Cardinal Health, Inc. — Form 10-Q Summary
Period clarification: The request labels this “2013 Q3,” but the filing is for the quarter ended March 31, 2014 (Cardinal Health fiscal 2014 third quarter), and covers the nine months ended that date. Financial amounts below are in U.S. dollars; tables show millions except per-share data.
Business context and reporting period
Cardinal Health provides pharmaceutical and medical products and services through its Pharmaceutical and Medical segments. The quarter’s results reflect the August 31, 2013 expiration of its pharmaceutical distribution contract with Walgreens, which had represented about 20% of fiscal 2013 consolidated revenue.
Key financial results
| Metric | Three months ended March 31, 2014 | Year-over-year change | Nine months ended March 31, 2014 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $21,427 | Down 13% | $68,190 | Down 10% |
| Gross margin | $1,297 | Flat | $3,905 | Up 6% |
| Operating earnings | $508 | Up 7% | $1,498 | Up 4% |
| Earnings from continuing operations | $315 | Down 9% | $929 | Up 1% |
| Net earnings | $315 | From $345 | $932 | From $920 |
| Diluted EPS | $0.91 | From $1.00 | $2.70 | From $2.67 |
| Operating cash flow | Not provided for quarter | — | $1,808 | From $1,427 |
Gross margin was approximately 6.1% of revenue for the quarter and 5.7% for the nine-month period, compared with approximately 5.3% and 4.9%, respectively, in the prior-year periods. The filing attributes margin support to generic programs and generic price appreciation, partly offset by customer pricing changes.
At March 31, 2014, cash and equivalents were $3,041, total assets were $24,701, and shareholders’ equity was $6,532. Current assets of $16,936 exceeded current liabilities of $13,147 (current ratio approximately 1.29). Long-term obligations were $3,679 and current obligations/short-term borrowings were $241, for total obligations of $3,920. Cash exceeded these obligations by approximately $879.
Nine-month cash generation included $1,473 from a decrease in trade receivables and $350 from a decrease in inventories, partly offset by a $1,392 decrease in accounts payable. Investing cash outflow was $286; financing cash outflow was $382, including $312 of dividends and $389 of share repurchases. Cash rose by $1,140 to $3,041.
Material changes versus prior comparable periods
- Pharmaceutical revenue fell 15% in the quarter and 12% year to date. Management attributed the decline primarily to Walgreens, with an additional nine-month impact from the earlier expiration of the Express Scripts contract. New and existing customer growth partly offset these losses.
- Medical revenue increased 7% for the quarter and 11% year to date, principally reflecting acquisitions, including AssuraMed. Medical segment profit rose 11% and 30%, respectively.
- Pharmaceutical segment profit declined 9% in the quarter but increased 2% year to date. Consolidated operating earnings improved partly because the prior-year quarter included $33 million of restructuring costs and $21 million of impairments.
- Quarterly continuing-operations earnings declined despite higher operating earnings. The effective tax rate rose to 38.0% from 22.7%; the prior-year quarter benefited from $57 million of favorable discrete tax items, including a $64 million deferred-tax-liability revaluation. Current-quarter earnings included a $32 million pretax gain from selling minority investments.
- Cash increased substantially, partly because Walgreens-related working-capital balances declined. The company repurchased $389 million of shares during the nine months, compared with $200 million in the prior-year period.
Outlook, management commentary, risks and unusual items
- Management expected the Walgreens expiration to continue adversely affecting year-over-year revenue and operating-earnings comparisons through the remainder of fiscal 2014 and the first quarter of fiscal 2015. The filing provides no specific earnings or revenue guidance.
- Cardinal and CVS planned a 50/50 generic sourcing joint venture, expected to begin operating as soon as July 1, 2014, subject to final documentation and customary conditions. Cardinal agreed to pay CVS $25 million quarterly over the venture’s initial 10-year term.
- Management said future generic price appreciation is uncertain. Medical segment results were moderated by procedural-volume softness and lower Presource kitting volumes.
- Liquidity sources included $3.0 billion of cash, a $1.5 billion revolving credit facility, a commercial paper program of up to $1.5 billion, and a reduced $700 million receivables sales facility. There were no borrowings under the revolving facility, commercial paper program, or receivables facility at quarter end, other than $41 million of standby letters of credit. The company reported compliance with its financial covenants and said it expected adequate resources for anticipated needs.
- Material legal and regulatory matters included discussions with the DEA and DOJ regarding controlled-substance distribution, West Virginia claims concerning opioid diversion controls, and a DOJ investigation of a Medical segment federal prime-vendor agreement. The company could not estimate reasonably possible losses for the described proceedings; it stated outcomes could materially affect a particular period’s results.
- Tax uncertainties included IRS audits for fiscal 2006–2010, including transfer-pricing matters. Unrecognized tax benefits were $539 million at March 31, 2014; the company estimated a possible net decrease of approximately zero to $90 million over the next 12 months, excluding penalties and interest.
- The company announced a $320 million all-cash agreement to acquire Access Closure after quarter end, with closing expected in May 2014 subject to customary conditions and regulatory clearances. The Medical segment’s Waukegan restructuring was expected to incur approximately $5 million of additional costs, primarily through fiscal year-end.
Important facts for investors to verify
- How much of the revenue and earnings pressure from Walgreens and Express Scripts has been offset by new customer growth, and what the post-Walgreens run rate implies.
- Whether generic-program margins and price appreciation persist, given management’s warning that their future magnitude and timing are uncertain.
- The economics and implementation status of the CVS sourcing joint venture, including the recurring $25 million quarterly payment.
- Developments and potential financial exposure from the DEA/DOJ, West Virginia, and federal False Claims Act matters, as well as IRS transfer-pricing audits.
- Cash-flow sustainability after the working-capital reductions associated with Walgreens, and capital allocation among acquisitions, dividends, and repurchases.