Cardinal Health, Inc. — Q2 Fiscal 2016 Form 10-Q
Reporting period: Quarter and six months ended December 31, 2015. Comparisons are with the corresponding prior-year periods unless noted. Cardinal Health distributes pharmaceutical and medical products and reports Pharmaceutical and Medical segments.
Financial performance
| Metric | Three months ended Dec. 31, 2015 | Six months ended Dec. 31, 2015 | Prior-year comparison |
|---|---|---|---|
| Revenue | $31.445 billion | $59.499 billion | Up 23% and 20%, respectively |
| Gross margin | $1.609 billion | $3.188 billion | Up 11% and 14%, respectively |
| Operating earnings, GAAP | $563 million | $1.183 billion | Up 3% and 17%, respectively |
| Operating earnings, non-GAAP | $726 million | $1.463 billion | Up 14% and 22%, respectively |
| Net earnings attributable to Cardinal Health | $326 million | $709 million | Up 13% and 28%, respectively |
| Diluted EPS, GAAP | $0.98 | $2.14 | Up 14% and 30%, respectively |
| Diluted EPS, non-GAAP | $1.30 | $2.68 | Up 8% and 22%, respectively |
| Operating cash flow | Not separately provided | $1.411 billion | $1.014 billion in prior-year period |
Approximate gross margin rate was 5.1% for the quarter and 5.4% for the six-month period, versus approximately 5.7% and 5.6% a year earlier. Management cited new mail-order customer onboarding and customer pricing changes as pressures on gross margin rate; generics-program performance was a favorable factor. A $39 million LIFO charge also reduced current-period gross margin.
Pharmaceutical revenue rose 25% for the quarter and 22% for the six months; segment profit rose 16% and 29%. Medical revenue rose 9% and 5%, while segment profit declined 8% and 10%. Medical profit was pressured by acquisition and divestiture impacts, including the fair-value step-up of Cordis inventory, and by the Canada business in the six-month period.
Financial position and liquidity
- Cash and equivalents were $2.324 billion at December 31, 2015, down from $4.616 billion at June 30, 2015. The decline primarily reflected $3.284 billion of acquisition spending and $259 million of dividends, partly offset by $1.411 billion of operating cash flow.
- Long-term obligations plus current borrowings totaled $5.525 billion; cash-adjusted debt was approximately $3.201 billion. Debt figures include $354 million current and $5.171 billion long-term obligations.
- Current assets were $21.829 billion and current liabilities $18.879 billion. The company also held $198 million in available-for-sale securities.
- A $1.5 billion revolving credit facility and a $950 million committed receivables sales facility were available; there were no borrowings under these facilities at period end, apart from $40 million in standby letters of credit. The company reported compliance with its debt covenants.
- Capital expenditures were $175 million for the six months, compared with $83 million a year earlier. Dividends declared were $0.3870 per share for the quarter.
Material changes, outlook, and risks
- Acquisitions: Cardinal Health acquired Harvard Drug for $1.1 billion in July 2015, a 71% interest in naviHealth for $238 million net of cash acquired in August, and Cordis for $1.9 billion in October. Acquisitions supported revenue growth but increased amortization and integration costs, debt-related interest expense, and goodwill and intangible assets. Purchase-price allocations remained preliminary.
- Drivers and unusual items: Growth reflected existing and new pharmaceutical distribution customers, acquisitions, and generics-program performance; customer pricing changes partly offset these benefits. Current-period GAAP results included higher acquisition-related costs and the LIFO charge. Prior-year comparisons included litigation charges and a $60 million debt-extinguishment loss. Non-GAAP results exclude specified items and should be considered alongside GAAP results.
- Management outlook: The filing provides no specific earnings or revenue guidance. Management stated that cash, committed facilities, and projected operating cash flow were expected to cover working capital, planned capital needs, contractual obligations, debt service, dividends, and share repurchases. Additional acquisitions could require capital-markets financing.
- Contingencies: The company continued discussions with the Department of Justice concerning potential civil fines related to a DEA matter and reported a $44 million accrual. West Virginia litigation alleges failures involving controls against diversion of controlled substances; Cardinal Health said it was vigorously defending itself. The company could not estimate reasonably possible losses for certain matters; outcomes could materially affect an individual period.
- Other exposures: Unrecognized tax benefits were $530 million, with a possible net decrease of zero to $190 million over the next 12 months, excluding penalties and interest. The company also has quarterly payments to CVS Health under the Red Oak generic-sourcing venture; payments increased by $10 million beginning in fiscal 2016 and could increase further if another milestone is achieved.
- The company said disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How Cordis, Harvard Drug, and naviHealth perform relative to acquisition assumptions, including purchase-price allocations, integration costs, and Cordis inventory step-up effects.
- Whether pharmaceutical customer growth and generics-program gains can offset pricing pressure and the lower gross margin rate associated with onboarding the mail-order customer.
- Debt, interest expense, operating cash conversion, and acquisition funding needs; the company used substantial cash for acquisitions during the period.
- Developments and potential financial exposure in the DEA and West Virginia proceedings, and changes in tax contingencies.
- Any future changes to formal guidance, which this filing does not specify, and the assumptions behind non-GAAP measures.