Business context and reporting period
Cardinal Health, Inc. filed this unaudited Form 10-Q for the fiscal second quarter and six months ended December 31, 2010 (fiscal 2011). The company distributes pharmaceutical and medical products and reports Pharmaceutical and Medical segments. Unless noted otherwise, amounts are in millions of dollars.
Financial performance
| Metric | Three months ended Dec. 31, 2010 | Prior-year quarter | Six months ended Dec. 31, 2010 | Prior-year six months |
|---|---|---|---|---|
| Revenue | $25,371.8 | $24,919.7 | $49,809.3 | $49,700.4 |
| Gross margin | $994.2 | $957.7 | $1,956.4 | $1,866.5 |
| Operating earnings | $343.9 | $366.8 | $707.8 | $606.7 |
| Earnings from continuing operations | $215.0 | $230.2 | $509.3 | $168.4 |
| Net earnings | $215.4 | $234.5 | $510.2 | $196.3 |
| Diluted EPS, continuing operations | $0.61 | $0.64 | $1.45 | $0.47 |
| Operating cash flow | Not separately reported quarterly | $361.1 continuing operations | $783.8 continuing operations |
Quarterly revenue rose 2%; six-month revenue was essentially flat. Gross margin was approximately 3.9% of revenue for both the quarter and six-month period, versus approximately 3.8% and 3.8%, respectively, in the comparable periods. Operating margin was approximately 1.4% for the quarter and 1.4% for six months, versus 1.5% and 1.2% in the prior periods.
- Pharmaceutical segment profit increased 11% for the quarter and 25% for six months; Medical segment profit was flat for the quarter and decreased 15% for six months.
- Six-month operating cash flow fell to $361.1 from $783.8. Working capital included a $1,600.3 inventory cash use, substantially offset by a $1,762.8 increase in accounts payable.
- Cash and equivalents were $1,348.0 at December 31, down from $2,755.3 at June 30. Total debt and other short-term borrowings were $2,670.1, including $289.9 current.
- Quarterly cash dividends declared were $0.195 per share; six-month dividends were $0.390 per share.
Material changes versus prior periods
- Six-month continuing earnings rose substantially, partly reflecting lower prior-year Spin-Off restructuring costs and a lower effective tax rate. Current-period results included a $74.8 gain on sale of the remaining CareFusion shares; the prior period included a $39.9 debt-extinguishment loss.
- Pharmaceutical gross margin benefited from generic launches and sourcing programs, acquisitions, and six-month branded margin growth. Customer pricing and rebates partially offset these benefits.
- Medical gross margin declined, mainly from higher oil-related, latex and other commodity costs; prior-year flu-related demand and a one-time CareFusion intercompany revenue item also affected comparisons.
- Cash usage reflected $2,295.0 of acquisitions, partly offset by $705.9 proceeds from CareFusion share sales and $494.5 net proceeds from long-term borrowing. The company completed acquisitions of Kinray ($1.3 billion), Yong Yu ($470 million, including assumed debt) and P4 Healthcare ($506.1 million plus contingent consideration).
Outlook, risks and unusual items
- Management expected low-single-digit growth in Pharmaceutical end markets and flat growth in Medical markets for the remainder of fiscal 2011. It expected commodity costs to weigh on Medical costs; generic deflation had been lower than historical trends. Management expected the acquisitions to be slightly accretive in the second half of fiscal 2011. No specific earnings guidance is provided in the supplied filing text.
- Management said cash, projected operating cash flow and committed facilities were adequate for expected needs. Available liquidity included a $1.5 billion revolving facility and a $950 million receivables sales facility; neither had an outstanding balance at quarter-end. The company complied with facility covenants. Access to commercial paper was limited by its credit rating.
- The company issued $500 million of 4.625% notes due 2020 and expected to use part of the proceeds to repay $220 million of 6.75% notes at maturity in February 2011.
- The IRS proposed $598.1 million of additional tax, excluding penalties and interest, concerning transfer pricing and intellectual property. Cardinal disputed the proposed adjustments; CareFusion would be liable for $462.1 million under the tax agreement if the tax is ultimately paid. Cardinal reported $704.2 million of unrecognized tax benefits and $238.4 million of accrued penalties and interest.
- Cardinal reported a $249.9 million receivable for CareFusion tax indemnifications. It also carried $95.2 million fair value of contingent consideration for P4 Healthcare, dependent on future EBITDA targets.
- Acquisition purchase-price allocations remained preliminary; goodwill rose to $3,824.1, including goodwill from recent acquisitions. Management cited acquisition integration, global operations and commodity volatility among relevant risks. It stated pending litigation was not expected to materially adversely affect the consolidated financial statements.
Important facts for investors to verify
- Whether acquired businesses deliver the expected earnings contribution and whether preliminary purchase accounting, goodwill and contingent consideration estimates change.
- How operating cash flow and working capital evolve, particularly inventory, receivables and payable terms.
- The outcome and timing of IRS audits, the potential tax exposure, and recovery under the CareFusion indemnification arrangements.
- Whether generic economics, customer pricing and Medical segment commodity costs support management’s market outlook and profitability expectations.