Business context and reporting period
Cardinal Health, Inc. filed this unaudited Form 10-Q for the quarter ended March 31, 2010 (fiscal 2010 third quarter), with year-to-date results for the nine months ended that date. The supplied metadata says “2009 Q3,” but the filing itself covers 2010 Q3. Cardinal operates Pharmaceutical and Medical segments, distributing healthcare products and providing related services.
The August 31, 2009 CareFusion spin-off materially affects comparisons: CareFusion’s results are reported as discontinued operations through the spin-off date, and the prior-year periods include CareFusion operations.
Financial performance and position
Amounts are in millions, except per-share data and percentages.
| Metric | Three months 2010 | Three months 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Revenue | $24,342.8 | $24,089.3 | $74,043.2 | $71,644.3 |
| Gross margin | $1,010.1 | $986.9 | $2,876.6 | $2,803.3 |
| Operating earnings | $366.3 | $380.9 | $973.0 | $980.7 |
| Earnings from continuing operations | $224.8 | $215.1 | $393.2 | $556.2 |
| Net earnings | $222.4 | $312.9 | $418.7 | $878.4 |
| Diluted EPS, continuing operations | $0.62 | $0.60 | $1.09 | $1.54 |
| Net diluted EPS | $0.61 | $0.87 | $1.16 | $2.43 |
- Revenue rose 1% in the quarter and 3% year to date. Gross margin increased 2% and 3%, respectively; gross margin as a share of revenue was approximately 4.15% and 3.89%.
- Operating earnings fell 4% in the quarter and 1% year to date, with higher SG&A more than offsetting gross-margin growth. Operating margin was approximately 1.50% for the quarter and 1.31% year to date.
- Net earnings declined chiefly because discontinued-operations earnings were much lower after the CareFusion spin-off. Continuing-operations earnings increased 5% in the quarter but declined 29% year to date.
- For the nine months, income-tax provision was $510.0 million and the effective tax rate was 56.5%, including a $171.9 million charge related to anticipated repatriation of foreign earnings. The comparable 2009 effective rate was 36.1%.
- Pharmaceutical segment revenue was $22,226.2 million for the quarter (+less than 1%) and $67,483.2 million year to date (+3%); segment profit was $306.7 million (+7%) and $774.8 million (+2%). Medical revenue was $2,122.7 million (+7%) and $6,592.2 million (+9%); segment profit was $107.8 million (-16%) and $325.2 million (+8%).
Cash flow, debt and liquidity
- Nine-month operating cash flow was $1,809.9 million, including $1,662.0 million from continuing operations. Working-capital movements included a $1,722.7 million increase in accounts payable, partly offset by increases in receivables ($365.4 million) and inventory ($381.1 million).
- Investing activities provided $105.6 million, including $270.7 million from CareFusion share sales, partly offset by $141.8 million of capital expenditures. Financing activities used $498.3 million overall; continuing-operations financing used $1,782.1 million, including debt repayments and dividends, while discontinued-operations financing provided $1,283.8 million.
- Cash and equivalents were $2,638.8 million at March 31, 2010, versus $1,221.6 million at June 30, 2009. Total debt and other short-term borrowings were $2,108.2 million versus $3,637.8 million; long-term obligations excluding current amounts were $1,875.6 million. Cash exceeded current debt, but current liabilities were $12,747.4 million, including $10,766.6 million of accounts payable.
- The company reported no outstanding commercial-paper borrowings or balance under its $950 million committed receivables sales facility at quarter-end. Its $1.5 billion revolving credit facility supported the commercial-paper program. Management said available resources were adequate for anticipated needs; the company was in compliance with its financial covenants.
Material changes, outlook and risks
- Cardinal sold 10.9 million CareFusion shares during the nine months, recognizing a $43.3 million pre-tax gain; it held about 30.5 million shares valued at $805.2 million at March 31. It expected to sell the remaining shares by the end of fiscal 2011, subject to market conditions.
- A September 2009 debt tender retired more than $1.1 billion of debt and produced a $39.9 million pre-tax extinguishment loss. The company estimated approximately $34.1 million of additional restructuring costs, primarily related to the spin-off.
- No specific earnings guidance is provided in the supplied filing text. Management cited continued competitive pricing pressure. It also identified exposure to generic-drug launch timing and price deflation, branded-drug price appreciation, customer losses and a prolonged shortage of radioisotope feedstock affecting nuclear pharmacy services.
- Healthcare reform legislation may adversely affect results. Among the cited provisions, a 2.3% medical-device excise tax was scheduled to begin in 2013, and a Medicaid generic-drug reimbursement change was expected to take effect in October 2010.
- The IRS proposed additional tax of $598.1 million, excluding penalties and interest, for transfer-pricing and intellectual-property matters; $462.1 million related to CareFusion under the tax matters agreement. Cardinal disputed the proposed adjustments and said it believed it was adequately reserved. The company also disclosed other litigation and regulatory exposures, whose unfavorable resolution could materially affect a period.
- Subsequent events: Cardinal reported receiving $40.8 million in early May 2010 from settlement of an antitrust claim, to be recognized in the June 2010 quarter; it entered a definitive agreement to sell Martindale and expected completion before fiscal year-end; and it entered additional $440 million notional pay-floating interest-rate swaps.
Key facts for investors to verify
- Separate continuing-operations trends from discontinued operations when assessing the sharp year-over-year decline in net income and EPS, and account for the CareFusion spin-off’s effect on comparability.
- Assess the sustainability of operating cash flow, particularly its dependence on increased accounts payable and other working-capital timing.
- Review the tax charge, IRS proposed adjustments, CareFusion indemnification arrangements and potential changes in unrecognized tax benefits.
- Track the remaining CareFusion stake, sale timing and gains, alongside debt reduction, restructuring costs and the Medical segment’s quarterly profit decline.
- Monitor competitive and regulatory risks, including pharmaceutical pricing and generic launches, radioisotope supply, healthcare reform provisions and pending legal matters.