Cardinal Health, Inc. — Q2 Fiscal 2018 Form 10-Q
Reporting period: Quarter and six months ended December 31, 2017; comparisons are with the corresponding prior-year periods. Cardinal Health operates Pharmaceutical and Medical segments.
Financial performance
| Metric | Three months ended Dec. 31, 2017 | Six months ended Dec. 31, 2017 |
|---|---|---|
| Revenue | $35.2 billion, up 6% | $67.8 billion, up 4% |
| GAAP operating earnings | $399 million, down 26% | $661 million, down 39% |
| Non-GAAP operating earnings | $730 million, up 4% | $1.34 billion, down 2% |
| GAAP net earnings attributable to Cardinal Health | $1.053 billion, versus $324 million | $1.168 billion, versus $633 million |
| GAAP diluted EPS | $3.33, versus $1.02 | $3.68, versus $1.97 |
| Non-GAAP diluted EPS | $1.51, up 13% | $2.60, up 1% |
| Gross margin | $1.861 billion, up 16% | $3.533 billion, up 11% |
The sharp GAAP earnings and EPS increases primarily reflect the Tax Act benefit, including a provisional net transitional tax benefit of $894 million, as well as the lower tax rate on current U.S. earnings. The reported GAAP effective tax rates were negative 231.9% for the quarter and negative 136.6% for the six months. Non-GAAP results exclude specified items, including acquisition-related costs, litigation charges, restructuring and the transitional tax benefit.
Revenue growth reflected pharmaceutical distribution and specialty customer sales, partly offset by the loss of a large mail-order distribution contract that expired in May 2017. Medical revenue also benefited from acquisitions and customer growth. Pharmaceutical segment profit fell 4% for the quarter and 8% for the six months; Medical segment profit rose 38% and 22%, respectively.
Cash flow, balance sheet and liquidity
- Operating cash flow was $1.46 billion for the six months, compared with $658 million a year earlier; the increase was primarily attributed to working-capital changes.
- Cash and equivalents were $1.249 billion at December 31, 2017, down from $6.879 billion at June 30, 2017. Cash use included $6.141 billion for acquisitions, $403 million to redeem notes, $296 million in dividends, $168 million in capital expenditures and $150 million in share repurchases.
- Total long-term obligations, including current obligations and other short-term borrowings, were $9.8 billion, versus $10.4 billion at June 30. Net interest expense increased 96% for the quarter to $87 million and 91% for the six months to $168 million, primarily due to acquisition financing.
- Commercial paper outstanding was $151 million; there were no amounts outstanding on the $2.0 billion revolving credit facility or $1.0 billion receivables facility. The company was in compliance with its leverage covenant, which temporarily increased following the Patient Recovery acquisition.
- Management stated it believes available capital resources and projected operating cash flow are adequate for anticipated needs, obligations, dividends and debt service. The quarterly dividend was $0.4624 per share; a new $1.0 billion repurchase program was approved February 7, 2018.
Material developments, outlook and risks
- Patient Recovery acquisition: Acquired from Medtronic on July 29, 2017, for $6.1 billion cash. It expanded the Medical segment and contributed to its revenue and profit growth. Management expects a greater Medical segment profit contribution in the second half of fiscal 2018 than in the first half. Purchase-price allocation remained subject to adjustment.
- China divestiture: The China distribution business sale closed February 1, 2018, for $1.2 billion gross proceeds and approximately $800 million net proceeds. The company recorded a $67 million non-deductible write-down and $57 million estimated tax expense in the quarter; the final loss on sale was not yet available when the statements were prepared.
- Fiscal 2018 outlook: Pharmaceutical segment profit is expected to be below fiscal 2017, primarily due to generic pharmaceutical customer pricing changes. Their timing, magnitude and profit impact remain uncertain. Red Oak Sourcing benefits partly offset the pressures.
- Tax Act: The accounting remains provisional; adjustments may be recorded during the remainder of fiscal 2018 and first half of fiscal 2019. The legislation also introduces tax provisions affecting the company beginning July 1, 2018.
- Costs and unusual items: Six-month restructuring and severance expense included $125 million of contract termination costs to shift certain international surgeon-glove distribution to a direct model. Acquisition-related costs and amortization increased, and IVC filter litigation charges rose.
- Contingencies: At December 31, the company had accrued $184 million, net of expected insurance recoveries, for Cordis IVC filter claims; it could not estimate reasonably possible losses beyond the accrual. As of February 2, 2018, it was named in 343 opioid-related lawsuits across 36 jurisdictions and could not predict their outcome or estimate a loss range. It was also cooperating with state investigations.
- Other risks: The acquisition increased foreign-exchange exposure, which had not yet been quantified, and increased direct commodity-price exposure by approximately $108 million. The filing also identifies uncertainty around working capital, product liability, regulatory matters, and other risks described in prior SEC filings.
Important facts for investors to verify
- How provisional Tax Act estimates and the tax rate affect subsequent reported and adjusted earnings.
- Whether generic pricing pressure, Red Oak benefits and the information-systems project affect Pharmaceutical segment profit as anticipated.
- Patient Recovery integration, final purchase accounting, expected profit contribution and acquisition-related debt costs.
- Final proceeds and accounting loss for the China distribution sale, including related tax effects.
- Developments in opioid and IVC filter litigation, including potential exposure beyond recorded accruals.
- Cash conversion and working-capital trends, leverage covenant headroom, and the company’s use of capital for dividends and repurchases.