Cardinal Health, Inc. — Q1 Fiscal 2017 Form 10-Q
Reporting period: Three months ended September 30, 2016; comparisons are to the three months ended September 30, 2015 unless noted. Cardinal Health provides healthcare products and services through its Pharmaceutical and Medical segments.
Financial results
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Revenue | $32.039 billion | $28.055 billion | +14% |
| Gross margin | $1.590 billion | $1.579 billion | +1% |
| GAAP operating earnings | $535 million | $620 million | -14% |
| Non-GAAP operating earnings | $669 million | $737 million | -9% |
| GAAP net earnings attributable to Cardinal Health | $309 million | $383 million | -19% |
| GAAP diluted EPS | $0.96 | $1.15 | -17% |
| Non-GAAP diluted EPS | $1.24 | $1.38 | -10% |
| Cash provided by operating activities | $104 million | Cash used: $52 million | Improved |
Revenue growth reflected pharmaceutical distribution sales to new and existing customers, including a new mail-order customer. Pharmaceutical revenue rose 14% to $28.762 billion; Medical revenue rose 12% to $3.279 billion. Gross margin dollars were nearly flat, while gross margin as a percentage of revenue fell 67 basis points. The filing attributes the rate decline to generic customer pricing changes and product mix from the new mail-order customer.
Pharmaceutical segment profit fell 19% to $534 million, primarily due to generic pharmaceutical customer pricing changes, lower branded-drug inflation, and the loss of a large distribution customer beginning April 1, 2016. Medical segment profit increased 26% to $127 million, primarily from acquisitions and Cardinal Health Brand products. The Cordis acquisition contributed to Medical growth; it was completed October 2, 2015 for $1.9 billion.
Cash, liquidity, and debt
Cash and equivalents were $2.001 billion at September 30, 2016, down from $2.356 billion at June 30, 2016. Quarterly cash uses included $250 million for share repurchases, $149 million for dividends, and $100 million for capital expenditures. Operating cash flow was $104 million; working-capital movements included increased receivables and inventory. Cash held outside the United States was $622 million and repatriation could trigger taxes.
Long-term obligations and other short-term borrowings had a carrying amount of $5.532 billion. The company reported no amounts outstanding under its $1.75 billion revolving credit facility or $700 million committed receivables sales facility; commercial paper capacity is up to $1.5 billion and is backed by the revolver. The company was in compliance with applicable financial covenants. Management said available capital resources and projected operating cash flow were adequate for anticipated needs, while noting that additional acquisitions could require capital-markets financing.
Outlook, risks, and unusual items
- Management expected fiscal 2017 Pharmaceutical segment profit to be below fiscal 2016. The timing, size, and profit effects of pharmaceutical pricing changes remained uncertain. The filing does not provide a clear numerical full-year consolidated earnings or EPS forecast in the supplied text.
- Acquisition-related costs were $122 million, including $101 million of intangible-asset amortization, versus $105 million of acquisition-related costs and $67 million of amortization a year earlier. Non-GAAP measures exclude specified items and should be considered alongside GAAP results.
- The effective tax rate was 37.3%, compared with 32.3%; the prior-year rate included $28 million of net favorable discrete tax items. Unrecognized tax benefits totaled $532 million; possible changes over the next 12 months ranged from no change to a net decrease of $175 million, excluding penalties and interest.
- The company had a $44 million accrual for the DEA matter involving its Lakeland, Florida distribution center and continued settlement discussions with the U.S. Department of Justice. West Virginia controlled-substance litigation was ongoing; the company was unable to estimate a reasonably possible loss range for certain matters.
- As of October 31, 2016, Cardinal Health and Cordis were defendants in 31 IVC-filter product-liability lawsuits involving approximately 250 plaintiffs. The company said it had accrued primarily for legal defense costs and did not believe reasonably possible losses beyond the accrual would be material.
- A generic sourcing venture with CVS Health requires quarterly payments of $45.6 million for the remainder of its initial 10-year term following achievement of specified milestones.
- Management reported effective disclosure controls and no material changes in internal control during the quarter. A multi-year Pharmaceutical systems replacement is expected to begin transitioning selected processes later in fiscal 2017; ineffective implementation could adversely affect internal controls.
Most important facts for investors to verify
- Whether pricing changes, lower branded-drug inflation, and the lost distribution customer continue to pressure Pharmaceutical segment profit, and how the new mail-order business affects margins.
- How operating cash flow and working-capital requirements develop, given quarterly cash generation and the company’s capital returns.
- The status and potential financial exposure of the DEA and West Virginia matters, Cordis product-liability lawsuits, and tax audits or unrecognized tax benefits.
- The remaining Red Oak Sourcing payment commitment, acquisition-related amortization, and any additional financing needs for acquisitions.
- Progress on the Pharmaceutical systems implementation and any effects on financial reporting controls.