Cardinal Health, Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2011, the three months ended September 30, 2010. Financial statements are unaudited; amounts are in millions except per-share data.
Business context and results
Cardinal Health distributes pharmaceutical and medical products and services through its Pharmaceutical and Medical segments. Results are compared with the three months ended September 30, 2009, a period affected by the CareFusion spin-off and related costs.
| Metric | Q1 FY2011 | Q1 FY2010 | Change / note |
|---|---|---|---|
| Revenue | $24,437.5 | $24,780.7 | Down 1% |
| Gross margin | $962.2 | $908.8 | Up 6%; gross margin rate about 3.9% vs. 3.7% |
| Operating earnings | $363.9 | $239.9 | Up 52%; operating margin about 1.5% vs. 1.0% |
| Earnings from continuing operations | $294.4 | Loss of $61.8 | 2011 includes a $74.8 gain on sale of CareFusion shares |
| Net earnings/(loss) | $294.8 | Loss of $38.2 | Includes discontinued operations of $0.4 vs. $23.6 |
| Diluted EPS | $0.84 | Loss of $0.11 | 2011 continuing-operations EPS was also $0.84 |
| Operating cash flow | $217.0 | $406.0 | Continuing-operations cash flow was $217.7 vs. $261.6 |
Segment performance and material changes
- Pharmaceutical: Revenue was $22,272.8, down 1%; segment profit increased 42% to $296.4. Generic programs, including new launches, added $61 to gross margin, while branded margin growth added $45. Renewed-contract pricing reduced gross margin by $28. Customer losses exceeded gains by $222 in revenue; generic conversions also reduced branded sales.
- Medical: Revenue was $2,169.4, down 3%; segment profit fell 28% to $82.9. Commodity costs reduced gross margin by $15. The prior-year comparison benefited from a $14 one-time intercompany revenue gain and stronger flu-product demand.
- Consolidated revenue declined despite higher gross margin. Operating earnings also benefited from much lower restructuring and impairment costs than in the prior-year quarter: restructuring was $1.8 vs. $59.6, and impairments/loss on asset sales were $1.9 vs. $23.6. Prior-year restructuring included about $50 of spin-off costs.
- Interest expense declined to $22.0 from $33.9, reflecting lower debt and interest-rate-swap effects. The prior-year period included a $39.9 debt-extinguishment loss.
- The effective tax rate was 30.6% vs. 135.3%. The 2011 rate benefited by $28 from releasing a deferred-tax valuation allowance related to the CareFusion stock sale; the prior-year rate was adversely affected by a $171.9 adjustment concerning offshore earnings.
Cash, debt and liquidity
- Cash and equivalents were $2,712.2 at September 30, 2010, down from $2,755.3 at June 30. Cash flow from operations was $217.0; investing activities provided $84.1, including $705.9 proceeds from the CareFusion share sale, offset in part by $559.9 of net acquisition spending. Financing used $344.2, including $269.8 for treasury-share purchases and $70.3 of dividends.
- Cash-funded acquisition of P4 Healthcare was completed for $509.1, with up to $150 in potential earn-outs; estimated acquisition-date fair value of the contingent obligation was $95. Long-term obligations were $1,906.4 and current obligations/short-term borrowings were $233.6, totaling about $2,140.0. Cash exceeded these obligations by about $572.
- Current assets were $15,918.2 and current liabilities $12,451.6. The company reported $2.7 billion of cash, a $1.5 billion revolving credit facility, a $1.5 billion commercial-paper program backed by that facility, and a $950 million committed receivables sales facility. No commercial-paper or receivables-facility balances were outstanding; the company was in compliance with its leverage and interest-coverage covenants.
- Capital expenditures were $62.0, primarily for information technology. The quarterly dividend declared was $0.195 per share. The existing repurchase authorization was completed; a new $750 million program was approved November 3, 2010.
Outlook, risks and unusual items
- Management expected low-single-digit growth in the Pharmaceutical segment’s primary market and flat growth in the Medical segment’s primary market for the remainder of fiscal 2011. No specific company earnings or revenue guidance was provided in the supplied filing text.
- Management said pharmaceutical nuclear-pharmacy raw-material shortages experienced through fiscal 2010 had been resolved and supply was returning toward normal. It cited customer gains and losses, sales mix and customer growth as factors that could cause results to differ from market trends.
- The IRS proposed $598.1 of additional taxes, excluding penalties and interest, relating to transfer pricing and an intellectual-property transfer. Cardinal disputes the proposed adjustments; under the CareFusion tax matters agreement, CareFusion is liable for $462.1 if the tax is ultimately payable. Cardinal said its reserves were adequate. At quarter-end, it recorded $247.3 of CareFusion tax-indemnification receivable; unrecognized tax benefits were $734.9, with $238.1 of accrued interest and penalties.
- P4 Healthcare added $375.2 of goodwill and $225.7 of identifiable intangible assets; the purchase-price allocation remained subject to adjustment. Earn-out fair value depends on unobservable assumptions, including future EBITDA and achievement probabilities.
- Management said it believed available cash, projected operating cash flow and credit access were adequate for anticipated needs. Additional acquisitions could require supplemental funding, and integration benefits are not assured. Management stated pending litigation was not expected to have a material adverse effect; product issues could nonetheless lead to recalls, costs or sales interruptions.
- Cardinal sold its remaining 30.5 million CareFusion shares for $705.9 and recognized a $74.8 gain. A new accounting rule changed the classification of the committed receivables sales facility; there were no outstanding amounts under it at quarter-end.
Important facts for investors to verify
- How much of the reported earnings improvement reflects recurring segment performance versus the CareFusion gain, favorable tax item and lower prior-year spin-off and impairment charges.
- Whether generic and branded margin gains can offset Pharmaceutical customer losses, contract-pricing pressure and lower branded volumes.
- Whether Medical segment profitability recovers amid commodity-cost pressure and comparisons with prior-year flu demand and one-time revenue recognition.
- Developments in the IRS audits, the amount and collectability of CareFusion indemnification, and potential changes in tax reserves and accrued interest or penalties.
- P4 Healthcare integration, final purchase-price allocation, achievement of earn-out targets, and resulting goodwill and contingent-liability valuations.
- Working-capital and cash-flow trends, particularly the substantial inventory increase, alongside acquisition spending, share repurchases and access to committed liquidity.