UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended June 30, 2017
or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ________ to ________
Commission File Number: 1-11373
Cardinal Health, Inc.
(Exact name of registrant as specified in its charter)
Ohio | 31-0958666 |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) |
7000 Cardinal Place, Dublin, Ohio | 43017 |
(Address of principal executive offices) | (Zip Code) |
(614) 757-5000 | |
(Registrant’s telephone number, including area code) | |
Securities registered pursuant to Section 12(b) of the Act: | |
Title of class | Name of each exchange on which registered |
Common shares (without par value) | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None | |
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ | Accelerated filer o |
Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company o |
Emerging growth company o | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act o | |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
The aggregate market value of voting stock held by non-affiliates or registrant on December 31, 2016, was the following: $22,624,332,824.
The number of the registrant’s common shares, without par value, outstanding as of July 31, 2017, was the following: 316,453,664.
Documents Incorporated by Reference:
Portions of the registrant’s Definitive Proxy Statement to be filed for its 2017 Annual Meeting of Shareholders are incorporated by reference into the sections of this Form 10-K addressing the requirements of Part III of Form 10-K.
Cardinal Health Fiscal 2017 Form 10-K |
Table of Contents
Page | |
1 | Cardinal Health | Fiscal 2017 Form 10-K | |
Introduction | ||
Introduction
References to Cardinal Health and Fiscal Years
As used in this report, "we," "our," "us," "Cardinal Health" and similar pronouns refer to Cardinal Health, Inc. and its subsidiaries, unless the context requires otherwise. Our fiscal year ends on June 30. References to fiscal 2017, 2016, 2015, 2014 and 2013 and to FY17, FY16, FY15, FY14 and FY13 are to the fiscal years ended June 30, 2017, 2016, 2015, 2014 and 2013, respectively. Except as otherwise specified, information in this report is provided as of June 30, 2017.
Non-GAAP Financial Measures
In this report, including in the "Fiscal 2017 Overview" section of Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A"), we use financial measures that are derived from consolidated financial data but are not presented in our financial statements that are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). These measures are considered “non-GAAP financial measures” under the Securities and Exchange Commission (“SEC”) rules. The reasons we use these non-GAAP financial measures and the reconciliations to their most directly comparable GAAP financial measures are included in the “Explanation and Reconciliation of Non-GAAP Financial Measures” section following MD&A in this report.
Important Information Regarding Forward-Looking Statements
This report (including information incorporated by reference) includes forward-looking statements addressing expectations, prospects, estimates and other matters that are dependent upon future events or developments. Many forward-looking statements appear in MD&A, but there are others throughout this report, which may be identified by words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “will,” “should,” “could,” “would,” “project,” “continue,” “likely,” and similar expressions, and include statements reflecting future results or guidance, statements of outlook and expense accruals. These matters are subject to risks and uncertainties that could cause actual results to differ materially from those projected, anticipated or implied. The most significant of these risks and uncertainties are described in “Risk Factors” in this report and in Exhibit 99.1 to the Form 10-K included in this report. Forward-looking statements in this report speak only as of the date of this document. Except to the extent required by applicable law, we undertake no obligation to update or revise any forward-looking statement.
Available Information
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports are available free of charge on our website (www.cardinalhealth.com), under the “Investors — Financial Reporting — SEC Filings” caption, as soon as reasonably practicable after we electronically file them with, or furnish them to, the SEC. You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website (www.sec.gov) where you can search for annual, quarterly and current reports, proxy and information statements, and other information regarding us and other public companies.
Cardinal Health | Fiscal 2017 Form 10-K | 2 | |
MD&A | Results of Operations | |
Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A)
About Cardinal Health
Cardinal Health, Inc. is an Ohio corporation formed in 1979 and is a global, integrated healthcare services and products company providing customized solutions for hospitals, healthcare systems, pharmacies, ambulatory surgery centers, clinical laboratories and physician offices. We provide medical products and pharmaceuticals and cost-effective solutions that enhance supply chain efficiency. We connect patients, providers, payers, pharmacists and manufacturers for integrated care coordination and better patient management. We manage our business and report our financial results in two segments: Pharmaceutical and Medical.
Pharmaceutical Segment
Our Pharmaceutical segment distributes branded and generic pharmaceutical, specialty pharmaceutical, and over-the-counter healthcare and consumer products in the United States. This segment also provides services to pharmaceutical manufacturers and healthcare providers to support the development, marketing, and distribution of specialty pharmaceutical products; operates nuclear pharmacies and radiopharmaceutical manufacturing facilities; provides pharmacy management services to hospitals, as well as medication therapy management and patient outcomes services to hospitals, other healthcare providers and payers; and repackages generic pharmaceuticals and over-the-counter healthcare products. This segment also imports and distributes pharmaceuticals, over-the-counter healthcare and consumer products and provides specialty pharmacy and other services in China.
Medical Segment
Our Medical segment manufactures, sources and distributes Cardinal Health branded medical, surgical and laboratory products, which are sold in the United States, Canada, Europe, Asia and other markets. In addition to distributing Cardinal Health branded products, this segment also distributes a broad range of national brand products and provides supply chain services and solutions to hospitals, ambulatory surgery centers, clinical laboratories and other healthcare providers in the United States, Canada and China. This segment also distributes medical products to patients' homes and provides post-acute care management and transition services and software to hospitals, other healthcare providers and payers in the United States.
3 | Cardinal Health | Fiscal 2017 Form 10-K | |
MD&A | Results of Operations | |
Consolidated Results
Fiscal 2017 Overview
Revenue
Revenue for fiscal 2017 was $130.0 billion, a 7 percent increase from the prior year, due primarily to sales growth from pharmaceutical distribution customers.
GAAP and Non-GAAP Operating Earnings
(in millions) | 2017 | 2016 | Change | |||||||
GAAP | $ | 2,120 | $ | 2,459 | (14 | )% | ||||
Restructuring and employee severance | 56 | 25 | ||||||||
Amortization and other acquisition-related costs | 527 | 459 | ||||||||
Impairments and (gain)/loss on disposal of assets | 18 | 21 | ||||||||
Litigation (recoveries)/charges, net | 48 | (69 | ) | |||||||
Non-GAAP | $ | 2,769 | $ | 2,895 | (4 | )% | ||||
The sum of the components may not equal the total due to rounding.
During fiscal 2017, GAAP operating earnings decreased 14 percent to $2.1 billion and non-GAAP operating earnings decreased 4 percent to $2.8 billion. The decreases in both GAAP and non-GAAP operating earnings were primarily due to generic pharmaceutical customer pricing changes and the previously disclosed loss of a large pharmaceutical distribution customer. The decreases were partially offset by the benefits of Red Oak Sourcing within our Pharmaceutical segment generics program and growth from our Medical segment. Changes in litigation (recoveries)/charges, net and amortization of acquisition-related intangible assets related to the acquisition of Cordis also contributed to the decrease in GAAP operating earnings during fiscal 2017.
GAAP and Non-GAAP Diluted EPS
($ per share) | 2017 | 2016 | Change | |||||||
GAAP | $ | 4.03 | $ | 4.32 | (7 | )% | ||||
Restructuring and employee severance | 0.11 | 0.05 | ||||||||
Amortization and other acquisition-related costs | 1.13 | 0.96 | ||||||||
Impairments and (gain)/loss on disposal of assets | 0.04 | 0.04 | ||||||||
Litigation (recoveries)/charges, net | 0.09 | (0.13 | ) | |||||||
Non-GAAP | $ | 5.40 | $ | 5.24 | 3 | % | ||||
The sum of the components may not equal the total due to rounding.
During fiscal 2017, GAAP diluted earnings per share from continuing operations attributable to Cardinal Health, Inc. ("diluted EPS") decreased 7 percent to $4.03 and non-GAAP diluted EPS increased 3 percent to $5.40. GAAP diluted EPS decreased due to lower GAAP operating earnings, partially offset by a lower effective tax rate and fewer shares outstanding as a result of share repurchases. Non-GAAP diluted EPS increased primarily due to a lower effective tax rate and fewer shares outstanding as a result of share repurchases, partially offset by lower non-GAAP operating earnings.
Cash and Equivalents
Our cash and equivalents balance was $6.9 billion at June 30, 2017 compared to $2.4 billion at June 30, 2016. The increase in cash and equivalents during fiscal 2017 was driven by the proceeds from a $5.2 billion debt issuance and $1.2 billion provided by operating activities, partially offset by $600 million paid for share repurchases, $577 million paid in dividends, $387 million in capital expenditures and $310 million in debt repayments.
In July 2017, we used $6.1 billion to fund the acquisition of the Patient Care, Deep Vein Thrombosis and Nutritional Insufficiency businesses from Medtronic plc, as discussed below, and used $403 million to redeem our 1.7% notes due 2018.
Cardinal Health | Fiscal 2017 Form 10-K | 4 | |
MD&A | Results of Operations | |
Significant Developments in Fiscal 2017 and Trends
Acquisition of Medtronic's Patient Recovery Business
On July 29, 2017, we acquired the Patient Care, Deep Vein Thrombosis, and Nutritional Insufficiency businesses (the "Patient Recovery Business") from Medtronic plc ("Medtronic") for $6.1 billion in cash. The Patient Recovery Business manufactures 23 medical product categories sold into multiple healthcare channels, and includes numerous industry-leading brands, such as Curity, Kendall, Dover, Argyle and Kangaroo. The acquisition further expands the Medical segment's portfolio of self-manufactured products. We funded the acquisition through $4.5 billion in new long-term debt, the use of existing cash, and borrowings under our existing credit arrangements.
Trends
Within our Pharmaceutical segment, we expect fiscal 2018 segment profit to be less than our fiscal 2017 segment profit due primarily to generic pharmaceutical customer pricing changes, which also negatively impacted Pharmaceutical segment profit during fiscal 2017. However, as is generally the case, the frequency, timing, magnitude, and profit impact of pharmaceutical customer pricing changes and branded and generic pharmaceutical manufacturer pricing changes remain uncertain and their impact on Pharmaceutical segment profit and consolidated operating earnings in fiscal 2018 could be more or less than we expect.
In fiscal 2018, we expect the acquisition of the Patient Recovery Business will significantly increase the Medical segment's revenue and segment profit. We also expect the acquisition will significantly increase amortization and acquisition-related costs in fiscal 2018 due to the size and complexity of the acquisition. We expect our interest expense, net to increase in fiscal 2018 primarily due to the debt issued to fund a portion of the purchase price of the acquisition of the Patient Recovery Business.
5 | Cardinal Health | Fiscal 2017 Form 10-K | |
MD&A | Results of Operations | |
Results of Operations
Revenue
Revenue | Change | ||||||||||||||||
(in millions) | 2017 | 2016 | 2015 | 2017 | 2016 | ||||||||||||
Pharmaceutical | $ | 116,463 | $ | 109,131 | $ | 91,116 | 7 | % | 20 | % | |||||||
Medical | 13,524 | 12,430 | 11,395 | 9 | % | 9 | % | ||||||||||
Total segment revenue | 129,987 | 121,561 | 102,511 | 7 | % | 19 | % | ||||||||||
Corporate | (11 | ) | (15 | ) | 20 | N.M. | N.M. | ||||||||||
Total revenue | $ | 129,976 | $ | 121,546 | $ | 102,531 | 7 | % | 19 | % | |||||||
Fiscal 2017 Compared to Fiscal 2016
Pharmaceutical Segment
Fiscal 2017 Pharmaceutical segment revenue grew primarily due to sales growth from the addition of OptumRx and from other pharmaceutical distribution customers, including continued branded pharmaceutical price appreciation, all of which increased revenue by $7.0 billion.
Medical Segment
Fiscal 2017 Medical segment revenue grew primarily due to sales growth from new and existing customers and $212 million in contributions from acquisitions.
Fiscal 2016 Compared to Fiscal 2015
Pharmaceutical Segment
Fiscal 2016 Pharmaceutical segment revenue grew primarily due to sales growth from the addition of OptumRx and from other pharmaceutical distribution customers, including continued branded pharmaceutical price appreciation, all of which increased revenue by $16.9 billion. Acquisitions also contributed $2.1 billion to revenue growth.
Medical Segment
Fiscal 2016 Medical segment revenue grew primarily due to acquisitions, net of divestitures, which contributed $645 million, and sales growth from existing businesses.
Cost of Products Sold
Cost of products sold for fiscal 2017 and 2016 increased $8.4 billion (7 percent) and $18.2 billion (19 percent) compared to the prior-year periods, respectively, as a result of the same factors affecting the changes in revenue and gross margin.
Cardinal Health | Fiscal 2017 Form 10-K | 6 | |
MD&A | Results of Operations | |
Gross Margin
Consolidated Gross Margin | Change | |||||||||||||||
(in millions) | 2017 | 2016 | 2015 | 2017 | 2016 | |||||||||||
Gross margin | $ | 6,544 | $ | 6,543 | $ | 5,712 | N.M. | 15 | % | |||||||
Fiscal 2017 Compared to Fiscal 2016
Fiscal 2017 consolidated gross margin was essentially flat versus the prior-year period.
Consolidated gross margin for fiscal 2017 was positively impacted by sales growth from pharmaceutical distribution customers ($260 million) and acquisitions in both segments ($132 million) and was negatively impacted by the previously disclosed loss of a large pharmaceutical distribution customer.
Gross margin rate contracted during fiscal 2017, primarily due to generic pharmaceutical customer pricing changes, partially offset by the benefits from Red Oak Sourcing within our Pharmaceutical segment generics program.
Fiscal 2016 Compared to Fiscal 2015
Fiscal 2016 consolidated gross margin increased $831 million (15 percent), and was favorably impacted by sales growth from pharmaceutical distribution customers ($510 million) and acquisitions, net of divestitures ($576 million).
Gross margin rate contracted during fiscal 2016, primarily due to changes in product mix driven by the on-boarding of a new mail order customer, OptumRx, starting in October 2015, and also due to the adverse impact of customer pricing changes. Our gross margin rate was favorably impacted by performance under our Pharmaceutical segment generics program. Our generics program had strong year-over-year performance from Red Oak Sourcing.
Distribution, Selling, General and Administrative ("SG&A") Expenses
SG&A Expenses | Change | ||||||||||||||||
(in millions) | 2017 | 2016 | 2015 | 2017 | 2016 | ||||||||||||
SG&A expenses | $ | 3,775 | $ | 3,648 | $ | 3,240 | 3 | % | 13 | % | |||||||
Fiscal 2017 Compared to Fiscal 2016
Fiscal 2017 SG&A expenses increased primarily due to acquisitions ($112 million) and costs related to a multi-year project to replace certain Pharmaceutical segment finance and operating information systems, partially offset by reduced enterprise-wide incentive compensation.
Fiscal 2016 Compared to Fiscal 2015
Fiscal 2016 SG&A expenses increased primarily due to acquisitions, net of divestitures ($370 million).
7 | Cardinal Health | Fiscal 2017 Form 10-K | |
MD&A | Results of Operations | |
Segment Profit
We evaluate segment performance based on segment profit, among other measures. See Note 15 of the "Notes to Consolidated Financial Statements" for additional information on segment profit.
Segment Profit and Operating Earnings | Change | ||||||||||||||||
(in millions) | 2017 | 2016 | 2015 | 2017 | 2016 | ||||||||||||
Pharmaceutical | $ | 2,187 | $ | 2,488 | $ | 2,094 | (12 | )% | 19 | % | |||||||
Medical | 572 | 457 | 433 | 25 | % | 6 | % | ||||||||||
Total segment profit | 2,759 | 2,945 | 2,527 | (6 | )% | 17 | % | ||||||||||
Corporate | (639 | ) | (486 | ) | (366 | ) | 31 | % | 33 | % | |||||||
Total consolidated operating earnings | $ | 2,120 | $ | 2,459 | $ | 2,161 | (14 | )% | 14 | % | |||||||
Fiscal 2017 Compared to Fiscal 2016
Pharmaceutical Segment Profit
Fiscal 2017 Pharmaceutical segment profit decreased largely due to generic pharmaceutical customer pricing changes. The previously disclosed loss of a large pharmaceutical distribution customer, the adverse impact of customer repricings and reduced levels of branded pharmaceutical price appreciation also contributed to the decrease in Pharmaceutical segment profit. These were partially offset by the benefits of Red Oak Sourcing within our generics program.
Medical Segment Profit
Fiscal 2017 Medical segment profit increased due to strong performance from naviHealth, contributions from Cardinal Health branded products, reduced enterprise-wide incentive compensation, and contributions from distribution services. Cardinal Health branded products growth includes the prior year unfavorable impact on cost of products sold from the Cordis inventory fair value step up.
Corporate
As discussed further in sections that follow, the principal drivers for the change in Corporate during fiscal 2017 were the change in litigation (recoveries)/charges, net and higher amortization and other acquisition-related costs.
Fiscal 2016 Compared to Fiscal 2015
Pharmaceutical Segment Profit
Fiscal 2016 Pharmaceutical segment profit increased due to sales growth from pharmaceutical distribution customers and performance under our generics program, partially offset by the adverse impact of customer pricing changes. Acquisitions also contributed to Pharmaceutical segment profit growth. Our generics program benefited from strong year-over-year performance from Red Oak Sourcing.
Medical Segment Profit
Fiscal 2016 Medical segment profit increased due to the contribution from Cardinal Health branded products. Acquisitions, net of divestitures, which included the unfavorable impact on cost of products sold from the fair value step up of inventory acquired with Cordis, also contributed to segment profit growth. Fiscal 2016 Medical segment profit growth was partially offset by a decline in the results from our Canada business.
Corporate
As discussed further in sections that follow, the principal driver for the change in Corporate in fiscal 2016 was increased amortization and other acquisition-related costs primarily related to the acquisitions of Cordis and Harvard Drug, partially offset by litigation recoveries.
Cardinal Health | Fiscal 2017 Form 10-K | 8 | |
MD&A | Results of Operations | |
Other Components of Consolidated Operating Earnings
In addition to revenue, gross margin, and SG&A expenses discussed previously, consolidated operating earnings were impacted by the following:
(in millions) | 2017 | 2016 | 2015 | ||||||||
Restructuring and employee severance | $ | 56 | $ | 25 | $ | 44 | |||||
Amortization and other acquisition-related costs | 527 | 459 | 281 | ||||||||
Impairments and (gain)/loss on disposal of assets, net | 18 | 21 | (19 | ) | |||||||
Litigation (recoveries)/charges, net | 48 | (69 | ) | 5 | |||||||
Amortization and Other Acquisition-Related Costs
Amortization of acquisition-related intangible assets was $392 million, $355 million and $189 million for fiscal 2017, 2016 and 2015, respectively. The increase in amortization of acquisition-related intangible assets during fiscal 2017 and fiscal 2016 was largely due to the acquisition of Cordis. Transaction and integration costs associated with the Cordis acquisition were $61 million and $78 million during fiscal 2017 and 2016, respectively.
Transaction and integration costs associated with the acquisition of the Patient Recovery Business were $54 million during fiscal 2017.
Litigation (Recoveries)/Charges, Net
During fiscal 2017, we incurred litigation charges of $45 million due to accrued expenses relating to the Cordis-related IVC filter product liability claims and the settlement of the State of West Virginia matter. See Note 8 of the "Notes to Consolidated Financial Statements" for additional information.
During fiscal 2016 and 2015, we received and recognized income of $80 million and $71 million, respectively, from settlements of class action antitrust lawsuits in which we were a class member. During fiscal 2015, we incurred litigation charges of $68 million related to government investigations.
Earnings From Continuing Operations Before Income Taxes
In addition to the items discussed above, earnings from continuing operations before income taxes was impacted by the following:
Earnings from Continuing Operations Before Income Taxes | Change | ||||||||||||||||
(in millions) | 2017 | 2016 | 2015 | 2017 | 2016 | ||||||||||||
Other (income)/expense, net | $ | (5 | ) | $ | 5 | $ | (7 | ) | N.M. | N.M. | |||||||
Interest expense, net | 201 | 178 | 141 | 13 | % | 26 | % | ||||||||||
Loss on extinguishment of debt | — | — | 60 | N.M. | (100 | )% | |||||||||||
Interest Expense, Net
Fiscal 2017 interest expense increased primarily due to $5.2 billion of new long-term debt issued in June 2017, $4.5 billion of which was used to fund the acquisition of the Patient Recovery Business in July 2017. Fees relating to a commitment for an unsecured bridge term loan facility obtained in connection with the acquisition also contributed to the increase in interest expense. No amounts were drawn under the bridge loan facility and we terminated the commitment letter in June 2017.
Fiscal 2016 interest expense increased primarily as a result of the additional $1.5 billion of debt issued in June 2015 to fund the Harvard Drug and Cordis acquisitions.
Loss on Extinguishment of Debt
In fiscal 2015, we redeemed certain debt resulting in a loss on the extinguishment of debt of $60 million ($37 million, net of tax).
9 | Cardinal Health | Fiscal 2017 Form 10-K | |
MD&A | Results of Operations | |
Provision for Income Taxes
The provision for income taxes decreased in fiscal 2017 primarily due to a decrease in earnings from continuing operations and a 4.4 percentage point decrease in the effective tax rate as discussed below.
Generally, fluctuations in the effective tax rate are due to changes in the distribution of income among non-U.S. taxing jurisdictions with lower income tax rates and other reconciling items. A reconciliation of the provision based on the federal statutory income tax rate to our effective income tax rate from continuing operations is as follows (see Note 7 of the "Notes to Consolidated Financial Statements" for additional information):
2017 | 2016 | 2015 | ||||||
Provision at Federal statutory rate | 35.0 | % | 35.0 | % | 35.0 | % | ||
State and local income taxes, net of federal benefit | 1.0 | 1.5 | 4.1 | |||||
Foreign tax rate differential | (0.2 | ) | (0.6 | ) | (2.4 | ) | ||
Nondeductible/nontaxable items | 0.2 | 1.0 | 0.7 | |||||
Other | (3.3 | ) | 0.2 | 1.0 | ||||
Effective income tax rate | 32.7 | % | 37.1 | % | 38.4 | % | ||
Fiscal 2017
The fiscal 2017 effective income tax rate was favorably impacted by the change in other items, which decreased 3.5 percentage points from fiscal 2016 primarily due to the realignment of foreign subsidiaries in anticipation of closing the acquisition of the Patient Recovery Business and also with deductions related to U.S. production activities. The state and local income tax rate decreased 0.5 percentage points primarily due to resolutions with state taxing authorities.
Ongoing Audits
The IRS is currently conducting audits of fiscal years 2008 through 2014.
Fiscal 2016 and Fiscal 2015
The fiscal 2016 effective income tax rate was favorably impacted by the state and local income tax rate, which decreased 2.6 percentage points from fiscal 2015 due to resolutions with state taxing authorities and a shift in the distribution of income among jurisdictions. The foreign tax rate differential decreased 1.8 percentage points primarily due to the deferred tax benefits recognized in fiscal 2015.
The fiscal 2015 effective income tax rate was unfavorably impacted by the state and local income tax rate, which increased 1.9 percentage points due to the de-recognition of certain state tax benefits. The foreign tax rate differential also increased 1.2 percentage points primarily due to recognition of deferred tax benefits resulting from new tax legislation. In addition, the change in measurement of uncertain tax positions increased 1.3 percentage points primarily as a result of proposed assessment of additional tax.
Cardinal Health | Fiscal 2017 Form 10-K | 10 | |
MD&A | Liquidity and Capital Resources | |
Liquidity and Capital Resources
We currently believe that, based on available capital resources (cash on hand and committed credit facilities) and projected operating cash flow, we have adequate capital resources to fund working capital needs; currently anticipated capital expenditures; currently anticipated business growth and expansion; contractual obligations; tax payments; and current and projected debt service requirements, dividends, and share repurchases. If we decide to engage in one or more additional acquisitions, depending on the size and timing of such transactions, we may need to access capital markets for additional financing.
Cash and Equivalents
Our cash and equivalents balance was $6.9 billion at June 30, 2017 compared to $2.4 billion at June 30, 2016. The increase in cash and equivalents during fiscal 2017 was driven by the proceeds from the $5.2 billion debt issuance and $1.2 billion provided by operating activities, partially offset by $600 million paid for share repurchases, $577 million paid in dividends, $387 million in capital expenditures and $310 million in debt repayments. The $1.8 billion decrease in net cash provided by operating activities was primarily due to an increase in working capital as a result of changes in timing of customer and vendor payments, some of which related to implementation of the new Pharmaceutical segment finance and operating information systems. At June 30, 2017, our cash and equivalents were held in cash depository accounts with major banks or invested in high quality, short-term liquid investments. On July 29, 2017, we acquired the Patient Recovery Business for $6.1 billion in cash.
The cash and equivalents balance at June 30, 2017 included $569 million of cash held by subsidiaries outside of the United States. Although the vast majority of cash is available for repatriation, bringing the cash into the United States could trigger U.S federal, state and local income tax obligations. Because the earnings are considered permanently reinvested, no U.S. tax provision has been
accrued related to the repatriation of these earnings. It is not practicable to evaluate the amount of U.S. tax that might be payable on the remittance of such earnings.
The decrease in cash and equivalents during fiscal 2016 of $2.2 billion was driven by $3.6 billion deployed for acquisitions, $651 million paid for share repurchases, $512 million paid in dividends and $465 million in capital expenditures, partially offset by net cash provided by operating activities of $3.0 billion, which was positively impacted by increased net earnings and working capital improvements.
During fiscal 2015 we deployed $1.0 billion of cash on share repurchases, $503 million on acquisitions and $460 million on dividends. Net cash provided by operating activities of $2.5 billion benefited from a net working capital decrease in excess of $500 million as a result of the Walgreens contract expiration.
Changes in working capital, which impact operating cash flow, can vary significantly depending on factors such as the timing of customer payments, inventory purchases and payments to vendors in the regular course of business, as well as fluctuating working capital needs driven by customer and product mix.
Other Financing Arrangements and Financial Instruments
Credit Facilities and Commercial Paper
In addition to cash and equivalents and operating cash flow, other sources of liquidity at June 30, 2017 include a $1.75 billion revolving credit facility and a $700 million committed receivables sales facility program. We also have a $1.75 billion commercial paper program, backed by our revolving credit facility. At June 30, 2017, we had no amounts outstanding under our revolving credit facility or our committed receivables sales facility program. Under our commercial paper program, we had a maximum amount outstanding of $855 million and an average daily amount outstanding of $58 million during fiscal 2017.
Our revolving credit facility and committed receivables sales facility programs require us to maintain a consolidated leverage ratio of no more than 3.25-to-1 as of the last day of each quarter. As a result of the acquisition of the Patient Recovery Business, we temporarily
increased this ratio to 4.25-to-1. As of June 30, 2017, we were in compliance with these financial covenants.
Long-Term Obligations
At June 30, 2017, we had total long-term obligations of $9.1 billion.
In June 2017, we sold $1 billion aggregate principal amount of 1.948% notes due 2019, $1.15 billion aggregate principal amount of 2.616% notes due 2022, $350 million aggregate principal amount of floating rate notes due 2022, $750 million aggregate principal amount of 3.079% notes due 2024, $1.35 billion aggregate principal amount of 3.410% notes due 2027 and $600 million aggregate principal amount of 4.368% notes due 2047. In addition to funding a portion of the purchase price of the acquisition of the Patient Recovery Business described below, in July 2017 we used a portion of the debt proceeds to redeem our $400 million 1.7% notes due 2018.
11 | Cardinal Health | Fiscal 2017 Form 10-K | |
MD&A | Liquidity and Capital Resources | |
Funding for Acquisition of Medtronic's Patient Recovery Business
On July 29, 2017, we acquired the Patient Recovery Business from Medtronic for $6.1 billion in cash. We funded the acquisition using $4.5 billion of the proceeds from long-term debt issued in June 2017, cash on hand, $400 million in commercial paper and $300 million borrowed under our receivables sales facility. The new long-term debt was issued in June 2017 primarily to fund a portion of the purchase price of this acquisition. We also had obtained a commitment letter in April 2017 from a financial institution for a $4.5 billion unsecured bridge term loan facility that could have been used to complete the acquisition. We incurred fees related to the facility, which are included in interest expense, net. No amounts were drawn under the bridge term loan facility and we terminated the commitment letter in June 2017.
Available-for-Sale Securities
At June 30, 2017 and 2016, we held $65 million and $200 million, respectively, of marketable securities, which are classified as available-for-sale. In July 2017, we liquidated $65 million of our marketable securities.
Risk Management
We use interest rate swaps, foreign currency contracts and commodity contracts to manage our exposure to cash flow variability. We also use interest rate swaps to protect the value of our debt and use foreign currency forward contracts to protect the value of our existing and forecasted foreign currency assets and liabilities. See the "Quantitative and Qualitative Disclosures About Market Risk" section as well as Note 1 and Note 11 of the “Notes to Consolidated Financial Statements” for information regarding the use of financial instruments and derivatives as well as foreign currency, interest rate and commodity exposures.
Capital Deployment
Capital Expenditures
Capital expenditures during fiscal 2017, 2016 and 2015 were $387 million, $465 million and $300 million, respectively.
We expect capital expenditures in fiscal 2018 to be between $500 million and $540 million primarily for information technology projects, growth projects in our core business and for integration of the acquisition of the Patient Recovery Business.
Dividends
During fiscal 2017, we paid quarterly dividends totaling $1.80 per share, an increase of 16 percent from fiscal 2016.
On May 3, 2017, our Board of Directors approved a quarterly dividend of $0.4624 per share, or $1.85 per share on an annualized basis, which was paid on July 15, 2017 to shareholders of record on July 3, 2017.
Share Repurchases
During fiscal 2017, we repurchased $600 million of our common shares. We funded the repurchases with available cash. At June 30, 2017, we had $443 million remaining under our existing $1.0 billion share repurchase program.
Acquisition of Medtronic's Patient Recovery Business
Described above under "Funding for Acquisition of Medtronic's Patient Recovery Business."
Long-Term Obligations Repayment Plans
We plan to reduce our long-term obligations by approximately $500 million in each of fiscal 2018, 2019 and 2020 by paying off long-term debt as it comes due.
Cardinal Health | Fiscal 2017 Form 10-K | 12 | |
MD&A | Other | |
Contractual Obligations
At June 30, 2017, our contractual obligations, including estimated payments due by period, are as follows:
(in millions) | 2018 | 2019 to 2020 | 2021 to 2022 | There-after | Total | ||||||||||||||
Long-term debt and short-term borrowings (1) | $ | 1,328 | $ | 1,950 | $ | 1,750 | $ | 5,424 | $ | 10,452 | |||||||||
Interest on long-term debt | 320 | 590 | 542 | 2,250 | 3,702 | ||||||||||||||
Capital lease obligations (2) | 2 | 5 | 2 | 2 | 11 | ||||||||||||||
Other liabilities (3) | 4 | — | — | — | 4 | ||||||||||||||
Operating leases (4) | 110 | 171 | 100 | 107 | 488 | ||||||||||||||
Purchase obligations and other payments (5) | 341 | 331 | 234 | 244 | 1,150 | ||||||||||||||
Total contractual obligations (6) | $ | 2,105 | $ | 3,047 | $ | 2,628 | $ | 8,027 | $ | 15,807 | |||||||||
(1) | Represents maturities of our long-term debt obligations and other short-term borrowings excluding capital lease obligations described below. See Note 6 of the “Notes to Consolidated Financial Statements” for further information. |
(2) | Represents maturities of our capital lease obligations included within long-term obligations in our consolidated balance sheets. |
(3) | Represents cash outflows by period for certain of our liabilities in which cash outflows could be reasonably estimated. Long-term liabilities, such as unrecognized tax benefits and deferred taxes, have been excluded from the |
table above because of the inherent uncertainty of the underlying tax positions or because of the inability to reasonably estimate the timing of any cash outflows. See Note 7 of the “Notes to Consolidated Financial Statements” for further discussion of income taxes. Additionally, the carrying value of redeemable noncontrolling interests are excluded from the table, as the ultimate amount and timing of any future cash payments related to the redemption amount are uncertain. See Note 1 and Note 12 of the “Notes to Consolidated Financial Statements” for additional information regarding redeemable noncontrolling interests.
(4) | Represents minimum rental payments for operating leases having initial or remaining non-cancelable lease terms as described in Note 8 of the “Notes to Consolidated Financial Statements.” |
(5) | A purchase obligation is defined as an agreement to purchase goods or services that is legally enforceable and specifies all significant terms, including fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and approximate timing of the transaction. The purchase obligation amounts disclosed above represent estimates of the minimum for which we are obligated and the time period in which cash outflows will occur. Purchase orders and authorizations to purchase that involve no firm commitment from either party are excluded from the above table. In addition, contracts that can be unilaterally canceled with no termination fee or with proper notice are excluded from our total purchase obligations except for the amount of the termination fee or the minimum amount of goods that must be purchased during the requisite notice period. Purchase obligations and other payments also includes quarterly payments of $45.6 million that we are required to pay CVS Health Corporation ("CVS"), in connection with the establishment of Red Oak Sourcing and will be in place for the remaining seven years of the agreement. See Note 8 of the “Notes to Consolidated Financial Statements” for additional information. |
(6) | Excludes obligations from acquisitions not closed as of June 30, 2017. |
Off-Balance Sheet Arrangements
We had no significant "off-balance sheet arrangements" at June 30, 2017, as that term is defined in the SEC rules.
Recent Financial Accounting Standards
See Note 1 of the “Notes to Consolidated Financial Statements” for a discussion of recent financial accounting standards.
13 | Cardinal Health | Fiscal 2017 Form 10-K | |
MD&A | Critical Accounting Policies and Sensitive Accounting Estimates | |
Critical Accounting Policies and Sensitive Accounting Estimates
Critical accounting policies are those accounting policies that (i) can have a significant impact on our financial condition and results of operations and (ii) require the use of complex and subjective estimates based upon past experience and management’s judgment. Other people applying reasonable judgment to the same facts and circumstances could develop different estimates. Because estimates are inherently uncertain, actual results may differ. In this section, we describe the significant policies applied in preparing our consolidated financial statements that management believes are the most dependent on estimates and assumptions. For further discussion of accounting policies for items within this section and of additional accounting policies, see Note 1 of the “Notes to Consolidated Financial Statements.”
Allowance for Doubtful Accounts
The allowance for doubtful accounts includes general and specific reserves. We determine our allowance for doubtful accounts by reviewing accounts receivable aging, industry trends, customer financial strength and credit standing, historical write-off trends and payment history. We regularly evaluate how changes in economic conditions may affect credit risks. See Note 1 of the “Notes to Consolidated Financial Statements” for further information on our policy for Receivables and Allowance for Doubtful Accounts.
A hypothetical 0.1 percent increase or decrease in the reserve as a percentage of trade receivables at June 30, 2017, would result in an increase or decrease in bad debt expense of $8 million. We believe the reserve maintained and expenses recorded in fiscal 2017 are appropriate. At this time, we are not aware of any analytical findings
or customer issues that are likely to lead to a significant future increase in the allowance for doubtful accounts as a percentage of revenue.
The following table presents information regarding the allowance for doubtful accounts over the past three fiscal years:
(in millions, except percentages) | 2017 | 2016 | 2015 | ||||||||
Allowance for doubtful accounts | $ | 137 | $ | 135 | $ | 135 | |||||
Reduction to allowance for customer deductions and write-offs | 58 | 74 | 66 | ||||||||
Charged to costs and expenses | 60 | 74 | 64 | ||||||||
Allowance as a percentage of customer receivables | 1.7 | % | 1.8 | % | 2.0 | % | |||||
Allowance as a percentage of revenue | 0.11 | % | 0.11 | % | 0.13 | % | |||||
Inventories
A substantial portion of our inventories (56 percent and 58 percent at June 30, 2017 and 2016, respectively) are valued at the lower of cost, using the last-in, first-out ("LIFO") method, or market. These are primarily merchandise inventories at the core pharmaceutical distribution facilities within our Pharmaceutical segment (“distribution facilities”). The LIFO impact on the consolidated statements of earnings depends on pharmaceutical manufacturer price appreciation or deflation and our fiscal year-end inventory levels, which can be meaningfully influenced by customer buying behavior immediately preceding our fiscal year-end. Prices for branded pharmaceuticals generally tend to rise, resulting in an increase in cost of products sold, whereas prices for generic pharmaceuticals generally tend to decline, resulting in a decrease in cost of products sold. See Note 1 of the “Notes to Consolidated Financial Statements” for further information on our policy for Inventories.
Using LIFO, if there is a decrease in inventory levels that have experienced pharmaceutical price appreciation, the result generally will be a decrease in future cost of products sold as our older inventory is held at a lower cost. Conversely, if there is a decrease in inventory levels that have experienced a pharmaceutical price decline, the result generally will be an increase in future cost of products sold as our older inventory is held at a higher cost.
We believe that the average cost method of inventory valuation provides a reasonable approximation of the current cost of replacing inventory within these distribution facilities. As such, the LIFO reserve is the difference between (a) inventory at the lower of LIFO cost or market and (b) inventory at replacement cost determined using the average cost method of inventory valuation. If we had used the average cost method of inventory valuation for all inventory within the distribution facilities, the value of our inventories would not have changed in fiscal 2017 or 2016 because inventories valued at LIFO were $46 million and $9 million higher than the average cost value at June 30, 2017 and 2016, respectively. We do not record inventories in excess of replacement cost. As such, we did not record any changes in our LIFO reserve in fiscal 2017 and 2016.
Our remaining inventory that is not valued at the lower of LIFO or market is stated at the lower of cost, using the first-in, first-out method, or market. Inventories presented in the consolidated balance sheets are net of reserves for excess and obsolete inventory which were $76 million and $79 million at June 30, 2017 and 2016, respectively. We reserve for inventory obsolescence using estimates based on historical experience, historical and projected sales trends, specific categories of inventory, age of on-hand inventory and manufacturer return policies. If actual conditions are less favorable than our assumptions, additional inventory reserves may be required.
Cardinal Health | Fiscal 2017 Form 10-K | 14 | |
MD&A | Critical Accounting Policies and Sensitive Accounting Estimates | |
Business Combinations
The assets acquired and liabilities assumed in a business combination, including identifiable intangible assets, are recorded at their estimated fair values as of the acquisition date. For further discussion of the Business Combinations accounting policy, see Note 1 of the “Notes to Consolidated Financial Statements.”
Critical estimates and assumptions include: expected future cash flows for customer relationships, trademarks, trade names, patents,
developed technology, in-process research and development ("IPR&D") and other identifiable intangible assets; discount rates that reflect the risk factors associated with future cash flows; and estimates of useful lives. See Note 2 of the “Notes to Consolidated Financial Statements” for additional information regarding our acquisitions.
Goodwill and Other Intangible Assets
Purchased goodwill and intangible assets with indefinite lives are tested for impairment annually or when indicators of impairment exist. Goodwill impairment testing involves a comparison of the estimated fair value of reporting units to the respective carrying amount, which may be performed utilizing either a qualitative or quantitative assessment. A reporting unit is defined as an operating segment or one level below an operating segment (also known as a component).
We have two operating segments, which are the same as our reportable segments: Pharmaceutical and Medical. These operating segments are comprised of divisions (components), for which discrete financial information is available. Components are aggregated into reporting units for purposes of goodwill impairment testing to the extent that they share similar economic characteristics. Our reporting units are: Pharmaceutical operating segment (excluding our Nuclear Pharmacy Services division and Cardinal Health China - Pharmaceutical division); Nuclear Pharmacy Services division; Cardinal Health China - Pharmaceutical division; Medical operating segment (excluding our Cardinal Health at Home division and naviHealth division) (“Medical Unit”); Cardinal Health at Home division; and naviHealth division.
Goodwill impairment testing involves judgment, including the identification of reporting units and the estimation of the fair value of each reporting unit and, if necessary, the estimation of the implied fair value of goodwill. Our determination of estimated fair value of our reporting units is based on a combination of the income-based and market-based approaches. We use discount rates that are commensurate with the risks and uncertainty inherent in the respective reporting units and in our internally-developed forecasts. Under the market-based approach, we determine fair value by comparing our reporting units to similar businesses or guideline companies whose securities are actively traded in public markets.
Estimating the fair value of reporting units requires the use of estimates and significant judgments that are based on a number of factors including actual operating results. The use of alternate estimates and assumptions or changes in the industry or peer groups could materially affect the determination of fair value for each reporting unit and potentially result in goodwill impairment. If a reporting unit fails to achieve expected earnings or otherwise fails to meet current financial plans, or if there were changes to any other key assumptions used in the tests, the reporting unit could incur a goodwill impairment in a future period.
We performed annual impairment testing in fiscal 2017, 2016 and 2015 and concluded that there were no impairments of goodwill as the estimated fair value of each reporting unit exceeded its carrying value. For our annual impairment test in fiscal 2017, the fair value of our Medical Unit exceeded its carrying value of $6.8 billion by approximately 6 percent, which is lower than in past years due to recent performance of our Cordis acquisition. For this test, we used a discount rate of 8.5 percent and a terminal growth rate of 2.0 percent. The goodwill balance for our Medical Unit is $2.6 billion. A decrease in future cash flows, an increase in the discount rate or a decrease in the terminal growth rate, among other things, could result in a goodwill impairment for the Medical Unit. If we were to alter our impairment testing in fiscal 2017 by increasing the discount rate by 1.0 percent, there would have been an impairment indicator for our Medical Unit and we would have performed Step 2 of the goodwill impairment test. Similarly, changes in other key assumptions used in the test could result in an impairment indicator for our Medical Unit. For any of our other reporting units, there would not have been an impairment indicator for fiscal 2017 if we raised the discount rate by 1.0 percent. Subsequent to June 30, 2017, we acquired the Patient Recovery Business as discussed in Note 18, which will be included in the Medical Unit going forward and is expected to significantly contribute to the profit of this unit.
Intangible assets with finite lives are amortized using a combination of straight-line and accelerated methods based on the expected cash flows from the asset over their estimated useful lives. We review intangible assets with finite lives for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable.
The impairment test for indefinite-lived intangibles other than goodwill (primarily IPR&D) requires comparing the fair value of the indefinite-lived intangible asset to the carrying value of the asset as of the impairment testing date.
We estimate the fair value of our indefinite-lived intangibles under the income approach using a discounted cash flow model. We use our internal forecasts to estimate future cash flows, which we believe are consistent with those of a market participant, and include an estimate of long-term growth rates based on our most recent views of the long-term outlook for the indefinite-lived intangible including, among other factors, assumptions on regulatory approval for IPR&D.
15 | Cardinal Health | Fiscal 2017 Form 10-K | |
MD&A | Critical Accounting Policies and Sensitive Accounting Estimates | |
Determining whether an impairment of indefinite-lived intangibles occurred requires estimating future undiscounted cash flows expected to be generated by the asset group. Actual results may differ materially from those used in our forecasts.
See Note 1 of "Notes to Consolidated Financial Statements" for additional information regarding goodwill and other intangible assets.
Vendor Reserves
In the ordinary course of business, our vendors may dispute deductions taken against payments otherwise due to them or assert other disputes. These disputed transactions are researched and resolved based upon findings of the research performed. At any given time, there are outstanding items in various stages of research and resolution. In determining appropriate reserves for areas of exposure with our vendors, we assess historical experience and current outstanding claims. We have established various levels of reserves based on the type of claim and status of review. For further discussion on the Vendor Reserves, see Note 1 of “Notes to Consolidated Financial Statements.”
Vendor reserves were $50 million and $62 million at June 30, 2017 and 2016, respectively. Approximately 77 percent of the vendor reserve at the end of fiscal 2017 pertained to the Pharmaceutical segment compared to 66 percent at the end of fiscal 2016. The reserve balance will fluctuate due to variations in outstanding claims from period-to-period, timing of resolutions and specific vendor issues.
The ultimate outcome of specific claims may be different than our original estimate and may require adjustment. We believe, however, that reserves recorded for such disputes are reasonable based upon current facts and circumstances.
Loss Contingencies and Self-Insurance
We accrue for contingencies related to disputes, litigation and regulatory matters if it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated.
Because these matters are inherently unpredictable and unfavorable developments or outcomes can occur, assessing contingencies is highly subjective and requires judgments about future events.
We also self-insure for employee healthcare, certain product liability matters, auto liability, property and workers' compensation and maintain insurance for individual losses exceeding certain limits when available.
Self-insurance accruals include an estimate for expected settlements on pending claims, defense costs, administrative fees, claims adjustment costs and an estimate for claims incurred but not reported.
For certain types of exposures, we develop the estimate of expected ultimate costs to settle each claim which is based on specific information related to each claim if available. Other estimates are based on an assessment of outstanding claims, historical analysis and current payment trends. For claims incurred but not reported, the liabilities are calculated and derived in accordance with generally accepted actuarial practices or using an estimated lag period.
We regularly review contingencies and self-insurance accruals to determine whether our accruals and related disclosures are adequate. The amount of loss may differ from these estimates. See Note 8 of the “Notes to Consolidated Financial Statements” for additional information regarding loss contingencies and product liability lawsuits.
Cardinal Health | Fiscal 2017 Form 10-K | 16 | |
MD&A | Critical Accounting Policies and Sensitive Accounting Estimates | |
Provision for Income Taxes
Our income tax expense, deferred income tax assets and liabilities, and unrecognized tax benefits reflect management’s assessment of estimated future taxes to be paid on items in the consolidated financial statements.
The following table presents information about our tax position at June 30:
(in millions) | 2017 | 2016 | |||||
Total deferred income tax assets (1) | $ | 692 | $ | 567 | |||
Valuation allowance for deferred income tax assets (2) | (237 | ) | (93 | ) | |||
Net deferred income tax assets | 455 | 474 | |||||
Total deferred income tax liabilities | (2,331 | ) | (2,130 | ) | |||
Net deferred income tax liability | $ | (1,876 | ) | $ | (1,656 | ) | |
(1) | Total deferred income tax assets included $378 million and $193 million of loss and tax credit carryforwards at June 30, 2017 and 2016, respectively. |
(2) | The valuation allowance primarily relates to federal, state and international loss carryforwards for which the ultimate realization of future benefits is uncertain. |
Expiring loss and credit carryforwards and the required valuation allowances are adjusted quarterly. After applying the valuation allowances, we do not anticipate any limitations on our use of any of the other net deferred income tax assets described above.
We believe that our estimates for the valuation allowances against deferred tax assets and unrecognized tax benefits are appropriate based on current facts and circumstances. The amount we ultimately pay when matters are resolved may differ from the amounts accrued. For a further discussion on Provision for Income Taxes, see Note 1 of the “Notes to the Consolidated Financial Statements.”
Tax benefits from uncertain tax positions are recognized when it is more likely than not that the position will be sustained upon examination of the technical merits of the position, including resolutions of any related appeals or litigation processes. The amount recognized is measured as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon settlement.
If any of our assumptions or estimates were to change, an increase or decrease in our effective income tax rate by 1 percent would have caused income tax expense to increase or decrease $19 million for fiscal 2017. See Note 7 of the “Notes to Consolidated Financial Statements” for additional information regarding unrecognized tax benefits.
Share-Based Compensation
Employee share-based compensation is recognized in the consolidated statements of earnings based on the grant date fair value of the awards. The grant date market price of our common shares determines the fair value of restricted share units and performance share units. The fair value of stock options is determined using a lattice valuation model. We believe the lattice model provides reasonable estimates because it takes into account employee exercise patterns based on changes in our stock price and other variables and it provides for a range of input assumptions.
We analyze historical data to estimate option exercise behaviors and post-vesting forfeitures to be used within the lattice model. The expected life of the options granted, which represents the length of time in years that the options granted are expected to be outstanding,
is calculated from the option valuation model. Expected volatilities are based on implied volatility from traded options on our common shares and historical volatility over a period of time commensurate with the contractual term of the option grant (up to ten years).The forfeiture estimates are adjusted as circumstances change and ultimately reflect actual forfeitures when an award vests. Actual forfeitures in future reporting periods could be higher or lower than our current estimates. Compensation expense for nonvested performance share units depends on our periodic assessment of the probability of the targets being achieved and our estimate, which may vary over time, of the number of shares that ultimately will be issued. See Note 16 of the "Notes to Consolidated Financial Statements" for additional information regarding share-based compensation.
17 | Cardinal Health | Fiscal 2017 Form 10-K | |
Explanation and Reconciliation of Non-GAAP Financial Measures | ||
Explanation and Reconciliation of Non-GAAP Financial Measures
This report, including the "Fiscal 2017 Overview" section within MD&A, contains financial measures that are not calculated in accordance with GAAP. In addition to analyzing our business based on financial information prepared in accordance with GAAP, we use these non-GAAP financial measures internally to evaluate our performance, evaluate the balance sheet, engage in financial and operational planning, and determine incentive compensation because we believe that these measures provide additional perspective on and, in some circumstances are more closely correlated to, the performance of our underlying, ongoing business. We provide these non-GAAP financial measures to investors as supplemental metrics to assist readers in assessing the effects of items and events on our financial and operating results on a year-over-year basis and in comparing our performance to that of our competitors. However, the non-GAAP financial measures that we use may be calculated differently from, and therefore may not be comparable to, similarly titled measures used by other companies. The non-GAAP financial measures disclosed by us should not be considered a substitute for, or superior to, financial measures calculated in accordance with GAAP, and the financial results calculated in accordance with GAAP and reconciliations to those financial statements set forth below should be carefully evaluated.
Exclusions from Non-GAAP Financial Measures
Management believes it is useful to exclude the following items from the non-GAAP measures presented in this report for its own and for investors’ assessment of the business for the reasons identified below:
• | LIFO charges and credits are excluded because the factors that drive last-in first-out ("LIFO") inventory charges or credits, such as pharmaceutical manufacturer price appreciation or deflation and year-end inventory levels (which can be meaningfully influenced by customer buying behavior immediately preceding our fiscal year-end), are largely out of our control and cannot be accurately predicted. The exclusion of LIFO charges from non-GAAP metrics allows for a better comparison of our current financial results to our historical financial results and to our peer group companies’ financial results. |
• | Restructuring and employee severance costs are excluded because they relate to programs in which we fundamentally change our operations and because they are not part of the ongoing operations of our underlying business. |
• | Amortization and other acquisition-related costs are excluded primarily for consistency with the presentation of the financial results of our peer group companies. Additionally, costs for amortization of acquisition-related intangible assets are non-cash amounts, which are variable in amount and frequency and are significantly impacted by the timing and size of acquisitions, so their exclusion allows for better comparison of historical, current and forecasted financial results. We also exclude other acquisition-related costs, which are directly related to an acquisition but do not meet the criteria to be recognized on the acquired entity’s initial balance sheet as part of the purchase price allocation. These costs are also significantly impacted by the timing, complexity and size of acquisitions. |
• | Impairments and gain or loss on disposal of assets are excluded because they do not occur in or reflect the ordinary course of our ongoing business operations and their exclusion results in a metric that more meaningfully reflects the sustainability of our operating performance. |
• | Litigation recoveries or charges, net are excluded because they often relate to events that may have occurred in prior or multiple periods, do not occur in or reflect the ordinary course of our business and are inherently unpredictable in timing and amount. Beginning in the third quarter of fiscal 2017, consistent with the presentation of financial results by peer medical device companies, in litigation recoveries or charges, net we began to classify accrued losses and legal fees, net of expected recoveries, related to mass tort product liability claims, including claims for injuries allegedly caused by Cordis OptEase and TrapEase inferior vena cava (IVC) filter products. Such amounts would not have materially affected litigation recoveries or charges, net in prior periods, so have not been reclassified for those periods. |
• | Loss on extinguishment of debt is excluded because it does not typically occur in the normal course of business and may obscure analysis of trends and financial performance. Additionally, the amount and frequency of this type of charge is not consistent and is significantly impacted by the timing and size of debt financing transactions. |
The tax effect for each of the items listed above is determined using the tax rate and other tax attributes applicable to the item and the jurisdiction(s) in which the item is recorded. The gross, tax and net impact of each item are presented with our GAAP to non-GAAP reconciliations.
Cardinal Health | Fiscal 2017 Form 10-K | 18 | |
Explanation and Reconciliation of Non-GAAP Financial Measures | ||
Definitions
Growth rate calculation: growth rates in this report are determined by dividing the difference between current period results and prior period results by prior period results.
Non-GAAP operating earnings: operating earnings excluding (1) LIFO charges/(credits), (2) restructuring and employee severance, (3) amortization and other acquisition-related costs, (4) impairments and (gain)/loss on disposal of assets and (5) litigation (recoveries)/charges, net.
Non-GAAP earnings before income taxes: earnings before income taxes excluding (1) LIFO charges/(credits), (2) restructuring and employee severance, (3) amortization and other acquisition-related costs, (4) impairments and (gain)/loss on disposal of assets, (5) litigation (recoveries)/charges, net and (6) loss on extinguishment of debt.
Non-GAAP net earnings attributable to Cardinal Health, Inc.: net earnings attributable to Cardinal Health, Inc. excluding (1) LIFO charges/(credits), (2) restructuring and employee severance, (3) amortization and other acquisition-related costs, (4) impairments and (gain)/loss on disposal of assets, (5) litigation (recoveries)/charges, net and (6) loss on extinguishment of debt, each net of tax.
Non-GAAP diluted EPS attributable to Cardinal Health, Inc.: non-GAAP net earnings attributable to Cardinal Health, Inc. divided by diluted weighted-average shares outstanding.
19 | Cardinal Health | Fiscal 2017 Form 10-K | |
Explanation and Reconciliation of Non-GAAP Financial Measures | ||
GAAP to Non-GAAP Reconciliations
(in millions, except per common share amounts) | Operating Earnings | Operating Earnings Growth Rate | Earnings Before Income Taxes | Provision for Income Taxes | Net Earnings1,2 | Net Earnings1,2 Growth Rate | Diluted EPS1,2 | Diluted EPS1,2 Growth Rate | |||||||||||||
Fiscal Year 2017 | |||||||||||||||||||||
GAAP | $ | 2,120 | (14 | )% | $ | 1,924 | $ | 630 | $ | 1,288 | (10 | )% | $ | 4.03 | (7 | )% | |||||
Restructuring and employee severance | 56 | 56 | 20 | 36 | 0.11 | ||||||||||||||||
Amortization and other acquisition-related costs | 527 | 527 | 165 | 362 | 1.13 | ||||||||||||||||
Impairments and loss on disposal of assets | 18 | 18 | 6 | 12 | 0.04 | ||||||||||||||||
Litigation (recoveries)/charges, net | 48 | 48 | 19 | 29 | 0.09 | ||||||||||||||||
Non-GAAP | $ | 2,769 | (4 | )% | $ | 2,572 | $ | 839 | $ | 1,727 | — | % | $ | 5.40 | 3 | % | |||||
Fiscal Year 2016 | |||||||||||||||||||||
GAAP | $ | 2,459 | 14 | % | $ | 2,276 | $ | 845 | $ | 1,427 | 18 | % | $ | 4.32 | 20 | % | |||||
Restructuring and employee severance | 25 | 25 | 9 | 16 | 0.05 | ||||||||||||||||
Amortization and other acquisition-related costs | 459 | 459 | 143 | 316 | 0.96 | ||||||||||||||||
Impairments and loss on disposal of assets | 21 | 21 | 6 | 15 | 0.04 | ||||||||||||||||
Litigation (recoveries)/charges, net | (69 | ) | (69 | ) | (27 | ) | (42 | ) | (0.13 | ) | |||||||||||
Non-GAAP | $ | 2,895 | 17 | % | $ | 2,711 | $ | 976 | $ | 1,732 | 18 | % | $ | 5.24 | 20 | % | |||||
Fiscal Year 2015 | |||||||||||||||||||||
GAAP | $ | 2,161 | 15 | % | $ | 1,967 | $ | 755 | $ | 1,212 | 4 | % | $ | 3.61 | 7 | % | |||||
Restructuring and employee severance | 44 | 44 | 15 | 29 | 0.09 | ||||||||||||||||
Amortization and other acquisition-related costs | 281 | 281 | 100 | 181 | 0.54 | ||||||||||||||||
Impairments and (gain)/loss on disposal of assets | (19 | ) | (19 | ) | (10 | ) | (9 | ) | (0.03 | ) | |||||||||||
Litigation (recoveries)/charges, net | 5 | 5 | (14 | ) | 19 | 0.06 | |||||||||||||||
Loss on extinguishment of debt | — | 60 | 23 | 37 | 0.11 | ||||||||||||||||
Non-GAAP | $ | 2,472 | 16 | % | $ | 2,339 | $ | 870 | $ | 1,469 | 11 | % | $ | 4.38 | 14 | % | |||||
Fiscal Year 2014 | |||||||||||||||||||||
GAAP | $ | 1,885 | 89 | % | $ | 1,798 | $ | 635 | $ | 1,163 | 247 | % | $ | 3.37 | 247 | % | |||||
Restructuring and employee severance | 31 | 31 | 11 | 20 | 0.06 | ||||||||||||||||
Amortization and other acquisition-related costs | 223 | 223 | 79 | 144 | 0.42 | ||||||||||||||||
Impairments and (gain)/loss on disposal of assets | 15 | 15 | 5 | 10 | 0.03 | ||||||||||||||||
Litigation (recoveries)/charges, net | (21 | ) | (21 | ) | (8 | ) | (13 | ) | (0.04 | ) | |||||||||||
Non-GAAP | $ | 2,133 | 4 | % | $ | 2,047 | $ | 722 | $ | 1,324 | 3 | % | $ | 3.84 | 3 | % | |||||
Fiscal Year 2013 | |||||||||||||||||||||
GAAP | $ | 996 | (44 | )% | $ | 888 | $ | 553 | $ | 335 | (69 | )% | $ | 0.97 | (68 | )% | |||||
Restructuring and employee severance | 71 | 71 | 27 | 44 | 0.13 | ||||||||||||||||
Amortization and other acquisition-related costs | 158 | 158 | 52 | 106 | 0.31 | ||||||||||||||||
Impairments and (gain)/loss on disposal of assets | 859 | 859 | 37 | 822 | 2.39 | ||||||||||||||||
Litigation (recoveries)/charges, net | (38 | ) | (38 | ) | (15 | ) | (23 | ) | (0.07 | ) | |||||||||||
Non-GAAP | $ | 2,046 | 10 | % | $ | 1,938 | $ | 654 | $ | 1,284 | 15 | % | $ | 3.73 | 16 | % | |||||
1 | from continuing operations |
2 | attributable to Cardinal Health, Inc. |
The sum of the components may not equal the total due to rounding.
We apply varying tax rates depending on the item's nature and tax jurisdiction where it is incurred.
Cardinal Health | Fiscal 2017 Form 10-K | 20 | |
Selected Financial Data | ||
Selected Financial Data
The consolidated financial data below includes all business combinations as of the date of acquisition that occurred during these periods. The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and related notes and MD&A.
(in millions, except per common share amounts) | 2017 | 2016 | 2015 | 2014 | 2013 (1) | ||||||||||||||
Earnings Data: | |||||||||||||||||||
Revenue | $ | 129,976 | $ | 121,546 | $ | 102,531 | $ | 91,084 | $ | 101,093 | |||||||||
Operating earnings | 2,120 | 2,459 | 2,161 | 1,885 | 996 | ||||||||||||||
Earnings from continuing operations | 1,294 | 1,431 | 1,212 | 1,163 | 335 | ||||||||||||||
Earnings/(loss) from discontinued operations, net of tax | — | — | 3 | 3 | (1 | ) | |||||||||||||
Net earnings | 1,294 | 1,431 | 1,215 | 1,166 | 334 | ||||||||||||||
Less: Net earnings attributable to noncontrolling interests | (6 | ) | (4 | ) | — | — | — | ||||||||||||
Net earnings attributable to Cardinal Health, Inc. | $ | 1,288 | $ | 1,427 | $ | 1,215 | $ | 1,166 | $ | 334 | |||||||||
Basic earnings per common share attributable to Cardinal Health, Inc.: | |||||||||||||||||||
Continuing operations | $ | 4.06 | $ | 4.36 | $ | 3.65 | $ | 3.41 | $ | 0.98 | |||||||||
Discontinued operations | — | — | 0.01 | 0.01 | — | ||||||||||||||
Net basic earnings per common share attributable to Cardinal Health, Inc. | $ | 4.06 | $ | 4.36 | $ | 3.66 | $ | 3.42 | $ | 0.98 | |||||||||
Diluted earnings per common share attributable to Cardinal Health, Inc.: | |||||||||||||||||||
Continuing operations | $ | 4.03 | $ | 4.32 | $ | 3.61 | $ | 3.37 | $ | 0.97 | |||||||||
Discontinued operations | — | — | 0.01 | 0.01 | — | ||||||||||||||
Net diluted earnings per common share attributable to Cardinal Health, Inc. | $ | 4.03 | $ | 4.32 | $ | 3.62 | $ | 3.38 | $ | 0.97 | |||||||||
Cash dividends declared per common share | $ | 1.8091 | $ | 1.6099 | $ | 1.4145 | $ | 1.2500 | $ | 1.0900 | |||||||||
Balance Sheet Data: | |||||||||||||||||||
Total assets | $ | 40,112 | $ | 34,122 | $ | 30,142 | $ | 26,033 | $ | 25,819 | |||||||||
Long-term obligations, less current portion | 9,068 | 4,952 | 5,211 | 3,171 | 3,686 | ||||||||||||||
Total Cardinal Health, Inc. shareholders' equity | 6,808 | 6,554 | 6,256 | 6,401 | 5,975 | ||||||||||||||
(1) | During fiscal 2013, we recognized a non-cash goodwill impairment charge of $829 million ($799 million, net of tax) related to our Nuclear Pharmacy Services division. |
21 | Cardinal Health | Fiscal 2017 Form 10-K | |
Disclosures about Market Risk | |
Quantitative and Qualitative Disclosures About Market Risk
We are exposed to cash flow and earnings fluctuations as a result of certain market risks. These market risks primarily relate to foreign exchange, interest rate, and commodity price-related changes. We maintain a hedging program to manage volatility related to these market exposures which employs operational, economic, and derivative financial instruments in order to mitigate risk. See Note 1 and Note 11 of the “Notes to Consolidated Financial Statements” for further discussion regarding our use of derivative instruments.
Foreign Exchange Rate Sensitivity
By the nature of our global operations, we are exposed to cash flow and earnings fluctuations resulting from foreign exchange rate variation. These exposures are transactional and translational in nature. Principal drivers of this foreign exchange exposure include the Canadian dollar, Euro, Thai baht, Mexican peso, Japanese yen, Chinese renminbi, Philippine peso, Singapore dollar, Russian ruble, and Australian dollar.
Transactional Exposure
Transactional exposure arises from the purchase and sale of goods and services in currencies other than our functional currency or the functional currency of our subsidiaries. As part of our risk management program, at the end of each fiscal year we perform a sensitivity analysis on our forecasted transactional exposure for the upcoming fiscal year. These analyses include the estimated impact of our hedging program, which is designed to mitigate transactional exposure. Our forecasted transactional exposure at June 30, 2017 increased from the prior year primarily as a result of the increased transaction volume in foreign currencies due to the acquisition of Cordis, and we expect our transactional exposure to further increase in fiscal 2018 due to our acquisition of the Patient Recovery Business. At June 30, 2017 and 2016, we had hedged approximately 25 and 29 percent of transactional exposures, respectively.
The following table summarizes the analysis as it relates to transactional exposure and the impact of a hypothetical 10 percent fluctuation in foreign currency exchange rates, assuming rates collectively shift in the same direction and we are unable to change customer pricing in response to those shifts, for the upcoming fiscal year:
June 30 | |||||||
(in millions) | 2017 (1) | 2016 | |||||
Net hypothetical transactional exposure | $ | 638 | $ | 621 | |||
Sensitivity gain/loss | $ | 64 | $ | 62 | |||
Estimated offsetting impact of hedges | (16 | ) | (18 | ) | |||
Hypothetical net gain/loss | $ | 48 | $ | 44 | |||
(1) | This analysis excludes exposures that may be added as a result of acquisitions that have not yet closed as of June 30, 2017. |
Translational Exposure
We have exposure related to the translation of financial statements of our foreign operations into U.S. dollars, our functional currency. We perform a similar analysis to that previously described related to this translational exposure. Our forecasted translational exposure at June 30, 2017 was essentially flat compared to the prior period, however we expect our translational exposure to increase in fiscal 2018 due to our acquisition of the Patient Recovery Business. We have not typically hedged any of our translational exposure and no hedging impact was included in our analysis at June 30, 2017 and 2016.
The following table summarizes translational exposure and the impact of a hypothetical 10 percent strengthening or weakening in the U.S. dollar, assuming rates collectively shift in the same direction, for the upcoming fiscal year:
June 30 | |||||||
(in millions) | 2017 (1) | 2016 | |||||
Net hypothetical translational exposure | $ | 199 | $ | 201 | |||
Sensitivity gain/loss | 20 | 20 | |||||
(1) | This analysis excludes exposures that may be added as a result of acquisitions that have not yet closed as of June 30, 2017. |
Cardinal Health | Fiscal 2017 Form 10-K | 22 | |
Disclosures about Market Risk | |
Interest Rate Sensitivity
We are exposed to changes in interest rates primarily as a result of our borrowing and investing activities to maintain liquidity and fund operations. The nature and amount of our long-term and short-term debt can be expected to fluctuate as a result of business requirements, market conditions and other factors. Our policy is to manage exposures to interest rates using a mix of fixed and floating rate debt as deemed appropriate by management. We utilize interest rate swap instruments to mitigate our exposure to interest rate movements.
As part of our risk management program, we perform an annual sensitivity analysis on our forecasted exposure to interest rates for the upcoming fiscal year. This analysis assumes a hypothetical 50 basis point change in interest rates. At June 30, 2017 and 2016, the
potential increase or decrease in annual interest expense under this analysis as a result of this hypothetical change was $16 million and $9 million, respectively.
We are also exposed to market risk from changes in interest rates related to our cash and cash equivalents, which includes marketable securities that are classified as available-for-sale and are carried at fair value in the consolidated balance sheets. The fair value of our cash and cash equivalents is subject to change primarily as a result of changes in market interest rates and investment risk related to the issuers' credit worthiness. At both June 30, 2017 and 2016, a hypothetical increase or decrease of 50 basis points in interest rates would cause a potential increase or decrease of up to $1 million and $11 million, respectively, in the estimated fair value.
Commodity Price Sensitivity
We are directly exposed to market price changes for certain commodities, including oil-based resins, nitrile, cotton, diesel fuel and latex. We typically purchase raw materials at either market prices or prices tied to a commodity index and some finished goods at prices based in part on a commodity price index. We also are indirectly exposed to fluctuations in certain commodity prices through the purchase of finished goods and various energy-related commodities, including natural gas and electricity, through our normal course of business where our contracts are not directly tied to a commodity index. As part of our risk management program, we perform sensitivity analysis on our forecasted commodity exposure for the upcoming fiscal year. Our forecasted commodity exposure at June 30, 2017 was essentially flat compared to the prior period, however we expect our commodity exposure to increase in fiscal 2018 due to our acquisition of the Patient Recovery Business. At June 30, 2017 and 2016, we had hedged a portion of these direct commodity exposures (see Note 11 of the “Notes to Consolidated Financial Statements” for further discussion).
The table below summarizes our analysis of these forecasted direct and indirect commodity exposures and the potential gain/loss given a hypothetical 10 percent fluctuation in commodity prices, assuming pricing collectively shifts in the same direction and we are unable to change customer pricing in response to those shifts, for the upcoming fiscal year:
June 30 | |||||||
(in millions) | 2017 (1) | 2016 | |||||
Hypothetical commodity exposure | $ | 411 | $ | 417 | |||
Sensitivity gain/loss | $ | 41 | $ | 42 | |||
Hypothetical offsetting impact of hedges | (1 | ) | (1 | ) | |||
Hypothetical net gain/loss | $ | 40 | $ | 41 | |||
(1) | This analysis excludes exposures that may be added as a result of acquisitions that have not yet closed as of June 30, 2017. |
We believe our total gross range of direct and indirect exposure to commodities, excluding exposure that may be added as a result of the acquisition of the Patient Recovery Business, is $400 million to $500 million for fiscal 2018.
23 | Cardinal Health | Fiscal 2017 Form 10-K | |
Business | ||
Business
General
Cardinal Health, Inc. is a global, integrated healthcare services and products company providing customized solutions for hospitals, healthcare systems, pharmacies, ambulatory surgery centers, clinical laboratories and physician offices. We provide medical products and pharmaceuticals and cost-effective solutions that enhance supply chain efficiency from hospital to home. We connect patients, providers, payers, pharmacists and manufacturers for integrated care coordination and better patient management.
Pharmaceutical Segment
In the United States, our Pharmaceutical segment:
• | distributes branded and generic pharmaceutical and over-the-counter healthcare and consumer products through its Pharmaceutical Distribution division to retailers (including chain and independent drug stores and pharmacy departments of supermarkets and mass merchandisers), hospitals and other healthcare providers. This division: |
• | maintains prime vendor relationships that streamline the purchasing process resulting in greater efficiency and lower costs for our retail, hospital and other healthcare provider customers; |
• | provides services to pharmaceutical manufacturers, including distribution, inventory management, data reporting, new product launch support and chargeback administration; |
• | provides pharmacy management services to hospitals as well as medication therapy management and patient outcomes services to hospitals, other healthcare providers and payers, and operates pharmacies in community health centers; and |
• | repackages generic pharmaceuticals and over-the-counter healthcare products; |
• | distributes specialty pharmaceutical products to hospitals and other healthcare providers; provides consulting, patient support and other services for specialty pharmaceutical products to pharmaceutical manufacturers and healthcare providers; and provides specialty pharmacy services through its Specialty Solutions division; and |
• | operates nuclear pharmacies and manufacturing facilities through its Nuclear Pharmacy Services division, which manufactures, prepares and delivers radiopharmaceuticals for use in nuclear imaging and other procedures in hospitals and physician offices. During fiscal 2017, this division also began operating a facility to contract manufacture a radiopharmaceutical treatment (Xofigo) and acquired the North American rights to Lymphoseek, a radiopharmaceutical diagnostic imaging agent. |
In China, the Pharmaceutical segment distributes branded, generic and specialty pharmaceutical, over-the-counter healthcare and consumer products, provides logistics, marketing and other services and operates direct-to-patient specialty pharmacies through Cardinal Health China. In July 2017, we announced that we are exploring strategic alternatives for the Cardinal Health China pharmaceutical and medical distribution businesses. Our other
medical product businesses in China, including Cordis and the Patient Recovery Business acquired from Medtronic, are not part of this exploration.
See Note 15 of the “Notes to Consolidated Financial Statements” for Pharmaceutical segment revenue, profit and assets for fiscal 2017, 2016 and 2015.
Pharmaceutical Distribution
Our Pharmaceutical Distribution division’s gross margin includes margin from our generic pharmaceutical program, from distribution services agreements with branded pharmaceutical manufacturers and from over-the-counter healthcare and consumer products. It also includes manufacturer cash discounts.
Margin from our generic pharmaceutical program includes price discounts and rebates from manufacturers and may include price appreciation on some products. Our earnings on generic pharmaceuticals are generally highest during the period immediately following the initial launch of a product, because generic pharmaceutical selling prices are generally highest during that period and tend to decline over time.
Margin from distribution services agreements with branded pharmaceutical manufacturers relates primarily to fees we receive for providing a range of distribution and related services to manufacturers and also, to a lesser extent, includes benefits from price appreciation on branded pharmaceutical products.
Sourcing Venture With CVS Health Corporation
In July 2014, we established Red Oak Sourcing, a U.S.-based generic pharmaceutical sourcing venture with CVS with an initial term of 10 years. Red Oak Sourcing negotiates generic pharmaceutical supply contracts on behalf of both companies.
Specialty Pharmaceutical Products and Services
We refer to products and services offered by our Specialty Solutions division as “specialty pharmaceutical products and services.” The Specialty Solutions division distributes oncology, rheumatology, urology, nephrology and other pharmaceutical products ("specialty pharmaceutical products") and human-derived plasma products to hospitals, dialysis clinics, physician offices and other healthcare providers; provides consulting, patient support, logistics, group purchasing and other services to pharmaceutical manufacturers and healthcare providers primarily supporting the development, marketing and distribution of specialty pharmaceutical products; and provides specialty pharmacy services. Our use of the
Cardinal Health | Fiscal 2017 Form 10-K | 24 | |
Business | ||
terminology "specialty pharmaceutical products and services" may not be comparable to the terminology used by other industry participants.
Medical Segment
Our Medical segment manufactures and sources Cardinal Health branded medical, surgical and laboratory products, including cardiovascular and endovascular products; wound care products; single-use surgical drapes, gowns and apparel; exam and surgical gloves; and fluid suction and collection systems. We further expanded this segment's portfolio of manufactured products through the acquisition of the Patient Recovery Business from Medtronic in July 2017, which includes incontinence, wound care, enteral feeding, urology, operating room supply, electrode and needle, syringe and sharps disposal product lines. Our manufactured products are sold directly or through third-party distributors in the United States, Canada, Europe, Asia and other markets.
The Medical segment also distributes a broad range of national brand products and provides supply chain services and solutions
to hospitals, ambulatory surgery centers, clinical laboratories and other healthcare providers in the United States, Canada and China.
This segment also distributes medical products to patients' homes in the United States through our Cardinal Health at Home division and provides services and software to hospitals, other healthcare providers and payers to help manage the complex processes of patient discharge from an acute-care facility (“post-acute care”) through naviHealth.
This segment also assembles and sells sterile and non-sterile procedure kits. It also provides supply chain services, including spend management, distribution management and inventory management services, to healthcare providers.
See Note 15 of the “Notes to Consolidated Financial Statements” for Medical segment revenue, profit and assets for fiscal 2017, 2016 and 2015.
Acquisitions
We have acquired a number of businesses over the years that have enhanced our core strategic areas of self-manufactured medical products, generic pharmaceutical distribution and services, specialty pharmaceutical products and services, international and post-acute care. We expect to continue to pursue additional acquisitions in the future.
During the last five fiscal years, we completed the following three large acquisitions:
Date | Company | Location | Lines of Business | Acquisition Price (in millions) | |
10/15 | Cordis business of Johnson & Johnson | Fremont, CA | Cardiovascular and endovascular products | $1,944 | |
07/15 | The Harvard Drug Group | Livonia, MI | Pharmaceutical product distribution | $1,115 | |
03/13 | AssuraMed, Inc. | Twinsburg, OH | Medical product distribution to patients' homes | $2,070 | |
We have also completed several smaller acquisitions during the last five fiscal years, including: in fiscal 2017, the acquisition of the North American rights to Lymphoseek, a radiopharmaceutical diagnostic imaging agent, from Navidea Biopharmaceuticals, Inc.; in fiscal 2016, the acquisition of an 82 percent ownership interest in naviHealth, a provider of post-acute care management services, and CuraSpan Health Group, Inc., a provider of discharge planning and care transition software; in fiscal 2015, the acquisitions of Tradex International, Inc., a supplier of disposable gloves, and Metro Medical Supply, Inc., a distributor of specialty pharmaceuticals and medical and surgical products; and in fiscal 2014, the acquisition of Access Closure, Inc., a manufacturer and distributor of extravascular closure devices.
As discussed above, on July 29, 2017, we acquired the Patient Recovery Business from Medtronic for $6.1 billion in cash.
25 | Cardinal Health | Fiscal 2017 Form 10-K | |
Business | ||
Customers
Our largest customers, CVS and OptumRx, accounted for 23 percent and 11 percent of our fiscal 2017 revenue, respectively. In the aggregate, our five largest customers, including CVS and OptumRx, accounted for 50 percent of our fiscal 2017 revenue. Our pharmaceutical distribution agreements with CVS extend through June 2019.
We have agreements with group purchasing organizations (“GPOs”) that act as agents to negotiate vendor contracts on behalf of their
members. Our two largest GPO relationships in terms of member revenue are with Vizient Inc. and Premier, Inc. Sales to members of these two GPOs, under numerous contracts across all of our businesses, collectively accounted for 21 percent of our revenue in fiscal 2017.
Suppliers
We rely on many different suppliers. Products obtained from our five largest suppliers accounted for an aggregate of 27 percent of our revenue during fiscal 2017, but no single supplier’s products accounted for more than 7 percent of revenue.
Competition
We operate in a highly competitive environment in the distribution of pharmaceuticals and related healthcare services. We also operate in a highly competitive environment in the development, manufacturing and distribution of medical and surgical products. We compete on many levels, including price, service offerings, support services, breadth of product lines and product quality and efficacy.
In the Pharmaceutical segment, we compete with wholesale distributors with national reach (including McKesson Corporation and AmerisourceBergen Corporation), regional wholesale distributors, self-warehousing chains, specialty distributors, third-party logistics companies, companies that provide specialty pharmaceutical services and nuclear pharmacies, among others. In addition, the Pharmaceutical segment has experienced competition from a
number of organizations offering generic pharmaceuticals, including telemarketers. We also compete with manufacturers that sell their products directly.
In the Medical segment, our manufacturing and procedural kit businesses compete with diversified healthcare companies as well as companies that are more focused on specific product categories. We also compete with many different national medical product distributors, including Medline Industries, Inc. and Owens & Minor, Inc., regional medical product distributors, companies that distribute medical products to patients' homes and third-party logistics companies. In addition, we compete with manufacturers that sell their products directly.
Employees
At June 30, 2017, we had approximately 28,000 employees in the United States and approximately 12,400 employees outside of the United States. In July 2017, we added approximately 3,500 employees in the United States and approximately 5,900 employees
outside the United States through the acquisition of the Patient Recovery Business. Overall, we consider our employee relations to be good.
Intellectual Property
We rely on a combination of trade secret, patent, copyright and trademark laws, nondisclosure and other contractual provisions, and technical measures to protect our products, services and intangible assets. We hold patents, and continue to pursue patent protection throughout the world, relating to the manufacture, operation and use of various medical and surgical products, to certain distribution and logistics systems, to the production and distribution of our nuclear pharmacy products and to other service offerings. We also operate under licenses for certain proprietary technologies, and in certain instances we license our technologies to third parties.
We believe that we have taken all necessary steps to protect our proprietary rights, but no assurance can be given that we will be able to successfully enforce or protect our rights in the event that they are infringed upon by a third party. While all of these proprietary rights are important to our operations, we do not consider any particular patent, trademark, license, franchise or concession to be material to our overall business.
Cardinal Health | Fiscal 2017 Form 10-K | 26 | |
Business | ||
Regulatory Matters
Our business is highly regulated in the United States, at both the federal and state level, and in foreign countries. Depending upon the specific business, we may be subject to regulation by government entities including:
• | the U.S. Drug Enforcement Administration (the “DEA”); |
• | state controlled substance authorities and boards of pharmacy; |
• | certain agencies within the U.S. Department of Health and Human Services, including the U.S. Food and Drug Administration (the “FDA”), the Centers for Medicare and Medicaid Services, the Office of Inspector General and the Office for Civil Rights; |
• | state health departments, insurance departments, Medicaid departments or other comparable state agencies; |
• | the U.S. Nuclear Regulatory Commission (the “NRC”); |
• | the U.S. Federal Trade Commission (the "FTC"); |
• | U.S. Customs and Border Protection; and |
• | agencies comparable to those listed above in markets outside the United States. |
These regulatory agencies have a variety of civil, administrative and criminal sanctions at their disposal for failure to comply with applicable legal or regulatory requirements. They can suspend our ability to manufacture and distribute products, initiate product recalls, seize products or impose criminal, civil and administrative sanctions.
Distribution
The FDA, DEA and various state authorities regulate the marketing, purchase, storage and distribution of pharmaceutical and medical products under various federal and state statutes including the federal Prescription Drug Marketing Act of 1987, Drug Quality and Security Act of 2013 (the “DQSA”), and Controlled Substances Act (the "CSA"). The CSA governs the sale, packaging, storage and distribution of controlled substances. Wholesale distributors of controlled substances must hold valid DEA registrations and state-level licenses, meet various security and operating standards, and comply with the CSA.
Manufacturing and Marketing
We sell our manufactured products in the United States, Canada, Europe, Asia and other markets. The FDA and other governmental agencies in the United States, as well as foreign governmental agencies, administer requirements that cover the design, testing, safety, effectiveness, manufacturing (including good manufacturing practices), quality systems, labeling, promotion and advertising (including restrictions on promoting or advertising a product other than for the product's cleared or approved uses), distribution, importation and post-market surveillance for most of our manufactured products. In addition, we need specific approval or clearance from, and registrations with, regulatory authorities before we can market and sell some products in the United States and certain other countries, including countries in the European Union ("EU").
In the United States, authorization to commercially market a medical device is generally received in one of two ways. The first, known as
pre-market notification or the 510(k) process, requires us to demonstrate that a medical device is substantially equivalent to a legally marketed medical device. The second more rigorous process, known as pre-market approval (“PMA”), requires us to independently demonstrate that a medical device is safe and effective. Many of our Medical segment products are cleared through the 510(k) process and certain Cordis products must be approved through the PMA process.
In the EU, we are required to comply with applicable Medical Device Directives ("MDDs") and obtain CE Mark Certification in order to market medical devices. The EU regulatory bodies finalized a new Medical Device Regulation ("MDR") in 2017, which replaces the existing MDDs after a three-year transition period. Among other things, the MDR clarifies that private label distributors are deemed to be the manufacturer, which will increase our regulatory obligations in the EU with respect to private label products.
It can be costly and time-consuming to obtain regulatory approvals, clearances and registrations of medical devices, and they might not be granted on a timely basis, if at all. Even after we obtain approval or clearance to market a product or obtain product registrations, the product and our manufacturing processes are subject to continued regulatory oversight, including periodic inspection of manufacturing facilities by FDA and other regulatory authorities both in the United States and internationally.
From time to time, we may determine that products we manufacture or market do not meet our specifications, regulatory requirements or published standards. When we or a regulatory agency identify a quality or regulatory issue, we investigate and take appropriate corrective action, which may include recalling the product, correcting the product at the customer location, revising product labeling and notifying customers.
Nuclear Pharmacies and Related Businesses
Our nuclear pharmacies and radiopharmaceutical manufacturing facilities (including for Xofigo) require licenses or permits and must abide by regulations issued by the NRC, applicable state boards of pharmacy and the radiologic health agency or department of health of each state in which we operate, including pharmacy sterile compounding standards and practices. In addition, our radiopharmaceutical manufacturing facilities also must comply with FDA regulations, including good manufacturing practices.
Product Tracing and Supply Chain Integrity
Title II of the DQSA, known as the Drug Supply Chain Security Act, establishes a phased-in national system for tracing pharmaceutical products through the pharmaceutical distribution supply chain to prevent the introduction of counterfeit, adulterated or mislabeled drugs. The first phase of implementation began in 2015, and upon full implementation in 2023, we and other supply chain stakeholders will participate in an electronic, interoperable, prescription drug tracing system. In addition, the FDA also has issued regulations requiring most medical device labeling to bear a unique device identifier. These regulations are being phased in through 2020. The
27 | Cardinal Health | Fiscal 2017 Form 10-K | |
Business | ||
MDR finalized in the EU in 2017 also introduces a new unique device identifier requirement with a three-year transition period.
Government Healthcare Programs
We are subject to U.S. federal healthcare fraud and abuse laws. These laws generally prohibit persons from soliciting, offering, receiving or paying any compensation in order to induce someone to order, recommend or purchase products or services that are in any way paid for by Medicare, Medicaid or other federally-funded healthcare programs. They also prohibit submitting any fraudulent claim for payment by the federal government. There are similar state healthcare fraud and abuse laws that apply to Medicaid and other state-funded healthcare programs. Violations of these laws may result in criminal or civil penalties, as well as breach of contract claims and qui tam actions (false claims cases initiated by private parties purporting to act on behalf of federal or state governments).
Some businesses within each of our segments are Medicare-certified suppliers or participate in other federal and state healthcare programs, such as state Medicaid programs and the federal 340B drug pricing program. These businesses are subject to accreditation and quality standards and other rules and regulations, including applicable reporting, billing, payment and record-keeping requirements. Other businesses within each segment manufacture pharmaceutical or medical products or repackage pharmaceuticals that are purchased or reimbursed through, or are otherwise governed by, federal or state healthcare programs. Failure to comply with applicable eligibility requirements, standards and regulations could result in civil or criminal sanctions, including the loss of our ability to participate in Medicare, Medicaid and other federal and state healthcare programs.
Our U.S. federal and state government contracts are subject to specific procurement requirements. Failure to comply with applicable rules or regulations or with contractual or other requirements may result in monetary damages and criminal or civil penalties as well as termination of our government contracts or our suspension or debarment from government contract work.
Health and Personal Information Practices
We collect, handle and maintain patient-identifiable health information. The U.S. Health Insurance Portability and Accountability Act of 1996 ("HIPAA"), as augmented by the Health Information Technology for Economic and Clinical Health Act, and state laws regulate the use and disclosure of patient-identifiable health information, including requiring specified privacy and security
measures. We also collect, handle and maintain other sensitive personal and financial information that is subject to U.S. federal and state laws protecting such information.
The processing and disclosure of personal information is also highly regulated in many other countries in which we operate. In Europe, for example, we are subject to the EU data protection regulations, including the current EU Directive on Data Protection, which requires member states to impose minimum restrictions on the collection, use and transfer of personal data. A new EU General Data Protection Regulation ("GDPR") that will become effective in 2018 and will apply uniformly across the EU includes, among other things, a requirement for prompt notice of data breaches to data subjects and supervisory authorities in certain circumstances and significant fines for non-compliance. The GDPR also requires companies processing personal data of individuals residing in the EU to comply with EU privacy and data protection rules.
Antitrust Laws
The U.S. federal government, most U.S. states and many foreign countries have laws that prohibit certain types of conduct deemed to be anti-competitive. Violations of these laws can result in various sanctions, including criminal and civil penalties. Private plaintiffs also could bring civil lawsuits against us in the United States for alleged antitrust law violations, including claims for treble damages.
Environmental, Health and Safety Laws
In the United States and other countries, we are subject to various federal, state and local environmental laws, as well as laws relating to safe working conditions and laboratory practices.
Laws Relating to Foreign Trade and Operations
U.S. and foreign laws require us to abide by standards relating to the import and export of finished goods, raw materials and supplies and the handling of information. We also must comply with various export control and trade embargo laws, which may require licenses or other authorizations for transactions within some countries or with some counterparties.
Similarly, we are subject to U.S. and foreign laws concerning the conduct of our foreign operations, including the U.S. Foreign Corrupt Practices Act, Chinese anti-corruption laws, the U.K. Bribery Act and other foreign anti-bribery laws. Among other things, these laws generally prohibit companies and their intermediaries from offering, promising or making payments to officials of foreign governments for the purpose of obtaining or retaining business.
Cardinal Health | Fiscal 2017 Form 10-K | 28 | |
Business | ||
Other Information
Although our agreements with manufacturers sometimes require us to maintain inventory levels within specified ranges, our distribution businesses are generally not required by our customers to maintain particular inventory levels other than as needed to meet service level requirements. Certain supply contracts with U.S. government entities require us to maintain sufficient inventory to meet emergency demands, but we do not believe those requirements materially affect inventory levels.
Our customer return policies generally require that the product be physically returned, subject to restocking fees. We only allow customers to return products that can be added back to inventory and resold at full value, or that can be returned to vendors for credit.
We offer market payment terms to our customers.
Revenue and Long-Lived Assets by Geographic Area
See Note 15 of the “Notes to Consolidated Financial Statements” for revenue and long-lived assets by geographic area.
29 | Cardinal Health | Fiscal 2017 Form 10-K | |
Risk Factors | ||
Risk Factors
The risks described below could materially and adversely affect our results of operations, financial condition, liquidity or cash flows. These are not the only risks we face. Our businesses also could be affected by risks that we are not presently aware of or that we currently consider immaterial to our operations.
We could suffer the adverse effects of competitive pressures.
As described in greater detail in the "Business" section, we operate in markets that are highly competitive. Because of competition, our businesses face continued pricing pressure from our customers and suppliers. If we are unable to offset margin reductions caused by these pricing pressures through steps such as sourcing or cost control measures, additional service offerings and sales of higher margin products, our results of operations and financial condition could be adversely affected.
Our Pharmaceutical segment’s generic pharmaceutical program could be adversely affected by pricing changes and fewer product launches.
Prices for generic pharmaceuticals generally decline over time. During fiscal 2017, generic pharmaceutical customer pricing changes negatively impacted Pharmaceutical segment profit and our consolidated operating earnings and are expected to have a similar negative effect in fiscal 2018. At times, some generic pharmaceuticals may experience price appreciation, which can positively affect our margins. The number of generic pharmaceuticals experiencing price appreciation or declines and the magnitude of pricing changes is uncertain in future fiscal years, and could adversely affect our margins.
The number of new generic pharmaceutical launches also varies from year to year, and the margin impact of these launches varies from product to product. Fewer product launches or launches that are less profitable than prior launches could adversely affect our margins.
Our generic pharmaceutical program has benefited from sourcing generic pharmaceuticals through our Red Oak Sourcing venture with CVS, which sources for both us and CVS. If the venture does not continue to be successful, our margins could be adversely affected.
Our Pharmaceutical segment’s margins under our distribution services agreements with branded pharmaceutical manufacturers are affected by service fees we receive from the manufacturers and prices established by the manufacturers.
Our distribution services agreements with branded pharmaceutical manufacturers generally provide that we receive fees from the manufacturers to compensate us for the services we provide them. Under some agreements, branded pharmaceutical price appreciation also serves as part of our compensation. If our service fees are reduced or, in cases where our compensation is based in part on branded pharmaceutical price appreciation, if manufacturers determine not to increase prices or to implement only small increases, our margins could be adversely affected.
Our business is subject to rigorous regulatory and licensing requirements.
As described in greater detail in the "Business" section, our business is highly regulated in the United States, at both the federal and state level, and in foreign countries. If we fail to comply with regulatory requirements, or if allegations are made that we fail to comply, our results of operations and financial condition could be adversely affected.
To lawfully operate our businesses, we are required to obtain and hold permits, product registrations, licenses and other regulatory approvals from, and to comply with operating and security standards of, numerous governmental bodies. For example, as a wholesale distributor of controlled substances, we must hold valid DEA registrations and state-level licenses, meet various security and operating standards, and comply with the CSA. Failure to maintain or renew necessary permits, product registrations, licenses or approvals, or to comply with required standards, could have an adverse effect on our results of operations and financial condition.
Products that we manufacture, source, distribute or market must comply with regulatory requirements. Noncompliance or concerns over noncompliance may result in suspension of our ability to distribute, import or manufacture products, product bans, recalls or seizures, or criminal or civil sanctions, which, in turn, could result in product liability claims and lawsuits, including class actions. In addition, it can be costly and time-consuming to obtain regulatory approvals or product registrations to market a medical device, and such approvals or registrations might not be granted on a timely basis, if at all.
We are required to comply with laws relating to healthcare fraud and abuse. The requirements of these laws are complex and subject to varying interpretations, and it is possible that regulatory authorities could challenge our policies and practices. If we fail to comply with these laws, we could be subject to federal or state government investigations or qui tam actions (false claims cases initiated by private parties purporting to act on behalf of federal or state governments), which could result in civil or criminal sanctions, including the loss of licenses or the ability to participate in Medicare, Medicaid and other federal and state healthcare programs. Such sanctions and damages could adversely affect our results of operations and financial condition.
Some businesses within each of our segments are Medicare-certified suppliers or participate in other federal and state healthcare programs, such as state Medicaid program and the federal 340B drug pricing program. In addition, other businesses within each segment manufacture pharmaceutical or medical products or repackage pharmaceuticals that are purchased or reimbursed through, or are otherwise governed by, federal or state healthcare programs. Failure to comply with applicable eligibility requirements, standards and regulations could result in civil or criminal sanctions, including the loss of our ability to participate in Medicare, Medicaid and other federal and state healthcare programs.
Cardinal Health | Fiscal 2017 Form 10-K | 30 | |
Risk Factors | ||
Our government contracts are subject to specific procurement requirements. Failure to comply with applicable rules or regulations or with contractual or other requirements may result in monetary damages and criminal or civil penalties as well as termination of our government contracts or our suspension or debarment from government contract work.
We collect, handle and maintain patient-identifiable health information and other sensitive personal and financial information, which are subject to federal, state and foreign laws that regulate the use and disclosure of such information. Regulations currently in place continue to evolve, and new laws in this area could further restrict our ability to collect, handle and maintain personal or patient information, or could require us to incur additional compliance costs, either of which could have an adverse impact on our results of operations. Violations of federal, state or foreign laws concerning privacy and data protection could subject us to civil or criminal penalties, breach of contract claims, costs for remediation and harm to our reputation.
Our global operations are required to comply with the U.S. Foreign Corrupt Practices Act, Chinese anti-corruption laws, the U.K. Bribery Act and similar anti-bribery laws in other jurisdictions and U.S. and foreign export control, trade embargo and customs laws. If we fail to comply with any of these laws, we could suffer civil or criminal sanctions.
Our China operations are subject to national, regional and local regulations. The regulatory environment in China is evolving, and officials in the Chinese government exercise broad discretion in deciding how to interpret and apply regulations. It is possible that the Chinese government's current or future interpretation and application of existing or new regulations will negatively impact our China operations, result in regulatory investigations or lead to fines or penalties.
CVS is a large customer that generates a significant amount of our revenue.
Our sales and credit concentration is significant. CVS accounted for 23 percent of our fiscal 2017 revenue and 20 percent of our gross trade receivable balance at June 30, 2017. Our pharmaceutical distribution agreements with CVS extend through June 2019. If CVS does not renew our agreements with them, terminates the agreements due to an alleged default by us, defaults in payment or significantly reduces its purchases from us, our results of operations and financial condition could be adversely affected.
We could be subject to adverse changes in the tax laws or challenges to our tax positions.
We are a large multinational corporation with operations in the United States and many foreign countries. As a result, we are subject to the tax laws of many jurisdictions.
From time to time, legislative initiatives are proposed in the United States and other jurisdictions in which we operate that could adversely affect our tax positions, effective tax rate or tax payments. Examples of such initiatives include the repeal of the LIFO (last-in, first-out) method of inventory accounting for income tax purposes, a change in the current U.S. taxation treatment of income from foreign operations, new U.S. import tariffs or taxes, the establishment or
increase in taxation at the U.S. state level on the basis of gross revenues, recommendations of the base erosion and profit shifting project undertaken by the Organization for Economic Cooperation and Development and the European Commission’s investigation into illegal state aid.
Tax laws are complex and subject to varying interpretations. Tax authorities have challenged some of our tax positions and it is possible that they will challenge others. These challenges may adversely affect our effective tax rate or tax payments.
Changes to the U.S. healthcare environment may not be favorable to us.
In recent years, the U.S. healthcare industry has undergone significant changes designed to increase access to medical care, improve safety and patient outcomes, contain costs and increase efficiencies. These changes include adoption of the Patient Protection and Affordable Care Act, a general decline in Medicare and Medicaid reimbursement levels, efforts by healthcare insurance companies to limit or reduce payments to pharmacies and providers, the basis for payments beginning to transition from a fee-for-service model to value-based payments and risk-sharing models, and the industry shifting away from traditional healthcare venues like hospitals and into clinics, physician offices and patients’ homes.
We expect the U.S. healthcare industry to continue to change significantly in the future. Possible changes include repeal and replacement of major parts of the Patient Protection and Affordable Care Act, further reduction or limitations on governmental funding at the state or federal level, efforts by healthcare insurance companies to further limit payments for products and services or changes in legislation or regulations governing prescription pharmaceutical pricing, healthcare services or mandated benefits. These possible changes, and the uncertainty surrounding these possible changes, may cause healthcare industry participants to reduce the amount of products and services they purchase from us or the price they are willing to pay for our products and services, which could adversely affect us.
Consolidation in the U.S. healthcare industry may negatively impact our results of operations.
In recent years, U.S. healthcare industry participants, including distributors, manufacturers, healthcare providers, insurers and pharmacy chains, have consolidated or formed strategic alliances. Consolidations create larger enterprises with greater negotiating power, and also could result in the possible loss of a customer where the combined enterprise selects one distributor from two incumbents. If this consolidation trend continues, it could adversely affect our results of operations.
Our business and operations depend on the proper functioning of information systems, critical facilities and distribution networks. Our business could be adversely affected if we experience a cyber-attack or other systems breach.
We rely on our and third-party service providers' information systems for a wide variety of critical operations, including to obtain, rapidly process, analyze and manage data to:
• | facilitate the purchase and distribution of inventory items from numerous distribution centers; |
31 | Cardinal Health | Fiscal 2017 Form 10-K | |
Risk Factors | ||
• | receive, process and ship orders on a timely basis; |
• | manage accurate billing and collections for thousands of customers; |
• | process payments to suppliers; |
• | facilitate manufacturing and assembly of medical products; and |
• | generate financial information. |
Our business also depends on the proper functioning of our critical facilities, including our national logistics center, and our distribution networks. Our results of operations could be adversely affected if our or a service provider's information systems, critical facilities or distribution networks are disrupted (including disruption of access), are damaged or fail, whether due to physical disruptions, such as fire, natural disaster, pandemic or power outage, or due to cyber-security incidents, ransomware or other actions of third parties, including labor strikes, political unrest and terrorist attacks. Manufacturing disruptions also can occur due to regulatory action, production quality deviations, safety issues or raw material shortages or defects, or because a key product is manufactured at a single manufacturing facility with limited alternate facilities.
The Pharmaceutical segment is in a multi-year project to replace certain of its finance and operating information systems. If these new systems are not effectively implemented or they fail to operate as intended, it could adversely affect the Pharmaceutical segment’s supply chain operations and our internal control over financial reporting. In addition, from time to time, other businesses perform business process improvements or infrastructure modernizations or use service providers for key systems and processes, such as receiving and processing customer orders, customer service and accounts payable. If any of these initiatives are not successfully or efficiently implemented or maintained, they could adversely affect our business and our internal control over financial reporting.
Our business relies on the secure transmission, storage and hosting of patient-identifiable health information, financial information and other sensitive information relating to our customers, company and workforce. We have programs in place to detect, contain and respond to information security incidents. However, because the techniques used to obtain unauthorized access, disable or degrade service or sabotage systems change frequently and may be difficult to detect for long periods of time, we may be unable to anticipate these techniques or to implement adequate preventative measures. In addition, hardware, software or applications developed internally or procured from third parties may contain defects in design or manufacture or other problems that could unexpectedly compromise information security. Unauthorized parties also may attempt to gain access to our or a service provider's systems or facilities through fraud, trickery or other forms of deception. Any compromise of our or a service provider's information systems, including unauthorized access to or use or disclosure of sensitive information, could adversely impact our operations, results of operations or our ability to satisfy legal requirements, including those related to patient-identifiable health information.
We may become involved in legal proceedings that could adversely impact our cash flows or results of operations.
Due to the nature of our business, which includes the distribution of controlled substances and the manufacture of medical products, we may from time to time become involved in disputes, litigation and regulatory matters. Litigation is inherently unpredictable and the unfavorable outcome of one or more of these legal proceedings could adversely affect our results of operations or financial condition.
For example, a number of governmental entities (including counties and municipalities) have filed lawsuits against pharmaceutical wholesale distributors (including us), pharmaceutical manufacturers and retail chains relating to the distribution of prescription opioid pain medications. Some states and other governmental entities have indicated they are considering filing similar lawsuits. We are vigorously defending ourselves in these lawsuits. The defense and resolution of these current and future lawsuits could adversely affect our results of operations and financial condition. See Note 8 of the “Notes to Consolidated Financial Statements" regarding these matters.
Some of the products that we distribute or manufacture have been and may in the future be alleged to cause personal injury, subjecting us to product liability claims. For example, we are a defendant in product liability lawsuits that allege personal injuries associated with the use of Cordis OptEase and TrapEase inferior vena cava (IVC) filter products and we have accrued an amount for losses and legal defense costs related to these lawsuits, which are discussed in Note 8 of the “Notes to Consolidated Financial Statements." Any settlement of or judgment for a product liability claim that is not covered by insurance and is in excess of any prior accruals could adversely affect our results of operations and financial condition.
We also operate in an industry characterized by extensive intellectual property litigation. Patent litigation can result in significant damage awards and injunctions that could prevent the manufacture and sale of affected products or force us to make royalty payments in order to continue selling the affected products.
Acquisitions can have unanticipated results.
An important element of our growth strategy has been to acquire other businesses that expand or complement our existing businesses. In fiscal 2017, we spent $132 million to acquire other businesses and in July 2017, we acquired the Patient Recovery Business from Medtronic for $6.1 billion. The acquisition of the Patient Recovery Business as well as other acquisitions involve the following risks: we may overpay for a business or fail to realize the synergies and other benefits we expect from the acquisition; our management’s attention may be diverted to integration efforts; we may fail to retain key personnel of the acquired business; future developments may impair the value of our purchased goodwill or intangible assets; we may face difficulties or delays establishing, integrating or combining operations and systems; we may assume liabilities related to legal proceedings involving the acquired business; we may face challenges retaining the customers of the acquired business; or we may encounter unforeseen internal control, regulatory or compliance issues.
We depend on certain suppliers to make their raw materials and products available to us and are subject to fluctuations in costs of raw materials and products.
Cardinal Health | Fiscal 2017 Form 10-K | 32 | |
Risk Factors | ||
We depend on the availability of various components, compounds, raw materials and energy supplied by others for our operations. In some instances, for reasons of quality assurance, cost effectiveness, or availability, we procure certain components and raw materials from a sole supplier. Any of our supplier relationships could be interrupted due to events beyond our control, including natural disasters, or could be terminated. In addition, due to the stringent regulations and requirements of the FDA regarding the manufacture of our products, we may not be able to quickly establish additional or replacement sources for certain components or materials. A sustained supply reduction or interruption, and an inability to develop alternative sources for such supply, could have an adverse effect on our business.
Our manufacturing businesses use oil-based resins, pulp, cotton, latex and other commodities as raw materials in many products. Prices of oil and gas also affect our distribution and transportation costs. Prices of these commodities are volatile and can fluctuate significantly, causing our costs to produce and distribute our products to fluctuate. Due to competitive dynamics and contractual limitations, we may be unable to pass along cost increases through higher prices. If we cannot fully offset cost increases through other cost reductions, or recover these costs through price increases or surcharges, our results of operations could be adversely affected.
Our results of operations may suffer upon the bankruptcy, insolvency, or other credit failure of a customer that has a substantial amount owed to us.
Most of our customers buy products and services from us on credit, which is made available to customers based on our assessment of creditworthiness. The bankruptcy, insolvency or other credit failure of any customer that has a substantial amount owed to us could adversely affect our results of operations.
Recent acquisitions have increased the extent of our exposure to the economic, political and currency risks of international operations.
We conduct our operations in various regions of the world outside of the United States, including Europe and Asia. The scope and complexity of our international operations expanded with the acquisitions of Cordis and the Patient Recovery Business and we may continue to expand our operations outside the United States. Global developments can affect our business in many ways. Our
global operations are affected by local economic environments, including inflation, recession and competition. In addition, we conduct our business in U.S. dollars and various functional currencies of our foreign subsidiaries. Changes in foreign currency exchange rates could adversely affect our financial results, which are reported in U.S. dollars. We may not be able to hedge to protect us against these exposures, and any hedges may not successfully mitigate these exposures. Political changes also can disrupt our global operations, as well as our customers and suppliers, in a particular location. Divergent or unfamiliar regulatory systems and labor markets also can increase the risks and burdens of operating in numerous countries.
Our goodwill may become impaired, which would require us to record a significant charge to earnings in accordance with generally accepted accounting principles.
U.S. GAAP requires us to test our goodwill for impairment on an annual basis, or more frequently if indicators for potential impairment exist. The testing required by GAAP involves estimates and judgments by management. Although we believe our assumptions and estimates are reasonable and appropriate, any changes in key assumptions, including a failure to meet business plans or other unanticipated events and circumstances such as a rise in interest rates, may affect the accuracy or validity of such estimates. We may be required to record a significant charge to earnings in our consolidated financial statements during the period in which any impairment of our goodwill is determined, which charge could adversely affect our results of operations. See "Critical Accounting Policies and Sensitive Accounting Estimates" in MD&A above for more information regarding goodwill impairment testing.
Economic conditions may adversely affect demand for our products and services.
Deterioration in general economic conditions in the United States and other countries in which we do business could adversely affect the amount of prescriptions filled and the number of medical procedures undertaken and, therefore, reduce purchases of our products and services, which could adversely affect our results of operations. In addition, deteriorating economic conditions may increase bankruptcies, insolvencies or other credit failures of customers or suppliers, which, if they have a substantial amount owed to us, also could adversely affect our results of operations.
33 | Cardinal Health | Fiscal 2017 Form 10-K | |
Properties and Legal Proceedings | ||
Properties
In the United States and Puerto Rico, at June 30, 2017, the Pharmaceutical segment operated 24 primary pharmaceutical distribution facilities and one national logistics center; six specialty distribution facilities; and more than 140 nuclear pharmacy and radiopharmaceutical manufacturing facilities. The Medical segment operated more than 70 medical-surgical distribution, assembly, manufacturing and other operating facilities in the United States and Puerto Rico. Our U.S. operating facilities are located in 45 states.
Outside the United States and Puerto Rico, at June 30, 2017, our Medical segment operated 20 facilities in Canada, the Dominican Republic, Malaysia, Malta, Mexico and Thailand that engage in manufacturing, distribution or research. In addition, our Pharmaceutical and Medical segments utilized various distribution and pharmacy facilities in China.
At June 30, 2017, we owned more than 70 operating facilities and leased more than 230 operating facilities around the world. Our
principal executive offices are headquartered in an owned building located at 7000 Cardinal Place in Dublin, Ohio.
In connection with the acquisition of the Patient Recovery Business in July 2017, we acquired nine manufacturing facilities in the United States and eight manufacturing facilities outside the United States in Canada, Costa Rica, Germany, Ireland, Japan, Malaysia, Mexico and Thailand.
We consider our operating properties to be in satisfactory condition and adequate to meet our present needs. However, we regularly evaluate operating properties and may make further additions and improvements or consolidate locations as we seek opportunities to expand or enhance the efficiency of our business.
Legal Proceedings
The legal proceedings described in Note 8 of the "Notes to Consolidated Financial Statements" are incorporated in this "Legal Proceedings" section by reference.
Cardinal Health | Fiscal 2017 Form 10-K | 34 | |
Market for Registrant's Common Equity | ||
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common shares are listed on the New York Stock Exchange under the symbol “CAH.” The following table reflects the range of the reported high and low closing prices of our common shares as reported on the New York Stock Exchange Composite Tape and the per share dividends declared for the fiscal years ended June 30, 2017 and 2016 and paid quarterly. It also reflects the range of the reported high and low closing prices of our common shares from July 1, 2017 through the period ended on July 31, 2017 and the per share dividends declared from July 1, 2017 through the period ended on July 31, 2017:
High | Low | Dividends Declared | |||||||||
Fiscal 2016 | |||||||||||
Quarter Ended: | |||||||||||
September 30, 2015 | $ | 87.02 | $ | 76.72 | $ | 0.3870 | |||||
December 31, 2015 | 90.85 | 77.12 | 0.3870 | ||||||||
March 31, 2016 | 89.68 | 76.16 | 0.3870 | ||||||||
June 30, 2016 | 87.20 | 73.69 | 0.4489 | ||||||||
Fiscal 2017 | |||||||||||
Quarter Ended: | |||||||||||
September 30, 2016 | $ | 84.92 | $ | 75.26 | $ | 0.4489 | |||||
December 31, 2016 | 76.71 | 65.17 | 0.4489 | ||||||||
March 31, 2017 | 83.80 | 72.47 | 0.4489 | ||||||||
June 30, 2017 | 82.71 | 71.18 | 0.4624 | ||||||||
Fiscal 2018 | $ | 78.69 | $ | 76.29 | $ | — | |||||
At July 31, 2017 there were approximately 8,239 shareholders of record of our common shares.
We anticipate that we will continue to pay quarterly cash dividends in the future. The payment and amount of future dividends remain, however, within the discretion of our Board of Directors and will depend upon our future earnings, financial condition, capital requirements and other factors.
Issuer Purchases of Equity Securities
Period | Total Number of Shares Purchased (1) | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Programs (2) | Approximate Dollar Value of Shares That May Yet be Purchased Under the Programs (2) (in millions) | |||||||||
April 2017 | 104 | $ | 72.21 | — | $ | 443 | |||||||
May 2017 | 104 | 72.33 | — | 443 | |||||||||
June 2017 | 104 | 75.55 | — | 443 | |||||||||
Total | 312 | $ | 73.36 | — | $ | 443 | |||||||
(1) | Reflects 104, 104 and 104 common shares purchased in April, May and June 2017, respectively, through a rabbi trust as investments of participants in our Deferred Compensation Plan. |
(2) | On May 4, 2016, our Board of Directors approved a $1.0 billion share repurchase program that expires on December 31, 2019. During the three months ended June 30, 2017, we repurchased no common shares under this program. We have $443 million available under this program. |
35 | Cardinal Health | Fiscal 2017 Form 10-K | |
Market for Registrant's Common Equity | ||
Five Year Performance Graph
The following line graph compares the cumulative total return of our common shares with the cumulative total return of the Standard & Poor’s Composite—500 Stock Index (the "S&P 500 Index") and the Standard & Poor's Composite—500 Healthcare Index (the "S&P 500 Healthcare Index"). The line graph assumes, in each case, an initial investment of $100 on June 30, 2012, based on the market prices at the end of each fiscal year through and including June 30, 2017, and reinvestment of dividends. The S&P 500 Index and S&P 500 Healthcare Index investments are weighted on the basis of market capitalization at the beginning of each period.
June 30 | ||||||||||||||||||
2012 | 2013 | 2014 | 2015 | 2016 | 2017 | |||||||||||||
Cardinal Health, Inc. | $ | 100.00 | $ | 115.29 | $ | 170.78 | $ | 211.95 | $ | 201.61 | $ | 206.15 | ||||||
S&P 500 Index | 100.00 | 120.58 | 150.20 | 161.33 | 167.74 | 197.72 | ||||||||||||
S&P 500 Healthcare Index | 100.00 | 127.74 | 166.13 | 206.25 | 202.09 | 227.28 | ||||||||||||
Cardinal Health | Fiscal 2017 Form 10-K | 36 | |
Reports | ||
Management Reports
Evaluation of Disclosure Controls and Procedures
We evaluated, with the participation of our principal executive officer and principal financial officer, the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")) as of June 30, 2017. Based on this evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures were effective as of June 30, 2017 to provide reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. Our internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, controls deemed effective now may become inadequate in the future because of changes in conditions, or because compliance with policies or procedures has deteriorated or been circumvented.
Management assessed the effectiveness of our internal control over financial reporting as of June 30, 2017. In making this assessment, management used the criteria established in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the “COSO criteria”). Based on management’s assessment and the COSO criteria, management believes that our internal control over financial reporting was effective as of June 30, 2017.
Our independent registered public accounting firm, Ernst & Young LLP, has issued a report on our internal control over financial reporting. Ernst & Young LLP’s report appears following this "Management Reports" section and expresses an unqualified opinion on the effectiveness of our internal control over financial reporting.
Changes in Internal Control Over Financial Reporting
The Pharmaceutical segment is in a multi-year project to replace certain finance and operating information systems, which is affecting internal control over financial reporting. During the quarter ended June 30, 2017, we continued to transition selected processes to the new systems. If these new systems are not effectively implemented or fail to operate as intended, it could adversely affect our internal control over financial reporting. Except for the changes made in connection with implementing the new systems described above, there were no changes in our internal control over financial reporting during the quarter ended June 30, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
37 | Cardinal Health | Fiscal 2017 Form 10-K | |
Reports | ||
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
The Board of Directors and Shareholders of Cardinal Health, Inc.
We have audited Cardinal Health, Inc. and subsidiaries' internal control over financial reporting as of June 30, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Cardinal Health, Inc. and subsidiaries' management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying “Management's Report on Internal Control Over Financial Reporting.” Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Cardinal Health, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of June 30, 2017, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Cardinal Health, Inc. and subsidiaries as of June 30, 2017 and 2016 and the related consolidated statements of earnings, comprehensive income, shareholders' equity and cash flows for each of the three years in the period ended June 30, 2017 of Cardinal Health, Inc. and subsidiaries and our report dated August 10, 2017 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP |
Columbus, Ohio |
August 10, 2017 |
Cardinal Health | Fiscal 2017 Form 10-K | 38 | |
Reports | ||
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of Cardinal Health, Inc.
We have audited the accompanying consolidated balance sheets of Cardinal Health, Inc. and subsidiaries as of June 30, 2017 and 2016, and the related consolidated statements of earnings, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended June 30, 2017. Our audits also included the financial statement schedule listed in the Index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cardinal Health, Inc. and subsidiaries at June 30, 2017 and 2016, and the consolidated results of their operations and their cash flows for each of the three years in the period ended June 30, 2017, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Cardinal Health, Inc. and subsidiaries' internal control over financial reporting as of June 30, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated August 10, 2017 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP |
Columbus, Ohio |
August 10, 2017 |
39 | Cardinal Health | Fiscal 2017 Form 10-K | |
Financial Statements | ||
Financial Statements and Supplementary Data
Page | |
Consolidated Financial Statements and Schedule: | |
Cardinal Health | Fiscal 2017 Form 10-K | 40 | |
Financial Statements | ||
Consolidated Statements of Earnings
(in millions, except per common share amounts) | 2017 | 2016 | 2015 | ||||||||
Revenue | $ | 129,976 | $ | 121,546 | $ | 102,531 | |||||
Cost of products sold | 123,432 | 115,003 | 96,819 | ||||||||
Gross margin | 6,544 | 6,543 | 5,712 | ||||||||
Operating expenses: | |||||||||||
Distribution, selling, general and administrative expenses | 3,775 | 3,648 | 3,240 | ||||||||
Restructuring and employee severance | 56 | 25 | 44 | ||||||||
Amortization and other acquisition-related costs | 527 | 459 | |||||||||