CAH

Business Context and Reporting Period

Company: Cardinal Health, Inc.
Filing Type: Form 10-K (Annual Report)
Reporting Period: Fiscal year ended June 30, 2010
Business Overview: A global healthcare solutions company operating primarily in two segments: Pharmaceutical (distribution of branded/generic drugs, nuclear pharmacy, specialty services) and Medical (distribution and manufacturing of medical/surgical products).
Key Event: The fiscal year followed the August 31, 2009, spin-off of CareFusion Corporation. Cardinal Health retained a 19% stake (approx. 30.5 million shares) in CareFusion, which is required to be disposed of by August 31, 2014.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Consolidated revenue increased 3% to $98.5 billion. The Pharmaceutical segment grew 2% ($89.8 billion), while the Medical segment grew 7% ($8.8 billion).
• Profitability Decline: Net earnings dropped significantly to $642.2 million from $1.15 billion in 2009. This was primarily driven by a higher effective tax rate (51.6% vs. 34.6%) due to a $168 million charge for repatriation of foreign earnings and a shift in business mix toward higher-tax U.S. jurisdictions.
• Segment Performance: Pharmaceutical segment profit declined 3% due to pricing changes on renewed contracts, fewer generic launches, and a severe shortage of radioisotopes affecting nuclear pharmacy operations. Medical segment profit increased 11% driven by volume growth and lower commodity costs.
• Debt Reduction: Long-term obligations decreased by approximately $1.4 billion, largely due to a debt tender in September 2009 where the company purchased over $1.1 billion of debt securities using cash distributed from CareFusion.
• Working Capital: Cash and equivalents increased by $1.5 billion, driven by $2.0 billion in net cash provided by operating activities and improved working capital management (DSO improved to 18.6 days).

Guidance, Outlook, and Risks

• Outlook: Management expects low single-digit revenue growth in fiscal 2011. Gross margins are expected to face pressure from competitive pricing and commodity costs, though the company is implementing programs to improve margins.
• Healthcare Reform: The Patient Protection and Affordable Care Act (signed March 2010) is expected to increase demand for products but also introduces cost-reduction measures, including a 2.3% excise tax on medical device manufacturers starting in 2013.
• Supply Chain Risks: The nuclear pharmacy business faces a prolonged shortage of a critical radioisotope due to reactor downtimes, expected to normalize in the first half of fiscal 2011. The Medical segment anticipates negative year-over-year impacts from higher commodity prices (oil, latex, etc.).
• Customer Concentration: The top five customers accounted for 57% of revenue in 2010. Walgreen Co. and CVS Caremark Corporation individually accounted for 24% and 22% of revenue, respectively.
• Regulatory & Tax: The company is subject to ongoing IRS audits (fiscal years 2001-2007) with proposed adjustments of $598 million. The company disputes these but believes reserves are adequate.

Investor Verification Checklist

• Tax Rate Volatility: Verify the sustainability of the 51.6% effective tax rate and the impact of the $168 million repatriation charge on future earnings.
• Radioisotope Supply: Monitor the resolution of the nuclear pharmacy isotope shortage and its impact on the Pharmaceutical segment's margins in fiscal 2011.
• Customer Concentration: Assess the risk associated with the top two customers (Walgreens and CVS) representing 46% of total revenue.
• Debt Covenants: Confirm continued compliance with the 4-to-1 interest coverage and 3.25-to-1 leverage ratios required by credit facilities.
• CareFusion Disposition: Track the company's progress in disposing of its remaining 30.5 million CareFusion shares, which must be sold by August 31, 2014.
• IRS Audit Status: Review updates on the $598 million proposed tax adjustment from the IRS regarding transfer pricing and intellectual property transfers.