Cardinal Health, Inc. — Q2 Fiscal 2019 Form 10-Q
Reporting period: Quarter and six months ended December 31, 2018; filed February 7, 2019. Cardinal Health operates Pharmaceutical and Medical segments, distributing pharmaceuticals and manufacturing, sourcing and distributing medical products and services.
Financial results
| Metric | Q2 FY2019 | Q2 FY2018 | Six months FY2019 | Six months FY2018 |
|---|---|---|---|---|
| Revenue | $37.740B (+7%) | $35.186B | $72.953B (+8%) | $67.827B |
| Gross margin | $1.730B (-7%); rate down 71 bps | $1.861B | $3.397B (-4%); rate down 55 bps | $3.533B |
| GAAP operating earnings | $504M (+26%) | $399M | $1.320B (+100%) | $661M |
| Non-GAAP operating earnings | $637M (-13%) | $730M | $1.178B (-12%) | $1.340B |
| GAAP diluted EPS | $0.93 (-72%) | $3.33 | $2.88 (-22%) | $3.68 |
| Non-GAAP diluted EPS | $1.29 (-15%) | $1.51 | $2.58 (-1%) | $2.60 |
| Operating cash flow | Not presented as a quarterly figure | $736M | $1.460B |
Quarterly GAAP net earnings attributable to Cardinal Health were $280M, versus $1.053B a year earlier; six-month earnings were $873M versus $1.168B. Prior-year results included large transitional tax benefits from the Tax Act. Current-period GAAP operating earnings also benefited from the naviHealth sale in the six-month period; the $508M pretax gain is excluded from non-GAAP results.
Segment performance and key changes
- Pharmaceutical: Revenue rose 8% in both periods, to $33.740B for Q2 and $65.155B for six months. Segment profit fell 14% to $443M in Q2 and 13% to $851M for six months. Generics program performance and pharmaceutical customer contract renewals weighed on profit; specialty pharmaceutical growth partly offset the pressure.
- Medical: Q2 revenue declined 1% to $4.006B; six-month revenue increased 1% to $7.807B. Segment profit fell 14% to $188M in Q2 and 7% to $323M for six months, primarily reflecting higher costs for Cardinal Health Brand products.
- Gross margin declines reflected product mix, weaker generics-program contribution and customer contract renewals. Specialty pharmaceutical growth provided a partial offset.
- Q2 GAAP operating earnings benefited from improved litigation comparisons and growth in specialty pharmaceuticals. Six-month results also benefited from the $508M naviHealth divestiture gain and comparisons with prior-year costs, including $125M of surgeon-glove contract termination costs.
Liquidity, debt and capital allocation
- Cash and equivalents were $2.182B at December 31, 2018, up from $1.763B at June 30, 2018. Six-month operating cash flow was $736M. The naviHealth sale generated $737M cash proceeds; the company also paid $600M for share repurchases and $293M in dividends.
- Total long-term obligations, including current portions and other short-term borrowings, were $9.0B. No amounts were outstanding at period-end under the $2.0B commercial paper program, its $2.0B revolving credit facility, or the $1.0B committed receivables facility. The company reported compliance with financial covenants.
- Current assets were $25.091B and current liabilities $23.824B at December 31, 2018. The filing states management believed available capital resources and projected operating cash flow were adequate for anticipated needs.
- Capital expenditures were $116M for the six months. The quarterly dividend was $0.4763 per share. A new $1.0B repurchase authorization was approved; $1.293B remained available under all programs at December 31, 2018.
Outlook, risks and unusual items
- The provided filing text does not state specific earnings or revenue guidance. Management said liquidity was adequate for anticipated operating, investment, debt-service and shareholder-return needs; acquisitions could require additional financing.
- In August 2018, Cardinal Health sold its 98% naviHealth ownership for $737M cash and a 44% partnership interest, retaining certain call rights. It recorded a $508M pretax gain and estimated approximately $130M of fiscal 2019 tax expense related to the transaction.
- The New York Opioid Stewardship Act assessment was ruled unconstitutional in December 2018. Cardinal Health reversed the related accrual in Q2; New York filed notice of appeal in January 2019.
- Cardinal Health faced more than 1,500 opioid-related lawsuits. The company said outcomes and reasonably possible losses could not be estimated; three cases were set for trial in October 2019. It reported vigorously defending the matters.
- For Cordis IVC filter litigation, the company had accrued $302M net of estimated insurance recoveries; its estimated high end of loss was approximately $519M. The filing also reports 212 coordinated California lawsuits and 22 similar suits elsewhere as of January 31, 2019.
- Following a $1.4B Medical-segment goodwill impairment in fiscal 2018, management warned that adverse changes in assumptions or business conditions could result in further impairment. The six-month period also included $34M of severance costs from enterprise-wide cost-saving measures.
- Non-GAAP results exclude specified items and are supplemental, not substitutes for GAAP measures. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether pharmaceutical generics performance and customer contract renewals improve, and whether gross-margin-rate pressure persists.
- How much of the six-month GAAP earnings increase reflects the one-time naviHealth gain versus ongoing operations; compare GAAP and non-GAAP results.
- Developments in opioid litigation and the New York assessment appeal, including any change to the company’s inability to estimate potential losses.
- Updates to IVC filter reserves, insurance recoveries and the estimated loss range.
- Medical segment performance and assumptions supporting goodwill valuations, as further impairment could affect results.
- Cash generation, working-capital movements, debt and covenant headroom as leverage limits tighten under the amended facilities.