How did Cardinal Health's profitability change in fiscal 1995?

Net earnings rose to $85.0 million, or $2.01 per fully diluted share, from $33.9 million, or $0.86, in fiscal 1994. Fiscal 1994 was depressed by $35.9 million of pre-tax Whitmire merger costs. Excluding those unusual items, fiscal 1994 earnings were $63.0 million, or $1.60 per share, so fiscal 1995 earnings grew about 35% on a comparable basis. The effective tax rate also fell to 42.0% from 50.3%, because the 1994 merger costs were partly nondeductible.

Is Cardinal's margin structure improving or deteriorating?

Gross margin as a percentage of sales has declined for three straight years, to 5.95% in fiscal 1995 from 6.42% in fiscal 1993. Management attributes this to lower selling margins on high-volume customers in a competitive market. The pace of decline moderated, with the fourth-quarter fiscal 1995 gross margin roughly equal to the prior-year quarter. SG&A efficiency improved, falling to 3.85% of sales, which partly offset the gross margin pressure.

Why is operating cash flow so low despite strong earnings?

Operating cash flow was only $10.5 million against $85.0 million of net earnings. The main reason is working capital growth: trade receivables rose $130.6 million and merchandise inventories rose $159.0 million, which together outweighed the $152.3 million increase in accounts payable. Part of the increase in inventories and payables reflects seasonal purchase timing. Investors should watch whether cash conversion improves as growth moderates.

What are the main risks and legal exposures disclosed?

The main legal exposure is a purported class action antitrust suit, consolidated in the Northern District of Illinois, alleging that wholesalers conspired with manufacturers to inflate prices through chargeback pricing. Under a Judgment Sharing Agreement, manufacturers reimburse up to $9 million of wholesaler litigation costs, and the company's joint and several liability is capped at the lesser of 1% of any judgment or $1 million. Other risks include customer concentration, with K-Mart at about 11% of sales, and the thin margins typical of drug distribution.

What is the Medicine Shoppe transaction and how would it affect shareholders?

Cardinal signed a definitive merger agreement on August 26, 1995 to acquire Medicine Shoppe International, a franchisor of independent retail pharmacies, in an all-stock deal. Cardinal would issue roughly 6.0 to 6.8 million common shares, and up to about 7.2 million in certain circumstances, depending on the average share price. The company expects pooling-of-interests accounting, and the deal requires Medicine Shoppe shareholder approval. Existing shareholders would be diluted from roughly 42.2 million shares outstanding.

CAH 10-K FY1995 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed September 21, 1995. Cited figures are marked; the original filing is the authoritative source.

Cardinal Health, Inc. (NYSE: CAH) reported a strong fiscal 1995 (year ended June 30, 1995), with net sales up 35% to $7.81 billion^a (internal growth of 25%, plus the Humiston-Keeling and Behrens acquisitions) and net earnings rising to $85.0 million, or $2.01 per share, from $33.9 million, or $0.86 per share, in fiscal 1994.

Fiscal 1994 included $35.9 million^b of pre-tax Whitmire merger costs, so on a comparable basis earnings grew roughly 35% (fiscal 1994 excluding unusual items was $63.0 million, or $1.60 per share). The company is a national full-service drug wholesaler whose economics are thin: gross margin fell to 5.95% from 6.13% and 6.42% in the prior two years, although SG&A improved to 3.85% of sales, and the company attributes the margin decline to competition and a shift toward high-volume customers such as K-Mart, which accounted for about 11% of sales. Balance sheet growth was substantial.

Total assets rose to $1.84 billion^c from $1.40 billion, inventories reached $1.07 billion, and shareholders' equity increased to $548.2 million, helped by a September 1994 public offering that raised about $70 million in net proceeds for the company. Working capital grew to $601.3 million. Operating cash flow was only $10.5 million, however, because receivables and inventory growth absorbed most of the cash generated by earnings and payables.

Long-term debt was roughly flat at $209 million^d, and the company had $322 million of unused credit lines, which management considers adequate for its needs. The filing also flags a pending $26.9 million-to-date merger integration, a proposed all-stock acquisition of Medicine Shoppe International for 6.0 to 6.8 million shares (up to 7.2 million), and the Brand Name Prescription Drug antitrust litigation. Management believes the litigation will not have a material adverse effect, and a Judgment Sharing Agreement caps the company's joint and several exposure at the lesser of 1% of any judgment or $1 million.

02—Key points

Key Highlights

Net sales rose 35% to $7.81 billion in fiscal 1995, with 25% from internal growth and the rest from acquisitions (Humiston-Keeling, Behrens).
Net earnings increased to $85.0 million ($2.01 per share) from $33.9 million ($0.86 per share); excluding fiscal 1994 unusual items, EPS grew from $1.60 to $2.01 (about 26%).
Gross margin continued to compress to 5.95% from 6.13% (fiscal 1994) and 6.42% (fiscal 1993), reflecting competitive pricing and a shift toward high-volume customers; SG&A improved to 3.85% of sales from 4.03%.
Shareholders' equity rose 49% to $548.2 million, aided by a $70.5 million common share offering in September 1994 and $18.1 million in tax benefits from stock options and restricted stock.
Operating cash flow was just $10.5 million as inventories (+$159 million) and receivables (+$131 million) grew with the business, against a $152 million increase in accounts payable.
Largest customer K-Mart accounted for about 11% of net sales; the five largest suppliers accounted for about 22% of purchases, and the largest single supplier for about 5.9%.
Pending Medicine Shoppe merger (6.0 to 6.8 million shares, expected to be a pooling-of-interests) and ongoing antitrust litigation over chargeback pricing, which management considers without merit and not materially adverse.

03—Questions

Frequently Asked Questions

How did Cardinal Health's profitability change in fiscal 1995?
Net earnings rose to $85.0 million, or $2.01 per fully diluted share, from $33.9 million, or $0.86, in fiscal 1994. Fiscal 1994 was depressed by $35.9 million of pre-tax Whitmire merger costs. Excluding those unusual items, fiscal 1994 earnings were $63.0 million, or $1.60 per share, so fiscal 1995 earnings grew about 35% on a comparable basis. The effective tax rate also fell to 42.0% from 50.3%, because the 1994 merger costs were partly nondeductible.
Is Cardinal's margin structure improving or deteriorating?
Gross margin as a percentage of sales has declined for three straight years, to 5.95% in fiscal 1995 from 6.42% in fiscal 1993. Management attributes this to lower selling margins on high-volume customers in a competitive market. The pace of decline moderated, with the fourth-quarter fiscal 1995 gross margin roughly equal to the prior-year quarter. SG&A efficiency improved, falling to 3.85% of sales, which partly offset the gross margin pressure.
Why is operating cash flow so low despite strong earnings?
Operating cash flow was only $10.5 million against $85.0 million of net earnings. The main reason is working capital growth: trade receivables rose $130.6 million and merchandise inventories rose $159.0 million, which together outweighed the $152.3 million increase in accounts payable. Part of the increase in inventories and payables reflects seasonal purchase timing. Investors should watch whether cash conversion improves as growth moderates.
What are the main risks and legal exposures disclosed?
The main legal exposure is a purported class action antitrust suit, consolidated in the Northern District of Illinois, alleging that wholesalers conspired with manufacturers to inflate prices through chargeback pricing. Under a Judgment Sharing Agreement, manufacturers reimburse up to $9 million of wholesaler litigation costs, and the company's joint and several liability is capped at the lesser of 1% of any judgment or $1 million. Other risks include customer concentration, with K-Mart at about 11% of sales, and the thin margins typical of drug distribution.
What is the Medicine Shoppe transaction and how would it affect shareholders?
Cardinal signed a definitive merger agreement on August 26, 1995 to acquire Medicine Shoppe International, a franchisor of independent retail pharmacies, in an all-stock deal. Cardinal would issue roughly 6.0 to 6.8 million common shares, and up to about 7.2 million in certain circumstances, depending on the average share price. The company expects pooling-of-interests accounting, and the deal requires Medicine Shoppe shareholder approval. Existing shareholders would be diluted from roughly 42.2 million shares outstanding.

04—Continue

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