CARDINAL HEALTH INC quarterly report, Q3 FY2016

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Business context and reporting period

Cardinal Health, Inc. is a healthcare services and products company with Pharmaceutical and Medical segments. The supplied filing is a fiscal 2016 third-quarter Form 10-Q for the quarter ended March 31, 2016, filed May 3, 2016. This differs from the request metadata’s “2015 Q3.” Comparisons below are with the prior-year periods.

Financial results and position

  • Revenue: Q3 revenue was $30.662 billion, up 21%; nine-month revenue was $90.162 billion, up 20%. Pharmaceutical revenue rose 22% in both periods; Medical revenue rose 13% for the quarter and 8% for nine months.
  • Profit and EPS: Q3 GAAP operating earnings were $656 million (+11%), net earnings attributable to Cardinal Health were $386 million (+6%), and diluted EPS was $1.17 (+7%). Nine-month figures were $1.839 billion (+15%), $1.095 billion (+19%), and $3.30 (+20%), respectively. Non-GAAP diluted EPS was $1.43 for Q3 (+20%) and $4.10 for nine months (+21%).
  • Margins: Gross margin was $1.689 billion for Q3 (+16%) and $4.877 billion for nine months (+15%). Gross margin rate contracted, primarily due to onboarding a new mail-order customer; generics-program performance helped, while customer pricing changes and LIFO charges weighed on the rate.
  • Segments: Q3 segment profit was $660 million in Pharmaceutical (+16%) and $128 million in Medical (+26%). Nine-month segment profit was $1.945 billion (+25%) and $335 million (+1%), respectively.
  • Cash flow and liquidity: Nine-month operating cash flow was $2.330 billion, versus $1.672 billion a year earlier. Cash and equivalents were $2.598 billion at March 31, down from $4.616 billion at June 30, 2015. The company cited $3.383 billion of acquisition spending, $386 million of dividends, $300 million of repurchases, and $284 million of capital expenditures as uses of cash.
  • Debt: Long-term obligations and other short-term borrowings totaled $5.546 billion at March 31, compared with $5.492 billion at June 30, 2015. Net interest expense rose 28% in both the quarter and nine-month period, primarily due to debt issued in June 2015. No amounts were drawn on the $1.5 billion revolving credit facility; the company reported compliance with its financial covenants.

Material changes versus prior year

  • Growth reflected existing and new pharmaceutical distribution customers, acquisitions, and generics-program performance; customer pricing changes partially offset gains.
  • Acquisitions included Harvard Drug ($1.1 billion), naviHealth (71% interest; $238 million net of cash acquired), and Cordis ($1.9 billion). Acquisition-related amortization and costs increased, and acquisition spending drove a substantial decline in cash.
  • GAAP results included $12 million of Q3 and $51 million of nine-month LIFO charges. Prior-year nine-month results included a $60 million debt-extinguishment loss and $54 million of net litigation charges; current-period nine-month results included net litigation recoveries of $3 million.

Outlook, risks and unusual items

  • Management expected fiscal 2016 capital expenditures of $450 million to $480 million and said available capital resources and projected operating cash flow were adequate for anticipated needs. Additional acquisitions could require capital-markets financing. The supplied filing text does not provide a clear earnings or EPS guidance range.
  • Key legal matters include a DEA investigation concerning controlled-substance distribution, for which Cardinal accrued $44 million at March 31, 2016, and West Virginia litigation alleging failures to control diversion and report suspicious orders. The company said it could not estimate a reasonably possible loss range for certain matters; outcomes in a particular period could be material.
  • Unrecognized tax benefits were $542 million. The company estimated a possible net decrease of up to $195 million within 12 months, excluding penalties and interest.
  • Cardinal described forward-looking statements as subject to risks and uncertainties and undertook no general obligation to update them. It reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

  1. Confirm the intended reporting period: this filing covers fiscal Q3 2016, not Q3 2015.
  2. Assess whether acquisition-driven revenue and profit growth can be sustained, particularly given the gross-margin-rate pressure from customer onboarding and pricing.
  3. Review cash conversion and working-capital movements, especially inventory growth and the substantial acquisition-related cash outflow.
  4. Track acquisition integration, purchase-price allocations, amortization, Cordis inventory step-up effects, and naviHealth’s redeemable noncontrolling interest.
  5. Monitor resolution and potential financial effects of the DEA, West Virginia, and tax matters, including exposures that the company could not quantify.