Cardinal Health, Inc. — Q3 Fiscal 2017 Form 10-Q
Reporting period: Quarter and nine months ended March 31, 2017. The filing was signed May 2, 2017. The business operates through Pharmaceutical and Medical segments. (The request metadata says “2016 Q3,” but the filing identifies the period as Q3 fiscal 2017.)
Financial performance
| Metric | Three months ended March 31, 2017 | Nine months ended March 31, 2017 |
|---|---|---|
| Revenue | $31.821 billion, up 4% | $97.010 billion, up 8% |
| Gross margin | $1.728 billion, up 2%; margin rate down 8 basis points | $4.921 billion, up 1%; margin rate down 34 basis points |
| GAAP operating earnings | $605 million, down 8% | $1.681 billion, down 9% |
| Non-GAAP operating earnings | $759 million, down 4% | $2.129 billion, down 5% |
| Net earnings attributable to Cardinal Health | $381 million, versus $386 million | $1.014 billion, versus $1.095 billion |
| Diluted EPS | GAAP $1.20, up 3%; non-GAAP $1.53, up 7% | GAAP $3.17, down 4%; non-GAAP $4.10, unchanged |
| Operating cash flow | Not separately presented for the quarter | $460 million, versus $2.330 billion |
Segment results: Pharmaceutical revenue was $28.406 billion for the quarter, up 3%, while segment profit fell 7% to $611 million. Medical revenue was $3.418 billion, up 9%, and segment profit rose 16% to $148 million. For nine months, Pharmaceutical segment profit declined 14% to $1.682 billion; Medical segment profit increased 30% to $435 million.
Cash, debt and liquidity
- Cash and equivalents were $1.368 billion at March 31, 2017, down from $2.356 billion at June 30, 2016. Nine-month cash uses included $600 million of share repurchases, $435 million of dividends and $293 million of capital expenditures.
- Operating cash flow fell by $1.870 billion year over year, primarily due to working-capital changes. Inventory increased $1.010 billion; accounts payable increased $225 million.
- Long-term obligations plus current obligations and short-term borrowings totaled $5.461 billion at March 31, 2017. Interest expense, net, was $46 million for the quarter and $134 million for nine months.
- The company had no balance outstanding under its $1.75 billion revolving credit facility or $700 million receivables sales facility. It was in compliance with its 3.25-to-1 leverage covenant; a temporary 4.25-to-1 limit may apply for a material acquisition.
Changes, outlook and notable items
- Management attributed weaker operating earnings principally to generic pharmaceutical customer pricing changes and the loss of a large pharmaceutical distribution customer beginning April 1, 2016. Reduced branded pharmaceutical inflation also weighed on nine-month results. Red Oak Sourcing benefits and Medical segment growth partly offset these pressures.
- Management expects fiscal 2018 Pharmaceutical segment profit to be below expected fiscal 2017 profit, primarily due to generic pharmaceutical customer pricing changes. The frequency, timing and financial impact of pricing changes remain uncertain.
- On April 18, 2017, after quarter-end, Cardinal agreed to acquire specified Medtronic businesses for $6.1 billion in cash, subject to adjustments, with closing expected in Q1 fiscal 2018, subject to customary conditions including regulatory clearance. Planned financing includes $4.5 billion of new long-term debt, existing cash and expected operating cash flow; a $4.5 billion bridge-loan commitment was also obtained.
- Quarterly GAAP EPS benefited from a lower effective tax rate and fewer shares outstanding; the Q3 effective tax rate was 32.3%, including $31 million of favorable discrete items. For nine months, the rate was 34.4%.
- Litigation charges were $18 million for the quarter and $37 million for nine months, including Cordis IVC filter claims and the West Virginia settlement. Cardinal agreed to pay West Virginia $20 million without admitting liability. At March 31, it had accrued $93 million, net of expected insurance recoveries, for IVC filter losses and legal defense costs. Other controlled-substance distribution lawsuits remained unresolved, and the company could not estimate potential losses.
- The Pharmaceutical segment was transitioning selected processes to replacement finance and operating systems. Management identified potential adverse effects on internal controls if implementation is ineffective, while concluding disclosure controls were effective as of March 31.
Important facts for investors to verify
- How generic pricing changes, branded-drug inflation and the lost distribution customer affect Pharmaceutical segment profit and the fiscal 2018 outlook.
- The Medtronic acquisition’s closing conditions, final purchase price, financing terms, leverage impact and ability to realize expected benefits.
- Working-capital trends and operating cash generation, given the sharp year-over-year decline and lower cash balance.
- Developments in IVC filter product-liability claims and controlled-substance litigation, including whether reserves remain adequate.
- Execution and control impacts of the Pharmaceutical systems transition, as well as the effects of acquisition-related amortization and other excluded items on non-GAAP comparisons.