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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 December 31, 2003 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 [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
Yes [X] No [ ]
The number of Registrant's Common Shares outstanding at the close of
business on January 31, 2004 was as follows:
Common Shares, without par value: 435,008,787
CARDINAL HEALTH, INC. AND SUBSIDIARIES
Index *
Page No.
--------
Part I. Financial Information:
Item 1. Financial Statements:
Condensed Consolidated Statements of Earnings for the Three and Six Months
Ended December 31, 2003 and 2002 (unaudited)....................................... 3
Condensed Consolidated Balance Sheets at December 31, 2003 and
June 30, 2003 (unaudited).......................................................... 4
Condensed Consolidated Statements of Cash Flows for the Six Months Ended
December 31, 2003 and 2002 (unaudited)............................................. 5
Notes to Condensed Consolidated Financial Statements............................... 6
Item 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition............................................................ 20
Item 3. Quantitative and Qualitative Disclosures about Market Risk......................... 27
Item 4. Controls and Procedures............................................................ 27
Part II. Other Information:
Item 1. Legal Proceedings.................................................................. 27
Item 4. Submission of Matters to a Vote of Security Holders................................ 28
Item 6. Exhibits and Reports on Form 8-K................................................... 29
* 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 COMMON SHARE AMOUNTS)
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2003 2002 2003 2002
------------- ------------- ----------- --------------
Operating revenue $ 14,093.6 $ 12,706.3 $ 27,381.9 $ 24,122.9
Operating cost of products sold 12,922.9 11,626.8 25,128.0 22,036.5
------------- ------------- ----------- --------------
Operating gross margin 1,170.7 1,079.5 2,253.9 2,086.4
Bulk deliveries to customer warehouses and other 2,256.8 1,384.7 4,357.2 3,054.2
Cost of products sold - bulk deliveries and other 2,256.8 1,384.7 4,357.2 3,054.2
------------- ------------- ----------- --------------
Bulk gross margin - - - -
Selling, general and administrative expenses 586.9 526.2 1,134.5 1,046.9
Special items - merger charges 7.8 22.0 16.4 33.4
- other (11.3) (59.6) (6.7) (52.3)
------------- ------------- ----------- --------------
Operating earnings 587.3 590.9 1,109.7 1,058.4
Interest expense and other 19.4 31.5 47.4 62.1
------------- ------------- ----------- --------------
Earnings before income taxes and discontinued operations 567.9 559.4 1,062.3 996.3
Provision for income taxes 187.0 191.9 351.0 340.5
------------- ------------- ----------- --------------
Earnings from continuing operations 380.9 367.5 711.3 655.8
Loss from discontinued operations (net of tax of $3.1
and $4.2, respectively, for the three and six months
ended December 31, 2003) (5.1) - (6.9) -
------------- ------------- ----------- --------------
Net earnings $ 375.8 $ 367.5 $ 704.4 $ 655.8
============= ============= =========== ==============
Basic earnings per Common Share:
Continuing operations $ 0.88 $ 0.83 $ 1.63 $ 1.48
Discontinued operations (0.01) - (0.02) -
------------- ------------- ----------- --------------
Net basic earnings per Common Share $ 0.87 $ 0.83 $ 1.61 $ 1.48
============= ============= =========== ==============
Diluted earnings per Common Share:
Continuing operations $ 0.87 $ 0.82 $ 1.61 $ 1.45
Discontinued operations (0.01) - (0.02) -
------------- ------------- ----------- --------------
Net diluted earnings per Common Share $ 0.86 $ 0.82 $ 1.59 $ 1.45
============= ============= =========== ==============
Weighted average number of Common Shares outstanding:
Basic 433.2 442.0 436.8 444.1
Diluted 439.0 450.0 442.8 452.1
Cash dividends declared per Common Share $ 0.030 $ 0.025 $ 0.060 $ 0.050
See notes to condensed consolidated financial statements.
Page 3
CARDINAL HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN MILLIONS)
DECEMBER 31, JUNE 30,
2003 2003
--------------- ----------------
ASSETS
Current assets:
Cash and equivalents $ 544.3 $ 1,724.0
Trade receivables, net 3,369.3 2,784.4
Current portion of net investment in sales-type leases 192.2 171.8
Inventories 8,543.8 7,623.3
Prepaid expenses and other 736.8 776.0
Assets held for sale from discontinued operations 151.8 170.1
--------------- ----------------
Total current assets 13,538.2 13,249.6
--------------- ----------------
Property and equipment, at cost 3,945.4 3,755.3
Accumulated depreciation and amortization (1,768.1) (1,665.8)
--------------- ----------------
Property and equipment, net 2,177.3 2,089.5
Other assets:
Net investment in sales-type leases, less current portion 515.0 557.3
Goodwill and other intangibles, net 2,897.7 2,332.3
Other 390.3 292.7
--------------- ----------------
Total $ 19,518.5 $ 18,521.4
=============== ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes payable, banks $ 1.5 $ -
Current portion of long-term obligations 251.7 228.7
Accounts payable 6,349.0 5,288.4
Other accrued liabilities 1,791.1 1,733.0
Liabilities from discontinued operations 72.0 64.3
--------------- ----------------
Total current liabilities 8,465.3 7,314.4
--------------- ----------------
Long-term obligations, less current portion 2,472.4 2,471.9
Deferred income taxes and other liabilities 988.5 977.0
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 - 469.5 million
shares and 467.2 million shares at December 31, 2003
and June 30, 2003, respectively 2,486.6 2,403.7
Retained earnings 7,195.3 6,517.3
Common Shares in treasury, at cost, 35.5 million shares
and 18.8 million shares at December 31, 2003 and
June 30, 2003, respectively (2,113.3) (1,135.8)
Other comprehensive income/(loss) 30.7 (19.2)
Other (7.0) (7.9)
---------------- ----------------
Total shareholders' equity 7,592.3 7,758.1
---------------- ----------------
Total $ 19,518.5 $ 18,521.4
================ ================
See notes to condensed consolidated financial statements.
Page 4
CARDINAL HEALTH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
SIX MONTHS ENDED
DECEMBER 31,
2003 2002
-------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Earnings from continuing operations $ 711.3 $ 655.8
Adjustments to reconcile earnings from continuing operations
to net cash from operating activities:
Depreciation and amortization 143.2 126.5
Provision for bad debts (2.7) 10.5
Change in operating assets and liabilities, net of effects from
acquisitions:
Increase in trade receivables (488.3) (327.8)
Increase in inventories (861.3) (952.3)
Decrease in net investment in sales-type leases 22.0 136.2
Increase in accounts payable 964.3 590.0
Other accrued liabilities and operating items, net 59.9 120.0
-------------- ---------------
Net cash provided by operating activities 548.4 358.9
-------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of subsidiaries, net of cash acquired and proceeds
from divestitures (499.1) (7.8)
Proceeds from sale of property, equipment and other assets 5.2 33.8
Additions to property and equipment (164.1) (172.3)
-------------- ---------------
Net cash used in investing activities (658.0) (146.3)
-------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in commercial paper and short-term debt 0.6 (0.7)
Reduction of long-term obligations (202.8) (13.1)
Proceeds from long-term obligations, net of issuance costs 78.5 6.1
Proceeds from issuance of Common Shares 80.0 77.0
Purchase of treasury shares (1,000.0) (642.7)
Dividends on Common Shares (26.4) (22.3)
-------------- ---------------
Net cash used in financing activities (1,070.1) (595.7)
-------------- ---------------
NET DECREASE IN CASH AND EQUIVALENTS (1,179.7) (383.1)
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD 1,724.0 1,382.0
-------------- ---------------
CASH AND EQUIVALENTS AT END OF PERIOD $ 544.3 $ 998.9
============== ===============
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 inter-company 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, 2003 (the "2003 Form 10-K"). Without limiting the
generality of the foregoing, Note 1 of the "Notes to Consolidated Financial
Statements" from the 2003 Form 10-K is specifically incorporated herein by
reference.
RECENT FINANCIAL ACCOUNTING STANDARDS. In December 2003, the Financial
Accounting Standards Board ("FASB") issued a revision to Statement of Financial
Accounting Standards ("SFAS") No. 132, "Employers Disclosures about Pensions and
Other Postretirement Benefits." The revision relates to employers' disclosures
about pension plans and other postretirement benefit plans. It does not alter
the measurement or recognition provisions of the original Statement 132. It
requires additional disclosures regarding assets, obligations, cash flows and
net periodic benefit costs of pension plans and other defined benefit
postretirement plans. Excluding certain disclosure requirements, the revised
Statement is effective for financial statements with fiscal years ended after
December 15, 2003. Interim period disclosures are effective for interim periods
beginning after December 15, 2003.
In December 2003, the FASB issued a revision to Interpretation No. 46,
"Consolidation of Variable Interest Entities." This Interpretation defines when
a business enterprise must consolidate a variable interest entity. The
Interpretation provisions are effective for variable interest entities commonly
referred to as special-purpose entities for periods ending after December 15,
2003. The Interpretation provisions apply to all other types of variable
interest entities for financial statement periods ending after March 15, 2004.
The Company does not have any material unconsolidated variable interest entities
as of December 31, 2003, that would require consolidation. See Note 4 in the
"Notes to Consolidated Financial Statements" in the 2003 Form 10-K for
discussion of the Company's special purpose accounts receivable and financing
entity which is included in the consolidated financial statements. Adoption of
the subsequent provisions of the Interpretation are not expected to have a
material impact on the Company's financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS No. 149"). SFAS No. 149
amends and clarifies the financial accounting and reporting requirements, as
were originally established in SFAS No. 133, for derivative instruments and
hedging activities. SFAS No. 149 provides greater clarification of the
characteristics of a derivative instrument so that contracts with similar
characteristics will be accounted for consistently. SFAS No. 149 is effective
for contracts entered into or modified after June 30, 2003, as well as for
hedging relationships designated after June 30, 2003, excluding certain
implementation issues that have been effective prior to this date under SFAS No.
133. The adoption of SFAS No. 149 did not have a material effect on the
Company's financial position or results of operations.
ACCOUNTING FOR STOCK-BASED COMPENSATION. At December 31, 2003, the Company
maintained several stock incentive plans for the benefit of certain employees.
The Company accounts for these plans in accordance with Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. Except for costs related to restricted stock and restricted
stock units, no compensation expense has been recognized in net earnings, as all
options granted had an exercise price equal to the market value of the
underlying stock on the date of grant. The following tables illustrate the
effect on net earnings and earnings per Common Share after adjusting for
anticipated plan changes if the Company adopted the fair value recognition
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation":
Page 6
For the Three Months For the Six Months
Ended Ended
(in millions) December 31, December 31,
2003 2002 2003 2002
----------------------------- ----------------------------
Net earnings, as reported $ 375.8 $ 367.5 $ 704.4 $ 655.8
Stock based employee compensation expense
included in net earnings, net of related tax effects 0.5 0.4 0.9 0.9
Total stock-based employee compensation expense
determined under fair value method for all awards,
net of related tax effects (27.1) (22.5) (48.9) (40.2)
----------------------------- ----------------------------
Pro forma net earnings $ 349.2 $ 345.4 $ 656.4 $ 616.5
============================= ============================
For the Three Months For the Six Months
Ended Ended
December 31, December 31,
2003 2002 2003 2002
---------------------- ---------------------
Basic earnings per Common Share:
As reported $ 0.87 $ 0.83 $ 1.61 $ 1.48
Pro forma basic earnings per Common Share $ 0.81 $ 0.78 $ 1.50 $ 1.39
Diluted earnings per Common Share:
As reported $ 0.86 $ 0.82 $ 1.59 $ 1.45
Pro forma diluted earnings per Common Share $ 0.80 $ 0.77 $ 1.48 $ 1.36
2. EARNINGS PER SHARE AND SHAREHOLDERS' EQUITY
Basic earnings per Common Share ("Basic EPS") 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 ("Diluted EPS") is similar to the computation for Basic EPS, 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 Common Shares used to compute
Basic EPS and Diluted EPS for the three and six months ended December 31, 2003
and 2002:
For the Three Months Ended For the Six Months Ended
December 31, December 31,
(in millions) 2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------------------
Weighted-average shares - basic 433.2 442.0 436.8 444.1
Effect of dilutive securities:
Employee stock options 5.8 8.0 6.0 8.0
- -----------------------------------------------------------------------------------------------------------
Weighted-average shares - diluted 439.0 450.0 442.8 452.1
===========================================================================================================
The potentially dilutive employee stock options that were antidilutive for
the three months ended December 31, 2003 and 2002, were 32.5 million and 21.5
million, respectively, and for the six months ended December 31, 2003 and 2002,
were 32.5 million and 21.7 million, respectively.
On August 1, 2003, the Company's Board of Directors authorized the
repurchase of Common Shares up to an aggregate amount of $1.0 billion. Pursuant
to this authorization, the Company repurchased approximately 17.0 million Common
Shares having an aggregate cost of approximately $1.0 billion. The average price
paid per share was $58.65. This repurchase was completed during the first
quarter of fiscal 2004, and the repurchased shares were placed into treasury
shares to be used for general corporate purposes.
Page 7
3. COMPREHENSIVE INCOME
The following is a summary of the Company's comprehensive income for the
three and six months ended December 31, 2003 and 2002:
For the Three Months Ended For the Six Months Ended
December 31, December 31,
(in millions) 2003 2002 2003 2002
----------- ------------ ----------- ------------
Net earnings $ 375.8 $ 367.5 $ 704.4 $ 655.8
Foreign currency translation adjustment 58.8 19.6 49.9 28.2
Net unrealized gain/(loss) on derivative
instruments (3.2) (2.9) - 12.4
----------- ------------ ----------- ------------
Total comprehensive income $ 431.4 $ 384.2 754.3 $ 696.4
=========== ============ =========== ============
4. BUSINESS COMBINATION COSTS, MERGER-RELATED COSTS AND OTHER SPECIAL ITEMS
The following is a summary of the special items for the three and six
months ended December 31, 2003 and 2002.
Three Months Ended Six Months Ended
Special Items Expense/(Income) December 31, December 31,
- ------------------------------------------------------------------------------------------------------------
(in millions) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------
Merger-Related Costs:
Employee-related costs $ 5.5 $ 11.8 $ 7.1 $ 15.0
Pharmaceutical distribution center consolidation 0.1 4.7 0.1 9.8
Asset impairments & other exit costs 0.2 1.5 0.4 2.0
Purchase acquisition foreign exchange rate
hedge (3.0) - (3.0) -
Other integration costs 5.0 4.0 11.8 6.6
- ------------------------------------------------------------------------------------------------------------
Total merger-related costs $ 7.8 $ 22.0 $ 16.4 $ 33.4
- ------------------------------------------------------------------------------------------------------------
Other Special Items:
Employee-related costs $ 0.7 $ 1.4 $ 1.6 $ 1.4
Manufacturing facility closures & restructurings 0.4 11.0 6.2 21.2
Litigation settlements (24.2) (89.9) (26.9) (92.8)
Asset impairments & other 11.8 17.9 12.4 17.9
- ------------------------------------------------------------------------------------------------------------
Total other special items $ (11.3) $ (59.6) $ (6.7) $ (52.3)
- ------------------------------------------------------------------------------------------------------------
Total special items $ (3.5) $ (37.6) $ 9.7 $ (18.9)
Tax effect of special items 0.2 15.5 (4.3) 12.4
- ------------------------------------------------------------------------------------------------------------
Net effect of special items $ (3.3) $ (22.1) $ 5.4 $ (6.5)
============================================================================================================
Net (increase)/decrease in Diluted EPS $ (0.01) $ (0.05) $ 0.01 $ (0.01)
============================================================================================================
MERGER-RELATED COSTS
Costs of integrating the operations of various merged companies are
recorded as merger-related costs when incurred. The merger-related costs
recognized during the three and six months ended December 31, 2003, were
primarily a result of the acquisition of Syncor International Corporation
("Syncor"). The merger-related costs recognized during the three and six months
ended December 31, 2002, were primarily a result of the acquisitions of Bindley
Western Industries, Inc. ("Bindley") and R.P. Scherer Corporation ("Scherer").
The following paragraphs provide additional detail regarding the types of
merger-related costs incurred by the Company.
EMPLOYEE-RELATED COSTS. During the periods shown in the table above, the
Company incurred employee-related costs associated with certain merger and
acquisition transactions. For the three and six months ended December 31, 2003,
the employee-related costs of $5.5 million and $7.1 million, respectively,
consisted primarily of retention bonuses and severance paid as a result of the
Syncor acquisition. The Syncor acquisition is expected to result in
approximately 150 employees being terminated, of which approximately 100
employees had been terminated as of December 31, 2003. For the three months
ended December 31, 2002, $8.8 million related to an approved plan to curtail
certain defined benefit pension plans within the Pharmaceutical Technologies and
Services segment. The remaining employee-related costs for the three and six
months ended December 31, 2002, primarily related to
Page 8
amortization expense of non-compete agreements associated with the Bindley and
Allegiance Corporation ("Allegiance") merger transactions.
PHARMACEUTICAL DISTRIBUTION CENTER CONSOLIDATION. During the three and six
months ended December 31, 2003, the Company incurred charges of $0.1 million
associated with its plan to close and consolidate Bindley distribution centers,
Bindley's corporate office and one of the Company's data centers as a result of
the acquisition of Bindley, as compared to $4.7 million and $9.8 million,
respectively, for the comparable periods in fiscal 2003. During the three and
six months ended December 31, 2002, the Company incurred employee-related costs
of $2.3 million and $3.2 million, respectively, primarily from the termination
of approximately 1,250 employees due to the distribution center closures. The
remaining merger-related items recorded during the three and six months ended
December 31, 2002, primarily related to exit costs to consolidate and close the
various facilities mentioned above, including asset impairment charges,
inventory move costs, contract and lease termination costs and duplicate salary
costs incurred during the shutdown periods.
ASSET IMPAIRMENTS & OTHER EXIT COSTS. During the three and six months ended
December 31, 2003, the Company incurred asset impairments and other exit costs
of $0.2 million and $0.4 million, respectively, as compared to $1.5 million and
$2.0 million, respectively, during the comparable periods in fiscal 2003. The
asset impairment costs incurred during the three and six months ended December
31, 2003, related primarily to the integration of acquired companies into the
Company's overall information technology system structure. Also, exit costs
associated with plans to consolidate operations as a result of the Syncor
acquisition were incurred during the three and six months ended December 31,
2003. Costs during the three and six months ended December 31, 2002, primarily
related to asset impairments and lease terminations incurred internationally as
a result of the Scherer acquisition, as well as expenses incurred to relocate
physical assets due to the closure and consolidation of Bergen Brunswig Medical
Corporation ("BBMC") facilities.
PURCHASE ACQUISITION FOREIGN EXCHANGE RATE HEDGE. During the three months
ended December 31, 2003, the Company recorded income of approximately $3.0
million related to two foreign currency hedges purchased in connection with The
Intercare Group, plc ("Intercare") acquisition (see Note 10 for additional
information regarding this acquisition). The Company paid premiums of
approximately $1.1 million to purchase two hedges protecting against foreign
currency fluctuations associated with the Intercare purchase price. These hedges
settled during the quarter ended December 31, 2003, and resulted in a gain for
the Company of approximately $4.1 million.
OTHER INTEGRATION COSTS. The Company incurred other integration costs
during the three and six months ended December 31, 2003, of $5.0 million and
$11.8 million, respectively, as compared to $4.0 million and $6.6 million,
respectively, during the comparable periods in fiscal 2003. The costs included
in this category generally relate to expenses incurred to integrate the merged
or acquired company's operations and systems into the Company's pre-existing
operations and systems. These costs include, but are not limited to, the
integration of information systems, employee benefits and compensation,
accounting/finance, tax, treasury, internal audit, risk management, compliance,
administrative services, sales and marketing and others.
OTHER SPECIAL ITEMS
EMPLOYEE-RELATED COSTS. During the three and six months ended December 31,
2003 and 2002, the Company recorded employee-related costs associated with
certain restructuring plans executed by the Company. The following paragraphs
provide additional details regarding these restructuring plans.
During the three months ended December 31, 2003, the Company recorded $0.7
million of employee-related costs associated with a European restructuring plan
within the Oral Technologies business, a business unit within the Pharmaceutical
Technologies and Services segment. The charges primarily represent severance
accrued upon communication of terms to employees. The restructuring plan was
completed by December 31, 2003, and resulted in the termination of approximately
50 employees.
As previously discussed in the Company's Form 10-Q for the fiscal quarter
ended September 30, 2003, and incorporated herein by reference, the Company
incurred employee-related costs of $0.9 million related to a realignment plan
implemented within the Healthcare Marketing Services business, a business unit
within the Pharmaceutical Technologies and Services segment.
During the three and six months ended December 31, 2002, the Company
incurred $1.4 million of employee-related costs associated with the
restructuring of certain operations within the Pharmaceutical Distribution and
Provider Services segment. The charges primarily represent severance accrued
upon communication of terms to
Page 9
employees. The restructuring plan was completed by June 30, 2003, and resulted
in the termination of approximately 30 employees.
MANUFACTURING FACILITY CLOSURES & RESTRUCTURINGS. During the three and six
months ended December 31, 2003, the Company recorded a total of $0.4 million and
$6.2 million, respectively, as special items related to the closure and/or
restructuring of certain manufacturing facilities, as compared to $11.0 million
and $21.2 million, respectively, during the comparable periods in fiscal 2003.
These closure and/or restructuring activities occurred within the Medical
Products and Services and the Pharmaceutical Technologies and Services segments.
During fiscal 2003 and 2004, the Company initiated plans to close and/or
restructure certain manufacturing facilities within the Medical Products and
Services segment. In connection with the implementation of these plans, the
Company incurred costs totaling $0.4 million and $5.3 million, respectively,
during the three and six months ended December 31, 2003, as compared to $5.9
million and $16.2 million, respectively, during the comparable periods in fiscal
2003. These charges included asset impairment costs of $0.4 million and $1.9
million, respectively, during the three and six months ended December 31, 2003,
as compared to $1.4 million and $8.9 million, respectively, during the
comparable periods in fiscal 2003. The restructuring charges during the six
months ended December 31, 2003, also included employee-related costs of $2.8
million, as compared to $3.3 million and $4.6 million, respectively, during the
three and six months ended December 31, 2002, the majority of which represent
severance accrued upon communication of terms to employees. The remaining
charges during the three and six months ended December 31, 2003 and 2002,
primarily related to exit costs incurred to relocate physical assets. Some of
the restructuring plans were completed during fiscal 2003, while other plans
will be completed throughout fiscal 2004 and 2005. These restructuring plans
will result in the termination of approximately 1,600 employees, of which
approximately 1,075 employees had been terminated as of December 31, 2003.
During the first quarter of fiscal 2004, the Company recorded charges of
$0.9 million which represents the remaining lease obligations for a facility
that was vacated as a result of a restructuring plan completed during fiscal
2003 within the Pharmaceutical Technologies and Services segment.
During the three and six months ended December 31, 2002, the Company
incurred costs of $5.0 million related to plans to close and/or restructure
certain manufacturing facilities within the Pharmaceutical Technologies and
Services segment. In connection with the implementation of these plans, the
Company incurred asset impairment charges, severance costs and exit costs,
primarily related to dismantling machinery and equipment and transferring
certain technologies to other existing facilities within the Company. As a
result of these restructuring plans, the Company terminated approximately 75
employees. These restructuring plans were substantially completed during fiscal
2003 and the first half of fiscal 2004.
LITIGATION SETTLEMENTS. During the three and six months ended December 31,
2003, the Company recorded income from litigation settlements of $24.2 million
and $26.9 million, respectively, as special items, as compared to $89.9 million
and $92.8 million, respectively, during the comparable periods in fiscal 2003.
The $24.2 million recorded during the three months ended December 31, 2003,
resulted from the settlement of antitrust claims alleging that certain
pharmaceutical drug manufacturers took improper actions to delay or prevent
generic drug competition. The remaining settlements during the six months ended
December 31, 2003, and all the settlements during the three and six months ended
December 31, 2002, resulted from the recovery of antitrust claims against
certain vitamin manufacturers for amounts overcharged in prior years. The total
recovery of antitrust claims against certain vitamin manufacturers through
December 31, 2003 was $140.9 million (net of attorney fees, payments due to
other interested parties and expenses withheld). While the Company continues to
have pending claims with smaller vitamin manufacturers, the total amount of
future recovery is not currently estimable, but the Company believes it is not
likely to be a material amount.
ASSET IMPAIRMENTS & OTHER. During the three and six months ended December
31, 2003, the Company incurred asset impairments and other charges of $11.8
million and $12.4 million, respectively, as compared to $17.9 million during the
comparable periods in fiscal 2003. During the three months ended December 31,
2003 and 2002, $10.9 million and $10.1 million, respectively, related to asset
impairment charges resulting from the Company's decision to exit certain North
American commodity operations in its Pharmaceutical Technologies and Services
segment. The remaining charges of $1.5 million during the six months ended
December 31, 2003, related to a plan to restructure the Company's delivery of
information technology infrastructure services. The remaining $7.8 million
during the six months ended December 31, 2002, related to a one-time writeoff of
design, tooling and development costs.
Page 10
ACCRUAL ROLLFORWARD
The following table summarizes the activity related to the liabilities
associated with the Company's special items during the six months ended December
31, 2003.
For the Six
Months Ended
(in millions) December 31, 2003
-----------------
Balance at June 30, 2003 $ 45.7
Additions(1) 36.6
Payments (45.6)
------
Balance at December 31, 2003 $ 36.7
======
(1) Amount represents items that have been either expensed as incurred or
accrued according to generally accepted accounting principles. This amount
does not include litigation settlement income of $26.9 million recorded as
a special item during the six months ended December 31, 2003.
Also, in connection with the restructuring and integration plans related to
Syncor, the Company accrued, as part of its acquisition adjustments, a liability
of $15.1 million related to employee termination and relocation costs and $10.4
million related to closing of duplicate facilities. As of December 31, 2003, the
Company paid $11.1 million of employee-related costs and $0.5 million
associated with the facility closures.
SUMMARY
Certain merger, acquisition and restructuring costs are based upon
estimates. Actual amounts paid may ultimately differ from these estimates. If
additional costs are incurred or recorded amounts exceed costs, such changes in
estimates will be recorded in special items when incurred.
The Company estimates it will incur additional costs in future periods
associated with various mergers, acquisitions and restructuring activities
totaling approximately $70 million (approximately $45 million net of tax). This
estimate is subject to adjustment pending resolution of Syncor
acquisition-related litigation contingencies. The Company believes it will incur
these costs to properly integrate and rationalize operations, a portion of which
represents facility rationalizations and implementing efficiencies regarding
information systems, customer systems, marketing programs and administrative
functions, among other things. Such amounts will be expensed when incurred.
5. SEGMENT INFORMATION
The Company's operations are principally managed on a products and services
basis and are comprised of four reportable business segments: Pharmaceutical
Distribution and Provider Services, Medical Products and Services,
Pharmaceutical Technologies and Services and Automation and Information
Services. During the first quarter of fiscal 2004, the Company transferred its
Consulting and Services business, previously included within the Medical
Products and Services segment, to its Clinical Services and Consulting business
within the Pharmaceutical Distribution and Provider Services segment. Also
during the first quarter of fiscal 2004, the Company transferred its clinical
information business, previously included within the Automation and Information
Services segment, to its Clinical Services and Consulting business within the
Pharmaceutical Distribution and Provider Services segment. These transfers were
done to better align business operations. Prior period financial results have
not been restated as each of these businesses is not significant within the
respective segments, and, therefore, the transfers did not have a material
impact on each segment's growth rates. The Company has not made any material
changes in the segments reported or the measurement basis of segment profit or
loss from the information provided in the 2003 Form 10-K.
The Pharmaceutical Distribution and Provider Services segment involves the
distribution of a broad line of pharmaceuticals, health care, and other
specialty pharmaceutical products and other items typically sold by hospitals,
retail drug stores and other health care providers. In addition, this segment
provides services to the health care industry through integrated pharmacy
management, temporary pharmacy staffing, as well as franchising of
apothecary-style retail pharmacies.
The Medical 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 health care providers.
The Pharmaceutical Technologies and Services segment provides services to
the health care industry through the development and manufacture 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, radiopharmaceutical manufacturing and
distribution, pharmaceutical development and analytical science expertise, as
well as medical education, marketing and contract sales services. During the
three months ended December 31, 2003, the Company completed its acquisition of
Intercare. The results of Intercare's operations for
Page 11
the period following the completion of the transaction have been included within
this segment for the quarter ended December 31, 2003. See Note 10 for additional
information regarding the Intercare acquisition.
The Automation and Information Services segment provides services to
hospitals and other health care providers, focusing on meeting customer needs
through unique and proprietary automation and information products and services.
In addition, this segment markets point-of-use supply systems in the non-health
care market.
The Company evaluates the performance of the segments based on operating
earnings after the corporate allocation of administrative expenses. Information
about interest income and expense and income taxes is not provided on a segment
level. In addition, special charges are not allocated to the segments. The
accounting policies of the segments are the same as described in the summary of
significant accounting policies.
The following tables include revenue and operating earnings for the three
and six months ended December 31, 2003 and 2002, for each segment and
reconciling items necessary to agree to amounts reported in the condensed
consolidated financial statements:
NET REVENUE For the Three Months Ended For the Six Months Ended
(in millions) December 31, December 31,
2003 2002 2003 2002
----------------------------- -----------------------------
Operating revenue:
Pharmaceutical Distribution and Provider Services $ 11,414.5 $ 10,505.4 $ 22,238.4 $ 19,823.7
Medical Products and Services 1,839.2 1,638.8 3,572.4 3,234.3
Pharmaceutical Technologies and Services 658.9 416.1 1,265.4 803.3
Automation and Information Services 187.4 164.5 330.1 298.3
Corporate (1) (6.4) (18.5) (24.4) (36.8)
----------------------------- -----------------------------
Total operating revenue 14,093.6 12,706.3 27,381.9 24,122.9
============================= =============================
Bulk deliveries to customer warehouses and other:
Pharmaceutical Distribution and Provider Services 2,208.5 1,336.9 4,268.0 2,967.7
Pharmaceutical Technologies and Services 48.3 47.8 89.2 86.5
----------------------------- -----------------------------
Total bulk deliveries to customer warehouses and
other $ 2,256.8 $ 1,384.7 $ 4,357.2 $ 3,054.2
============================= =============================
OPERATING EARNINGS For the Three Months Ended For the Six Months Ended
(in millions) December 31, December 31,
2003 2002 2003 2002
----------------------------- -----------------------------
Operating earnings:
Pharmaceutical Distribution and Provider Services $ 271.0 $ 295.0 $ 537.0 $ 556.8
Medical Products and Services 160.2 143.6 310.4 282.3
Pharmaceutical Technologies and Services 112.9 85.1 219.9 157.8
Automation and Information Services 79.6 69.3 132.6 115.5
Corporate (2) (36.4) (2.1) (90.2) (54.0)
----------------------------- -----------------------------
Total operating earnings $ 587.3 $ 590.9 $ 1,109.7 $ 1,058.4
============================= =============================
(1) Corporate operating revenue primarily consists of foreign currency
translation adjustments and the elimination of intersegment revenues.
(2) Corporate operating earnings include special items of $3.5 million and
$37.6 million in the three-month periods ended December 31, 2003 and
2002, respectively, and ($9.7) million and $18.9 million for the
six-month periods ended December 31, 2003 and 2002, respectively. See
Note 4 for further discussion of the Company's special items. Corporate
operating earnings also include unallocated corporate administrative
expenses and investment spending.
Page 12
6. LEGAL PROCEEDINGS
Latex Litigation
On September 30, 1996, Baxter International Inc. ("Baxter") and its
subsidiaries transferred to Allegiance and its subsidiaries Baxter's U.S. health
care distribution business, surgical and respiratory therapy business and health
care 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 December 31, 2003, there were 102 lawsuits pending against BHC and/or
Allegiance involving allegations of sensitization to natural rubber latex
products and some of these cases were 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 834 cases. During the fiscal year ended June 30, 2002,
Allegiance began settling some of these lawsuits with greater frequency. As of
December 31, 2003, Allegiance had resolved more than eighty-five percent of
these cases. About twenty percent of the lawsuits that have been resolved were
concluded without any liability to Baxter/Allegiance. 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 or results of
operations, and could be in the range of $0 to $20 million, net of insurance
proceeds (with the range reflecting the Company's reasonable estimation of
potential insurance coverage, and defense and indemnity costs). 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.
Shareholder Litigation against Cardinal Health
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. On or about March 21, 2003,
after the Company filed a Motion to Dismiss the complaint, an amended complaint
was filed alleging breach of fiduciary duties and corporate waste in connection
with the alleged failure by the Board of Directors of the Company to (a)
renegotiate or terminate the Company's proposed acquisition of Syncor and (b)
determine the propriety of indemnifying Monty Fu, the former Chairman of Syncor.
The Company filed a Motion to Dismiss the amended complaint and the plaintiffs
subsequently filed a second amended complaint which added three new individual
defendants and includes new allegations that the Company improperly recognized
revenue in December 2000 and September 2001 related to settlements with certain
vitamins manufacturers. The Company filed a Motion to Dismiss the second amended
complaint and, on November 20, 2003, the Court denied the motion. The Company
believes the allegations made in the second amended complaint, as with the
original complaint, are without merit and intends to vigorously defend this
action. The Company currently does not believe that the impact of this lawsuit,
if any, will have a material adverse effect on the Company's financial position,
liquidity or results of operations. The Company currently believes that there
will be some insurance coverage available under the Company's directors' and
officers' liability insurance policies in effect at the time this action was
filed.
Page 13
Shareholder Litigation against Syncor
Eleven purported class action lawsuits have been filed against Syncor and
certain of its officers and directors, asserting claims under the federal
securities laws (collectively referred to as the "federal securities actions").
All of these actions were filed in the United States District Court for the
Central District of California. The federal securities actions purport to be
brought on behalf of all purchasers of Syncor shares during various periods,
beginning as early as March 30, 2000, and ending as late as November 5, 2002 and
allege, among other things, that the defendants violated Section 10(b) of the
Exchange Act and Rule 10b-5 promulgated thereunder and Section 20(a) of the
Exchange Act, by issuing a series of press releases and public filings
disclosing significant sales growth in Syncor's international business, but
omitting mention of certain allegedly improper payments to Syncor's foreign
customers, thereby artificially inflating the price of Syncor shares. A lead
plaintiff has been appointed by the court in the federal securities actions and
a consolidated amended complaint was filed May 19, 2003, naming Syncor and 12
individuals, all former Syncor officers, directors and/or employees, as
defendants. Syncor filed a Motion to Dismiss the consolidated amended complaint
on August 1, 2003 and on December 12, 2003, the Court granted the motion to
dismiss without prejudice. A second amended consolidated class action complaint
was filed on January 28, 2004, naming Syncor and 14 individuals, all former
Syncor officers, directors and/or employees, as defendants.
On November 14, 2002, two additional actions were filed by individual
stockholders of Syncor in the Court of Chancery of the State of Delaware (the
"Delaware actions") against seven of Syncor's nine directors (the "director
defendants"). The complaints in each of the Delaware actions were identical and
alleged that the director defendants breached certain fiduciary duties to Syncor
by failing to maintain adequate controls, practices and procedures to ensure
that Syncor's employees and representatives did not engage in improper and
unlawful conduct. Both complaints asserted a single derivative claim, for and on
behalf of Syncor, seeking to recover all of the costs and expenses that Syncor
incurred as a result of the allegedly improper payments (including the costs of
the federal securities actions described above), and a single purported class
action claim seeking to recover damages on behalf of all holders of Syncor
shares in the amount of any losses sustained if consideration received in the
merger by Syncor stockholders was reduced. On November 22, 2002, the plaintiff
in one of the two Delaware actions filed an amended complaint adding as
defendants the Company, its subsidiary Mudhen Merger Corporation and the
remaining two Syncor directors, who are hereafter included in the term "director
defendants." These cases have been consolidated under the caption "In re: Syncor
International Corp. Shareholders Litigation" (the "consolidated Delaware
action"). On August 14, 2003, the Company filed a Motion to Dismiss the
operative complaint in the consolidated Delaware action. At the end of September
2003, plaintiffs in the consolidated Delaware actions moved the court to file a
second amended complaint. Monty Fu is the only defendant in the proposed second
amended complaint attached to this motion.
On November 18, 2002, two additional actions were filed by individual
stockholders of Syncor in the Superior Court of California for the County of Los
Angeles (the "California actions") against the director defendants. The
complaints in the California actions allege that the director defendants
breached certain fiduciary duties to Syncor by failing to maintain adequate
controls, practices and procedures to ensure that Syncor's employees and
representatives did not engage in improper and unlawful conduct. Both complaints
asserted a single derivative claim, for and on behalf of Syncor, seeking to
recover costs and expenses that Syncor incurred as a result of the allegedly
improper payments. An amended complaint was filed on December 6, 2002 in one of
the cases, purporting to allege direct claims on behalf of a class of
shareholders. The defendants' motion for a stay of the California actions
pending the resolution of the Delaware actions (discussed above) was granted on
April 30, 2003.
A proposed class action complaint was filed on April 8, 2003, against the
Company, Syncor and certain officers and employees of the Company by a purported
participant in the Syncor Employees' Savings and Stock Ownership Plan (the
"Syncor ESSOP"). A related proposed class action complaint was filed on
September 11, 2003, against the Company, Syncor and certain individual
defendants. Another related proposed class action complaint, captioned Thompson
v. Syncor International Corp., et al, was filed on January 14, 2004, against the
Company, Syncor and certain individual defendants. These related suits allege
that the defendants breached certain fiduciary duties owed under the Employee
Retirement Income Security Act ("ERISA"). It is expected that these related
suits will be consolidated. In addition, the United States Department of Labor
is conducting an investigation of the Syncor ESSOP with respect to its
compliance with ERISA requirements. The Company has responded to a subpoena
received from the Department of Labor and intends to fully cooperate in its
investigation.
Each of the actions described under the heading "Shareholder Litigation
against Syncor" is in its early stages and it is impossible to predict the
outcome of these proceedings or their impact on Syncor or the Company. However,
the Company currently does not believe that the impact of these actions will
have a material adverse effect on the Company's financial position, liquidity or
results of operations. The Company and Syncor believe the
Page 14
allegations made in the complaints described above are without merit and intend
to vigorously defend such actions and have been informed that the individual
director and officer defendants deny liability for the claims asserted in these
actions, believe they have meritorious defenses and intend to vigorously defend
such actions. The Company and Syncor currently believe that a portion of any
liability will be covered by insurance policies that the Company and Syncor have
with financially viable insurance companies, subject to self-insurance
retentions, exclusions, conditions, coverage gaps, policy limits and insurer
solvency.
DuPont Litigation
On September 11, 2003, E.I. Du Pont De Nemours and Company ("DuPont") filed
a lawsuit against the Company and others in the United States District Court for
the Middle District of Tennessee. The complaint alleges various causes of action
against the Company relating to the production and sale of surgical drapes and
gowns by the Company's Medical Products and Services segment. DuPont's claims
generally fall into the categories of breach of contract, false advertising and
patent infringement. The complaint does not request a specific amount of
damages. The Company believes that the claims made in the complaint are without
merit and it intends to vigorously defend this action. Although this action is
in its early stages and it is impossible to accurately predict the outcome of
the proceedings or their impact on the Company, the Company believes that it is
owed a defense and indemnity from its codefendants with respect to DuPont's
claim for patent infringement. The Company currently does not believe that the
impact of this lawsuit, if any, will have a material adverse effect on the
Company's financial position, liquidity or results of operations.
Informal Inquiry by the Securities and Exchange Commission
On October 9, 2003, the Company announced that it had received a request
for information from the Securities and Exchange Commission in connection with
an informal inquiry. The request seeks historical financial and related
information, including information pertaining to the accounting treatment of $22
million recovered from vitamin manufacturers who were found to have overcharged
the Company. The Company intends to cooperate fully and provide all information
required to satisfy the request.
Other Matters
For information relating to antitrust claims against certain vitamins
manufacturers, and antitrust claims against certain pharmaceutical
manufacturers, see the Litigation Settlements discussion in Note 4.
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 financial
position, liquidity or results of operations.
Page 15
7. GOODWILL AND OTHER INTANGIBLE ASSETS
Changes in the carrying amount of goodwill for the six months ended
December 31, 2003, were as follows:
Pharmaceutical Medical Automation
Distribution Products Pharmaceutical and
and Provider and Technologies Information
(in millions) Services Services and Services Services Total
- -------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2003 $ 96.1 $ 694.7 $1,423.2 $50.7 $2,264.7
Goodwill acquired - net of purchase price
adjustments, foreign currency
translation adjustments and other(1) 62.6 1.0 511.7 - 575.3
Goodwill related to the divestiture of
businesses - - (4.3) - (4.3)
Transfer(2) 31.6 (31.6) - - -
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2003 $190.3 $ 664.1 $1,930.6 $50.7 $2,835.7
===================================================================================================================
(1) During the second quarter of fiscal 2004, the Company completed the
acquisitions of Intercare and Medicap Pharmacies, Inc. ("Medicap"),
resulting in preliminary goodwill allocations of $481.8 million and
$62.5 million, respectively. See Note 10 for additional information
regarding these acquisitions. During the six months ended December 31,
2003, the Company also finalized the Syncor purchase price allocation
resulting in a goodwill reduction of $6.9 million. The remaining
amounts represent goodwill acquired from immaterial acquisitions,
purchase price adjustments from prior period acquisitions and foreign
currency translation adjustments.
(2) During the first quarter of fiscal 2004, the Company transferred its
Consulting and Services business, previously reported within the
Medical Products and Services segment, to its Clinical Services and
Consulting business within the Pharmaceutical Distribution and
Provider Services segment to better align business operations. This
transfer resulted in approximately $31.6 million of goodwill being
reclassed between the segments.
The purchase price allocations for the Intercare and Medicap acquisitions
are not yet finalized and are subject to adjustment as the Company assesses the
value of acquired intangible assets and certain other matters. As indicated in
Note 1 above, the preliminary purchase price allocations resulted in goodwill of
$481.8 million and $62.5 million, respectively. Initial valuations relating to
acquired intangible assets have not been completed; therefore, all excess
purchase price has been allocated to goodwill resulting in no amortization
expense during the quarter ended December 31, 2003, for identified intangibles
from these acquisitions. However, due to the short period of time between the
acquisition dates and quarter-end, the impact of not amortizing identified
intangibles would not be material.
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 June 30 and December 31, 2003, was as follows:
Gross Accumulated Net
(in millions) Intangible Amortization Intangible
- ---------------------------------------------------------------------------------------
June 30, 2003
Trademarks and patents $ 48.1 $20.8 $27.3
Non-compete agreements 27.3 21.9 5.4
Other 49.6 14.7 34.9
- ---------------------------------------------------------------------------------------
Total $125.0 $57.4 $67.6
- ---------------------------------------------------------------------------------------
December 31, 2003
Trademarks and patents $ 48.5 $22.2 $26.3
Non-compete agreements 29.2 24.3 4.9
Other 47.1 16.3 30.8
- ---------------------------------------------------------------------------------------
Total $124.8 $62.8 $62.0
- ---------------------------------------------------------------------------------------
See discussion above for information regarding intangible assets acquired
from the Intercare and Medicap transactions.
Page 16
Amortization expense for the three months ended December 31, 2003 and 2002,
was $2.4 million and $0.9 million, respectively, and for the six months ended
December 31, 2003 and 2002 was $4.7 million and $1.7 million, respectively.
Amortization expense for each of the next five fiscal years is estimated to
be:
(in millions) 2004 2005 2006 2007 2008
- --------------------------------------------------------------------------------------------
Amortization expense $9.4 $8.9 $8.5 $7.8 $4.9
8. GUARANTEES
The Company has contingent commitments related to certain operating lease
agreements. These operating leases consist of certain real estate and equipment
used in the operations of the Company. In the event of termination of these
operating leases, which range in length from one to ten years, the Company
guarantees reimbursement for a portion of any unrecovered property cost. At
December 31, 2003, the maximum amount the Company could be required to reimburse
was $386.8 million. Based upon current information, the Company believes that
the proceeds from the sale of properties under these operating lease agreements
would exceed its payment obligation. In accordance with FASB Interpretation No.
45, the Company has a liability of $4.6 million recorded as of December 31,
2003, related to these agreements.
In the ordinary course of business, the Company, from time to time, agrees
to indemnify certain other parties under agreements with the Company, including
under acquisition agreements, customer agreements and intellectual property
licensing agreements. Such indemnification obligations vary in scope and, when
defined, in duration. Generally, a maximum obligation is not explicitly stated
and, therefore, the overall maximum amount of the liability under such
indemnification obligations, if any, cannot be reasonably estimated.
Historically, the Company has not, individually or in the aggregate, made
payments under these indemnification obligations in any material amounts. In
certain circumstances, the Company believes that its existing insurance
arrangements, subject to the general deduction and exclusion provisions, would
cover portions of the liability that may arise from these indemnification
obligations. In addition, the Company believes that the likelihood of material
liability being triggered under these indemnification obligations is not
significant.
In the ordinary course of business, the Company, from time to time, enters
into agreements that obligate the Company to make fixed payments upon the
occurrence of certain events. Such obligations primarily relate to obligations
arising under acquisition transactions, where the Company has agreed to make
payments based upon the achievement of certain financial performance measures by
the acquired company. Generally, the obligation is capped at an explicit amount.
The Company's aggregate exposure for these obligations, assuming the achievement
of all financial performance measures, is not material. Any potential payment
for these obligations would be treated as an adjustment to the purchase price of
the related entity and would have no impact on the Company's results of
operations.
9. DISCONTINUED OPERATIONS
In connection with the acquisition of Syncor, the Company acquired certain
operations of Syncor that were or will be discontinued. Prior to the
acquisition, Syncor announced the discontinuation of certain operations
including the medical imaging business and certain overseas operations. The
Company is continuing with these plans and has added additional international
and non-core domestic businesses to the discontinued operations. In accordance
with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," the net assets and results of operations of these businesses are
presented as discontinued operations. The Company is currently overseeing the
planned sale of the discontinued operations and is actively marketing these
businesses. The Company expects to sell substantially all of the remaining
discontinued operations by the end of the third quarter of fiscal 2004. The net
assets for the discontinued operations are included within the Pharmaceutical
Technologies and Services segment.
Page 17
The results of discontinued operations for the three and six months ended
December 31, 2003 and 2002, are summarized as follows:
Three Six
Months Ended Months Ended
December 31, December 31,
(in millions) 2003 2002 2003 2002
----------------------------------- --------------------------------------
Revenue $24.7 $ - $50.9 $ -
Loss before income taxes (8.2) - (11.1) -
Income tax benefit 3.1 - 4.2 -
----------------------------------- --------------------------------------
Loss from discontinued operations $(5.1) $ - $(6.9) $ -
=================================== ======================================
Interest expense allocated to discontinued operations for the three and six
months ended December 31, 2003, was $0.1 million. Interest expense was allocated
to the discontinued operations based upon a ratio of the net assets of
discontinued operations versus the overall net assets of Syncor.
At December 31 and June 30, 2003, the major components of assets and
liabilities of the discontinued operations were as follows:
December 31, June 30,
(in millions) 2003 2003
------------- -------------
Current assets $ 43.6 $ 49.9
Property and equipment, net 51.8 63.2
Other assets 56.4 57.0
------------- -------------
Total assets $ 151.8 $ 170.1
============= =============
Current liabilities $ 50.7 $ 35.6
Long term debt and other 21.3 28.7
------------- -------------
Total liabilities $ 72.0 $ 64.3
============= =============
Cash flows generated from the discontinued operations are immaterial to the
Company and, therefore, are not disclosed separately.
10. ACQUISITIONS
Intercare Group, plc
During December 2003, the Company completed the purchase of Intercare, a
leading European pharmaceutical products and services company. The acquisition
expands the Company's global reach by increasing its scale of proprietary
sterile manufacturing and broadening its participation in the fast-growing
European generic (including manufacturing capabilities) and injectible product
market.
The cash transaction was valued at approximately $570 million, including
the repayment of approximately $150 million in Intercare debt. The results of
Intercare's operations for the period following the completion of the
transaction have been reported within the Company's Pharmaceutical Technologies
and Services segment for the quarter ended December 31, 2003.
See Note 7 for discussion of Intercare's preliminary purchase price
allocation.
Medicap Pharmacies, Inc.
During December 2003, Medicine Shoppe International, Inc. ("Medicine
Shoppe"), a wholly-owned subsidiary of the Company, completed the acquisition of
Medicap, a franchisor of 181 pharmacies across 34 states. This acquisition will
add to the geographic reach of the Company's existing franchise pharmacy
operations.
Page 18
The cash transaction was valued at approximately $69 million, including the
repayment of approximately $10 million in Medicap debt. The results of Medicap's
operations for the period following the completion of the transaction have been
reported within the Company's Pharmaceutical Distribution and Provider Services
segment.
See Note 7 for discussion of Medicap's preliminary purchase price
allocation.
Supplemental pro forma results of operations are not disclosed as the
impact to the Company of the acquisitions of Intercare and Medicap during the
three and six months ended December 31, 2003, individually and in the aggregate,
were not material.
11. OFF-BALANCE SHEET TRANSACTIONS
During the six months ended December 31, 2003 and 2002, the Company entered
into two separate agreements to transfer ownership of certain equipment lease
receivables, plus security interests in the related equipment, to the leasing
subsidiary of a bank in the amounts of $164.2 million and $200.0 million,
respectively. An immaterial gain was recognized from each of these transactions,
which was classified as operating revenue within the Company's results of
operations. In order to qualify for sale treatment under SFAS No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities," the Company formed two wholly-owned, special purpose,
bankruptcy-remote entities (the "SPEs") of Pyxis Corporation, a wholly-owned
subsidiary of the Company, and the SPEs formed two wholly-owned, qualified
special purpose entities (the "QSPEs") to effectuate the removal of the lease
receivables from the Company's consolidated financial statements. In accordance
with SFAS No. 140, the Company consolidates the SPEs and does not consolidate
the QSPEs. Both the SPEs and QSPEs are separate legal entities that maintain
separate financial statements from the Company and Pyxis. The assets of the SPEs
and QSPEs are available first and foremost to satisfy the claims of their
respective creditors.
Page 19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The discussion and analysis presented below is concerned with material
changes in financial condition and results of operations for the Company's
condensed consolidated balance sheets as of December 31, 2003, and June 30,
2003, and the condensed consolidated statements of earnings for the three and
six-month periods ended December 31, 2003 and 2002.
This discussion and analysis should be read together with management's
discussion and analysis included in the 2003 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 beginning on
page 8 of the 2003 Form 10-K and are incorporated herein by reference. The
Company disclaims any obligation to update any forward-looking statement.
EXECUTIVE-LEVEL OVERVIEW
The following summarizes the Company's results of operations for the three
and six-month periods ended December 31, 2003.
Three Months Ended Six Months Ended
(in millions, except per Common Share December 31, December 31,
----------------------------------- -----------------------------------
amounts) Growth (1) 2003 2002 Growth (1) 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Operating revenue 11% $14,093.6 $12,706.3 14% $27,381.9 $24,122.9
Operating earnings (1)% $ 587.3 $ 590.9 5% $ 1,109.7 $ 1,058.4
Earnings from continuing operations 4% $ 380.9 $ 367.5 8% $ 711.3 $ 655.8
Net earnings 2% $ 375.8 $ 367.5 7% $ 704.4 $ 655.8
Diluted earnings per Common Share 5% $ 0.86 $ 0.82 10% $ 1.59 $ 1.45
(1) Growth is calculated as the change (increase or decrease) for the
three and six months ended December 31, 2003, compared to the three
and six months ended December 31, 2002.
The results of operations during the three and six months ended December
31, 2003, reflect the breadth of products and services the Company offers and
the increasing demand for the Company's diverse portfolio of products and
services, which led to strong revenue growth in every segment of the Company.
The Company continues to experience strong demand for integrated solutions from
health care providers. These solutions include products and services from
multiple lines of businesses within the Company. These unique agreements
currently represent more than $6 billion of annual sales.
The Company has four operating business segments: Pharmaceutical
Distribution and Provider Services, Medical Products and Services,
Pharmaceutical Technologies and Services and Automation and Information
Services. The Company generated strong operating earnings within its Medical
Products and Services, Pharmaceutical Technologies and Services and Automation
and Information Services segments. These three segments now comprise over
one-half of the Company's operating earnings. The strong performances within
those three segments was offset by reduced earnings within the Pharmaceutical
Distribution and Provider Services segment, as further discussed below.
The Company's Pharmaceutical Distribution and Provider Services segment is
in transition in its business model from a "buy and hold," inventory
accumulation model to a "just-in-time," fee-for-service model. Historically, one
way the Company obtained value from manufacturers was by buying inventories from
them, holding those inventories and generating margins on the subsequent sale of
that inventory after pharmaceutical prices increased. The Company is currently
working with its pharmaceutical manufacturing vendors to transition towards a
"just-in-time," fee-for-service business model where the
Page 20
Company will be compensated for the many services it provides the manufacturer.
The Company has incurred mismatches in its vendor margins period over period
while this transition is occurring. The Company anticipates this business model
transition to continue through the remainder of the current fiscal year as well
as into fiscal 2005. However, the Company believes that the most severe of the
vendor margin mismatches occurred in the quarter ended December 31, 2003,
causing this segment to experience an 8% decline in operating earnings during
that quarter. The Company does not expect this trend to continue. As the
transition occurs, future periods should gradually evolve to reflect the new
model, under which earnings growth should more closely approximate revenue
growth.
This transition to a new business model has also affected the Company's
operating revenues. While the overall demand for the Company's products has not
changed, how the Company fills certain orders has changed. The previous "buy and
hold" model resulted in the Company holding large quantities of inventories and
filling certain "bulk" orders through the Company's inventory on-hand. These
types of sales were classified as "Bulk from Stock" and were reported within
operating revenue. With the transition to this new business model, the Company
will hold less inventory, and therefore will not fill these orders from its own
stock with the same frequency, but rather will act more as a pass-through entity
and record the revenue within its "Bulk Deliveries to Customer Warehouses" line
within the income statement.
The Company and certain pharmaceutical and medical-surgical product
manufacturers are in discussions regarding the risks of counterfeit products in
the supply chain and the manufacturers' concerns regarding the impact of
secondary market distribution on counterfeiting. The Company continues to work
with its suppliers to help minimize the risks associated with counterfeit
products in the supply chain.
The Medicare Prescription Drug, Improvement, and Modernization Act (the
"Medicare Act") was passed by Congress and enacted by President Bush on December
8, 2003. The Medicare Act is the largest expansion of the Medicare program since
its inception and provides participants with voluntary prescription drug
benefits effective in 2006 with an interim drug discount card. The Medicare Act
also includes provisions relating to medication management programs, generic
substitution and provider reimbursement. Based upon current information, the
Company believes the Medicare Act may create additional volume demand and
provide incentives for additional utilization of generic drugs, both of which
have potentially positive implications for the Company's pharmaceutical
distribution business.
During the three months ended December 31, 2003, the Company completed
acquisitions of Intercare and Medicap. The Company's trend with regard to
acquisitions has been to expand its role as a provider of services to the health
care industry. This trend has resulted in expansion into service areas which (a)
complement the Company's existing operations, and (b) provide opportunities for
the Company to develop synergies with, and thus strengthen, the acquired
business. As the health care industry continues to change, the Company
continually evaluates possible candidates for merger or acquisition and intends
to continue to seek opportunities to expand its role as a provider of services
to the health care industry through all its reporting segments. There can be no
assurance that it will be able to successfully pursue any such opportunity or
consummate any such transaction, if pursued. If additional transactions are
entered into or consummated, the Company would incur additional merger and
acquisition related costs, and there can be no assurance that the integration
efforts associated with any such transaction would be successful.
Page 21
GENERAL
The following discussions provide details regarding the results of
operations of the Company's four operating business segments. See Note 5 in
"Notes to Condensed Consolidated Financial Statements" for a description of
these segments.
RESULTS OF OPERATIONS
Operating Revenue
Three Months Ended Six Months Ended
December 31, December 31,
-------------------------------- --------------------------------
Percent of Total Percent of Total
Operating Revenues Operating Revenues
-------------------------------- --------------------------------
Growth (1) 2003 2002 Growth (1) 2003 2002
- -----------------------------------------------------------------------------------------------------------------
Pharmaceutical Distribution and Provider
Services 9% 81% 83% 12% 81% 82%
Medical Products and Services 12% 13% 13% 10% 13% 14%
Pharmaceutical Technologies and Services 58% 5% 3% 58% 5% 3%
Automation and Information Services 14% 1% 1% 11% 1% 1%
Total Company 11% 100% 100% 14% 100% 100%
- -----------------------------------------------------------------------------------------------------------------
(1) Growth is calculated as the change (increase or decrease) in
the operating revenue for the three and six months ended
December 31, 2003, compared to the three and six months ended
December 31, 2002.
TOTAL COMPANY. Total operating revenue for the three and six months
ended December 31, 2003, increased 11% and 14%, respectively, compared to the
same periods of the prior year. These increases resulted from a higher sales
volume across each of the Company's segments; revenue growth from existing
customers; addition of new customers, some of which resulted from new corporate
agreements with health care providers that integrate the Company's diverse
offerings; addition of new products; and pharmaceutical price increases. The
Company's revenue growth was adversely impacted by the decline in "Bulk from
Stock" sales, as was described within the "Executive-Level Overview" section.
PHARMACEUTICAL DISTRIBUTION AND PROVIDER SERVICES. This segment's
operating revenue growth of 9% and 12%, respectively, during the three and six
months ended December 31, 2003, resulted from strong sales to customers within
this segment's core pharmaceutical distribution business. "Store Door Sales"
(sales in which the Company breaks down bulk pharmaceuticals to customize orders
for delivery directly to the health care providers) within the pharmaceutical
distribution business showed particular strength, increasing 23% and 25% during
the three and six months ended December 31, 2003. The increase in "Store Door
Sales" was primarily due to increased sales volume to new and existing customers
and pharmaceutical price increases. This segment's growth was dampened by the
impact of declining "Bulk from Stock" sales, as was described within the
"Executive-Level Overview" section. To fully gauge downstream customer demand
within pharmaceutical distribution, three types of sales should be aggregated.
These sales types are "Store Door Sales" and "Bulk from Stock" (reported in
total as operating revenues) and "Bulk Deliveries to Customer Warehouses."
Revenue growth from these total sales activities was 15% and 17% during the
three and six months ended December 31, 2003, as compared to the comparable
periods a year ago.
MEDICAL PRODUCTS AND SERVICES. This segment's operating revenue growth
of 12% and 10%, respectively, during the three and six months ended December 31,
2003, resulted from increased sales momentum from new and existing contracts
within the distribution business, as well as increased sales from new
self-manufactured products. New contracts drove an increase in sales of both
distributed and self-manufactured products, with sales from the distribution
business showing particular strength during the three and six months ended
December 31, 2003. Sales of new self-manufactured products, including product
enhancements to the Company's existing surgeon gloves, bone-cement delivery
systems, thermal therapy products and procedure-based delivery systems,
contributed to this segment's revenue growth. This segment's revenue growth has
been well above industry averages during the current fiscal year.
PHARMACEUTICAL TECHNOLOGIES AND SERVICES. This segment's operating
revenue growth of 58% during the three and six months ended December 31, 2003,
resulted from particularly strong demand within the packaging services,
Page 22
oral technologies and nuclear pharmacy businesses. Packaging services generated
solid growth from both organic and new business, in particular new packaging
business of AstraZeneca's Crestor(TM). The oral technologies business also
contributed solid growth, with Lilly's Zyprexa(R) Zydis, an anti-psychotic drug,
and Wyeth's Advil(R) Liquigels showing particular strength. Increased sales
within the nuclear pharmacy business also contributed to this segment's growth.
This segment's revenue growth benefited from the inclusion of Syncor, an
acquisition that was completed on January 1, 2003. Syncor's results of
operations are not included in the prior period numbers. This segment's revenue
growth was partially dampened by a delay in the startup of commercial
manufacturing of key sterile products from signed contracts, now slated for the
third quarter of fiscal 2004.
AUTOMATION AND INFORMATION SERVICES. This segment's operating revenue
growth of 14% and 11%, respectively, during the three and six months ended
December 31, 2003, reflected healthy demand in all product categories, with
particular sales strength from the medication product lines (such as Pyxis
MedStation(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
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 net 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 various contracts. These contracts provide for the customer to
reimburse the Company for these expenses. Due to the Company not generating any
margin from these reimbursements, fluctuations in their amount have no impact on
the Company's net earnings.
Operating Earnings
Three Months Ended Six Months Ended
December 31, December 31,
-------------------------------- --------------------------------
Percent of Total Percent of Total
Operating Earnings Operating Earnings
-------------------------------- --------------------------------
Growth (1) 2003 2002 Growth (1) 2003 2002
- -----------------------------------------------------------------------------------------------------------------
Pharmaceutical Distribution and Provider
Services (8%) 43% 50% (4%) 45% 50%
Medical Products and Services 12% 26% 24% 10% 26% 26%
Pharmaceutical Technologies and Services 33% 18% 14% 39% 18% 14%
Automation and Information Services 15% 13% 12% 15% 11% 10%
Total Company (2) (1%) 100% 100% 5% 100% 100%
- -----------------------------------------------------------------------------------------------------------------
(1) Growth is calculated as the change (increase or decrease) in
the operating earnings for the three and six-month periods
ended December 31, 2003, compared to the three and six-month
periods ended December 31, 2002.
(2) The Company's overall operating earnings growth/(decline) of
(1%) and 5%, respectively, during the three and six-month
periods ended December 31, 2003, includes the effect of
special items. Special items are not allocated to the
segments. See Note 4 in "Notes to Condensed Consolidated
Financial Statements" for further information regarding the
Company's special items.
TOTAL COMPANY. Total operating earnings for the three months ended
December 31, 2003, decreased 1% compared to the same period of the prior year,
while operating earnings for the six months ended December 31, 2003, increased
5% compared to the same period of the prior year. The overall decrease during
the three months ended December 31, 2003, resulted primarily from the impact of
the Company's special items, which totaled income of $3.5 million during the
three months ended December 31, 2003, as compared to income of $37.6 million
during the same period a year ago. The impact of the special items was partially
offset by the Company's revenue growth of 11% during the quarter, which yielded
an 8% increase in gross margin primarily due to the continued dampening effect
of reduced vendor margins and competitive customer pricing pressures within the
Pharmaceutical Distribution
Page 23
and Provider Services segment driven by changes to its business model. These
changes are discussed further within the "Executive-Level Overview" section.
The 5% operating earnings growth during the six months ended December
31, 2003, resulted primarily from the Company's revenue growth of 14% during the
same time period, which yielded a gross margin increase of 8%. These increases
were partially offset by the impact of the Company's special items, which
totaled expense of $9.7 million during the six months ended December 31, 2003,
as compared to income of $18.9 million during the same period a year ago.
The growth rates for the three and six months ended December 31, 2003,
were positively impacted by the inclusion of Syncor, whose results of operations
are not included in the prior period numbers since the acquisition of Syncor was
completed January 1, 2003. These growth rates also reflect the increased
contributions from the Company's operating segments outside of the
Pharmaceutical Distribution and Provider Services segment, which generate higher
gross margins and operating earnings (as a percentage of operating revenue).
These segments now account for over one-half of the Company's operating
earnings.
The Company continues to leverage its expense structure through
disciplined expense control, and the productivity benefits resulting from scale
associated with revenue growth and previous investments in automation and
technology. Selling, general and administrative expenses as a percentage of
revenue were 4.16% and 4.14%, respectively, during the three and six months
ended December 31, 2003, as compared to 4.14% and 4.34%, respectively, for the
same periods a year ago. The overall increase in operating expenses was
primarily a result of the additional expenses resulting from the Syncor
acquisition, higher personnel costs associated with the overall business growth
and an increase in depreciation and amortization costs. Additionally, the
Company continues to invest in research and development and strategic
initiatives that will benefit future periods, which are charged against current
operating earnings as incurred. The increase in the Company's expenses for the
three and six months ended December 31, 2003, was partially offset by
adjustments of certain trade receivable reserves due to changes in
customer-specific credit exposures as well as improvements in customer credit,
billing and collection processes yielding significant reductions in past due and
uncollectible accounts.
PHARMACEUTICAL DISTRIBUTION AND PROVIDER SERVICES. This segment's
operating earnings declines of 8% and 4%, respectively, during the three and six
months ended December 31, 2003, resulted from reduced vendor margins, as further
discussed within the "Executive-Level Overview," and competitive pricing
pressures. These declines were partially offset by this segment's revenue growth
of 9% and 12% during the three and six months ended December 31, 2003, as well
as strong expense productivity throughout the segment.
MEDICAL PRODUCTS AND SERVICES. This segment's operating earnings growth
of 12% and 10%, respectively, during the three and six months ended December 31,
2003, resulted primarily from this segment's overall revenue growth of 12% and
10%, respectively, during the comparable periods, led by sales momentum in
distribution contracts. The gross margin impact of the increased mix of
distributed products, as well as increases in raw material costs, principally
plastic resin and natural rubber latex, were offset by productivity improvements
and strong expense controls.
PHARMACEUTICAL TECHNOLOGIES AND SERVICES. This segment's operating
earnings growth of 33% and 39%, respectively, during the three and six months
ended December 31, 2003, resulted from this segment's overall revenue growth of
58% during the comparable periods, as well as from manufacturing efficiencies
and strong expense productivity within each of the businesses in the segment.
This segment's operating earnings growth also benefited from the inclusion of
Syncor, an acquisition that was completed on January 1, 2003. Syncor's results
of operations are not included in the prior period numbers. Since Syncor's
operating earnings as a percentage of operating revenue is less than the other
business units within this segment, its inclusion had a deleveraging effect on
operating earnings growth in comparison to revenue growth. Also, as disclosed in
this segment's operating revenue discussion, this segment's operating earnings
growth was dampened by a delay in the startup of commercial manufacturing of
certain sterile products.
AUTOMATION AND INFORMATION SERVICES. This segment's operating earnings
growth of 15% during the three and six months ended December 31, 2003, resulted
from revenue growth of 14% and 11%, respectively, during the comparable periods,
combined with operational improvements, strong expense productivity and a
reduction in receivable reserves due to improvements in customer-specific credit
matters, as well as general improvements in customer credit, billing and
collection procedures, which have resulted in significant reductions in past due
and uncollectible accounts.
Page 24
Special Charges
See Note 4, which is incorporated herein by reference, in "Notes to
Condensed Consolidated Financial Statements" for detail of the Company's special
items during the three and six months ended December 31, 2003 and 2002.
Interest Expense and Other
The decrease in interest expense and other of $12.1 million and $14.7
million, respectively, during the three and six months ended December 31, 2003,
compared to the same periods in the prior fiscal year, resulted from lower
interest rates. The Company also recorded a net gain of approximately $8.9
million related to the sale of a non-strategic business during the second
quarter of fiscal 2004.
Provision for Income Taxes
The Company's provision for income taxes relative to earnings before
income taxes and discontinued operations was 32.9% and 33.0% for the three and
six months ended December 31, 2003, respectively, as compared to 34.3% and 34.2%
for the three and six months ended December 31, 2002. Fluctuations in the
effective tax rate are primarily due to changes within state and foreign
effective tax rates resulting from the Company's business mix and changes in the
tax impact of special items, which may have unique tax implications depending on
the nature of the item.
Loss from Discontinued Operations
See Note 9 in the "Notes to Condensed Consolidated Financial
Statements" for information on the Company's discontinued operations.
LIQUIDITY AND CAPITAL RESOURCES
Cash and equivalents decreased to $544.3 million at December 31, 2003,
from $1,724.0 million at June 30, 2003. The decrease in cash and equivalents
during this period was primarily driven by the repurchase of the Company's
shares and the completion of certain strategic acquisitions, partially offset by
strong operating cash flows. Each of these drivers is discussed in further
detail below.
Operating cash flow increased 53% during the six months ended December
31, 2003, as compared to the same period a year ago. Operating cash flow was
primarily driven by strong earnings from continuing operations, an increase in
accounts payable, and the sale of certain sales-type leases during the second
quarter of fiscal 2004, as further discussed below. These factors were partially
offset by increases in the Company's inventories and trade receivables. The
increase in accounts payable is primarily related to the timing of payments
related to the Company's increase in inventories during the six months ended
December 31, 2003. The increase in inventories was primarily due to continuing
increase in customer demand and normal seasonal inventory buying activities. The
increase in trade receivables was primarily attributed to sales activity during
the first two quarters of fiscal 2004.
The Company used cash of $658.0 million in investing activities,
primarily driven by capital deployment through strategic acquisitions and fixed
asset additions. The Company has funded these strategic acquisitions and capital
expenditures primarily through internal resources as a result of its strong
operating cash flows. For information regarding the acquisitions of Intercare
and Medicap, see Note 10 in the "Notes to Condensed Consolidated Financial
Statements."
The Company used cash of $1,070.1 million in financing activities,
primarily due to the repurchase of its Common Shares, as further discussed
below.
During the three months ended December 31, 2003 and 2002, the Company
sold certain sales-type leases and received proceeds of approximately $164.2
million and $200.0 million, respectively, related to the sales. See Note 11 in
the "Notes to Condensed Consolidated Financial Statements" for further
information related to this sale.
Shareholders' equity declined by $165.8 million at December 31, 2003,
as compared to June 30, 2003. Shareholders' equity decreased during this time
period primarily due to the repurchase of Common Shares of $1.0 billion and
dividends paid of $26.4 million. These decreases were partially offset by net
earnings of $704.4 million and the investment of $80.0 million by employees of
the Company through various employee stock benefit plans.
On August 1, 2003, the Company's Board of Directors authorized the
repurchase of Common Shares up to an aggregate amount of $1.0 billion. Pursuant
to this authorization, the Company repurchased approximately 17.0 million Common
Shares having an aggregate cost of approximately $1.0 billion. The average price
paid per share
Page 25
was $58.65. This repurchase was completed during the first quarter of fiscal
2004, and the repurchased shares were placed into treasury shares to be 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
See Note 1 in the "Notes to Condensed Consolidated Financial
Statements" for a discussion of recent financial accounting standards.
RECENT DEVELOPMENTS
On February 3, 2004, the Company announced organizational changes
resulting in the promotion of George L. Fotiades to President and Chief
Operating Officer of the Company, with all operations of the Company
reporting to Mr. Fotiades. In connection with this change, the Company entered
into a new three-year employment agreement with Mr. Fotiades effective as of
February 1, 2004. In addition, effective as of February 1, 2004, the Company
entered into an amended and restated employment agreement with Robert D. Walter,
its Chairman and Chief Executive Officer, which amended and restated agreement,
among other things, extended the "Initial Term" under Mr. Walter's employment
agreement from June 30, 2004 through February 1, 2007.
Page 26
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company believes that there has been no material change in the
quantitative and qualitative market risks from those discussed in the 2003 Form
10-K.
ITEM 4: CONTROLS AND PROCEDURES
The Company carried out an evaluation, as required by Exchange Act Rule
13a-15(b), under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer, and Executive Vice
President and Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures, as of the end of
the period covered by this report. Based upon that evaluation, the Chief
Executive Officer and the Executive Vice President and Chief Financial Officer
concluded that, as of the end of the period covered by this report, the
Company's disclosure controls and procedures were effective in timely alerting
them to material information relating to the Company (including its consolidated
subsidiaries) required to be included in the Company's periodic SEC filings.
The Company's management, including the Company's Chief Executive
Officer and the Executive Vice President and Chief Financial Officer, does not
expect that the Company's disclosure controls and procedures and its internal
controls will prevent all error and all fraud. A control system, no matter how
well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. Further, the design
of a control system must reflect the fact that there are resource constraints,
and the benefits of controls must be considered relative to their costs. Because
of the inherent limitations in all control systems, no evaluation of controls
can provide absolute assurance that all control issues and instances of fraud,
if any, within the Company have been detected. These inherent limitations
include the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake. Additionally, controls
can be circumvented by the individual acts of some persons, by collusion of two
or more people, or by management override of the control. The design of any
system of controls is also based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions.
Over time, controls may become inadequate because of changes in conditions, or
the degree of compliance with the policies or procedures may deteriorate.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and may not be detected. The
Company monitors its disclosure controls and procedures and internal controls on
an ongoing basis and makes modifications as necessary; the Company's intent in
this regard is that the disclosure controls and procedures and the internal
controls will be maintained as dynamic systems that change (including with
improvements and corrections) as conditions warrant.
During the three-month period ended December 31, 2003, there have been
no changes to internal controls that have materially affected, or are reasonably
likely to materially affect, the Company's financial reporting.
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, many of which are more
fully described in Part I, Item 3, of the 2003 Form 10-K, and the Form 10-Q for
the fiscal quarter ended September 30, 2003, and are incorporated herein by
reference. To the extent any such statements constitute "forward looking
statements," reference is made to Exhibit 99.01 of this Form 10-Q and beginning
on page 8 of the 2003 Form 10-K.
Reference is also made to Note 6 in the "Notes to Condensed
Consolidated Financial Statements" included herein for additional information
regarding various other pending legal proceedings relating to the Company.
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 pending in the United
States District Court for the District of Columbia (where it was transferred).
As of December 31, 2003, Scherer has entered into settlement agreements with the
majority of the
Page 27
defendants in consideration of payments of approximately $140.9 million, net of
attorney fees, payments due to other interested parties and expenses withheld
prior to the disbursement of the funds to Scherer. While the Company still has
pending claims with smaller vitamin manufacturers and cannot predict the outcome
of the claims against those defendants, the total amount of any future recovery
will not likely represent a material amount.
Antitrust Litigation against Pharmaceutical Manufacturers
During the past five years, numerous class action lawsuits have been
filed against certain prescription drug manufacturers alleging that the
prescription drug manufacturer, by itself or in concert with others, took
improper actions to delay or prevent generic drug competition against the
manufacturer's brand name drug. The Company has not been a name plaintiff in
any of the class actions, but has been a member of the direct purchasers class
(i.e. those purchasers who purchase directly from these drug manufacturers).
None of the class actions have gone to trial, but some have settled in the past
with the Company receiving proceeds from the settlement fund. Currently, there
are several such class actions pending in which the company is a class member.
See Note 4 in the "Notes to Condensed Consolidated Financial Statements" for a
discussion of recoveries to date. The Company is unable at this time to estimate
definitively future recoveries, if any, it will receive as a result of those
class actions.
Other Matters
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 financial
position, liquidity or results of operations.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Company's 2003 Annual Meeting of Shareholders was held on November 5,
2003.
(b) Proxies were solicited by the Company pursuant to Regulation 14A under the
Securities Exchange Act of 1934; there was no solicitation in opposition to the
nominees as listed in the proxy statement; and all director nominees were
elected to the class indicated in the proxy statement pursuant to the vote of
the Company's shareholders.
(c) Matters voted upon at the Annual Meeting were as follows:
(i) Election of Dave Bing, John F. Finn, John F. Havens, David W.
Raisbeck, and Robert D. Walter. The results of the shareholder vote
were as follows: Mr. Bing -- 376,097,955 for, 6,816,733 against,
2,705,242 withheld, and 0 broker non-votes; Mr. Finn -- 376,158,034
for, 6,756,654 against, 2,645,163 withheld, and 0 broker non-votes;
Mr. Havens -- 377,079,984 for, 5,834,704 against, 1,723,213 withheld,
and 0 broker non-votes; Mr. Raisbeck -- 376,072,862 for, 6,841,826
against, 2,730,335 withheld, and 0 broker non-votes; and Mr. Walter --
373,495,801 for, 9,418,887 against, 5,307,396 withheld, and 0 broker
non-votes.
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ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K:
(a) Listing of Exhibits:
Exhibit
Number Exhibit Description
10.01 Form of Nonqualified Stock Option Agreement under the Amended and
Restated Equity Incentive Plan, as amended
10.02 Form of Restricted Share Units Agreement under the Amended and
Restated Equity Incentive Plan, as amended
10.03 Form of Directors' Stock Option Agreement under the Amended and
Restated Equity Incentive Plan, as amended
10.04 Form of Directors' Stock Option Agreement under the Outside
Directors Equity Incentive Plan
10.05 Employment Agreement, dated and effective as of November 5, 2003,
between the Registrant and Ronald K. Labrum
10.06 First Amendment to the Registrant's Deferred Compensation Plan
31.01 Certification of Chairman and Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
31.02 Certification of Executive Vice President and Chief Financial
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.01 Certification of Chairman and Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.02 Certification of Executive Vice President and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
99.01 Statement Regarding Forward-Looking Information (1)
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(1) Included as an exhibit to the Registrant's Annual Report on Form 10-K
filed September 29, 2003 (File No. 1-11373) and incorporated herein by
reference.
(b) Reports on Form 8-K:
On February 6, 2004, the Company filed a Current Report on Form 8-K
under Item 5 which filed as exhibits the Amended and Restated Employment
Agreement, effective as of February 1, 2004, between the Company and Robert D.
Walter, and the Employment Agreement, effective as of February 1, 2004, between
the Company and George L. Fotiades.
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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: February 17, 2004 /s/ Robert D. Walter
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Robert D. Walter
Chairman and Chief Executive Officer
/s/ Richard J. Miller
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Richard J. Miller
Executive Vice President and Chief Financial
Officer
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