Cardinal Health, Inc. — Q2 Fiscal 2020 Form 10-Q
Reporting period: Quarter and six months ended December 31, 2019; fiscal year ends June 30. The interim financial statements are unaudited. Comparisons below are with the prior-year periods unless noted.
Business context and results
Cardinal Health is a healthcare services and products company operating through Pharmaceutical and Medical segments. Its distribution business generates substantial revenue but relatively thin gross margins.
| Metric | Quarter ended Dec. 31, 2019 | Six months ended Dec. 31, 2019 |
|---|---|---|
| Revenue | $39.735 billion, up 5% | $77.076 billion, up 6% |
| GAAP operating earnings/(loss) | $334 million, down 34% | $(4.930) billion, versus $1.320 billion earnings |
| GAAP net earnings/(loss) attributable to Cardinal Health | $220 million, versus $280 million | $(4.702) billion, versus $873 million earnings |
| GAAP diluted EPS | $0.75, versus $0.93 | $(15.99), versus $2.88 |
| Non-GAAP operating earnings | $646 million, up 1% | $1.223 billion, up 4% |
| Non-GAAP diluted EPS | $1.52, up 18% | $2.80, up 9% |
| Gross margin | $1.714 billion, down 1%; rate down 27 basis points | $3.393 billion, essentially flat; rate down 26 basis points |
| Operating cash flow | Not separately stated for the quarter | $44 million, versus $736 million |
Pharmaceutical revenue rose 6% in both periods, mainly from distribution and specialty solutions growth. Medical revenue was essentially flat for the quarter and up 2% for the six months. Segment profit increased 4% in the quarter and 4% year to date: Pharmaceutical segment profit rose 4% and 1%, respectively; Medical rose 4% and 13%.
Cash, debt and liquidity
- Cash and equivalents were $1.659 billion at December 31, 2019, down from $2.531 billion at June 30, 2019. Cash flow from operations was $44 million for the six months; capital expenditures were $149 million.
- Over the six months, the company repaid $793 million of long-term debt, repurchased $350 million of shares and paid $287 million in cash dividends. Net cash used in financing activities was $760 million.
- Total long-term obligations, including current maturities and other short-term borrowings, were $7.934 billion. This included $458 million of commercial paper and $225 million under the receivables sales facility. No amount was drawn on the $2.0 billion revolving credit facility.
- The company reported compliance with its quarterly net leverage covenant. Management said available capital, committed facilities and projected operating cash flow were adequate for anticipated needs, including potential opioid-settlement payments.
Material changes and unusual items
- Opioid litigation: The company recorded a $5.63 billion pre-tax charge ($5.14 billion after tax) in the six-month period. In October 2019 it agreed in principle to a settlement framework involving up to $5.56 billion in cash payments over 18 years, treatment-medication distribution for ten years and industry anti-diversion changes. Final terms and participation remain uncertain. A separate $66 million share of a settlement with two Ohio counties was paid in January 2020. The company cannot reasonably estimate costs for the non-cash settlement components.
- Surgical gown recalls: A January 2020 recall and field actions covered 9.1 million gowns and 2.9 million procedure packs after a supplier shifted production to unapproved sites, leaving sterility uncertain. A $96 million charge was recorded in the December quarter, including $56 million in cost of products sold and $40 million in SG&A. The company warned of potential further costs, regulatory actions, claims, shortages, delayed or canceled surgeries, reputational harm and lost sales; ultimate exposure is uncertain.
- Quarterly GAAP operating earnings also reflected higher restructuring costs and adverse Pharmaceutical customer contract renewals. Non-GAAP EPS benefited from a lower effective tax rate and share repurchases. The six-month prior-year comparison included a $508 million pre-tax gain from the naviHealth divestiture.
- Gross margin rate pressure reflected customer contract renewals, product mix and the recall charge. Enterprise-wide cost savings, specialty growth and the generics program partly offset these pressures.
Outlook, risks and contingencies
The filing provides no specific numerical fiscal 2020 earnings or revenue guidance. Management said generic pricing changes remain uncertain and could cause Pharmaceutical segment profit to differ from expectations. The settlement framework remains under negotiation, and the opioid accrual may not equal the ultimate loss. The estimated tax benefit related to the opioid charge is subject to significant judgment and possible challenge by tax authorities. Other disclosed exposures include IVC filter product-liability litigation, private opioid claims, government investigations, generic-drug antitrust litigation and blood-pressure medication recall litigation. Medical Unit goodwill had only about 4% fair-value headroom over carrying value in the fiscal 2019 annual test; recall-related or other adverse developments could affect future impairment assessments.
The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It adopted the lease accounting standard in fiscal 2020, recognizing $422 million of lease liabilities at adoption, with no material effect on results, liquidity or covenant compliance.
Important facts for investors to verify
- Whether the opioid settlement reaches definitive terms, what parties participate, and whether the $5.63 billion accrual and related tax assumptions remain adequate.
- Further recall costs, supply recovery and customer retention, as well as any regulatory, patient or customer claims related to the gowns and procedure packs.
- Operating cash flow and working-capital trends, given the $44 million six-month operating cash flow and substantial inventory increase.
- Progress on customer contract renewals, generic-program performance and cost savings, which influence underlying segment profit.
- Medical Unit goodwill valuation assumptions and developments in the IVC filter and other material legal proceedings.