CARDINAL HEALTH INC quarterly report, Q1 FY2019

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Cardinal Health, Inc. — Q1 Fiscal 2019 Form 10-Q

Business context and period: Cardinal Health is an integrated healthcare services and products company operating through Pharmaceutical and Medical segments. This unaudited filing covers the three months ended September 30, 2018, compared with the three months ended September 30, 2017, and balance-sheet changes from June 30, 2018.

Financial performance

  • Revenue: $35.213 billion, up 8% year over year. Pharmaceutical revenue was $31.416 billion, up 9%; Medical revenue was $3.801 billion, up 2%. Pharmaceutical distribution and specialty customer growth drove results; the China distribution divestiture partly offset growth.
  • Profit: GAAP operating earnings were $816 million versus $262 million; net earnings attributable to Cardinal Health were $593 million versus $115 million. GAAP diluted EPS was $1.94 versus $0.36. Results included a $508 million pre-tax gain on the naviHealth divestiture.
  • Adjusted results: Non-GAAP operating earnings declined 11% to $542 million, while non-GAAP diluted EPS rose 18% to $1.29. The filing’s non-GAAP measures exclude specified items and are not substitutes for GAAP results.
  • Margins and costs: Gross margin was $1.667 billion, essentially flat year over year; gross margin rate fell 39 basis points. Cost of products sold was $33.546 billion, up 8%, and SG&A was $1.155 billion, up 9%. Pharmaceutical segment profit fell 12% to $409 million; Medical segment profit rose 5% to $135 million.
  • Cash flow and capital allocation: Operating cash flow was $365 million, down from $1.181 billion. Investing activities provided $679 million, including divestiture proceeds; financing activities used $764 million. Cash and equivalents were $2.045 billion at quarter-end, versus $1.763 billion at June 30. The company spent $600 million on share repurchases and paid $150 million in dividends.
  • Debt and liquidity: Long-term obligations, including current portions and other short-term borrowings, totaled $9.0 billion. No amounts were outstanding under the commercial paper program, revolving credit facility, or receivables sales facility at September 30. The company reported compliance with its leverage covenant. Current assets were $24.445 billion and current liabilities were $23.057 billion.
  • Taxes: The effective tax rate was 19.4%, compared with 34.2%, primarily reflecting Tax Act benefits and discrete tax items. Tax Act accounting remained provisional; further adjustments could be recorded through December 2018.

Material changes and management commentary

  • In August 2018, Cardinal Health sold its 98% ownership interest in naviHealth for $737 million in cash and a 44% interest in a partnership owning naviHealth. It retained certain call rights to reacquire the business. The transaction generated the $508 million pre-tax gain and an initial $358 million equity-method investment.
  • Management attributed weaker Pharmaceutical segment profit to generics program performance and adverse customer contract renewals; specialty distribution and services partly offset the pressure. Higher costs for Cardinal Health Brand products, including Cordis, weighed on Medical performance. Management expects Cordis operating performance to improve in fiscal 2019.
  • Management stated that available capital resources and projected operating cash flow were adequate for anticipated operating needs, capital spending, debt service, dividends, and repurchases. Additional acquisitions could require capital-market financing.
  • The quarterly dividend was maintained at $0.4763 per share, or $1.91 annualized. In November 2018, the board approved a new $1.0 billion share repurchase authorization.

Risks, contingencies, and unusual items

  • Opioid matters: Cardinal Health was among defendants in more than 1,000 opioid-distribution lawsuits, including 50 purported class actions. The company said it could not predict outcomes or estimate a reasonably possible loss range. It accrued $34 million for the New York Opioid Stewardship Act assessment for 2017 and the first three quarters of 2018; the state’s estimate remained subject to validation and could vary significantly.
  • Cordis IVC filters: The company reported 198 coordinated California lawsuits involving approximately 2,218 plaintiffs and 19 similar lawsuits involving approximately 20 plaintiffs elsewhere. It had accrued $268 million, net of estimated insurance recoveries, for losses and defense costs; the estimated high end of the loss range was approximately $459 million, net of recoveries.
  • Medical goodwill: Following a $1.4 billion Medical segment goodwill impairment in fiscal 2018, management cautioned that weaker-than-expected earnings, higher interest rates, or adverse industry or economic trends could lead to further impairment.
  • Other items: The quarter included $32 million of restructuring and severance costs, $156 million of amortization and other acquisition-related costs, and $19 million of net litigation charges. The prior-year quarter included $132 million of restructuring and severance costs, including $125 million of contract termination costs.
  • The company’s filing identifies risks from litigation and regulatory matters, product quality and liability claims, tax uncertainty, working-capital variability, and other risks described in its 2018 Form 10-K. Disclosure controls were reported effective, with no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

  • How much of GAAP earnings and EPS growth reflects the one-time naviHealth gain and tax benefits, versus recurring operating performance.
  • Whether Pharmaceutical generics performance and customer contract renewals improve, and whether management’s expectation for Cordis improvement is realized.
  • Final New York opioid assessment amounts, developments in opioid litigation, and changes to the Cordis IVC filter loss estimate or insurance recoveries.
  • Whether Medical segment assumptions remain sufficient to avoid further goodwill impairment.
  • How cash conversion, working-capital requirements, debt levels, and covenant headroom evolve following share repurchases and dividends.
  • The filing provides no quantified full-year earnings guidance in the supplied text; verify subsequent outlook and any finalized Tax Act accounting adjustments.