Cardinal Health, Inc. — Q2 Fiscal 2017 Form 10-Q
Reporting period: Quarter and six months ended December 31, 2016. Cardinal Health operates Pharmaceutical and Medical segments, providing healthcare distribution, products and related services.
Financial performance
| Metric | Three months ended Dec. 31, 2016 | Six months ended Dec. 31, 2016 |
|---|---|---|
| Revenue | $33.15 billion, up 5% | $65.19 billion, up 10% |
| GAAP operating earnings | $542 million, down 4% | $1.076 billion, down 9% |
| Non-GAAP operating earnings | $701 million, down 4% | $1.370 billion, down 6% |
| Net earnings attributable to Cardinal Health | $324 million, versus $326 million | $633 million, versus $709 million |
| GAAP diluted EPS | $1.02, versus $0.98 | $1.97, versus $2.14 |
| Non-GAAP diluted EPS | $1.34, up 3% | $2.57, down 4% |
| Net cash from operating activities | Not separately provided for the quarter | $658 million, versus $1.411 billion |
Gross margin was approximately flat in dollars at $1.602 billion for the quarter and $3.192 billion for six months. Gross margin as a percentage of revenue declined 29 basis points for the quarter and 46 basis points for six months, primarily due to generic pharmaceutical customer pricing changes; the six-month rate was also affected by customer/product mix. Six-month SG&A expense rose 4% to $1.831 billion, driven largely by acquisitions.
Quarterly segment revenue was $29.743 billion for Pharmaceutical, up 5%, and $3.410 billion for Medical, up 8%. Segment profit was $537 million for Pharmaceutical, down 14%, and $159 million for Medical, up 50%. For six months, Pharmaceutical segment profit fell 17% to $1.071 billion, while Medical segment profit rose 39% to $286 million.
Liquidity, debt and capital allocation
- Cash and equivalents were $1.881 billion at December 31, 2016, down from $2.356 billion at June 30, 2016. Six-month cash uses included $600 million for share repurchases, $293 million for dividends and $213 million for capital expenditures.
- Long-term obligations plus current obligations and other short-term borrowings totaled $5.462 billion carrying value; estimated fair value was $5.611 billion. Net interest expense was $88 million for six months.
- The company reported $658 million in operating cash flow for the half-year, with working-capital movements including a $1.294 billion inventory increase and a $1.563 billion increase in accounts payable.
- A $1.75 billion revolving credit facility and a $700 million committed receivables sales facility were available, with no amounts outstanding under either at period-end. The commercial paper program was increased to $1.75 billion. Cardinal Health was in compliance with its maximum 3.25-to-1 consolidated leverage covenant.
- Management said available capital resources and projected operating cash flow were adequate for anticipated needs. The company had $443 million remaining under its share repurchase authorization at December 31, 2016. The annualized dividend rate was $1.80 per share.
Material changes and management outlook
- Pharmaceutical operating results were pressured by generic pharmaceutical customer pricing changes, the loss of a large distribution customer beginning April 1, 2016, and lower branded pharmaceutical inflation. Contributions from the remainder of the generics program partly offset these pressures.
- Medical growth benefited from Cardinal Health Brand products, acquisitions and comparison with a prior-year $21 million unfavorable Cordis inventory fair-value step-up impact. Cordis was acquired in October 2015.
- Management expected fiscal 2017 Pharmaceutical segment profit to be below fiscal 2016. It cautioned that the timing, magnitude and profit impact of pharmaceutical customer and manufacturer pricing changes remain uncertain. The supplied filing text does not state a specific full-year EPS or revenue guidance figure.
- Quarterly GAAP and non-GAAP diluted EPS improved partly because of a lower effective tax rate and fewer shares following repurchases; six-month EPS declined primarily due to lower operating earnings. The quarterly effective tax rate was 34.0%, including $12 million of net favorable discrete items; the six-month rate was 35.6%.
Contingencies, risks and other notable items
- In December 2016, Cardinal Health agreed to pay $44 million to the Department of Justice to resolve civil penalties related to controlled-substance matters involving Cardinal Health and Kinray. The DOJ agreed to take no further administrative or civil action on those matters.
- In January 2017, the company agreed, without admitting liability, to pay West Virginia $20 million to settle a controlled-substance lawsuit; a $20 million accrual was recorded in the December quarter.
- As of January 31, 2017, Cardinal Health and Cordis faced 41 product-liability lawsuits involving approximately 350 plaintiffs alleging injuries from Cordis IVC filters. The company said it was defending the claims and did not expect reasonably possible losses beyond its accrual to 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 after specified milestones were achieved.
- Potential changes in tax, trade and healthcare laws were identified as risks, including possible import tariffs and changes to the Affordable Care Act. A multi-year Pharmaceutical systems replacement project was expected to begin transitioning selected processes in the quarter ending March 31, 2017; ineffective implementation could adversely affect internal controls.
- Disclosure controls were assessed as effective at December 31, 2016, and no material changes in internal control over financial reporting were reported for the quarter. Management reported no material change in market-risk disclosures from the prior annual report.
Important facts for investors to verify
- Whether generic pricing and the loss of the large distribution customer continue to reduce Pharmaceutical segment profit, and how actual fiscal 2017 results compare with management’s below-prior-year expectation.
- Operating cash flow and working-capital trends, particularly inventory, receivables and payables, given the year-over-year cash-flow decline.
- Developments and accrual adequacy for the DOJ and West Virginia settlements and Cordis IVC-filter litigation.
- Availability and use of credit facilities, covenant headroom, and the pace of share repurchases and dividends.
- Implementation progress and control effects of the new Pharmaceutical finance and operating systems.