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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For The Quarter Ended September 30, 2002 Commission File Number 1-11373
CARDINAL HEALTH, INC.
(Exact name of registrant as specified in its charter)
OHIO 31-0958666
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
7000 CARDINAL PLACE, DUBLIN, OHIO 43017
(Address of principal executive offices and zip code)
(614) 757-5000
(Registrant's telephone number, including area code)
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 X No
--- ---
The number of Registrant's Common Shares outstanding at the close of
business on October 31, 2002 was as follows:
Common Shares, without par value: 442,502,027
-----------
Page 1
CARDINAL HEALTH, INC. AND SUBSIDIARIES
Index *
Page No.
-------
Part I. FINANCIAL INFORMATION:
Item 1. Financial Statements:
Condensed Consolidated Statements of Earnings for the Three Months
Ended September 30, 2002 and 2001 (unaudited)...................................... 3
Condensed Consolidated Balance Sheets at September 30, 2002 and
June 30, 2002 (unaudited).......................................................... 4
Condensed Consolidated Statements of Cash Flows for the Three Months Ended
September 30, 2002 and 2001 (unaudited)............................................ 5
Notes to Condensed Consolidated Financial Statements............................... 6
Item 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition............................................................ 14
Item 3. Quantitative and Qualitative Disclosures about Market Risk......................... 20
Item 4. Controls and Procedures............................................................ 20
Part II. OTHER INFORMATION:
Item 1. Legal Proceedings.................................................................. 20
Item 5. Other Information.................................................................. 21
Item 6. Exhibits and Reports on Form 8-K................................................... 21
* Items not listed are inapplicable.
Page 2
PART I. FINANCIAL INFORMATION
CARDINAL HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(UNAUDITED)
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED
SEPTEMBER 30,
2002 2001
-------------- ---------------
Operating revenue $ 11,416.6 $ 9,865.4
Operating cost of products sold 10,409.7 8,950.7
-------------- ---------------
Operating gross margin 1,006.9 914.7
Bulk deliveries to customer warehouses and other 1,669.5 1,908.0
Cost of products sold - bulk deliveries and other 1,669.5
1,908.0
-------------- ---------------
Bulk gross margin - -
Selling, general and administrative expenses 520.7 502.4
Special charges 18.7 12.3
-------------- ---------------
Operating earnings 467.5 400.0
Interest expense and other 30.6 28.6
-------------- ---------------
Earnings before income taxes 436.9 371.4
Provision for income taxes 148.6 125.0
-------------- ---------------
Earnings before cumulative effect of
change in accounting 288.3 246.4
Cumulative effect of change in accounting (See Note 7) - 70.1
-------------- ---------------
Net earnings $ 288.3 $ 176.3
============== ===============
Basic earnings per Common Share:
Before cumulative effect of change in accounting $ 0.65 $ 0.55
Cumulative effect of change in accounting - (0.16)
-------------- ---------------
Net basic earnings per Common Share $ 0.65 $ 0.39
============== ===============
Diluted earnings per Common Share:
Before cumulative effect of change in accounting $ 0.64 $ 0.53
Cumulative effect of change in accounting - (0.15)
-------------- ---------------
Net diluted earnings per Common Share $ 0.64 $ 0.38
============== ===============
Weighted average number of Common Shares outstanding:
Basic 446.2 449.6
Diluted 454.2 460.6
Cash dividends declared per Common Share $ 0.025 $ 0.025
See notes to condensed consolidated financial statements.
Page 3
CARDINAL HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN MILLIONS)
SEPTEMBER 30, JUNE 30,
2002 2002
---------------- -----------------
ASSETS
Current assets:
Cash and equivalents $ 945.6 $ 1,382.0
Trade receivables, net 2,554.8 2,295.4
Current portion of net investment in sales-type leases 190.6 218.3
Inventories 7,250.2 7,361.0
Prepaid expenses and other 670.3 649.9
---------------- -----------------
Total current assets 11,611.5 11,906.6
---------------- -----------------
Property and equipment, at cost 3,480.7 3,509.3
Accumulated depreciation and amortization (1,593.4) (1,614.9)
---------------- -----------------
Property and equipment, net 1,887.3 1,894.4
Other assets:
Net investment in sales-type leases, less current portion 644.8 618.6
Goodwill and other intangibles 1,567.9 1,544.1
Other 523.7 474.3
---------------- -----------------
Total $ 16,235.2 $ 16,438.0
================ =================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes payable, banks $ - $ 0.8
Current portion of long-term obligations 17.4 17.4
Accounts payable 5,299.8 5,504.5
Other accrued liabilities 1,320.9 1,287.7
---------------- -----------------
Total current liabilities 6,638.1 6,810.4
---------------- -----------------
Long-term obligations, less current portion 2,237.8 2,207.0
Deferred income taxes and other liabilities 1,005.6 1,027.6
Shareholders' equity:
Preferred Stock, without par value
Authorized - 0.5 million shares, Issued - none - -
Common Shares, without par value
Authorized - 755.0 million shares, Issued - 461.8
million shares and 461.0 million shares at
September 30, 2002 and June 30, 2002, respectively 2,137.4 2,105.2
Retained earnings 5,433.2 5,156.1
Common Shares in treasury, at cost, 18.4 million shares
and 12.2 million shares at September 30, 2002 and
June 30, 2002, respectively (1,110.2) (737.0)
Other comprehensive loss (97.0) (120.9)
Other (9.7) (10.4)
---------------- -----------------
Total shareholders' equity 6,353.7 6,393.0
---------------- -----------------
Total $ 16,235.2 $ 16,438.0
================ =================
See notes to condensed consolidated financial statements.
Page 4
CARDINAL HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
THREE MONTHS ENDED
SEPTEMBER 30,
2002 2001
--------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Earnings before cumulative effect of change in accounting $ 288.3 $ 246.4
Adjustments to reconcile earnings before cumulative effect of change in
accounting to net cash from operating activities:
Depreciation and amortization 62.2 61.2
Provision for bad debts 5.6 9.3
Change in operating assets and liabilities, net of effects from
acquisitions:
(Increase)/decrease in trade receivables (264.9) 151.7
(Increase)/decrease in inventories 110.8 (1,411.0)
Decrease in net investment in sales-type leases 1.5 186.0
Increase/(decrease) in accounts payable (204.7) 342.9
Other operating items, net (12.9) (67.2)
--------------- ----------------
Net cash used in operating activities (14.1) (480.7)
--------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of subsidiaries, net of cash acquired (5.4) -
Proceeds from sale of property and equipment 16.3 9.6
Additions to property and equipment (70.5) (58.3)
--------------- ----------------
Net cash used in investing activities (59.6) (48.7)
--------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in commercial paper and short-term debt (0.7) 405.1
Reduction of long-term obligations (3.0) (13.4)
Proceeds from long-term obligations, net of issuance costs 2.2 36.2
Proceeds from issuance of Common Shares 42.7 50.6
Purchase of treasury shares (392.7) -
Dividends on Common Shares (11.2) (11.2)
--------------- ----------------
Net cash provided by/(used in) financing activities (362.7) 467.3
--------------- ----------------
NET DECREASE IN CASH AND EQUIVALENTS (436.4) (62.1)
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD 1,382.0 934.1
--------------- ----------------
CASH AND EQUIVALENTS AT END OF PERIOD $ 945.6 $ 872.0
=============== ================
See notes to condensed consolidated financial statements.
Page 5
CARDINAL HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. The condensed consolidated financial statements of
Cardinal Health, Inc. (the "Company") include the accounts of all majority-owned
subsidiaries and all significant intercompany amounts have been eliminated.
These condensed consolidated financial statements have been prepared in
accordance with the instructions to Form 10-Q and include all of the information
and disclosures required by generally accepted accounting principles for interim
reporting. In the opinion of management, all adjustments necessary for a fair
presentation have been included. Except as disclosed elsewhere herein, all such
adjustments are of a normal and recurring nature.
The condensed consolidated financial statements included herein should be
read in conjunction with the audited consolidated financial statements and
related notes contained in the Company's Annual Report on Form 10-K for the
fiscal year ended June 30, 2002 (the "2002 Form 10-K"). Without limiting the
generality of the foregoing, Note 1 of the "Notes to Consolidated Financial
Statements" from the 2002 Form 10-K is specifically incorporated herein by
reference.
RECENT FINANCIAL ACCOUNTING STANDARDS. In June 2002, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial Accounting
Standards ("SFAS") No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities," effective for exit or disposal activities that are
initiated after December 31, 2002. This statement nullifies Emerging Issues Task
Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)." This statement requires that a liability for a cost
associated with an exit or disposal activity, other than those associated with a
business combination, be recognized when the liability is incurred instead of
recognizing the liability at the date of an entity's commitment to an exit plan
as was required in Issue 94-3. The Company will adopt the provisions of SFAS No.
146 for restructuring activities initiated after December 31, 2002. The adoption
of this statement is not anticipated to have a material effect on the Company's
financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections," effective for fiscal years beginning or transactions occurring
after May 15, 2002. This statement clarifies several accounting issues including
the classification of gains and losses from the early extinguishment of debt and
lease modifications that should be accounted for in a manner similar to a
sales-leaseback transaction. The adoption of this statement during the quarter
did not have a material effect on the Company's financial position or results of
operations.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," effective for fiscal years
beginning after December 15, 2001. SFAS No. 144 supersedes SFAS 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of," and provides a single accounting model for the disposal of long-lived
assets from continuing and discontinued operations. The adoption of this
statement during the quarter did not have a material effect on the Company's
financial position or results of operations.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," effective for fiscal years beginning after June 15,
2002. This statement addresses the diverse accounting practices for obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement costs. The adoption of this statement during the quarter did
not have a material effect on the Company's financial position or results of
operations.
Page 6
2. EARNINGS PER SHARE AND SHAREHOLDERS' EQUITY
Basic earnings per Common Share ("Basic") is computed by dividing net
earnings (the numerator) by the weighted average number of Common Shares
outstanding during each period (the denominator). Diluted earnings per Common
Share is similar to the computation for Basic, except that the denominator is
increased by the dilutive effect of stock options outstanding, computed using
the treasury stock method.
The following table reconciles the number of shares used to compute basic
and diluted earnings per share for the quarters ended September 30, 2002 and
2001:
(in millions) 2002 2001
- -------------------------------------------------------------------------------
Weighted-average shares - basic 446.2 449.6
Effect of dilutive securities:
Employee stock options 8.0 11.0
- -------------------------------------------------------------------------------
Weighted-average shares - diluted 454.2 460.6
===============================================================================
The potentially dilutive employee stock options that were antidilutive for
the quarters ended September 30, 2002 and 2001 were 13.6 million and 0.1
million, respectively.
On August 7, 2002, the Company's Board of Directors authorized the
repurchase of Common Shares up to an aggregate amount of $500 million. As of
September 30, 2002, 3.4 million Common Shares having an aggregate cost of
approximately $219.8 million had been repurchased through this plan. The
repurchased shares will be treasury shares used for general corporate purposes.
In September 2001, the Company's Board of Directors authorized the
repurchase of Common Shares up to an aggregate amount of $500 million. This
program expired by its terms in August 2002. The Company repurchased
approximately 3.2 million Common Shares having an aggregate cost of
approximately $191.7 million during the quarter ended September 30, 2002. The
cumulative amount repurchased under this program was approximately 8.3 million
Common Shares having an aggregate cost of approximately $500 million. The
repurchased shares will be treasury shares used for general corporate purposes.
3. COMPREHENSIVE INCOME
The following is a summary of the Company's comprehensive income for the
three months ended September 30, 2002 and 2001:
For the Three Months Ended
(in millions) September 30,
--------------------------------------
2002 2001
--------------------------------------
Net earnings $ 288.3 $ 176.3
Foreign currency translation adjustments 8.6 14.3
Unrealized gain on investment - 2.2
Reclassification adjustment for investment
losses included in net income - 3.2
Net unrealized gain/(loss) on derivative instruments 15.3 (6.5)
------------------- -----------------
Total comprehensive income $ 312.2 $ 189.5
=================== =================
Page 7
4. MERGER-RELATED COSTS AND OTHER SPECIAL ITEMS
The following is a summary of the special charges for the three-month
periods ended September 30, 2002 and 2001.
Special Charges Three Months Ended
September 30,
- -------------------------------------------------------------------------------------------------
(in millions) 2002 2001
- -------------------------------------------------------------------------------------------------
Merger-Related Costs:
Employee-related costs $ (3.2) $ (4.1)
Pharmaceutical distribution center consolidation (5.1) (0.3)
Other exit costs (0.5) (2.3)
Other integration costs (2.6) (5.6)
- -------------------------------------------------------------------------------------------------
Total merger-related costs $ (11.4) $ (12.3)
- -------------------------------------------------------------------------------------------------
Other Special Charges:
Manufacturing facility closures $ (10.2) $ -
Litigation settlements 2.9 -
- -------------------------------------------------------------------------------------------------
Total other special charges $ (7.3) $ -
- -------------------------------------------------------------------------------------------------
Total special charges $ (18.7) $ (12.3)
Tax effect of special charges 3.1 4.7
- -------------------------------------------------------------------------------------------------
Net effect of special charges $ (15.6) $ (7.6)
=================================================================================================
MERGER-RELATED COSTS
Costs of effecting mergers and subsequently integrating the operations of
the various merged companies are recorded as merger-related costs when incurred.
The merger-related costs currently being recognized are primarily a result of
the merger or acquisition transactions with Bindley Western Industries, Inc.
("Bindley"), Bergen Brunswig Medical Corporation ("BBMC"), Allegiance
Corporation ("Allegiance") and R.P. Scherer Corporation ("Scherer").
EMPLOYEE-RELATED COSTS. During the above-stated periods, the Company
incurred employee-related costs associated with certain of its merger
transactions. For the three months ended September 30, 2002 and 2001, $2.5
million related to amortization expense of noncompete agreements primarily
associated with the Bindley and Allegiance merger transactions. The remaining
employee-related costs for the three months ended September 30, 2002 primarily
related to retention bonuses associated with certain of the Company's smaller
acquisitions. The remaining employee-related costs for the three months ended
September 30, 2001 primarily related to payroll taxes from stock option
exercises from plans converted at the time of the Bindley, Allegiance and
Scherer mergers, as well as severance related to a change in control agreement
associated with the Allegiance merger. The total severance payout exceeded the
amount accrued at the time of the agreement resulting in additional expense.
PHARMACEUTICAL DISTRIBUTION CENTER CONSOLIDATION. In connection with the
merger transaction with Bindley, the Company anticipates closing and
consolidating a total of 16 Bindley distribution centers, Bindley's corporate
office, and one of the Company's data centers. These closures will result in the
termination of approximately 1,050 employees. As of September 30, 2002, a total
of 15 Bindley distribution centers have been closed, and the majority of the
1,050 employees have been terminated. During the first quarter of fiscal 2003
and 2002, the Company recorded charges of $5.1 million and $0.3 million,
respectively, primarily associated with the consolidations and closures noted
above. The Company incurred employee-related costs of $0.9 million in the first
quarter of fiscal 2003, primarily from the termination of employees due to the
distribution center closures. Exit costs related to the termination of contracts
and lease agreements of the distribution centers were incurred during the first
quarter of fiscal 2003 of $1.7 million. Also, asset impairment charges of $1.1
million were incurred during the first quarter of fiscal 2003. In addition,
during the first quarter of fiscal 2003, the Company incurred costs associated
with the consolidation of one of the Company's data centers of $1.4 million,
primarily related to duplicate salaries incurred during the consolidation
period. During the first quarter of fiscal 2002, the Company incurred charges of
$0.3 million primarily related to costs associated with moving inventory and
other assets during the consolidation of distribution centers. The Company
anticipates completing the distribution center and data center consolidations by
December 31, 2002. The Company anticipates completing the corporate office
consolidation by June 30, 2003.
Page 8
OTHER EXIT COSTS. Other exit costs related primarily to costs associated
with lease terminations, moving expenses, and asset impairments as a direct
result of the merger transactions with BBMC, Allegiance and Scherer.
OTHER INTEGRATION COSTS. Other integration costs, which primarily relate to
the Bindley, BBMC, and Allegiance transactions, included charges directly
related to the integration of operations of the transactions noted, such as
consulting costs related to information systems and employee benefit
integration, as well as relocation and travel costs directly associated with the
integrations.
OTHER SPECIAL CHARGES
MANUFACTURING FACILITY CLOSURES. During the first quarter of fiscal 2003,
the Company recorded a special charge of $10.2 million related to the closure of
a manufacturing facility within the Medical-Surgical Products and Services
segment. Asset impairment charges of $7.5 million were incurred during the
quarter. Also, exit costs of $1.4 million were incurred, primarily related to
dismantling and moving machinery and equipment. The remaining $1.3 million
related to severance costs associated with the termination of approximately 200
employees during the quarter. The closure is expected to be completed by
December 31, 2002.
LITIGATION SETTLEMENTS. During the first quarter of fiscal 2003, the
Company recorded income from litigation settlements of $2.9 million. These
settlements resulted from the recovery of antitrust claims against certain
vitamin manufacturers for amounts overcharged in prior years. The total recovery
through September 30, 2002 was $38.2 million, of which $35.3 million had
previously been recorded ($10.0 million in the second quarter of fiscal 2001,
$12.0 million in the first quarter of fiscal 2002, and $13.3 million in the
fourth quarter of fiscal 2002). The amounts previously recorded in the second
quarter of fiscal 2001 and the first quarter of fiscal 2002 were reflected as a
reduction of cost of goods sold, which is consistent with the classification of
the original overcharge, and were based on the minimum amounts estimated to be
recoverable based on the facts and circumstances available at the time they were
recorded. While the Company still has pending claims against other
manufacturers, the total amount of any future recovery is not currently
estimable. Any future recoveries will be recorded as a special item in the
period when a settlement is reached.
ACCRUAL ROLLFORWARD
The following table summarizes the activity related to the liabilities
associated with the Company's special charges during the quarter ended September
30, 2002.
For the Three
Months Ended
($ in millions) September 30, 2002
- ----------------------------------------------------------------
Balance at June 30, 2002 $64.7
Additions(1) 18.7
Payments (32.6)
----------------------
Balance at September 30, 2002 $50.8
======================
(1) Amount represents items that have been either expensed as incurred or
accrued according to generally accepted accounting principles.
SUMMARY
The net effect of the various special charges recorded during the three
months ended September 30, 2002 and 2001 was to reduce earnings before
cumulative effect of change in accounting by $15.6 million to $288.3 million and
by $7.6 million to $246.4 million, respectively, and to reduce reported diluted
earnings per Common Share before cumulative effect of change in accounting by
$0.03 per share to $0.64 per share and by $0.02 per share to $0.53 per share,
respectively.
5. SEGMENT INFORMATION
The Company is organized based on the products and services it offers.
Under this organizational structure, the Company operates within four operating
business segments: Pharmaceutical Distribution and Provider Services,
Medical-Surgical Products and Services, Pharmaceutical Technologies and
Services, and Automation and Information Services. The Company has not made any
significant changes in the segments reported or the basis of measurement of
segment profit or loss from the information provided in the 2002 Form 10-K.
The Pharmaceutical Distribution and Provider Services segment involves the
distribution of a broad line of pharmaceuticals, healthcare,
radiopharmaceuticals, and other specialty pharmaceutical products and other
Page 9
items typically sold by hospitals, retail drug stores and other healthcare
providers. In addition, this segment provides services to the healthcare
industry through integrated pharmacy management, temporary pharmacy staffing,
as well as franchising of apothecary-style retail pharmacies.
The Medical-Surgical Products and Services segment involves the manufacture
of medical, surgical and laboratory products and the distribution of these
products as well as products not manufactured internally to hospitals, physician
offices, surgery centers and other healthcare providers.
The Pharmaceutical Technologies and Services segment provides services to
the healthcare industry through the design of proprietary drug delivery systems
including softgel capsules, controlled release forms, Zydis(R) fast dissolving
wafers, and advanced sterile delivery technologies. It also provides
comprehensive packaging, pharmaceutical development and analytical science
expertise, as well as medical education, marketing and contract sales services.
The Automation and Information Services segment provides services to
hospitals and other healthcare providers through pharmacy automation equipment
and clinical information system services.
The Company evaluates the performance of the segments based on operating
earnings after the corporate allocation of administrative expenses. Special
charges are not allocated to the segments.
The following table includes revenue and operating earnings for the
three-month periods ended September 30, 2002 and 2001 for each segment and
reconciling items necessary to equal amounts reported in the condensed
consolidated financial statements:
For the Three Months Ended
September 30,
----------------------------------
(in millions) Net Revenue
----------------------------------
2002 2001
---------------- ----------------
Operating revenue:
Pharmaceutical Distribution and Provider Services $9,351.5 $7,960.7
Medical-Surgical Products and Services 1,595.5 1,509.5
Pharmaceutical Technologies and Services 354.1 300.7
Automation and Information Services 133.8 108.3
Corporate (1) (18.3) (13.8)
---------------- ----------------
Total operating revenue 11,416.6 9,865.4
Bulk deliveries to customer warehouses and other:
Pharmaceutical Distribution and Provider Services 1,630.8 1,908.0
Pharmaceutical Technologies and Services (2) 38.7 -
---------------- ----------------
Total bulk deliveries to customer warehouses and other 1,669.5 1,908.0
Total net revenue $13,086.1 $11,773.4
================ ================
Operating Earnings
----------------------------------
2002 2001
---------------- ----------------
Operating earnings:
Pharmaceutical Distribution and Provider Services $267.5 $221.8
Medical-Surgical Products and Services 138.7 126.5
Pharmaceutical Technologies and Services 67.0 57.7
Automation and Information Services 46.2 29.8
Corporate (3) (51.9) (35.8)
---------------- ----------------
Total operating earnings $467.5 $400.0
================ ================
(1) Corporate operating revenue primarily consists of foreign currency
translation adjustments.
(2) During the three months ended September 30, 2002, the Company began
classifying out-of-pocket expenses received through its recently acquired
sales and marketing services' business within the bulk deliveries to
customer warehouses and other line item. The customer is contractually
required to reimburse the Company for these expenses. The Company does not
generate any margin from these reimbursements.
(3) Corporate operating earnings include special charges of $18.7 million and
$12.3 million in the three-month periods ended September 30, 2002 and 2001,
respectively, and unallocated corporate administrative
Page 10
expenses and investment spending. In addition, during the first quarter of
fiscal 2003, the Company began expanding the use of its shared service
center, which previously supported the Medical-Surgical Products and
Services segment, to benefit and support company-wide initiatives and other
business segments. Accordingly, the cost of the shared service center,
which was previously reported within the Medical-Surgical Products and
Services segment, has been classified within Corporate earnings for the
first quarter of fiscal 2003 to be consistent with internal segment
reporting. The cost of these services for the first quarter of fiscal 2003
was approximately $4.8 million.
6. LEGAL PROCEEDINGS
On September 30, 1996, Baxter International Inc. ("Baxter") and its
subsidiaries transferred to Allegiance and its subsidiaries Baxter's U.S.
healthcare distribution business, surgical and respiratory therapy business and
healthcare cost-saving business as well as certain foreign operations (the
"Allegiance Business") in connection with a spin-off of the Allegiance Business
by Baxter (the "Baxter-Allegiance Spin-Off"). In connection with this spin-off,
Allegiance, which merged with a subsidiary of the Company on February 3, 1999,
agreed to indemnify Baxter, and to defend and indemnify Baxter Healthcare
Corporation ("BHC"), as contemplated by the agreements between Baxter and
Allegiance, for all expenses and potential liabilities associated with claims
arising from the Allegiance Business, including certain claims of alleged
personal injuries as a result of exposure to natural rubber latex gloves. The
Company is not a party to any of the lawsuits and has not agreed to pay any
settlements to the plaintiffs.
As of September 30, 2002, there were 368 lawsuits against BHC and/or
Allegiance involving allegations of sensitization to natural rubber latex
products. Some of the cases are now proceeding to trial. The total dollar amount
of potential damages cannot be reasonably quantified. Some plaintiffs plead
damages in extreme excess of what they reasonably can expect to recover, some
plead a modest amount, and some do not include a request for any specific dollar
amount. Not including cases that ask for no specific damages, the damage
requests per action have ranged from $10,000 to $240 million. All of these cases
name multiple defendants, in addition to Baxter/Allegiance. The average number
of defendants per case exceeds twenty-five. Based on the significant differences
in the range of damages sought and based on the multiple number of defendants in
these lawsuits, Allegiance cannot reasonably quantify the total amount of
possible/probable damages. Therefore, Allegiance and the Company do not believe
that these numbers should be considered as an indication of either reasonably
possible or probable liability.
Since the inception of this litigation, Baxter/Allegiance have been named
as a defendant in approximately 800 cases. As of September 30, 2002, fewer than
half of those lawsuits remain pending. Nearly half of the lawsuits that have
been resolved were concluded without any liability to Baxter/Allegiance. During
the fiscal year ended June 30, 2002, Allegiance began settling some of these
lawsuits with greater frequency. No individual claim has been settled for a
material amount, nor have all the settled claims, in the aggregate, comprised a
material amount. Due to the number of claims filed and the ongoing defense costs
that will be incurred, Allegiance believes it is probable that it will incur
substantial legal fees related to the resolution of the cases still pending.
Although the Company continues to believe that it cannot reasonably estimate the
potential cost to settle these lawsuits, the Company believes that the impact of
such lawsuits upon Allegiance will be immaterial to the Company's financial
position, liquidity and results of operations, and could be in the range of $0
to $20 million, net of insurance proceeds (with the top end of the range
reflecting virtually no insurance coverage, which the Company believes is an
unlikely scenario given the insurance coverage in place). The Company believes a
substantial portion of any liability will be covered by insurance policies
Allegiance has with financially viable insurance companies, subject to
self-insurance retentions, exclusions, conditions, coverage gaps, policy limits
and insurer solvency. The Company and Allegiance continue to believe that
insurance recovery is probable.
The Company also becomes involved from time-to-time in other litigation
incidental to its business, including, without limitation, inclusion of certain
of its subsidiaries as a potentially responsible party for environmental
clean-up costs. Although the ultimate resolution of the litigation referenced
herein cannot be forecast with certainty, the Company intends to vigorously
defend itself and does not currently believe that the outcome of any pending
litigation will have a material adverse effect on the Company's consolidated
financial statements.
7. CHANGE IN ACCOUNTING
In the first quarter of fiscal 2002, the method of recognizing revenue for
pharmacy automation equipment was changed from recognizing revenue when the
units were delivered to the customer to recognizing revenue when the units are
installed at the customer site. Management believes that the change in
accounting will provide for a more objectively determinable method of revenue
recognition. In addition, the Company has implemented other changes to better
service its customers and leverage operational efficiencies. The Company
recorded a cumulative effect of change in accounting of $70.1 million (net of
tax of $44.6 million) in the consolidated statement of earnings during the first
quarter of fiscal 2002. The after tax dilutive impact of the cumulative effect
was $0.15 per diluted share.
Page 11
8. GOODWILL AND OTHER INTANGIBLE ASSETS
Changes in the carrying amount of goodwill for the quarter ended September
30, 2002, were as follows:
Medical-
Pharmaceutical Surgical Automation
Distribution Products Pharmaceutical and
And Provider and Technologies Information
(in millions) Services Services and Services Services Total
- -----------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2002 $159.8 $675.4 $639.4 $50.7 $1,525.3
Goodwill acquired, net of purchase price
adjustments and other 5.1 3.2 3.5 - 11.8
- -----------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2002 $164.9 $678.6 $642.9 $50.7 $1,537.1
=======================================================================================================================
All intangible assets for the periods presented are subject to
amortization. Intangible assets are being amortized using the straight-line
method over periods that range from five to forty years. The detail of other
intangible assets by class as of September 30 and June 30, 2002 was as follows:
Gross Accumulated Net
(in millions) Intangible Amortization Intangible
- ------------------------------------------------ ------------------- ---------------------- ----------------
June 30, 2002
Trademarks and patents $28.7 $20.0 $8.7
Non-compete agreements 21.3 20.0 1.3
Other 17.7 8.9 8.8
- ------------------------------------------------ ------------------- ---------------------- ----------------
Total $67.7 $48.9 $18.8
- ------------------------------------------------ ------------------- ---------------------- ----------------
September 30, 2002
Trademarks and patents $33.8 $19.7 $14.1
Non-compete agreements 26.5 20.5 6.0
Other 20.1 9.4 10.7
- ------------------------------------------------ ------------------- ---------------------- ----------------
Total $80.4 $49.6 $30.8
- ------------------------------------------------ ------------------- ---------------------- ----------------
There were no significant acquisitions of other intangible assets for the
periods presented. Amortization expense for the quarters ended September 30,
2002 and 2001 was $0.8 million and $0.9 million, respectively. Amortization
expense for each of the next five fiscal years is estimated to be:
------------------------------------------------------------------
2003 2004 2005 2006 2007
------------------------------------------------------------------
Amortization expense $ 3.1 $ 2.6 $ 2.1 $ 1.9 $ 1.8
9. PENDING TRANSACTION
On June 14, 2002, the Company announced that it had entered into a
definitive agreement to acquire Syncor International Corporation ("Syncor"), a
Woodland Hills, California-based company, which is a leading provider of nuclear
pharmacy services. The proposed acquisition of Syncor is a stock-for-stock
merger transaction. Under the terms of the merger agreement, dated June 14,
2002, each Syncor share will be converted into 0.52 of a Common Share at the
completion of the proposed acquisition. Based on the closing sale price of a
Common Share as of November 13, 2002 and the exchange ratio contained in the
merger agreement, dated June 14, 2002, the value of the Common Shares to be
received by all of the Syncor stockholders in connection with the merger would
be approximately $950 million.
Page 12
On November 6, 2002, Syncor announced that a special committee of outside
directors, together with outside counsel, has been investigating the propriety
of certain payments made by foreign subsidiaries. These improper payments that
had been made in foreign countries by subsidiaries of Syncor were discovered by
the Company during its ongoing due diligence investigation of Syncor and
promptly reported to Syncor. On November 6th, Syncor also announced that in
order to provide additional time to complete the investigation of its foreign
operations and make any appropriate disclosures to stockholders, it has
postponed until Friday, December 6, 2002, its special meeting of stockholders to
vote on the pending merger with the Company. Following Syncor's November 6th
announcement, the Company indicated that it will continue to carefully monitor
the Syncor situation and assess the results of the Syncor special committee's
ongoing investigation as well as the results of the Company's continuing due
diligence review. The Company intends to use all appropriate resources and spend
the time necessary to complete its ongoing comprehensive due diligence review in
a deliberate manner. The Company intends to fully comply with its obligations
under the merger agreement.
The Company notes that its acquisition of Syncor is subject to the
satisfaction or waiver of a number of conditions set forth in the merger
agreement, dated June 14, 2002, between the parties. Following Syncor's November
6th announcement, the Company indicated publicly that it has not yet concluded
whether those conditions will be satisfied. There can be no assurance that the
transaction involving the acquisition of Syncor by the Company will be
completed.
On November 8, 2002, a complaint was filed by a purported shareholder
against the Company and its directors in the Court of Common Pleas, Delaware
County, Ohio, as a purported derivative action alleging breach of fiduciary
duties and corporate waste in connection with the alleged failure by the Board
of Directors of the Company to renegotiate or terminate the Company's proposed
acquisition of Syncor. Among other matters, the complaint requests that the
transaction with Syncor be enjoined and that damages be awarded against
defendants in an unspecified amount. The Company believes the allegations made
in the complaint are without merit and intends to vigorously defend itself.
Page 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Management's discussion and analysis is concerned with material changes in
financial condition and results of operations for the Company's condensed
consolidated balance sheets as of September 30, 2002 and June 30, 2002, and for
the condensed consolidated statements of earnings for the three-month periods
ended September 30, 2002 and 2001.
This discussion and analysis should be read together with management's
discussion and analysis included in the 2002 Form 10-K.
Portions of management's discussion and analysis presented below include
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. The words "believe", "expect", "anticipate",
"project", and similar expressions, among others, identify "forward-looking
statements", which speak only as of the date the statement was made. Such
forward-looking statements are subject to risks, uncertainties and other
factors, which could cause actual results to materially differ from those made,
projected or implied. The most significant of such risks, uncertainties and
other factors are described in Exhibit 99.01 to this Form 10-Q and on page 8 of
the 2002 Form 10-K and are incorporated herein by reference. The Company
disclaims any obligation to update any forward-looking statement.
GENERAL
The Company operates within four operating business segments:
Pharmaceutical Distribution and Provider Services, Medical-Surgical Products and
Services, Pharmaceutical Technologies and Services, and Automation and
Information Services. See Note 5 of "Notes to Condensed Consolidated Financial
Statements" for a description of these segments.
RESULTS OF OPERATIONS
Operating Revenue Percent of Total
Operating Revenues
-------------------------------
Three months ended September 30, Growth (1) 2002 2001
- --------------------------------------------------------------------------------------------------------
Pharmaceutical Distribution and Provider Services 17% 82% 81%
Medical-Surgical Products and Services 6% 14% 15%
Pharmaceutical Technologies and Services 18% 3% 3%
Automation and Information Services 24% 1% 1%
Total Company 16% 100% 100%
- --------------------------------------------------------------------------------------------------------
(1) Growth is calculated as the change (increase or decrease) in the
operating revenue for the three-month period ended September 30, 2002
as a percentage of the operating revenue for the three-month period
ended September 30, 2001.
Total operating revenue for the three months ended September 30, 2002
increased 16% compared to the same period of the prior year. This increase is a
result of a higher sales volume across various customer segments; pharmaceutical
price increases averaging approximately 5%; addition of new products; and the
addition of new customers, some of which was a result of new corporate
agreements with healthcare providers. In addition, acquisitions accounted for
approximately 1% of the overall growth.
The Pharmaceutical Distribution and Provider Services segment's operating
revenue growth during the first quarter of fiscal 2003 resulted from strong
sales to all customer segments, especially alternate site and chain pharmacies,
which yielded growth of approximately 25% and 19%, respectively. In addition,
pharmaceutical price increases, which averaged approximately 5%, contributed to
the growth in this segment.
The Medical-Surgical Products and Services segment's operating revenue
growth during the first quarter of fiscal 2003 resulted from an increase in
sales of distributed products. The addition of several new contracts as well as
increased demand for certain self-manufactured products, particularly custom
sterile kits and the proprietary Procedure Based Delivery Systems, contributed
to this segment's growth.
Page 14
The Pharmaceutical Technologies and Services segment's operating revenue
growth during the first quarter of fiscal 2003 resulted particularly from strong
demand for sterile manufacturing, development and analytical services, and sales
and marketing services. Products that showed particular strength included
Lilly's Zyprexa(R) , an anti-psychotic, Abbott's Kaletra(R) , an AIDS product,
as well as the broader line of sterile products. The completion of the
acquisitions of Magellan Laboratories Incorporated ("Magellan") and Boron,
LePore & Associates, Inc. ("BLP") during the fourth quarter of fiscal 2002
contributed to the growth in the first quarter of fiscal 2003. Magellan and BLP
contributed 14% of the overall growth for this segment.
The Automation and Information Services segment's operating revenue growth
during the first quarter of fiscal 2003 resulted from strong sales in the
patient safety and supply management product lines, such as MEDSTATION SN(R) and
SUPPLYSTATION(R).
Bulk Deliveries to Customer Warehouses and Other
The Pharmaceutical Distribution and Provider Services segment reports bulk
deliveries made to customers' warehouses as revenue. These sales involve the
Company acting as an intermediary in the ordering and subsequent delivery of
pharmaceutical products. Fluctuations in bulk deliveries result largely from
circumstances that the Company cannot control, including consolidation within
the customers' industries, decisions by customers to either begin or discontinue
warehousing activities, and changes in policies by manufacturers related to
selling directly to customers. Due to the lack of margin generated through bulk
deliveries, fluctuations in their amount have no significant impact on the
Company's earnings.
The Pharmaceutical Technologies and Services segment records out-of-pocket
reimbursements received through its sales and marketing services' business as
revenue. These out-of-pocket expenses, which generally include travel expenses
and other incidental costs, are incurred to fulfill the services required by the
contract. Within these contracts, the customer agrees to reimburse the Company
for the expenses. Due to the Company not generating any margin from these
reimbursements, fluctuations in their amount have no impact on earnings.
Gross Margin Three Months Ended
September 30,
- ---------------------------------------------------------------------------
(As a percentage of operating revenue) 2002 2001
- ---------------------------------------------------------------------------
Pharmaceutical Distribution and Provider Services 4.92% 5.21%
Medical-Surgical Products and Services 20.91% 21.42%
Pharmaceutical Technologies and Services 34.21% 33.82%
Automation and Information Services 70.86% 66.92%
Total Company 8.82% 9.27%
- ---------------------------------------------------------------------------
The overall gross margin as a percentage of operating revenue decreased
during the first quarter of fiscal 2003 compared to the same period of the prior
year. This decrease resulted primarily from a greater mix of relatively lower
margin pharmaceutical distribution operating revenues in the first quarter of
fiscal 2003 (82% of operating revenues in the quarter ended September 30, 2002
as compared to 81% of operating revenues for the same period last fiscal year),
as well as a greater mix of relatively lower margin distribution products within
the Medical-Surgical Products and Services segment. These decreases were
partially offset by increases within the Pharmaceutical Technologies and
Services and Automation and Information Services segments. The increase within
the Pharmaceutical Technologies and Services segment can be primarily attributed
to the mix of business within that segment. The increase within the Automation
and Information Services segment occurred primarily due to changes within the
segment's product mix as well as productivity improvements.
The Pharmaceutical Distribution and Provider Services segment's gross
margin as a percentage of operating revenue decreased during the first quarter
of fiscal 2003. This decrease was primarily due to a greater mix of high volume
customers where a lower cost of distribution and better asset management enabled
the Company to offer lower selling margins to its customers. Operating revenue
generated from sales to chain pharmacy and alternate site customers increased to
47% and 20%, respectively, of the total operating revenue for this segment
during the first quarter of fiscal 2003, up from 46% and 19%, respectively, for
the same period in the prior year. The decrease in selling margins was partially
offset by higher vendor margins from favorable price increases and manufacturer
marketing programs. There can be no assurance that vendor programs that occurred
in the current quarter will recur in the same form or at the same levels in the
future.
Page 15
The Medical-Surgical Products and Services segment's gross margin as a
percentage of operating revenue decreased during the first quarter of fiscal
2003. This decrease resulted primarily from the accelerated growth within the
relatively lower margin distribution business of this segment, which grew at a
slightly faster pace as compared to the relatively higher margin
self-manufacturing business. Increased price competition within the segment's
self-manufacturing business, specifically related to certain group purchasing
organization contracts, also contributed to the decline.
The Pharmaceutical Technologies and Services segment's gross margin as a
percentage of operating revenue increased during the first quarter of fiscal
2003. This resulted primarily from a change within the business mix and product
mix of the segment, which included an increase in the higher margin development
and analytical services and sales and marketing services businesses, mainly from
the acquisitions of Magellan and BLP. The gross margin in this segment was
negatively impacted by certain items that occurred in fiscal year 2002 that did
not recur in fiscal year 2003, namely the recording of pricing adjustments
related to the minimum recovery expected to be received for claims against
vitamin manufacturers for amounts overcharged in prior years (see Note 4 of
"Notes to Condensed Consolidated Financial Statements"). These pricing
adjustments were recorded as a reduction of cost of goods sold, consistent with
the classification of the original overcharge, and were based on the minimum
amounts estimated to be recoverable based on the facts and circumstances
available at the time they were recorded. The amount recorded for these pricing
adjustments was $12.0 million in the first quarter of fiscal 2002.
The Automation and Information Services segment's gross margin as a
percentage of operating revenue increased during the first quarter of fiscal
2003. This increase resulted from increased sales within the relatively higher
margin MEDSTATION(R) and newer version supply control products as well as
productivity gains realized from the operational improvements implemented early
last fiscal year.
Selling, General and Administrative Expenses Three Months Ended
September 30,
- --------------------------------------------------------------------------------
(As a percentage of operating revenue) 2002 2001
- --------------------------------------------------------------------------------
Pharmaceutical Distribution and Provider Services 2.06% 2.42%
Medical-Surgical Products and Services 12.21% 13.03%
Pharmaceutical Technologies and Services 15.28% 14.62%
Automation and Information Services 36.35% 39.43%
Total Company 4.56% 5.09%
- --------------------------------------------------------------------------------
Selling, general and administrative expenses as a percentage of operating
revenue decreased during the first quarter of fiscal 2003 as compared to the
same period of fiscal 2002. This decrease reflects economies of scale associated
with the Company's revenue growth. Significant productivity gains resulting from
continued cost control efforts and the continuation of consolidation and
selective automation of operating facilities contributed to the improvement. The
Company is continuing to take advantage of synergies from recent acquisitions to
decrease selling, general and administrative expenses as a percentage of
operating revenue. Also, the Company is realizing efficiencies from the
restructuring within the Medical-Surgical Products and Services segment, which
was initiated in the fourth quarter of fiscal 2002. Partially offsetting the
improvements in fiscal 2003 was an increase in selling, general and
administrative expenses as a percentage of operating revenue for the
Pharmaceutical Technologies and Services segment. This increase was primarily a
result of a change within the business mix of this segment.
Selling, general and administrative expenses grew 4% during the first
quarter of fiscal 2003 as compared to the same period in fiscal 2002. This
increase is primarily attributed to the acquisitions of Magellan and BLP. The
overall increase of selling, general and administrative expenses compares
favorably to the 16% growth in the Company's operating revenue for the same
period.
Page 16
Special Charges
The following is a summary of the special charges for the three-month
periods ended September 30, 2002 and 2001.
Special Charges Three Months Ended
September 30,
- ----------------------------------------------------------------------------------------
(in millions) 2002 2001
- ----------------------------------------------------------------------------------------
Merger-Related Costs:
Employee-related costs $ (3.2) $ (4.1)
Pharmaceutical distribution center consolidation (5.1) (0.3)
Other exit costs (0.5) (2.3)
Other integration costs (2.6) (5.6)
- ----------------------------------------------------------------------------------------
Total merger-related costs $ (11.4) $ (12.3)
- ----------------------------------------------------------------------------------------
Other Special Charges:
Manufacturing facility closures $ (10.2) $ -
Litigation settlements 2.9 -
- ----------------------------------------------------------------------------------------
Total other special charges $ (7.3) $ -
- ----------------------------------------------------------------------------------------
Total special charges $ (18.7) $ (12.3)
Tax effect of special charges 3.1 4.7
- ----------------------------------------------------------------------------------------
Net effect of special charges $ (15.6) $ (7.6)
========================================================================================
MERGER-RELATED COSTS
Costs of effecting mergers and subsequently integrating the operations of
the various merged companies are recorded as merger-related costs when incurred.
The merger-related costs currently being recognized are primarily a result of
the merger or acquisition transactions with Bindley Western Industries, Inc.
("Bindley"), Bergen Brunswig Medical Corporation ("BBMC"), Allegiance
Corporation ("Allegiance") and R.P. Scherer Corporation ("Scherer").
EMPLOYEE-RELATED COSTS. During the above-stated periods, the Company
incurred employee-related costs associated with certain of its merger
transactions. For the three months ended September 30, 2002 and 2001, $2.5
million relates to amortization expense of noncompete agreements primarily
associated with the Bindley and Allegiance merger transactions. The remaining
employee-related costs for the three months ended September 30, 2002 primarily
related to retention bonuses associated with certain of the Company's smaller
acquisitions. The remaining employee-related costs for the three months ended
September 30, 2001 primarily related to payroll taxes from stock option
exercises from plans converted at the time of the Bindley, Allegiance and
Scherer mergers, as well as severance related to a change in control agreement
associated with the Allegiance merger. The total severance payout exceeded the
amount accrued at the time of the agreement resulting in additional expense.
PHARMACEUTICAL DISTRIBUTION CENTER CONSOLIDATION. In connection with the
merger transaction with Bindley, the Company anticipates closing and
consolidating a total of 16 Bindley distribution centers, Bindley's corporate
office, and one of the Company's data centers. These closures will result in the
termination of approximately 1,050 employees. As of September 30, 2002, a total
of 15 Bindley distribution centers have been closed, and the majority of the
1,050 employees have been terminated. During the first quarter of fiscal 2003
and 2002, the Company recorded charges of $5.1 million and $0.3 million,
respectively, primarily associated with the consolidations and closures noted
above. The Company incurred employee-related costs of $0.9 million in the first
quarter of fiscal 2003, primarily from the termination of employees due to the
distribution center closures. Exit costs related to the termination of contracts
and lease agreements of the distribution centers were incurred during the first
quarter of fiscal 2003 of $1.7 million. Also, asset impairment charges of $1.1
million were incurred during the first quarter of fiscal 2003. In addition,
during the first quarter of fiscal 2003, the Company incurred costs associated
with the consolidation of one of the Company's data centers of $1.4 million,
primarily related to duplicate salaries incurred during the consolidation
period. During the first quarter of fiscal 2002, the Company incurred charges of
$0.3 million primarily related to costs associated with moving inventory and
other assets during the consolidation of distribution centers. The Company
anticipates completing the distribution center and data center consolidations by
December 31, 2002. The Company anticipates completing the corporate office
consolidation by June 30, 2003.
Page 17
OTHER EXIT COSTS. Other exit costs related primarily to costs associated
with lease terminations, moving expenses, and asset impairments as a direct
result of the merger transactions with BBMC, Allegiance and Scherer.
OTHER INTEGRATION COSTS. Other integration costs, which primarily relate to
the Bindley, BBMC, and Allegiance transactions, included charges directly
related to the integration of operations of the transactions noted, such as
consulting costs related to information systems and employee benefit
integration, as well as relocation and travel costs directly associated with the
integrations.
OTHER SPECIAL CHARGES
MANUFACTURING FACILITY CLOSURES. During the first quarter of fiscal 2003,
the Company recorded a special charge of $10.2 million related to the closure of
a manufacturing facility within the Medical-Surgical Products and Services
segment. Asset impairment charges of $7.5 million were incurred during the
quarter. Also, exit costs of $1.4 million were incurred, primarily related to
dismantling and moving machinery and equipment. The remaining $1.3 million
related to severance costs associated with the termination of approximately 200
employees during the quarter. The closure is expected to be completed by
December 31, 2002.
LITIGATION SETTLEMENTS. During the first quarter of fiscal 2003, the
Company recorded income from litigation settlements of $2.9 million. These
settlements resulted from the recovery of antitrust claims against certain
vitamin manufacturers for amounts overcharged in prior years. The total recovery
through September 30, 2002 was $38.2 million, of which $35.3 million had
previously been recorded ($10.0 million in the second quarter of fiscal 2001,
$12.0 million in the first quarter of fiscal 2002, and $13.3 million in the
fourth quarter of fiscal 2002). The amounts previously recorded in the second
quarter of fiscal 2001 and the first quarter of fiscal 2002 were reflected as a
reduction of cost of goods sold, which is consistent with the classification of
the original overcharge, and were based on the minimum amounts estimated to be
recoverable based on the facts and circumstances available at the time they were
recorded. While the Company still has pending claims against other
manufacturers, the total amount of any future recovery is not currently
estimable. Any future recoveries will be recorded as a special item in the
period when a settlement is reached.
SUMMARY
The net effect of the various special charges recorded during the three
months ended September 30, 2002 and 2001 was to reduce earnings before
cumulative effect of change in accounting by $15.6 million to $288.3 million and
by $7.6 million to $246.4 million, respectively, and to reduce reported diluted
earnings per Common Share before cumulative effect of change in accounting by
$0.03 per share to $0.64 per share and by $0.02 per share to $0.53 per share,
respectively.
The Company estimates that in future periods it will incur additional
merger-related costs, restructuring costs and integration expenses associated
with the various mergers and acquisitions it has completed to date (primarily
related to the Bindley merger and the acquisitions of Magellan and BLP) of
approximately $76.8 million ($49.5 million, net of tax). These costs are
expected to be incurred primarily in fiscal 2003 and 2004 and relate to the exit
of contractual arrangements, employee-related costs, and costs to properly
integrate operations and implement efficiencies. Such amounts will be charged to
expense when incurred.
PROVISION FOR INCOME TAXES
The Company's provision for income taxes relative to pre-tax earnings was
34.0% and 33.7% for the first quarters of fiscal 2003 and 2002, respectively.
Fluctuations in the effective tax rate are primarily due to the impact of
recording certain non-deductible special charges during various periods as well
as fluctuating state and foreign effective tax rates as a result of the
Company's business mix. The provision for income taxes excluding the impact of
special charges was 33.3% and 33.8% for the quarters ended September 30, 2002
and 2001, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Working capital decreased to $5.0 billion at September 30, 2002 from $5.1
billion at June 30, 2002. This decrease in working capital resulted primarily
from decreases in cash and equivalents and inventories of $436.4 million and
$110.8 million, respectively. Partially offsetting the decreases of cash and
equivalents and inventories was an increase in trade receivables of $259.4
million and a decrease in accounts payable of $204.7 million. The decrease in
cash and equivalents was primarily attributed to the repurchase of Common
Shares, resulting in a total cash outlay of $392.7 million. The decrease in
inventories is partially due to a shift from branded pharmaceuticals to generic
pharmaceuticals during the first quarter of fiscal 2003. Also, the achievement
of synergies from the Bindley merger contributed to the inventory decline. The
increase in trade receivables is consistent with the Company's
Page 18
revenue growth for the same time period. The change in accounts payable is due
primarily to the timing of inventory purchases and related payments.
Shareholders' equity declined by $39.3 million at September 30, 2002, as
compared to June 30, 2002. Shareholders' equity decreased during the quarter
primarily due to the repurchase of Common Shares of $392.7 million and dividends
of $11.2 million. These decreases were partially offset by net earnings of
$288.3 million and the investment of $42.7 million by employees of the Company
through various employee stock benefit plans.
On August 7, 2002, the Company's Board of Directors authorized the
repurchase of Common Shares up to an aggregate amount of $500 million. As of
September 30, 2002, 3.4 million Common Shares having an aggregate cost of
approximately $219.8 million had been repurchased through this plan. The
repurchased shares will be treasury shares used for general corporate purposes.
In September 2001, the Company's Board of Directors authorized the
repurchase of Common Shares up to an aggregate amount of $500 million. This
program expired by its terms in August 2002. The Company repurchased
approximately 3.2 million Common Shares having an aggregate cost of
approximately $191.7 million during the quarter ended September 30, 2002. The
cumulative amount repurchased under this program was approximately 8.3 million
Common Shares, having an aggregate cost of approximately $500 million. The
repurchased shares will be treasury shares used for general corporate purposes.
The Company believes that it has adequate capital resources at its disposal
to fund currently anticipated capital expenditures, business growth and
expansion, and current and projected debt service requirements, including those
related to business combinations.
OTHER
For information relating to the Company's pending transaction with Syncor,
including recent developments with respect to such pending transaction, see Note
9, "Pending Transaction", incorporated by reference herein.
For information on recent developments relating to the Company's
relationship with Kmart, see Item 5, "Other Information", incorporated by
reference herein.
Page 19
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company believes there has been no material change in the quantitative
and qualitative market risks from that discussed in the 2002 Form 10-K.
ITEM 4: CONTROLS AND PROCEDURES
Within 90 days prior to this filing, an evaluation was performed under the
supervision and with the participation of the Company's management, including
the CEO and CFO, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures. Based on that evaluation, the
Company's management, including the CEO and CFO, concluded that the Company's
disclosure controls and procedures were effective as of September 30, 2002.
To date, there have been no significant changes in the Company's internal
controls or in other factors that could significantly affect internal controls
subsequent to September 30, 2002. Management expects to continue reviewing the
Company's disclosure controls and procedures on an ongoing basis, looking for
opportunities to strengthen them where appropriate.
PART II. OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
The discussion below is limited to an update of material developments that
have occurred in the various judicial proceedings, which are more fully
described in Part I, Item 3, of the 2002 Form 10-K, and are incorporated herein
by reference.
The following disclosure should be read together with the disclosure set
forth in the 2002 Form 10-K, and to the extent any such statements constitute
"forward looking statements" reference is made to Exhibit 99.01 of this Form
10-Q and page 8 of the 2002 Form 10-K.
Latex Litigation
On September 30, 1996, Baxter International Inc. ("Baxter") and its
subsidiaries transferred to Allegiance and its subsidiaries Baxter's U.S.
healthcare distribution business, surgical and respiratory therapy business and
healthcare cost-saving business as well as certain foreign operations (the
"Allegiance Business") in connection with a spin-off of the Allegiance Business
by Baxter (the "Baxter-Allegiance Spin-Off"). In connection with this spin-off,
Allegiance, which merged with a subsidiary of the Company on February 3, 1999,
agreed to indemnify Baxter, and to defend and indemnify Baxter Healthcare
Corporation ("BHC"), as contemplated by the agreements between Baxter and
Allegiance, for all expenses and potential liabilities associated with claims
arising from the Allegiance Business, including certain claims of alleged
personal injuries as a result of exposure to natural rubber latex gloves. The
Company is not a party to any of the lawsuits and has not agreed to pay any
settlements to the plaintiffs.
As of September 30, 2002, there were 368 lawsuits against BHC and/or
Allegiance involving allegations of sensitization to natural rubber latex
products. Some of the cases are now proceeding to trial. The total dollar amount
of potential damages cannot be reasonably quantified. Some plaintiffs plead
damages in extreme excess of what they reasonably can expect to recover, some
plead a modest amount, and some do not include a request for any specific dollar
amount. Not including cases that ask for no specific damages, the damage
requests per action have ranged from $10,000 to $240 million. All of these cases
name multiple defendants, in addition to Baxter/Allegiance. The average number
of defendants per case exceeds twenty-five. Based on the significant differences
in the range of damages sought and based on the multiple number of defendants in
these lawsuits, Allegiance cannot reasonably quantify the total amount of
possible/probable damages. Therefore, Allegiance and the Company do not believe
that these numbers should be considered as an indication of either reasonably
possible or probable liability.
Since the inception of this litigation, Baxter/Allegiance have been named
as a defendant in approximately 800 cases. As of September 30, 2002, fewer than
half of those lawsuits remain pending. Nearly half of the lawsuits that have
been resolved were concluded without any liability to Baxter/Allegiance. During
the fiscal year ended June 30, 2002, Allegiance began settling some of these
lawsuits with greater frequency. No individual claim has been settled for a
material amount, nor have all the settled claims, in the aggregate, comprised a
material amount. Due to the number of claims filed and the ongoing defense costs
that will be incurred, Allegiance believes it is probable that it will incur
substantial legal fees related to the resolution of the cases still pending.
Although the Company continues to believe that it cannot reasonably estimate the
potential cost to settle these lawsuits, the Company believes that the impact of
such lawsuits upon Allegiance will be immaterial to the Company's financial
position, liquidity and results of operations, and could be in the range of $0
to $20 million, net of insurance proceeds (with the top end of the range
reflecting virtually no insurance coverage, which the Company believes is an
Page 20
unlikely scenario given the insurance coverage in place). The Company believes
a substantial portion of any liability will be covered by insurance policies
Allegiance has with financially viable insurance companies, subject to
self-insurance retentions, exclusions, conditions, coverage gaps, policy limits
and insurer solvency. The Company and Allegiance continue to believe that
insurance recovery is probable.
Vitamins Litigation
On May 17, 2000, Scherer, which was acquired by the Company in August 1998,
filed a civil antitrust lawsuit in the United States District Court for the
District of Illinois against certain of its raw material suppliers and other
alleged co-conspirators alleging that the defendants unlawfully conspired to fix
vitamin prices and allocate vitamin production volume and vitamin customers in
violation of U.S. antitrust laws. The complaint seeks monetary damages and
injunctive relief. After the lawsuit was filed, it was consolidated for
pre-trial purposes with other similar cases. The case is scheduled for trial in
the United States District Court for the District of Columbia (where it was
transferred) in March 2003. Scherer has entered into settlement agreements with
certain defendants. As of September 30, 2002, Scherer has received settlement
payments of approximately $38.2 million, net of attorney fees and expenses that
were withheld prior to the disbursement of the funds to Scherer. At the present
time, management cannot predict the outcome of this lawsuit, nor the estimated
damages and potential recovery, if any.
The Company also becomes involved from time-to-time in other litigation
incidental to its business, including, without limitation, inclusion of certain
of its subsidiaries as a potentially responsible party for environmental
clean-up costs. Although the ultimate resolution of the litigation referenced
herein cannot be forecast with certainty, the Company intends to vigorously
defend itself and does not currently believe that the outcome of any pending
litigation will have a material adverse effect on the Company's consolidated
financial statements.
ITEM 5: OTHER INFORMATION:
On January 22, 2002, Kmart Corporation ("Kmart") filed for Chapter 11
bankruptcy court protection. Cardinal Distribution, the most significant
business within the Pharmaceutical Distribution and Provider Services segment,
has serviced Kmart for more than ten years and has continued to service
approximately 1,400 of its stores nationwide since the inception of the
bankruptcy case. On October 30, 2002, Kmart and Cardinal Distribution extended
and amended their supply agreement, and the bankruptcy court authorized Kmart's
post-petition assumption of the agreement. Sales to Kmart represent
approximately 5% of the Company's total operating revenue, but earnings from
these sales are an even smaller percentage of the Company's total operating
earnings. Due to a unique consignment arrangement in which the Company still
owns the related pharmaceutical inventories, it has significantly limited its
credit exposure to Kmart. The Company is monitoring this Chapter 11 proceeding
closely, and does not anticipate any material impact on its consolidated
financial position and results of operations due to this bankruptcy filing.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K:
(a) Listing of Exhibits:
Exhibit Exhibit Description
Number -------------------
-------
10.01 Employment Agreement, dated November 13, 2002, between the
Registrant and James F. Miller*
10.02 Employment Agreement, dated November 13, 2002, between the
Registrant and George L. Fotiades*
99.01 Statement Regarding Forward-Looking Information (1)
- ---------
(1) Included as an exhibit to the Registrant's Annual Report on
Form 10-K filed September 30, 2002 (File No. 1-11373) and
incorporated herein by reference.
* Management contract or compensation plan or arrangement.
(b) Reports on Form 8-K:
On October 22, 2002, the Company filed a Current Report on Form 8-K
under Item 5 which filed as an exhibit the press release announcing the
Company's results for the quarter ended September 30, 2002.
On November 6, 2002, the Company filed a Current Report on Form 8-K
under Item 5, which filed as exhibits the press release announcing that the
Company's Board of Directors declared a regular quarterly dividend of
$0.025 per Common Share, without par value, payable on January 15, 2003 to
shareholders of record on January 1, 2003, and the press release of the
Company relating to the proposed acquisition of Syncor International
Corporation.
Page 21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CARDINAL HEALTH, INC.
Date: November 14, 2002 /s/ Robert D. Walter
--------------------------------------
Robert D. Walter
Chairman and Chief Executive Officer
/s/ Richard J. Miller
--------------------------------------
Richard J. Miller
Executive Vice President and Chief
Financial Officer
Page 22
CERTIFICATIONS
I, Robert D. Walter, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Cardinal Health,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 14, 2002 /s/ Robert D. Walter
------------------------------
Robert D. Walter
Chairman and Chief Executive Officer
Page 23
I, Richard J. Miller, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Cardinal Health,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 14, 2002 /s/ Richard J. Miller
-------------------------
Richard J. Miller
Executive Vice President, and
Chief Financial Officer
Page 24