriate to comment further on the specific supplier. We still feel incredibly good about the progress we're making with Cordis.
That color is very helpful. Thank you, Mike. Then just one quick question on the pharma outlook. When you talk about the challenges you're seeing, continuation of the generics program, can you maybe parse that out a little bit more? There's varying data points around the dynamics of the buy side, sell side spread. As you think about your book of business and where you're going to either whether it's potentially try to offset those headwinds or what you're seeing that you have to wait through, especially with your new contracting, maybe just dive in a little bit more into the color around how that's impacting the pharma outlook for 2020.
Sure. Thanks for the question, Michael. A couple things. First of all, the largest year-over-year driver for pharma being down is going to be our customer contract renewals with customers that we've already announced, that I mentioned CVS Health, Kroger. That is our biggest headwind year-over-year for pharma. Our second headwind is our generics program. It's a smaller headwind in FY '20 than it was in FY '19, so we like the progress that we're making. Specifically, to give you a little bit of color, and I hate to give a lot of details because we like to talk about it as one overall program, but I will give you a little color that we are seeing the generic deflation component itself beginning to improve.
When you take a look at the generic launches, the ability for Red Oak to continue to drive cost savings, some of those tailwinds are a little smaller, but we are seeing some market dynamics that would tell us that things are beginning to improve. Overall, our generics program continues to be a net headwind for us next year.
Operator, next question.
We will now move on to our next question from Lisa Gill of JPMorgan. Please go ahead. Your line is open.
Thanks very much. Good morning. Mike, just starting with the $130 million of cost savings, will that primarily be on the medical side or between the pharma and medical side? How do I think about that?
Yeah. It's really spread across both segments. I'm not sure if it's proportionally higher. It's not, I wouldn't say, a lot different on either side. Our functions obviously all are working on things to be more efficient. That will then get pushed into the segments. Each one of the segments are working on their components. I feel good that every single department, whether a business unit or a function, is committed to hitting our target of $130 million of incremental savings this coming year.
Just as a follow-up, when you talked about the renewals being the biggest headwind, as we think about those contracts over the four-year period of time, do the economics improve over that four-year period of time?
A couple of comments. First of all, there isn't any step downs in pricing over the next four years related to those, unless there would be some change in the number of stores or some large change or something like that from the customers that wouldn't be typical. Typically, those contracts have a fixed program over the lives of them. That's one thing to keep in mind. Other than that, they often can improve slightly just because volumes can go up over time, but typically, the rates don't change much. You may get few more dollars to your bottom line based on increased volumes. We're excited to be aligned with really excellent customers such as CVS and Kroger, who have been historically growing and have really good business models that we're excited to be partnered with them.
Operator, next question.
We will now take our next question from Robert Jones of Goldman Sachs. Please go ahead. Your line is open.
Great. Thanks for the questions. I guess, Mike, just to go back to the pharma guidance, obviously just because it does seem like a pretty big reversal from what you guys saw this quarter. Even if I exclude the additional opioid litigation charges that you shared, it still looks like you're calling for high single-digit declines in profit year-over-year. If I remember correctly, the comments I thought on the CVS renewal previously were that it was typical structure and nothing really different than what you'd seen in the past. Today, obviously, that plus Kroger seems like it's driving, if I'm hearing you correctly, it sounds like it's driving most of this anticipated decline year-over-year.
Could you maybe just share a little bit more around what you're seeing in those contract structures and pricing, even relative to maybe what you've seen in the past as far as those renewals have gone?
Yeah, a couple of things. I would say that, first of all, I still feel very confident that we got very fair and appropriate contract renewals with both of those accounts. Remember that they are contracts that are four years or longer. So they're a little bit longer than typically the contracts have been. Remember that it also is a full-year impact. Essentially, we have a full year-over-year impact because, as I mentioned, specifically the CVS, it was a July 1 start date. That's a very important component of thinking about the year-over-year impact. Hopefully that's helpful.
Okay, great. Yeah, I guess just one other thing you had mentioned, I believe you said was not in guidance, was any kind of tariff exposure. Is there anything you could share as far as just how we should think about the potential impact, how much of the portfolio is exposed to potential.
Yeah
changes or issues with tariffs?
Sure. As you can imagine, it is really hard to predict this. I will give you a little color in the sense that, first of all, currently in our numbers, we do have forecasted some small headwind related to tariffs that are already in place. We have already had the opportunity to deal with tariffs this past year. We have done a good job in managing the impact so far, and it was a small headwind for us in FY 2019. We built that continued assumption in. What we didn't build in was what new tariffs may be, because it is just so hard to predict.
Even when you get numbers such as a certain percentage and a certain dollar amounts, oftentimes after you get through all the wrangling, the medical products have had a chance to be carved out because of some of the concerns and issues it could create on increased pricing to consumers in the U.S. We constantly work with our industry to make sure we educate folks on the importance of those products and the cost that it could have on the healthcare system or shortages and other issues. It's so hard to predict what that could be. That's why we don't have anything built in at this time. Each time something comes up, we will make sure that we try to help give you some color on that and let you know what's going on those when they happen going forward. Next question.
We will now move to our next question from Kevin Caliendo of UBS. Please go ahead. Your line is open.
Great. Thank you. A couple questions. You mentioned quickly that generic deflation was improving. Is that on the sell side or on the buy side? Can you talk a little bit about the dynamics there?
Yeah. When we're talking about generic deflation for us, we're always talking about the sell side, because really the buy side is how Red Oak is doing. We continue to be very confident in the team and the capabilities of Red Oak Sourcing. The partnership there with CVS Health continues to operate very well. When I talked about that, what I'm saying is that we're seeing it improved from a sell side deflation standpoint. Remember, it's just one component of our overall generics program, and I get hesitant to just focusing on that because you still have to look at what the launches are going to deliver this year, what penetration's going to deliver this year, and what you're going to be able to do from a year-over-year cost savings standpoint. All in our generics program is still looking to be a net headwind for the year.
Thanks. Just a quick follow-up. Thinking about that $130 million, are you expecting that all to sort of drop to the EBIT line? I'm looking at cadence for the year. Medical was so lumpy in fiscal 2019. Is there any reason to think cadence for earnings over fiscal 2020 should be different than what we saw in fiscal 2019?
Well, I think, there was, to your point, some lumpiness in medical that we don't expect this next year. We had some bumps, remember, we talked about in our Q3 around transitioning off the TSAs. This Q4, we had the large charge related into Cardinal branded products. Those alone are two pretty lumpy items that occurred during the year. You can also have flu type of things, if it comes early or late, can affect both businesses. Those things, setting aside flu, the other two things we don't expect to happen this coming year, so we would expect medical to have a more normal cadence. As far as the $130 million, we will look at that all year long. If we're tracking ahead in other areas, we see some appropriate investments we want to make in the business for longer-term growth, we may make decisions there.
That's something that we will evaluate quarter to quarter as we move along, obviously, with the goal of always delivering on our commitments. We're excited to get after the $130 million in our $500 million overall target over the next five years.
Operator.
Next question.
We'll take our next question from Eric Percher of Nephron Research. Please go ahead. Your line is open.
Thank you. I'll stick with medical. Mike, when you looked out a year ago, you would've expected that the PSAs could've been bumpy. I don't know that you would've necessarily expected the charge, then obviously, there were service levels and cost reductions. When we look out over the next year and what needs to be accomplished, are there other elements that could be bumpy that you're looking at? What, in your mind, are the two or three items that have to occur in order to meet the expectations you're laying out here?
Yeah. Great question. I don't know that I see anything out there that, at this point in time, I would say gives me concern about bumpiness, like the TSAs. Again, I think we've done a good work of working through a lot of these challenges over the last year. I would say to your second part of the question around what are the things that we have to do well, I would say, the first thing that jumps out to me is we just recently restructured our commercial organization, and we're really excited about the increased focus that we're going to have on our customers and the way that it should free up the time of our sales reps to actually spend time selling.
That's going to be an important driver, somewhat for FY 2020, but more importantly, to really get the momentum going for beyond FY 2020 so that we can become the sales engine on Cardinal Health products and service and quality with our customers overall. That'd be one of the top ones for me. I think, second of all, the team on the operations side of Medical has got a lot of projects that they have on their list that they have laid out around both our manufacturing and our distribution supply chain network that are going to be important also, for the mid and longer term. We're going to be making some investments this year, to get after our manufacturing efficiency, and that, again, we think are going to pay big benefits for us going forward.
Making sure that we execute on the things to help both our manufacturing footprint and our distribution footprint are going to be important components.
Are there any major changes to the supply chain network that have to occur?
Well, some of those things that we're working on our manufacturing and distribution network, are going to be things like, possibly, where we manufacture, what type of automation we have in the plants. We're looking at our footprint and distribution and potentially relocating and changing some of our footprint to be more efficient in distribution. Yeah, there are things like that that need to be done and will be done, and we need to make sure that we stay on top of and execute flawlessly. Operator, next question.
We will now take our next question from Ross Muken of Evercore. Please go ahead. Your line is open.
Good morning, guys. I guess just getting back to the pharma business. It's hard to sort of compare apples to apples across the three major distributors. The other folks, obviously, had sort of highlighted more growth in the business. I guess it's not comparable. You guys have some of the opioid charges related in there. I guess if you think about what happened on the customer side with CVS and Kroger and kind of adjusting for that, I guess, do you feel like performance is more like for like versus the peers? I guess as we get through kind of this period, and I know we're only in 2020, but I guess after four years or so of kind of declines in that business, do you think we'll get back to growth after you get through these renewals, or is it too early to call that?
Yeah. I want to be careful not to comment on 2021 and forward other than we are absolutely committed to growing in the future. It's something we're talking about and focused on every single day. We have a lot of things going on that excite us to be able to grow in the future. It is hard for me to comment on other folks, but let me put it this way. I believe that we are executing very well across our pharma distribution business. Depending on how you want to adjust things or not adjust things, I feel very confident that we are performing very well compared to our competitors on that standpoint. Keep in mind that we have very different mixes than our competitors.
For example, in specialty, we're really excited about the growth and execution in our specialty business, but the tailwind that we get from specialty is smaller, just given the size of our respective businesses. Other than that and the timing of our renewals, I feel very good about where we are and how we would compare with anybody.
Maybe just on the capital allocation side, maybe just the thought, given where the stock is, of focusing more on the debt pay down front versus buying back more stock. I guess, what's the thought process of why you're more biased to sort of shoring up the balance sheet?
Really, it goes back to our commitment that we've made that related to our leverage ratios. We've made commitments that we're going to get those to certain levels over the time frame. From our standpoint, we feel that it's very important to focus on debt pay down in order to live up to the commitments that we've made. We also are committed to our dividend, although we plan to continue with very modest increases in our dividend until we get down to closer to the 30% to 35% payout ratios. As always, we'll continue to evaluate share repurchases. It's just that we've made commitments around our leverage ratio, and we want to live up to those commitments. Operator, next question.
We'll take our next question from Steven Valiquette of Barclays. Please go ahead. Your line is open.
All right. Great. Thanks. Good morning. Just to summarize the overall cost savings initiatives, if you go back a year ago, you mentioned you expected a cost structure savings in excess of $100 million in FY '19. You also talked about that zero-based budgeting journey to deliver greater than $200 million in savings by FY '20. I guess with the $133 million that you got in FY '19, $130 million more excited for FY '20, is this all tracking in line with what you visualized a year ago, or how would you characterize it just versus what you saw a year ago? Thanks.
Yeah, I think it's actually tracking ahead. We thought we would do $100 million this past year in FY '19 and be on a run rate of $200 million. We actually, as we said, delivered $133 in FY '19. We expect to do at least $130, so just those two alone would be $263 million. We're ahead of where we expected to be, and which is why I put out the comment that based on this work and based on the change in the way I think our entire team is thinking and looking at expenses and understanding prioritization, which is why we put out the target of $500 million over the next 5 years compared to our FY '18 run rate.
Okay. Just a quick one-liner question. In the Pharmaceutical Segment, do you think operating profit would grow in FY 2020 if you, in isolation, just excluded the pricing resets on the customer contract renewals?
Yeah, I don't want to get into that level of detail at this point in time. Just to reiterate that the customer contract renewals were the largest year-over-year headwind for us, and we're excited to be locked up for at least four years with our top three customers. Next question.
We'll now take our next question from Erin Wright of Credit Suisse. Please go ahead. Your line is open.
Hi, this is Katie on for Erin. You're forecasting, I guess, low single-digit top-line growth for the Medical segment. Is this how we should be thinking about that segment longer term? Can you speak to the latent synergy opportunities associated with the recent medical acquisitions? Thanks.
As far as the top-line number, that's kind of been historically what that industry has grown in. It has been a flattish to low single digits growth industry. As we become and have improved our execution, we would expect to continue to see our top-line growth be at least at what the industry growth rates are, and then a further acceleration to our bottom line as we continue to improve mix and get after our cost. I'm not sure, what was your other question exactly, Katie?
Yeah. Are there any other, I guess, latent synergy opportunities associated with recent medical acquisitions that you may see going forward?
Got it. Yeah, we still believe that our patient recovery business is still on track to get its $150 million of synergies exiting FY '20. That has the combination of working with our distribution network and our manufacturing teams, et cetera, sales teams working together, we have continued to have, and that has been reflected in all of our thoughts so far.
Okay, thanks.
Operator, next question.
We'll take our next question from Stephen Baxter of Wolfe Research. Please go ahead. Your line is open.
Hi. Thanks. I wanted to follow up on some of the moving pieces on the medical side of things. It seems like you're guiding medical EBIT up approximately $70 million. It sounds like this one-time item was somewhere between $50 million and $70 million based on the variation versus the prior guidance. I think you were talking about the patient recovery synergies still continuing to ramp throughout the year. Trying to understand, ex these moving pieces, it seems like medical EBIT would be flat to maybe down. I'm hoping to understand the moving pieces better. Do I have that right? If so, when do you think the core can get back to growth? Thank you.
I can't comment specifically on the size of those pieces, but I will tell you that, again, that charge for that exclusive distribution agreement was the largest difference between making our plan and not in Q4. We do expect to see growth across all the various components of medical next year. As you remember, I had mentioned earlier, we also are making some investments in medical this year, from an expense standpoint, in order to set us up for the future as we redo our distribution network and our manufacturing footprint. There are going to be some expenses that we will be incurring or investments that we'll be making that will be some headwind. You have to net all that together to get to where we are, and we feel good about medical at this point and confident we can deliver on this.
Okay, thanks. Just on the Pharma growth in the quarter, 7% obviously a big swing from where things have been recently. Just for our modeling purposes, would you be able to give any insight into what gross profit did in the Pharma Segment in the quarter in terms of growth?
Again, pharma had a good quarter, lived up to the expectations that we had for them for the year. As far as specifics, I would say the drivers have just been similar to what they have been. The large renewals, as I said, didn't essentially start until July, so we didn't see any of that large customer contract renewal until July 1. We did have a little bit year-over-year from last year's, but I wouldn't say that the drivers were a lot different. Specialty was the biggest positive driver. Brand mix and increased sales would've been the kind of second driver, and then the negative impact of our generics program and contract renewals that most of them already had been announced would be the negative drivers.
Operator, we have time for one more question.
We will now take our final question from John Ransom of Raymond James. Please go ahead. Your line is open.
Hey, Mike. Just to kind of pull back from the quarter a little bit. As we think about where you sit in the pharma chain, if you look at the stock price of Teva and Mylan, it would imply nuclear winter, and then you look at the margins of the retailers, and they go down every year. You just look at some of the trading action and some of the public chains. Just how do you think about your position when both your upstream and downstream customers are just experiencing what the financial markets would expect to see as just record distress? It just seems hard for a middleman, if you will, to stay prosperous when both partners upstream and downstream are struggling.
Yeah. Thanks for the question. Thanks for ending with such an easy one.
Sure.
First of all, I'd say we're way more than a middleman. I would start with that.
Sure.
I'm sure that's maybe the traditional piece of what we do, and I'm actually glad you said it because I think it's important for us to talk about that is we know we have a lot of areas that are more than just middleman. When I take a look at our medical services businesses, what we're doing at home, yeah, we're providing supplies, but it's really our unique relationships with insurers and with providers and how we connect them with the patients. There's so much more there with other technical businesses. We continue to see good headwinds or good tailwinds in specialty. We feel good about our nuclear business going forward. There's a lot of other things, but from when it comes to the pharma distribution business itself, it's definitely an ecosystem that is in a state of flux. I think all of our customers continue.
Luckily, we're aligned, I think, with very good customers in the sense of CVS, Kroger, Optum. We're aligned with strong players who have, I think, excellent game plans for continuing to grow in the future. That's helpful for us as we look at the way our retail independents have been resilient and are acting like scrappy entrepreneurs to figure out how to reduce their expenses, but at the same time, get into other niches. I like the way they're responding to all of this, and I think our position in having a broad portfolio with medical and pharma positions us well with the medical or with the downstream providers in the hospital marketplace.
There are a lot of challenges for sure, but I really believe in our position and our capabilities to be able to manage through this, and healthcare is going to continue to grow and stay an important piece. I think it's why many of us, if not all of us, stay at companies like Cardinal Health because we know how important it is, what we do every day.
On that point, I'm glad you mentioned independence. At a very high level, You always have market share ebbs and flows, but is your independent customer base just in terms of pharmacies you're servicing, is it the same, higher, or lower than it was, say, five years ago?
Compared to five years ago, we would definitely have more customers and have seen some growth in that business. It's a group of customers, as I said, that we've just had our retail business conference a couple weeks ago, and I had a chance to be down there and spend time, and it was a record conference for us. We had a couple thousand stores represented. The buzz amongst the group and the understanding that they need to do things differently and focus on various niches, the front end of their store, how to drive cost out. They are really looking to us as someone to help them run their business, manage their inventory, help them with things like medication therapy management, mobile technology, those types of things.
We continue to see this business as going to continue to be an important customer base for us going forward. That's the last question?
Yes.
At this time, it appears there are no further questions. I'd like to turn the conference back to Mr. Mike Kaufmann.
I want to just thank everyone for joining us this morning. We're really pleased that we delivered in FY '19, and we look forward to discussing our FY '20 progress with you very soon. Take care, everybody.
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.