Cardinal Health, Inc. — Q1 FY2015 Form 10-Q
Reporting period: Three months ended September 30, 2014; filed November 5, 2014. The interim financial statements are unaudited. Cardinal Health distributes pharmaceutical and medical products and reports Pharmaceutical and Medical segments.
Financial results
| Metric | Q1 FY2015 | Q1 FY2014 |
|---|---|---|
| Revenue | $24.070 billion | $24.523 billion |
| Gross margin | $1.341 billion | $1.264 billion |
| Operating earnings | $466 million | $471 million |
| Earnings from continuing operations | $266 million | $340 million |
| Net earnings | $266 million | $339 million |
| Diluted EPS | $0.78 | $0.99 |
| Operating cash flow | $61 million | $951 million |
- Gross margin rate was approximately 5.6%, versus 5.2%; operating margin was approximately 1.9% in both periods. Net margin was approximately 1.1%, versus 1.4%.
- Pharmaceutical revenue was $21.209 billion, down 3%; segment profit was $451 million, up 4%. Medical revenue was $2.852 billion, up 5%; segment profit was $113 million, up 6%.
- At September 30, cash and equivalents were $2.469 billion; current assets were $17.538 billion and current liabilities $14.896 billion. Long-term obligations were $3.164 billion, with $843 million current. Total obligations and short-term borrowings had a carrying amount of $4.007 billion.
- Operating cash flow was reduced by working-capital movements, including a $291 million increase in receivables and a $157 million decrease in accounts payable; inventory fell $199 million. Investing cash flow was negative $81 million and financing cash flow negative $376 million. Cash declined $396 million during the quarter.
- Quarterly dividend declared was $0.3425 per share. The company repurchased $360 million of shares during the quarter.
Material changes and management commentary
- Revenue declined 2%, primarily because the Walgreens distribution contract expired on August 31, 2013. Its loss reduced Pharmaceutical revenue by $3.3 billion year over year, partly offset by $2.6 billion growth from existing and new pharmaceutical customers.
- Gross margin rose 6%, with the net impact of customer growth and the Walgreens contract expiration increasing gross margin by $66 million. Generic-program performance supported margins, while customer pricing changes offset some benefit.
- Operating earnings fell 1%, principally reflecting higher litigation charges: $28 million versus $1 million, including a $27 million accrual related to the DEA investigation. SG&A increased 6%, primarily due to acquisitions.
- Continuing-operations earnings fell 22%, primarily because the prior-year period included a $63 million favorable tax-contest settlement. The current-period effective tax rate was 38.9%, versus 23.2%; the current rate reflected several discrete tax items.
- Management said cash resources, committed facilities and projected operating cash flow were adequate for expected working capital, investment, contractual obligations, debt service, dividends and repurchases. No quantitative earnings or revenue guidance is provided in the supplied filing text.
Outlook, commitments and risks
- In July 2014, Cardinal and CVS formed Red Oak Sourcing, a 50/50 generic-drug sourcing venture with an initial 10-year term. Cardinal committed to 39 quarterly payments of $25.6 million to CVS beginning October 2014; additional payments may be due if specified milestones are achieved. Fixed payments are to be expensed beginning in Q2 FY2015.
- The company reports ongoing controlled-substance-related matters, including the DEA investigation and West Virginia litigation. It accrued $27 million for the DEA matter; it could not estimate reasonably possible losses for certain other proceedings. Management did not believe currently known outcomes would materially affect overall financial position, results or cash flows, though a matter could be material in an individual period.
- The DOJ declined to intervene in a federal False Claims Act qui tam action concerning a Medical segment federal prime-vendor agreement; the private party may continue the action. The FTC was considering whether to take civil action regarding supplier arrangements in Nuclear Pharmacy Services.
- Unrecognized tax benefits were $524 million at quarter-end; the company estimated a possible $45 million decrease to a $20 million increase over the following 12 months, excluding interest and penalties. IRS audits include fiscal years 2006–2010, with transfer-pricing arrangements under consideration.
- On November 3, 2014, the receivables sales facility was renewed through November 2017 and increased from $700 million to $950 million. The company also reported no outstanding borrowings under its $1.5 billion revolving facility or commercial-paper program at quarter-end and compliance with financial covenants.
- October 2014 repurchases totaled $231 million. The board had $1.367 billion remaining under its share-repurchase authorization at September 30. No significant off-balance-sheet arrangements or material changes in contractual obligations were reported.
Important facts for investors to verify
- Whether pharmaceutical customer growth and generic-program performance continue to offset the Walgreens contract loss and customer pricing pressure.
- The cash-flow and working-capital trend, especially given the large year-over-year operating cash-flow decline.
- Developments and potential financial exposure in the DEA, West Virginia, False Claims Act and FTC matters, as well as tax audits and uncertain tax positions.
- The economics, payment obligations and milestone terms of Red Oak Sourcing, and the effect of its costs on future earnings.
- Future capital allocation, including repurchases, dividends, debt obligations and use of the expanded receivables facility.