CareFusion Margins Under Pressure

Monday afternoon, CareFusion reported below-plan third-quarter results. Revenue came in at $968 million (up 7% reported and constant currency), $27 million below our estimate of $995 million (+10.4%) and $19 million below consensus of $987 million. Medical systems (largely capital equipment) declined 2.2% while the disposables-oriented procedural solutions segment grew 25%; excluding the Vital Signs acquisition, growth was a solid 5% digits. EPS of $0.60 (up 1.3%) were $0.02 below our estimate and the Street. Thesis. Our thesis is unchanged.

We are encouraged by the number of committed dispensing contracts and the pending installations and their impact on future margins; the company’s product mix remains negative for margins. Combined with few new product launches and a still-constrained capital equipment environment, we believe the timeline to return to even midsingle-digit growth will be extended into fiscal 2015.

While we believe the risk to our estimates remains low, we will remain on the sidelines as we wait for more visibility for these measures to more substantially drive upside to our sales targets. The Good – Procedural solutions delivered a quarter marked by 25% growth; the dispensing business was flat year over year. Flat growth is an improvement this quarter as the segment has experienced roughly doubledigit declines the past four quarters.

As the backlog of revenue from the Pyxis ES remains to be materially seen, we expect positive fourth-quarter results in this segment. – The acquisition of Vital Signs added a nice boost to specialty disposables in the third quarter, up 75% (+5% organic), and we expect similar growth from this segment in the following quarter. The Bad – Despite a high level of committed contracts in dispensing, delayed installations remained in the quarter, actually booking the revenue. The new system (Pyxis ES) comprised 50% of dispensing revenues in the quarter while the company underestimated the length of time it would take to successfully implement the platform. – Gross margin missed our target by 260 basis points due to the lowermargin Vital Signs acquisition, product revenue mix, and a key supplier winding down its business.