Cardinal Health, Inc. — Fiscal 2017 Form 10-K
Business context and reporting period
This filing covers the fiscal year ended June 30, 2017, with comparisons to fiscal 2016. Although the request metadata refers to 2016 Q4, the source is an FY2017 annual report; the filing also provides unaudited FY2017 fourth-quarter results. Cardinal Health distributes pharmaceuticals and manufactures, sources and distributes medical products through its Pharmaceutical and Medical segments.
Key financial metrics
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Revenue | $129.976 billion | $121.546 billion | +7% |
| Gross margin | $6.544 billion | $6.543 billion | Essentially flat |
| GAAP operating earnings | $2.120 billion | $2.459 billion | -14% |
| Non-GAAP operating earnings | $2.769 billion | $2.895 billion | -4% |
| Net earnings attributable to Cardinal Health | $1.288 billion | $1.427 billion | -10% |
| GAAP diluted EPS | $4.03 | $4.32 | -7% |
| Non-GAAP diluted EPS | $5.40 | $5.24 | +3% |
| Cash from operating activities | $1.184 billion | $2.971 billion | Down $1.787 billion |
Gross margin was approximately 5.0% of revenue, versus 5.4% in FY2016; GAAP operating margin was approximately 1.6%, versus 2.0%. These percentages are calculated from reported figures. FY2017’s lower operating cash flow chiefly reflected working-capital movements and timing of customer and vendor payments, including effects associated with new systems implementation. Capital expenditures were $387 million; dividends paid were $577 million and share repurchases were $600 million.
At June 30, 2017, cash and equivalents were $6.879 billion, versus $2.356 billion a year earlier. Total debt and other short-term borrowings were $10.395 billion, including $1.327 billion current and $9.068 billion long-term. Cash rose mainly because of $5.171 billion in net proceeds from debt issuance. The company reported compliance with its financial covenants and no borrowings outstanding under its revolving credit facility or receivables sales facility at year-end.
Pharmaceutical revenue was $116.463 billion, up 7%, while segment profit fell 12% to $2.187 billion. Medical revenue was $13.524 billion, up 9%, and segment profit rose 25% to $572 million.
In the fourth quarter of FY2017, revenue was $32.966 billion, compared with $31.384 billion in the prior-year quarter. Net earnings attributable to Cardinal Health were $274 million versus $333 million, and diluted EPS was $0.86 versus $1.02.
Material changes versus the prior comparable period
- Revenue growth reflected pharmaceutical distribution customer growth, including OptumRx, and Medical segment growth. The large revenue base produces low margins, and gross margin dollars were virtually unchanged.
- Pharmaceutical segment profit declined on generic customer pricing changes, the loss of a large distribution customer, customer repricing and reduced branded-drug price appreciation. Red Oak Sourcing partly offset these pressures.
- Medical segment profit improved, supported by naviHealth, Cardinal Health branded products, distribution services and lower incentive compensation.
- GAAP earnings also reflected higher acquisition-related amortization and costs, restructuring charges, and $48 million of net litigation charges; FY2016 included $69 million of net litigation recoveries.
Outlook, risks and unusual items
- Management expected FY2018 Pharmaceutical segment profit to be below FY2017, principally because of generic pharmaceutical customer pricing changes; the timing and magnitude of pricing changes were uncertain.
- The July 29, 2017 acquisition of Medtronic’s Patient Recovery Business closed after year-end for $6.1 billion in cash. The company expected it to significantly increase Medical revenue and profit, as well as amortization and acquisition-related costs. It was funded with $4.5 billion of new long-term debt, cash, $400 million of commercial paper and $300 million borrowed under the receivables sales facility.
- Management expected FY2018 interest expense to rise due primarily to acquisition financing and capital expenditures of $500 million to $540 million. It planned to reduce long-term obligations by approximately $500 million in each of FY2018, FY2019 and FY2020.
- Key risks include generic-drug pricing and competition; customer concentration (CVS represented 23% and OptumRx 11% of FY2017 revenue); and the June 2019 expiration of CVS distribution agreements. The five largest customers together represented 50% of revenue.
- Legal exposures include opioid distribution lawsuits, whose outcomes and reasonably possible loss range the company said it could not estimate, and Cordis IVC filter product-liability litigation. The company had accrued $98 million, net of expected insurance recoveries, for IVC filter losses and legal defense costs at June 30, 2017.
- Other material uncertainties include integration and financing of the Medtronic acquisition, possible goodwill impairment (Medical Unit fair value exceeded carrying value by about 6% in FY2017), regulatory compliance, cyber and operating-system risks, and the ongoing replacement of Pharmaceutical segment finance and operating systems. The filing reported effective disclosure controls and internal control over financial reporting, with an unqualified audit opinion.
Important facts for investors to verify
- Confirm whether the intended period is FY2017 or 2016 Q4; this source is the FY2017 10-K.
- Track Pharmaceutical segment profit, generic pricing trends, Red Oak Sourcing benefits, and the customer loss/repricing impacts.
- Assess post-acquisition debt, cash generation, covenant headroom, interest costs and progress toward the stated debt-reduction plan.
- Monitor integration results and acquisition accounting for the Patient Recovery Business, including Medical segment performance and amortization costs.
- Follow developments in opioid and IVC filter litigation, including any changes to accruals, insurance recoveries or estimates of potential losses.
- Review customer concentration and CVS contract renewal/continuation risk, alongside implementation of the new Pharmaceutical systems.