Cardinal Health, Inc. — Form 10-Q Summary
Reporting period: Second quarter and first six months of fiscal 2015, ended December 31, 2014. All amounts are U.S. dollars. Cardinal Health distributes pharmaceutical and medical products and reports Pharmaceutical and Medical segments.
Financial performance
| Metric | Quarter ended Dec. 31, 2014 | Six months ended Dec. 31, 2014 | Prior-year comparison |
|---|---|---|---|
| Revenue | $25.537 billion | $49.607 billion | Up 15% and 6%, respectively |
| Gross margin | $1.454 billion | $2.794 billion | Up 8% and 7%; gross margin rate contracted in both periods |
| Operating earnings | $546 million | $1.012 billion | Up 5% and 2% |
| Earnings from continuing operations | $289 million | $555 million | Up 5%; down 10% |
| Net earnings | $289 million | $555 million | Prior year: $278 million and $617 million |
| Diluted EPS | $0.86 | $1.65 | Prior year: $0.80 and $1.79 |
| Operating cash flow | $1.014 billion for six months | Prior year: $988 million |
For the quarter, gross margin was approximately 5.7% of revenue versus 6.0% a year earlier; six-month gross margin was approximately 5.6% versus 5.6%. The filing attributes rate pressure to customer pricing, new hepatitis C products and customer mix, partly offset by generic-program performance, including Red Oak Sourcing.
Financial position and capital allocation
- Cash and equivalents were $2.881 billion at December 31, 2014, versus $2.865 billion at June 30, 2014. Current assets were $19.155 billion and current liabilities $16.030 billion.
- Total long-term obligations and other short-term borrowings were $3.976 billion, including $270 million current and $3.706 billion long-term. The company issued $1.2 billion of longer-dated notes and redeemed older notes; the refinancing generated a $60 million pretax extinguishment loss.
- Six-month investing cash outflow was $100 million and financing cash outflow was $898 million. Financing included $1.220 billion of long-term debt repayments, $1.182 billion of new debt proceeds, $684 million of share repurchases and $233 million of dividends.
- Inventory increased $1.142 billion from June 30, while accounts payable increased $1.453 billion. Management said working-capital cash flows can vary significantly with payment and purchasing timing.
- The company reported adequate capital resources, no borrowings under its $1.5 billion revolving credit facility or commercial paper program, and compliance with debt covenants. Its receivables facility was renewed and expanded to $950 million.
Material changes and management commentary
- Pharmaceutical revenue rose 16% in the quarter and 6% for six months, driven by existing and new distribution customers. Six-month growth was partly offset by the prior-year expiration of the Walgreens distribution contract.
- Medical revenue increased 4% in the quarter and 5% for six months, with acquisitions and modest existing-customer growth contributing. Medical segment profit fell 12% in the quarter and 4% for six months; Pharmaceutical segment profit rose 12% and 8%, respectively.
- Litigation charges increased materially: $44 million for the quarter and $72 million for six months, versus a $15 million recovery and a $13 million recovery in the comparable prior-year periods. Six-month results also included the debt-extinguishment loss. Prior-year tax benefits and charges affected year-over-year earnings comparisons.
- Red Oak Sourcing, a 50/50 generic sourcing venture with CVS Health, began in July 2014 with a 10-year initial term. Cardinal is committed to 39 quarterly payments of $25.6 million to CVS, beginning October 2014, with additional payments conditional on milestones.
- The filing provides no specific earnings or revenue guidance. Management stated it believes available capital and projected operating cash flow are adequate for anticipated needs, while noting acquisitions could require additional financing.
Risks, contingencies and unusual items
- Controlled-substance matters include ongoing DOJ discussions following the DEA investigation, a West Virginia state action, and a shareholder derivative complaint filed in January 2015. A $34 million accrual was recorded for the DEA matter.
- The company recorded a $27 million charge for a possible FTC settlement concerning supplier arrangements in its Nuclear Pharmacy Services business. It also disclosed a qui tam action involving its Cardinal Health at Home division; the DOJ had not decided whether to intervene.
- Management said it could not estimate reasonably possible losses for certain matters where damages or outcomes remain uncertain. It cautioned that one or more resolutions could materially affect a particular period, while not expecting the disclosed matters collectively to materially harm financial position, results or cash flows based on information then available.
- Unrecognized tax benefits totaled $525 million. The company estimated a possible net decrease of zero to $180 million within 12 months, excluding interest and penalties; IRS audits and transfer-pricing matters remain under review.
- Foreign currency translation reduced six-month comprehensive income by $64 million. The filing reported no material changes in market risks, critical accounting policies or internal controls.
Important facts for investors to verify
- Whether revenue growth and generic-program benefits can offset gross-margin-rate pressure and customer pricing changes.
- How working-capital movements, especially inventory and receivables, affect operating cash generation in subsequent periods.
- Developments and potential financial exposure in the DEA, FTC, West Virginia, qui tam and shareholder litigation matters.
- The effects of the CVS sourcing venture’s recurring payments and any milestone-based obligations.
- Debt, tax and share-repurchase trends, including the remaining $1.0 billion repurchase authorization reported at December 31, 2014.