Cardinal Health, Inc. — Fiscal 2016 Form 10-K
Period note: The filing covers the fiscal year ended June 30, 2016, not fiscal 2015 Q4. It includes unaudited quarterly results for fiscal 2016 Q4, ended June 30, 2016.
Business context and reporting period
Cardinal Health is an integrated healthcare products and services company reporting Pharmaceutical and Medical segments. Pharmaceutical distributes medicines and related products and provides pharmacy and specialty services; Medical distributes and manufactures medical products and provides post-acute care services.
Financial performance and liquidity
| Metric | FY2016 | FY2015 | Change |
|---|---|---|---|
| Revenue | $121.546 billion | $102.531 billion | +19% |
| Gross margin | $6.543 billion | $5.712 billion | +15% |
| Operating earnings, GAAP | $2.459 billion | $2.161 billion | +14% |
| Operating earnings, non-GAAP | $2.895 billion | $2.472 billion | +17% |
| Net earnings attributable to Cardinal Health | $1.427 billion | $1.215 billion | +17% |
| Diluted EPS, GAAP | $4.32 | $3.61 | +20% |
| Diluted EPS, non-GAAP | $5.24 | $4.38 | +20% |
- Gross margin rate was approximately 5.4% of revenue, versus approximately 5.6% in FY2015; GAAP operating margin was approximately 2.0%, versus 2.1%. The filing says gross margin rate contracted, reflecting customer mix and pricing changes.
- Pharmaceutical revenue was $109.131 billion (+20%) and segment profit was $2.488 billion (+19%). Medical revenue was $12.430 billion (+9%) and segment profit was $457 million (+6%).
- Cash from operations was $2.971 billion, up from $2.540 billion. Capital expenditures were $465 million; operating cash flow less capital expenditures was approximately $2.506 billion.
- Cash and equivalents fell to $2.356 billion from $4.616 billion, principally reflecting $3.614 billion of acquisitions, $651 million of share repurchases, $512 million of dividends and $465 million of capital expenditures.
- Long-term obligations, less current portion, were $4.952 billion; current portion and other short-term borrowings were $587 million. Total obligations in the debt note were $5.539 billion. The company had no borrowings under its revolving credit facility or commercial paper program at year-end.
- Current assets were $21.956 billion and current liabilities were $19.701 billion. Available liquidity included a $1.75 billion revolving credit facility and a $700 million committed receivables facility; the company reported compliance with facility covenants.
Material changes versus the prior year
- Revenue growth was driven by existing and new pharmaceutical distribution customers, continued branded-drug price appreciation and acquisitions. Acquisitions contributed $2.1 billion to Pharmaceutical revenue growth and $645 million to Medical growth, net of divestitures.
- FY2016 included acquisitions of Harvard Drug for approximately $1.1 billion, Cordis for approximately $1.9 billion and a majority interest in naviHealth. These expanded generic-drug distribution, manufactured medical products and post-acute care services.
- Pharmaceutical segment profit benefited from customer growth and the generics program, including Red Oak Sourcing, but was partly offset by adverse customer pricing changes. Medical segment profit improved with Cardinal Health Brand products and acquisitions, partly offset by weaker Canadian results.
- Acquisition-related amortization and other costs rose to $459 million from $281 million, largely related to Cordis and Harvard Drug. Net litigation recoveries were $69 million, including $80 million of antitrust settlement income; FY2015 included a $60 million debt-extinguishment loss.
- Interest expense increased to $178 million from $141 million, primarily due to debt issued to fund acquisitions. The effective tax rate decreased to 37.1% from 38.4%.
For fiscal 2016 Q4, revenue was $31.384 billion, gross margin $1.665 billion, earnings from continuing operations $335 million and diluted EPS from continuing operations attributable to Cardinal Health was $1.02.
Outlook, risks and unusual items
- Management expected FY2017 Pharmaceutical segment profit to be essentially flat year over year. The expected loss of a large distribution customer beginning April 1, 2016, adverse pricing and lower year-over-year benefit from generics were expected to weigh on results. Management anticipated significantly lower Pharmaceutical segment profit and consolidated operating earnings in FY2017 Q1 than in the prior-year quarter. Generic launch timing and profitability remain uncertain.
- FY2017 capital expenditures were expected to be $400 million to $450 million, primarily for IT, core-business growth and Cordis integration. The filing provides no clear consolidated FY2017 earnings or EPS guidance.
- Key exposures include intense competition and margin pressure, volatility in generic-drug pricing and launches, healthcare-industry consolidation, customer concentration, supplier availability, regulatory compliance, cybersecurity and system implementation, acquisition integration, foreign exchange and commodity costs.
- CVS Health accounted for 25% of FY2016 revenue and 22% of gross trade receivables. The five largest customers together represented 40% of revenue.
- Legal matters include the unresolved potential civil fines following a DEA controlled-substances investigation (a $44 million accrual at June 30, 2016), West Virginia controlled-substances litigation, and Cordis IVC-filter product-liability suits involving approximately 180 plaintiffs in 18 lawsuits as of August 9, 2016. Management said it could not estimate a reasonably possible loss range for certain matters and did not believe currently known outcomes would materially affect overall financial position, results or cash flows, though an individual quarter could be affected.
- Unrecognized tax benefits were $527 million; the IRS was auditing fiscal years 2006–2014. The company also reported $2.1 billion of foreign earnings intended to remain permanently invested abroad, with no U.S. repatriation tax provision accrued.
- Non-GAAP results exclude items including acquisition-related costs, restructuring, impairments and litigation recoveries or charges; assess them alongside GAAP results.
Important facts for investors to verify
- Whether FY2017 Pharmaceutical results meet management’s flat-profit expectation despite the customer loss, pricing pressure and reduced generics tailwind.
- Acquisition integration progress and the realized returns, costs and potential impairments associated with Cordis, Harvard Drug and naviHealth.
- Customer concentration and the terms, renewal prospects and performance of the CVS Health distribution relationship.
- Developments, accrual adequacy and potential cash exposure in the DEA, West Virginia, IVC-filter, tax-audit and other legal matters.
- Working-capital requirements, cash conversion, debt maturities and capacity for dividends, repurchases and further acquisitions.