Business Context and Reporting Period
Cardinal Health, Inc. is a healthcare services company distributing pharmaceuticals and medical products, providing related services, and supplying medical products to patients at home. This Form 10-K covers the fiscal year ended June 30, 2014, with comparisons to fiscal 2013 and 2012; it is not a quarterly filing. The filing also reports fourth-quarter fiscal 2014 results. The requested “2013 Q4” period does not match the filing’s primary reporting period.
The company reports Pharmaceutical and Medical segments. CVS represented 28% of fiscal 2014 revenue; the five largest customers together accounted for 42%.
Financial Performance
| Metric | FY 2014 | FY 2013 | Change |
|---|---|---|---|
| Revenue | $91.084 billion | $101.093 billion | Down 10% |
| Gross margin | $5.161 billion | $4.921 billion | Up 5% |
| Operating earnings | $1.885 billion | $996 million | Up 89% |
| Earnings from continuing operations | $1.163 billion | $335 million | Up 247% |
| Net earnings | $1.166 billion | $334 million | Up 249% |
| Diluted EPS, continuing operations | $3.37 | $0.97 | Up |
| Operating cash flow | $2.524 billion | $1.727 billion | Up |
- Gross margin was approximately 5.7% of revenue, versus 4.9% in fiscal 2013; operating margin was approximately 2.1%, versus 1.0%.
- Pharmaceutical revenue was $80.110 billion, down 12%; segment profit was $1.745 billion, up 1%. Medical revenue was $10.962 billion, up 9%; segment profit was $444 million, up 19%.
- Cash and equivalents were $2.865 billion at year-end, versus $1.901 billion. Total long-term obligations and other short-term borrowings were $3.972 billion, versus $3.854 billion. Shareholders’ equity was $6.401 billion.
- Current assets were $17.939 billion and current liabilities $15.115 billion. The company reported no borrowings under its revolving credit facility or commercial paper program at year-end and was in compliance with its financial covenants.
- Capital spending was $249 million. Cash deployed included $673 million for share repurchases, $519 million for acquisitions, and $415 million for dividends.
Material Changes and Unusual Items
- Revenue fell primarily because the Walgreens distribution contract expired on August 31, 2013. Walgreens revenue was $16.9 billion lower year over year; Express Scripts contract expiration also reduced the comparison by $2.0 billion. Management said Walgreens’ first-quarter fiscal 2014 revenue of $3.3 billion would make first-quarter fiscal 2015 comparisons particularly difficult.
- Operating earnings and continuing earnings improved substantially in part because fiscal 2013 included an $829 million non-cash goodwill impairment charge ($799 million after tax) for Nuclear Pharmacy Services. This impairment did not affect liquidity, operating cash flow, or debt covenant compliance.
- Fiscal 2014 gross margin benefited from acquisitions and strong generic programs, including generic drug price appreciation. Management cautioned that the frequency and magnitude of future price appreciation are uncertain and that its earnings contribution could be lower in fiscal 2015.
- Medical results benefited from acquisitions, including AssuraMed, acquired in fiscal 2013, and AccessClosure, acquired for $320 million in May 2014. Acquisition-related amortization and costs rose to $223 million from $158 million.
- Fiscal 2014 tax expense included net favorable discrete items of $37 million. Fiscal 2013’s 62.3% effective tax rate was elevated in part by the largely nondeductible goodwill impairment; the fiscal 2014 rate was 35.3%.
- Fourth-quarter fiscal 2014 revenue was $22.894 billion, gross margin $1.256 billion, continuing-operations earnings $234 million, and diluted continuing-operations EPS $0.68.
Outlook, Risks, and Contingencies
- Management expected fiscal 2015 capital expenditures of $335 million to $365 million, primarily for core-business growth and information technology. The filing does not provide a clear numerical earnings or revenue forecast.
- In July 2014, Cardinal Health and CVS formed Red Oak Sourcing, a 50/50 generic-drug sourcing joint venture with an initial 10-year term. Cardinal Health committed to 39 quarterly payments of $25.6 million to CVS beginning in October 2014, regardless of realized benefits; additional payments may apply if specified milestones are met.
- Management stated it believed available cash, committed credit facilities, and projected operating cash flow were adequate for anticipated needs. Future dividends and repurchases remain subject to Board discretion and business requirements.
- Key risks include intense pricing and margin pressure, dependence on CVS and other large customers, generic-drug launch and price volatility, healthcare regulation and reimbursement changes, cybersecurity and operational disruptions, supplier and commodity-cost exposure, acquisition integration, and foreign-market risks.
- Material disclosed matters include the continuing DOJ/DEA discussions following the Lakeland, Florida controlled-substance investigation; West Virginia litigation alleging failures to control diversion of controlled substances; and a DOJ request for information concerning a federal False Claims Act investigation involving a Medical segment government contract. The company said it could not estimate reasonably possible losses for the described matters; it did not believe outcomes would materially affect overall financial position, results, or cash flows, though an individual period could be affected.
- The company reported an unqualified audit opinion on its financial statements and internal controls. It also disclosed an $80 million favorable settlement effect from federal and state tax controversies, partially offset by tax-benefit remeasurement and proposed additional assessments.
Important Facts for Investors to Verify
- Confirm that the intended period is fiscal 2014 or fiscal 2013 fourth quarter; this filing’s fourth-quarter fiscal 2014 results differ from fiscal 2013’s fourth-quarter loss of $586 million, which included the Nuclear Pharmacy goodwill impairment.
- Assess revenue and profit trends after the Walgreens contract expiration, including the impact on customer concentration, working capital, and year-over-year comparisons.
- Evaluate whether generic-program performance and Red Oak Sourcing benefits justify the venture’s fixed payment commitment and any milestone-based payments.
- Review debt maturities, including $801 million of obligations due in fiscal 2015, and consider liquidity against ongoing capital returns and acquisition plans.
- Track developments in the controlled-substance investigations and litigation, the federal government-contract investigation, and IRS audits and uncertain tax positions.